Christopher william president of william industries which

Question

Christopher William, president of William Industries which produces widgets, has hired you to determine its cost of debt and the cost of equity capital. The stock currently sells for $25 per share and the dividend will be $5. Christopher argues that it will cost us $5 per share to use the stockholders money this year therefore the cost of equity is equal to 20%. Furthermore, Christopher believes that the cost of debt is 25%.

This is based upon the most recent financial statements which show that William Industries has total liabilities of $10 million and will face total interest expenses for the year of $2.5 million. Christopher argues that the company should increase its use of equity financing because debt costs 25% while equity only costs 20% and thus equity is cheaper.

Is Christopher’s analysis of the cost of equity, debt, and decision to increase the use of equity financing over debt financing accurate?

Answer 1

The cost of debt and cost of equity affects the overall financial position of the company. Thus the decision in regard to equity financing and debt financing are to be taken very carefully. The cost of debt is the average rate that the company pays in regard to all its debts. The cost of equity is the cost that is incurred regard to payment of the return that is expected by the shareholders on their investment.