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Pecking order hypothesis. Rachel can raise capital from the sources in the table: What is​ Rachel's...

Pecking order hypothesis. Rachel can raise capital from the sources in the table: What is​ Rachel's weighted average cost of capital if she needs to raise

a. $10,000?

b. $20,000​?

c. $30,000​?

Source of Funds

Interest Rate

Borrowing Limit

Parents

2​%

​$10,000

Friends

5.5​%

​$3,000

Bank loan

10​%

​$17,000

Credit card

14.5​%

​$5,000

Solutions

Expert Solution

a

Cost of capital = interest rate of parents = 2%

b

Total Capital value = Value of Parents + Value of Friends + Value of Bank loan
=10000+3000+7000
=20000
Weight of Parents = Value of Parents/Total Capital Value
= 10000/20000
=0.5
Weight of Friends = Value of Friends/Total Capital Value
= 3000/20000
=0.15
Weight of Bank loan = Value of Bank loan/Total Capital Value
= 7000/20000
=0.35
Cost of Capital = Weight of Parents*Cost of Parents+Weight of Friends*Cost of Friends+Weight of Bank loan*Cost of Bank loan
Cost of Capital = 2*0.5+5.5*0.15+10*0.35
Cost of Capital = 5.325

c

Total Capital value = Value of Parents + Value of Friends + Value of Bank loan
=10000+3000+17000
=30000
Weight of Parents = Value of Parents/Total Capital Value
= 10000/30000
=0.3333
Weight of Friends = Value of Friends/Total Capital Value
= 3000/30000
=0.1
Weight of Bank loan = Value of Bank loan/Total Capital Value
= 17000/30000
=0.5667
Cost of Capital = Weight of Parents*Cost of Parents+Weight of Friends*Cost of Friends+Weight of Bank loan*Cost of Bank loan
Cost of Capital = 2*0.3333+5.5*0.1+10*0.5667
Cost of Capital = 6.8833

jeff jeffy answered 1 year ago
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