Cost of Capital
Guided Response: Review several of your classmates’ posts. Respond to at least two classmates by sharing whether you agree or disagree with their view of the use of the company’s capital. Explain your reasoning.
Classmate #1
company has the following
Cost of equity :12%
cost of debt 20%
market valve equity 12,000.00
market value of debt 16,000.00
tax rate=32%
WACC= E/V * Re + d/v*Rd(1-Tc)
=1200000/200000*12%+1600000/200000 x20(1-32%)
=0.05% + 10.88%
=15.88%
it is not worth the investment for the corporation division I would think due to the high percentage
Classmate #2
The formula of and a calculated example of the weighted average cost of capital (WACC) is as follows:
WACC = (W_d)(K_d^new)(1 –t) + (W_pdf)(K_pfd^new) + (W_(ret earn))(K_(ret earn))
WACC = (0.25)(7.7)(1 – .20) + (.060)(10.59) + (.523)(.20)
WACC = 1.54% + .64% + 10.46%
WACC = 12.64%
If the overall company weighted average cost of capital were used as the hurdle rate for all divisions, then the more risky divisions would get the greater share of capital. According to Hickman, Byrd, & McPherson (2013), “Investors in a particularly risky company demand higher returns on their securities, which increases the company’s WACC” (p. 258). The discount rate is increased when a firm’s and their investor’s risk increase.
References
Hickman, K., Byrd, J., McPherson, M. (2013). Essentials of Finance. (Ashford University ed.). San Diego, CA: Bridgepoint Education, Inc.
