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Cost of Capital Assignment help | Debt and Equity
- 1. Debt and Equity: Cost of Capital Assignment Help 1 www.assignmenthelpexperts.com
- 2. There are namely two elements of cost of capital: ◦ Debt Capital ◦ Equity Capital 2www.assignmenthelpexperts.com
- 3. By applying following formula cost of debt is calculated. Kd = I/P*100 Where, Kd= Cost of Debt P = Principle I = Interest 3www.assignmenthelpexperts.com
- 4. Cost of equity (Es) = Rf + Beta x (Rm- Rf) Where, Beta= sensitivity to movements in the relevant market Rf = Risk free rate of return Rm = Market rate of return 4www.assignmenthelpexperts.com
- 5. Formula Kw = ∑XW/ ∑W Where, Kw = Weighted average cost of capital ∑XW = After tax cost of different sources of capital ∑W = Weights assigned to a particular sources of capital 5www.assignmenthelpexperts.com
- 6. Present value of loan (PV) -600000 Future Value (FV) 0 Annaul Payement (PMT) 100000 Number of years (NPER) 10 Expected rate of interet 11% Presentvalue ofloan(PV) -600000 Future Value (FV) 0 Annaul Payement(PMT) 100000 Numberofyears(NPER) 10 Expectedrate ofinteret 11% 6www.assignmenthelpexperts.com
- 7. Costofequity(Es)=Rf+Betax(Rm-Rf) Beta 1.39 Rf 3% Rm 12% CostofEquity 15.51% 7www.assignmenthelpexperts.com
- 8. Source (1) Amount ($) Proportion Cost of Capital Debt Capital Long- & short-term debt 600,000 30% 11% Equity Capital Common internal stock equity 400,000 20% New common stock equity 1,000,000 50% Total Equity 1,400,000 70% 15.51% Total Capital 2,000,000 100% Corporate Tax rate 35% Cost of Debt 3.30% Cost of Equity 10.86% WACC 9% Debt Capital Long- & short-term debt 600,000 30% 11% Equity Capital Common internalstock equity 400,000 20% New common stock equity 1,000,000 50% Total Equity 1,400,000 70% 15.51% TotalCapital 2,000,000 100% Corporate Tax rate 35% WACC 13% 8 www.assignmenthelpexperts.co m
- 9. Decision Making Competitive Advantage 9www.assignmenthelpexperts.com
- 10. WACC Cost of Debt Cost of Equity 10www.assignmenthelpexperts.com
- 11. Capital structure Cost of capital Role of cost of capital 11www.assignmenthelpexperts.com
- 12. Baker, H. K. (2011). The Art of Capital Restructuring: Creating Shareholder Value Through Mergers and Acquisitions. USA: John Wiley and Sons. Bragg, S.M. (2012). Business Ratios and Formulas: A Comprehensive Guide (3rd ed.). USA: John Wiley and Sons. Brechner, R.A. (2012). Contemporary mathematics for business and consumers. 6th ed. USA: Cengage Learning. Drury, C. (2006). Cost And Management Accounting: An Introduction (6th ed.). UK: Cengage Learning EMEA Mukherjee, S. & Mahakud, J. (2010). Dynamic adjustment towards target capital structure: evidence from Indian companies, Journal of Advances in Management Research, 7(2), p. 250 – 266. 12www.assignmenthelpexperts.com
- 13. Ooi, J.L. (2000). Managerial opportunism and the capital structure decisions of property Companies, Journal of Property Investment & Finance, 18(3), p. 316 – 331. Pratt, S.P. & Grabowski, R.J. (2010). Cost of Capital: Applications and Examples (4th ed.). Canada: John Wiley and Sons. Rhodes, T. (2006). Euromoney Encyclopedia of Debt Finance. Cornwall: Euromoney Books. 13www.assignmenthelpexperts.com
- 14. Get business and Finance assignment help from experienced assignment writing experts. We ensure you that your assignment paper will be according to your guidelines with 100% original assignment help. info@assignmenthelpexperts.com 14www.assignmenthelpexperts.com
Editor's Notes
- A framework that defines how an organization is engaged to finance its overall functions by using different funding sources can be defined as capital structure. There are two funding sources namely debt and equity that are used by organization on frequent basis. The appropriate combination of both debt and equity allows organization to increase its market value by minimizing the cost of capital. The capital that is obtained by an organization through loan can be defined as debt capital. In contrast, equity capital is raised by issuing the shares to the different stakeholders such as employees, society etc (Pratt & Grabowski, 2010). Each source of funding creates significant risks and benefits for given company in different situations.
