A firm must raise $10 million dollars in funding for a capital investment project. Two million dollars will be raised by issuing debt with an interest rate of 10 percent, while the remainder will be raised by issuing stocks that will yield a return of 12 percent. The firm's marginal tax rate is 30 percent. What is the firm's composite cost of capital?

Question

Quizplus · Accepted Answer

The composite cost of capital is calculated by taking the weighted average of the cost of debt and the cost of equity. The after-tax cost of debt is 10% * (1 - 0.30) = 7%. The weights are 2/10 for debt and 8/10 for equity. Thus, the composite cost is (2/10 * 7%) + (8/10 * 12%) = 11%.

A Firm Must Raise $10 Million Dollars in Funding for a Capital