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A firm is worth $100 million and has a cost of capital of 11%. It is all equity financed. If the firm sells $30 million of debt with a 7% promised return and uses it to repurchase part of the firms stock, what will the firms cost of capital then be? O Not determinable O 10.4% 9.8% O 11.0%

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Answer: Option-(c): 9.8% Reason Cost of debt 796 0.30 [Debts promised return] [S30/ $100] [7% x 0.30] Weight of debt Weighted cost of debt Cost of equity Weight of equity 2.1% 11% 0.70 Weighted cost of equity Weighted Average Cost of Capital (WACC) 7.7% 9.8% [$70 $100] [11% x 0.70] [2.1% +7.7%) NOTE As the total capital of the firm of $100 will remain the same even after issuing debt of $30 to repurchase existing equity stock, balance in equity will be $70 after such repurchase using fresh debt raised. That is, capital structure after the fresh debt issued Debt+ Equity $30$70 $100. Accordingly, weight of the debt $30 $100 0.30; Weight of the equity $70/ $100 0.70

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