Finance - CHALLENGE 3.3: Cost of Capital

Using the following variables, calculate an organization's cost of debt on a $100,000 bond. Rf: 2% Credit-risk rate: 6% t: 20%

$6,400

Using the following variables, calculate an organization's cost of preferred stock. Dpref: $50 Ppref: $1000 g: 5%

10.0%

The discounted cash flow approach is useful for __________.

considering existing and future resources to make optimal investment decision

Using the following variables, calculate an organization's cost of common equity. Rf: 2% βs: 1.2 (Rm - Rf): 6%

9.2%

x x x x x x x x x x x x x x xCompany A Company B Market Value of Equityx x x$200,000 $300,000 Market Value of Debt x x x $150,000 $200,000 Cost of Equity x x x x x x x x x x x x8% 5% Cost of Debtx x xx x x x x x x x x x 3% 2% Tax Rate x x x x x x x x x x x x x x 30% 30% Based solely on their current weighted average cost of capital, which company should pursue an investment opportunity with an expected return of 6%?

Both Company A and Company B.

What two components typically comprise a company's capital structure, and therefore its WACC?

Debt and equity

x x x x x x x x x x x x x x xCompany A Company B Market Value of Equityx x x$350,000 $150,000 Market Value of Debt x x x $100,000 $150,000 Cost of Equity x x x x x x x x x x x x9% 10% Cost of Debtx x xx x x x x x x x x 1.5% 2% Tax Rate x x x x x x x x x x x x x x 30% 25% Based solely on their current weighted average cost of capital, which company should pursue an investment opportunity with an expected return of 5.5%?

Neither Company A nor Company B.

x x x x x x x x x x x x x x xCompany A Company B Market Value of Equityx x x$400,000 $200,000 Market Value of Debt x x x x $200,000 $500,000 Cost of Equityx x xx x xx x xx x x 10% 8% Cost of Debtx x xx x xx x xx x x x 2% 2% Tax Ratex x xx x xx x xx x xx x xx 25% 35% Based solely on their current weighted average cost of capital, which company should pursue an investment opportunity with an expected return of 6%?

Only Company B.

When making investment decisions, what measurement tells you the compensation needed to assume a given level of risk?

Required rate of return

What is the weighted average cost of capital (WACC)?

The combination of interest rates being incurred from both debt and equity.

The capital asset pricing model is useful for __________.

determining whether an asset's expected return will offset its susceptibility to market risk

The bond yield plus risk premium (BYPRP) approach is useful for determining __________.

the value of a company's publicly traded equity