The market value of Charter Cruise Company's equity is $15 million and the market value of its debt is $5 million.If the required rate of return on the equity is 20% and that on its debt is 8%,calculate the company's cost of capital.(Assume no taxes.)

Question

Quizplus · Accepted Answer

The cost of capital is the weighted average of the required rates of return on equity and debt, weighted by their market values. 
Weight of equity = $15 million / ($15 million + $5 million) = 0.75 
Weight of debt = $5 million / ($15 million + $5 million) = 0.25 
Cost of capital = (0.75 x 20%) + (0.25 x 8%) = 15% + 2% = 17%

The Market Value of Charter Cruise Company's Equity Is $15