Question

Assume a for-profit skilled nursing facility chain has a target capital structure that is 40 percent debt and 60 percent equity. Assume the chain plans to finance a new project with 50 percent debt and 50 percent equity. The marginal before-tax cost of debt is 8 percent, the tax rate is 35 percent, and the marginal cost of equity is estimated to be 14 percent. What is the organization’s corporate cost of capital (rounded to the nearest tenth of a percent)?

Answer 1

Answer:

The organization’s corporate cost of capital is 10.5%

Explanation:

The steps to compute cost of capital is shown below:

Step 1 : first we have to compute the after tax value

Step 2: Than, multiply the after tax value with weight-age of capital structure

So, after tax value = rate of capital structure × (1 - tax rate)

Now, apply these steps so that cost of capital can be computed.

For equity , After tax value is 14% and cost of capital is equals to

= 14% × 60%

= 8.4%

Thus, for equity, the cost of capital is 8.4%

For debt, After tax value is =  8% × (1 - 0.35) = 5.2%

and cost of capital is equals to

= 5.2% × 40%

= 2.08

Thus, for debt, the cost of capital is 2.08%

So, the  organization’s corporate cost of capital is

= cost of debt + cost of equity

= 8.4% + 2.08%

=10.5%

Hence, the organization’s corporate cost of capital is 10.5%