Parker Pacific,Inc.has $2,000,000 in debt and $3,000,000 in stockholders' equity.If the debt carries an interest rate of 14%,and the stockholders are demanding a 15% rate of return,Parker's cost of capital is:

Question

Quizplus · Accepted Answer

The cost of capital is the weighted average of the cost of debt and the cost of equity.

Cost of debt = 14%

Cost of equity = 15%

Weight of debt = debt / (debt + equity) = 2,000,000 / (2,000,000 + 3,000,000) = 0.4

Weight of equity = equity / (debt + equity) = 3,000,000 / (2,000,000 + 3,000,000) = 0.6

Cost of capital = (0.4 x 14%) + (0.6 x 15%) = 5.6% + 9% = 14.6%

Therefore, the best choice is C) 14.6%.