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A firm has $4 billion in A-rated bonds with an expected interest rate of 3.1%. Its...

A firm has $4 billion in A-rated bonds with an expected interest rate of 3.1%. Its equity, worth $4 billion, is estimated to offer an expected geometric rate of return of about 14% per year. What is this firm's overall asset cost of capital?

Carry out calculations to at least 4 decimal places. Enter percentages as whole numbers. Example: 3.03% should be entered as 3.03. Do not include commas or dollar signs in numerical answers.

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Answer #1

Overall Cost of Capital is equal to the weighted average cost of capital of debt and equity

Cost of capital = cost of debt*Debt/(Equity + Debt) + Cost of Equity*Equity/(Debt + Equity)

Hence, overall cost of capital = 3.1%*4/8 + 14%*4/8

= 8.55%

i.e. 8.55

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