he Manx Company was recently formed to manufacture a new product. It has the following capital structure in market value terms: Debentures $ 6,000,000 Preferred stock $2,000,000 Common stock(320,000 shares) $8,000,000 Total $16,000,000 The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of business suggests that the required return on equity is about 17 percent. (The CAPM approach was used to determine the required rate of return.) The Manx Company’s debt is currently yielding 13 percent, and its preferred stock is yielding 12 percent. Compute the firm’s present weighted average cost of capital.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
The Manx Company was recently formed to manufacture a new product. It has the following capital structure in market value terms:
|
Debentures |
$ 6,000,000 |
|
|
$2,000,000 |
|
Common stock(320,000 shares) |
$8,000,000 |
|
Total |
$16,000,000 |
The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of business suggests that the required
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