Cost of capital suppose Tom OBedlam president of Bedlam Products, Inc., has hired you to determine the

Question:

Cost of capital suppose Tom O’Bedlam president of Bedlam Products, Inc., has hired you to determine the firm’s cost of debt and cost of equity capital.

(a) The stock currently sells for $50 per share, to use the stockholders’ money this year, so the cost of equity is equal to 10 percent ($5/50). “What is wrong with this conclusion?

(b) Based on the most recent financial statements, Bedlam Products’ total liabilities are $8 million owe $8 million, and we will pay $1 million interest. Therefore, our cost of debt is obviously $1 million/8 million = 12.5%. “What’s wrong with this conclusion?

(c) Based on his own analysis, Tom is recommending that the company increase its use of equity financing because “debt costs 12.5 percent, but equity costs only 10 percent thus equity is cheaper. “Ignoring all the other issues, what do you think about the conclusion that the cost of equity is less than the cost of debt?

Cost Of Debt
The cost of debt is the effective interest rate a company pays on its debts. It’s the cost of debt, such as bonds and loans, among others. The cost of debt often refers to before-tax cost of debt, which is the company's cost of debt before taking... Cost Of Equity
The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the...