From the course: Finance Foundations (2019)

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Cost of capital: Split debt-equity financing

Cost of capital: Split debt-equity financing

From the course: Finance Foundations (2019)

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Cost of capital: Split debt-equity financing

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We've considered 100 percent debt financing, we've considered 100 percent equity financing. Now let's split the financing 50-50. Lily borrows $100 million, and she finds investors to provide the other $100 million. The investors insist on a rate of return of 17 percent. The lenders accept a rate of return of just five percent. In this case, the total cost of capital is $100 million plus five percent, or $105 million for the lenders and $100 million plus 17 percent, or 117 million for the investors. The total cost of capital, $222 million. 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. The forecast is that the cash flow will be $220 million. 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 this 17 percent required rate of return by the…

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