CS Executive · Corporate Accounting and Financial Management · Cost of Capital
Kaveri Industries has a target structure of 30% debt, 10% preference shares and 60% equity. The costs of new funds are: debt after tax 7%, preference 10%, equity 16%. Its marginal cost of capital is:
The marginal cost of capital is 12.7%. Multiply each cost by its target weight: 0.30 x 7 = 2.1, 0.10 x 10 = 1.0 and 0.60 x 16 = 9.6. Adding gives 12.7%. An unweighted average would give 11.0%, which is incorrect.
- A12.7%Correct
- B11.0%
- C12.0%
- D13.0%
Explanation
MCC = 0.30 x 7 + 0.10 x 10 + 0.60 x 16 = 2.1 + 1.0 + 9.6 = 12.7%. The simple average of 7, 10 and 16 is 11.0%, which wrongly ignores weights.
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