Cost of capital is one of those major
components that help determine the success rate of a business (Harrington, J.,
& Grabowski, 2014). Investors always want their investments to grow by the
cost of capital. So we can say that so the cost of capital helps measure or
calculate the discount rate of the cash flow of investment. It clarifies how
companies are going to finance their projects and what types of decisions
should be made. Ideally, all businesses seek a good balance between their
investments and profits while reducing the cost of capital.
In the cost of the capital game,
organizations calculate different costs in two ways -- the explicit cost of
capital and implicit cost of capital (2015). Implicit cost is an investment
opportunity that is given to the investor in order to keep them engaged. On the
other hand, the explicit cost is the cost that organizations use for making
capital investments, and this is payable to the investor in the form of a
strong stock price.
Question 1: Assuming
that the riskless rate is 2.3% and the market premium is 5.3%, calculate Zonk’s
cost of equity capital:
A. 10.4%
B. 7.69%
C. 11.89%
D.
8.28%
Question 2: Determine
the weight on debt capital that should be used to calculate Zonk’s
weighted-average cost of capital:
A. 21.7%
B. 21%
C. 50%
D. 58.2%
Question 3: Determine
the weight on equity capital that should be used to calculate Zonk’s
weighted-average cost of capital:
A. 79%
B. 78.3%
C. 41.8%
D. 50%
Question
4: Using the above information, calculate Zonk’s
weighted-average cost of capital:
A. 11.5%
B.
7.97%
C. 7.48%
D. 10.90%
Question 5: Assume
that Zonk is a potential leveraged buyout candidate. Assume that the buyer
intends to put in place a capital structure that has 70 percent debt with a
pretax borrowing cost of 14 percent and 30 percent common equity. Compute the
revised equity beta for Zonk based on the new capital structure.
A. 4.35
B.
4.34
C. 2.84
D. 3.91
Question 6: Assume
that Zonk is a potential leveraged buyout candidate. Assume that the buyer
intends to put in place a capital structure that has 70 percent debt with a
pretax borrowing cost of 14 percent and 30 percent common equity. Compute the
weighted average cost of capital for Zonk based on the new capital structure.
A. 8.85%
B. 12.56%
C. 13.01%
D.
9.94%
References
Estimating the Cost of Equity
Capital and the Overall Cost of Capital. (2015). Cost of Capital in
Litigation, 25-53. doi:10.1002/9781119200680.ch2
Harrington, J., &
Grabowski, R. J. (2014). Global Cost of Capital Models. Cost of
Capital, 1011-1051. doi:10.1002/9781118846780.ch39
Introduction to Cost of
Capital Applications: Valuation, Project Selection, and Ratemaking.
(2014). Cost of Capital, 11-16. doi:10.1002/9781118846780.ch02
Cost of Capital for a
Smaller-Sized Company. (2014). Cost of Capital, 1162-1167.
doi:10.1002/9781118846780.ch4
