You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm?.

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27-04-2022
Business

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You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm?.

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kanikabajaj294 kanikabajaj294 · Answer 1 · 2022-05-03T13:01:06+02:00

After analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt, the overall cost of capital for the firm is 15.8%.

What do you mean by the cost of capital?

The cost of capital refers to the minimum rate of return expected by its investors.

In other words, it refers to the cost of obtaining funds i.e. the average rate of return that the investors in a firm would expect for supplying the funds to the firm.

[tex]\begin{aligned}\text{k firm}&=\text{Debt}\times\text{ k debt} + \text{Equity}\times\text{ k equity}\\&=\left(0.35 \times 0.08\right) + \left(0.65\times0.2\right)\\&=0.158\\&=15.8\%\end{aligned}[/tex]

Therefore, the overall cost of capital is 15.8%.

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