- Cost of debt is calculated on the basis of interest rate that an organization bears to pay the loan back. When an organization obtains loan from bank or any other financial institution then it is required to make certain payment on annual, semiannual or monthly basis. The extra amount that an organization is paid for obtaining certain capital can be defined as cost of debt (Rhodes, 2006). With the above formula, an organization is enabled to analyze the cost that is to be paid by it for obtaining certain amount within a specific time period.
- This formula is quite effective to describe the relationship between risk and expected return. It allows organizations to determine the return and risk of common stock. This method includes both time value of money and risk. The risk free rate of return represents the time value of money and the value of beta represents risk. With consideration of beta (a risk measure), return on asset is compared with the market premium (Rm-Rf) over a specific time period (Baker, 2011).
- Weighted Average Cost of Capital Method is a method to combine both equity and debt capital for determining the overall cost of capital structure. With this, average of the costs of specific sources of capital employed in a business by the proportion they held in the capital structure of a firm is determined. By multiplying weight of each capital source with its amount an organization is enabled to determine weighted cost of capital structure (Bragg, 2012). This method includes both equity and debt amount on the individual basis that enables organization to make changes in an effective manner to reduce overall cost of capital.
- By using excel, cost of debt is determined as above. The amount is taken by organization as loan is considered as the present value of debt. Then annual payment that is paid by organization as interest of loan is the PMT in formula. After it, the time for which annual payment is paid by organization is determined, which is 7 years (Drury, 2006). The calculation shows that with the annual payment of $100000 for 10 years made against the loan of $600000 then the cost of debt will be equal to 11%.
- In order to calculate cost of equity, the above information is used. Firstly market premium is determined by subtracting risk free rate of return from market return. Then value of beta is multiplied by the market premium of the stock. This calculation helps to determine how much premium is gained by the organization over the specific time period with certain risk factors (Brechner, 2012). From the calculation, it is determined that required rate of return on equity or cost of equity for the firm is equal to 15.51%.
- ((Proportion of debt* cost of debt) *(1-.35) + (Proportion of equity* cost of equity)) For calculating cost of capital structure, Weighted Average Cost of Capital (WACC) method is used. Firstly the proportion of both equity and debt in formation of capital structure is determined. Following formula is used to determine the proportion in capital structure: Total debt or equity/ Total Capital*100*(1-tax rate) By obtaining proportion of both equity and debt, each is multiplied by its cost of capital. Cost of equity and debt is determined 11% and 15.51% respectively. Both equity and debt proportional is added to each other and then debt rate is multiplied by tax rate (Drury, 2006). Through the above process WACC is determined for the given capital structure.
- The determination of cost of capital is used in organization assignment help said that as a tool that guides them to take various decisions. In current business environment, the main basis of investment decision is cost of capital. Thorough this, organization is enabled to determine whether they invest their funds in own business or in other alternative option. It helps organization to gain opportunity cost from the capital. On the other hand, due to cost of capital, organization enables to make decision in regard to the source of funding. By determining the appropriate funding source, organization is enabled to get the fund in less cost (Ooi, 2000). It minimizes cost of capital, while creating value for organization that develops competitive advantage.
- The rate of return that is obtained from the WACC is expected by suppliers of fund. This rate is considered both equity and debt with consideration of their risk and time value of money. At the same time, it also considers the corporate tax rate as well that helps to provide feasible expected rate of return (Mukherjee & Mahakud, 2010). The fund providers expect that firms pay them at least WACC as the return on their investment.
- From the above discussion by assignment help experts it can be concluded that capital structure of any organization is constituted with debt and equity. Both equity and capital is obtained from different sources that make different cost of capital structure. The determination of cost of capital helps organizations to make sound decision in regard to the funding sources. By selecting appropriate founding sources with determination of opportunity cost and risk, organization enables to minimize capital cost, while creating value in this competitive business environment.