An investment banking firm has estimated the following after-tax cost of debt an

Question

An investment banking firm has estimated the following after-tax cost of debt and cost of equity for Marquez Luxury Travel Tours.

Proportion of Debt       After-tax Cost of Debt        Cost of Equity

30%                                 3.5%                                10.5%

40%                                 3.8%                                11.3%

50%                                 5.0%                                12.9%

60%                                 7.2%                                14.5%

What is the cost of capital at Marquez’ optimal capital structure given the above information?

   8.95%

   8.40%

   8.30%

   8.15%

Explanation / Answer

Solution:

The least among the above calculated is 8.30%.

Therefore the answer to the above question - 8.30 %

Cost Weight Weighted Cost Debt 3.50% 30% 1.05% Equity 10.50% 70% 7.35% Total 100% 8.40% Debt 3.80% 40% 1.52% Equity 11.30% 60% 6.78% Total 100% 8.30% Debt 5.00% 50% 2.50% Equity 12.90% 50% 6.45% Total 100% 8.95% Debt 7.20% 60% 4.32% Equity 14.50% 40% 5.80% Total 100% 10.12%

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