The current market rate of return is 12% and the risk-free rate is 4%. You have been given the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The b of the equity is 1.4 and the tax rate if 30%. What is the market value of debt and its' net cost to the firm?
A) 9,642,857; 8.4%.
B) 9,642,857; 12%.
C) 6,750,000; 8.4%.
D) 6,750,000; 12%.
E) 4,725,000; 12%.

Question

Quizplus · Accepted Answer

The market value of debt is $9,642,857 and its net cost to the firm is 8.4%.The market value of debt is calculated as follows:Market value of debt = $22.50 x 1,000,000 shares x 30% = $9,642,857The net cost of debt is calculated as follows:Net cost of debt = Yield to maturity x (1 - Tax rate) = 12% x (1 - 30%) = 8.4%

The Current Market Rate of Return Is 12% and the Risk-Free