Calcutta Industries has $4,500,000 in debt and $5,500,000 in stockholders' equity.If the debt carries an interest rate of 9%,and the stockholders are demanding a 16% rate of return,Calcutta's cost of capital is:

Question

Quizplus · Accepted Answer

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

Cost of debt = 9%

Cost of equity = 16%

Weight of debt = Debt / Total Capital = 4,500,000 / (4,500,000 + 5,500,000) = 0.45

Weight of equity = Equity / Total Capital = 5,500,000 / (4,500,000 + 5,500,000) = 0.55

Cost of capital = (Cost of debt * Weight of debt) + (Cost of equity * Weight of equity)

Cost of capital = (0.09 * 0.45) + (0.16 * 0.55)

Cost of capital = 0.0405 + 0.088

Cost of capital = 0.1285 or 12.85%

Calcutta Industries Has $4,500,000 in Debt and $5,500,000 in Stockholders