In financial analysis, it is important to select an appropriate discount rate. A project’s discount rate must be high to compensate investors for the project’s risk. The return that shareholders require from the company as a compensation for their investment risk is referred to as the cost of equity. Consider this case: Weghorst Co. is a 100% equity-financed company (no debt or preferred stock); hence, its WACC equals its cost of common equity. Weghorst Co.’s retained earnings will be sufficient to fund its capital budget in the foreseeable future. The company has a beta of 1.35, the risk-free rate is 4.5%, and the market return is 5.9%. What is Weghorst Co.’s cost of equity? 1.95% 19.08% 8.02% 6.39% Weghorst Co. is financed exclusively using equity funding and has a cost of equity of 10.65%. It is considering the following projects for investment next year: Project Required Investment Expected Rate of Return W $23,575 9.65% X $13,250 14.60% Y $10,975 14.10% Z $32,675 9.70% Each project has average risk, and Weghorst Co. accepts any project whose expected rate of return exceeds its cost of capital. How large should next year’s capital budget be? $36,825 $56,250 $45,925 $24,225
In financial analysis, it is important to select an appropriate discount rate. A project’s discount rate must be high to compensate investors for the project’s risk. The return that shareholders require from the company as a compensation for their investment risk is referred to as the cost of equity. Consider this case: Weghorst Co. is a 100% equity-financed company (no debt or preferred stock); hence, its WACC equals its cost of common equity. Weghorst Co.’s retained earnings will be sufficient to fund its capital budget in the foreseeable future. The company has a beta of 1.35, the risk-free rate is 4.5%, and the market return is 5.9%. What is Weghorst Co.’s cost of equity? 1.95% 19.08% 8.02% 6.39% Weghorst Co. is financed exclusively using equity funding and has a cost of equity of 10.65%. It is considering the following projects for investment next year: Project Required Investment Expected Rate of Return W $23,575 9.65% X $13,250 14.60% Y $10,975 14.10% Z $32,675 9.70% Each project has average risk, and Weghorst Co. accepts any project whose expected rate of return exceeds its cost of capital. How large should next year’s capital budget be? $36,825 $56,250 $45,925 $24,225
Chapter13: Capital Structure Concepts
Section: Chapter Questions
Problem 5P
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Concept explainers
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.
Question
In financial analysis, it is important to select an appropriate discount rate. A project’s discount rate must be high to compensate investors for the project’s risk. The return that shareholders require from the company as a compensation for their investment risk is referred to as the cost of equity .
Consider this case:
Weghorst Co. is a 100% equity-financed company (no debt or preferred stock ); hence, its WACC equals its cost of common equity. Weghorst Co.’s retained earnings will be sufficient to fund its capital budget in the foreseeable future. The company has a beta of 1.35, the risk-free rate is 4.5%, and the market return is 5.9%.
What is Weghorst Co.’s cost of equity?
1.95%
19.08%
8.02%
6.39%
Weghorst Co. is financed exclusively using equity funding and has a cost of equity of 10.65%. It is considering the following projects for investment next year:
|
Project
|
Required Investment
|
Expected
|
|---|---|---|
| W | $23,575 | 9.65% |
| X | $13,250 | 14.60% |
| Y | $10,975 | 14.10% |
| Z | $32,675 | 9.70% |
Each project has average risk, and Weghorst Co. accepts any project whose expected rate of return exceeds its cost of capital. How large should next year’s capital budget be?
$36,825
$56,250
$45,925
$24,225
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