Week Five – Individual Assignment

University of Phoenix

(A)

The weighted average cost can be calculated by completing the following:

Cost of capital = amount of liability x after-tax cost of liability + amount of equity x the cost of equity. The amount of liability is given by: liabilities / assets. Because total assets equals to total debt + total equity, the fraction of equity equals 1 (debt / assets); essentially, the cost of capital is (liability / assets) x after-tax cost of liability + (1- debt / assets) x the cost of equity. Therefore, the table is filled in this way:

Debt / Assets (AT) Debt Cost Equity Costs Capital Costs

0% 8% 12% 12%

10 8 12 11.6%

20 8 12 11.2%

30 8 13 11.5%

40 9 14 12.0%

50 10 15 12.5%

60 12 16 13.6%

(B)

As per the numbers in (A) the most beneficial capital composition is 20-percent liability and 80-percent equity; this composition fundamentally decreases the cost of capital, and therefore, the worth of the company would be lifted. Because total assets equal $100, the sum of liability must be 100 x 20%, which equals $20. The sum of equity must equal to 100 x 80%, which is equal to $80. Please see the table below:

Assets $100 Debt $20 Equity $80

(C)

As per the table, the cost of capital is decreasing at the beginning as a consequence of the reality that the fraction of liability is enhanced when matched up versus equity. The cost of equity is greater than the debt, and hence, when amount of liability is increased, the capital that is used is cheap which causes the cost of capital to reduce.

(D)

As per the table, when the sum of liability is increased, equity and debt costs are increased, which as a consequence, makes the cost of capital to increase; these costs (debt and equity) increase because of the fact that when liability levels raise, the