International Exchange has three divisions: A, B, and C. Division A has the least risk and Division C has the most risk. The firm has an after-tax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 37 percent debt and 63 percent equity. Division A's projects are assigned a discount rate that is 2.2 percent less than the firm's weighted average cost of capital. What is the discount rate applicable to Division A

Question

Jace Guerra

Business

31 December, 13:43

International Exchange has three divisions: A, B, and C. Division A has the least risk and Division C has the most risk. The firm has an after-tax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 37 percent debt and 63 percent equity. Division A's projects are assigned a discount rate that is 2.2 percent less than the firm's weighted average cost of capital. What is the discount rate applicable to Division A

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Kerry · Answer 1

Answer: 9.07%

Explanation:

The Weighted Average Cost of Capital is essentially how much it costs a company to raise all the capital it has including long term debt and equity.

It is calculated by weighing each category of capital with their cost to find the Weighted Average.

In this scenario therefore it will be calculated by,

= 0.37 (0.061) + 0.63 (0.143)

= 0.02257 + 0.09009

= 0.11266

= 11.27%

It is said that Division A's projects are assigned a discount rate that is 2.2 percent less than the firm's weighted average cost of capital. That would be,

= 11.27 - 2.2

= 9.07%

The discount rate applicable to Division A is 9.07%