Question

1. The Donald Grump Corporation, a publicly traded REIT, has expected total return to equity of 13%, average interest rate on its debt of 7.5%, and a debt/total asset value ratio of 40%.

1. What is Grump’s equity average cost of capital? 12 points.
2. What is Grump’s firm-level overall average cost of capital? 12 points.

Answer 1

Given,

Return on Equity = 13%

Return on Debt = 7.5%

Debt /Total Asset =40% =0.4

Answer a) Grump’s equity average cost of capital

As we know that Total Assets = Total Liabilities

Total Liabilities = Equity + Debt

From the Ratio Total Asset = Total Liabilities = 1, and Debt = 0.4,

So Equity = 1 - 0.4 = 0.6

Grump’s equity average cost of capital = 0.6 x 13% = 7.8%

Answer b) Grump’s firm-level overall average cost of capital

Cost of Capital = Cost of Equity + Cost of Debt

From the above answer Cost of Equity = 7.8%

From the Ratio Total Asset = Total Liabilities = 1, and Debt = 0.4

Grump’s debt average cost of capital = 0.4 x 7.5% = 3%

Grump’s firm-level overall average cost of capital = 7.8% + 3% = 10.8%