Given,
Return on Equity = 13%
Return on Debt = 7.5%
Debt /Total Asset =40% =0.4
Answer a) Grump’s equity average cost of capital
As we know that Total Assets = Total Liabilities
Total Liabilities = Equity + Debt
From the Ratio Total Asset = Total Liabilities = 1, and Debt = 0.4,
So Equity = 1 - 0.4 = 0.6
Grump’s equity average cost of capital = 0.6 x 13% = 7.8%
Answer b) Grump’s firm-level overall average cost of capital
Cost of Capital = Cost of Equity + Cost of Debt
From the above answer Cost of Equity = 7.8%
From the Ratio Total Asset = Total Liabilities = 1, and Debt = 0.4
Grump’s debt average cost of capital = 0.4 x 7.5% = 3%
Grump’s firm-level overall average cost of capital = 7.8% + 3% = 10.8%
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