What is Russell Corporations cost of capital?

Question

Russell Corporations capital structure consists of $5,000,000 of assets and $2,000,000 of liabilities. Joe Russell, the corporations CEO and largest shareholder says that the debt has an average interest rate of 9% and that shareholders want 16% return. What is Russell corporations cost of capital?

Answer 1

The cost of capital (COC) is the weighted sum of the after-tax cost of equity (COE) and the after-tax cost of debt (COD).

You didn't supply a tax rate so I'll assume 36%.

 

Equity weight = 5/(5+2) = 5/7

Debt weight = 2/(5+2) = 2/7

COE = 16% (note, this is already after tax)

COD = 9% (1-36%) = 5.76%

 

COC = 5/7(16%) + 2/7(5.76%) = 13.07%