From the course: Finance Foundations
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Cost of capital: Split debt-equity financing
From the course: Finance Foundations
Cost of capital: Split debt-equity financing
- We've considered 100% debt financing, we've considered 100% equity financing. Now let's split the financing 50/50. Lily borrows 100 million dollars and she finds investors to provide the other 100 million dollars. The investors insist on a rate of return of 17%. The lenders accept a rate of return of just 5%. In this case the total cost of capital is 100 million dollars plus 5%, or 105 million dollars for the lenders. And 100 million dollars plus 17% or 117 million for the investors. The total cost of capital 222 million dollars. Well, let's look and see if this capital structure will give a cost of capital low enough so that Lily's business will work. Total cost of capital we've computed is 222 million dollars. The forecast is that the cash flow will be 222 million dollars, it's still not going to work. The cost of capital is too high. The cost of capital determines whether a project is going to occur or not. Now first of all, why is the 17% required rate of return by the investors…
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