Suppose your company is financed 20% with debt and 80% with common stock. If the

Question

Suppose your company is financed 20% with debt and 80% with common stock. If the cost of new borrow A. ng will be 39 and the cost of equity is 12% what is the cost of capital to your company if they applicable tax rate is 30%? (4 points) B. If you were to invest in a project that has a zero NPV, what rate of return would you be earning on the project? (3 points) C. If you were to invest in a project that has a zero NPV, what rate of return would you be earning on the portion of the funds provided by the stockholders? (2 points)

Explanation / Answer

A.

Debt weight:0.2 Equity weight:0.8 Cost of debt:5% tax rate:30% after tax cost of debt:3.5% (5%*(1-.3))

cost of equity:12%

WACC=0.2*3.5%+0.8*12%

WACC=10.3%

B.

If you are invest in a project that has zero NPV

Cost of capital = Rate of return

Hence Rate of return is 10.3%

C.

Rate of return would be earning on the portion of the funds provided by stock holders

WACC=10.3%

10.3%=0.2*3.5%+0.8*rate of return

Rate of return on the portion of stockholders is=12%

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