Weighted Cost of Capital

a.      How do you determine a firm's cost of equity?

The cost of equity denotes the returns the financial markets demand to gain ownership of an asset and assume the dangers associated with possession rights.  According to Zafiris (2016), companies use this tool to quantify the return required by an ownership structure, including their investors. The capital asset pricing model (CAPM) lets businesses and investors estimate the cost of equity. Enterprises use the following CAPM formula to calculate the cost of equity:

Cost of equity = Risk-free rate of return + Premium expected for risk.

Cost of equity = Risk-free rate of return + Beta × (market rate of return – risk-free rate of return)

b.      How do you determine a firm's cost of debt?

The cost of debt, also known as after-tax cost of debt describes the interest an entity remits to its creditors to fulfill its obligations: loans, bonds and credit card interest. According to Frank and Shen (2016), in some entities, the variance between before- and the after-tax cost of debt relies on the deduction of interest expenses, making it an essential aspect of the weight average cost of capital (WACC). Companies calculate their cost of debt to understand the implications of their obligation, for example, the level of pressure it exerts on organizational operations. The cost of debt formula is:

Cost of Debt = Interest Expense (1 – Tax Rate)

c.       In determining the firm's overall cost of capital (WACC),...