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# What is composite cost of capital? Explain the process to compute it?

Hi I am Kiran. I am preparing for CA exam. I want know about finance, What is composite cost of capital? Explain the process to compute it?

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In this the cost of debt is calculated in the beginning and it is used to find out the cost of capital and other weights of cost is been calculated after the calculation each and every individual weight of the component is added and then it gives the final composite cost.

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Hi Composite cost of capital is also known as weighted average cost of capital which is a measurable unit for it. It also tells about the component costs of common stock, preferred stock, and debt. Each of these components is given weightage on the basis of the associated interest rate and other gains and losses with it. It shows the cost of each additional capital as against the average cost of total capital raised. The process to compute this is first computing the weighted average cost of capital which is the collection of weights of other costs summed together. The formula is given as:- WACC= Wd (cost of debt) + Ws (cost of stock/RE) + Wp (cost of pf. Stock)< /STRONG> In this the cost of debt is calculated in the beginning and it is used to find out the cost of capital and other weights of cost is been calculated after the calculation each and every individual weight of the component is added and then it gives the final composite cost. A company's cost to borrow money given the proportional amounts of each type of debt and equity a company has taken on. A company's debt and equity, or its capital structure, typically includes common stock, preferred stock and bonds. A high composite cost of capital, indicates that a company has high borrowing costs; a low composite cost of capital signifies low borrowing costs.

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Composite cost of capital is also known as weighted average cost of capital which is a measurable unit for it. It also tells about the component costs of common stock, preferred stock, and debt. Each of these components is given weightage on the basis of the associated interest rate and other gains and losses with it. It shows the cost of each additional capital as against the average cost of total capital raised. The process to compute this is first computing the weighted average cost of capital which is the collection of weights of other costs summed together. The formula is given as:- WACC= Wd (cost of debt) + Ws (cost of stock/RE) + Wp (cost of pf. Stock) ------------------------------------------------------------------------ In this the cost of debt is calculated in the beginning and it is used to find out the cost of capital and other weights of cost is been calculated after the calculation each and every individual weight of the component is added and then it gives the final composite cost.

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DEFINITION of 'Composite Cost Of Capital' A company's cost to borrow money given the proportional amounts of each type of debt and equity a company has taken on. A company's debt and equity, or its capital structure, typically includes common stock, preferred stock and bonds. The cost of using external funds, or the cost of debt capital, is the interest rate you must pay lenders. However, because interest expenses are tax deductible, the after-tax cost of debt, kd, is the interest rate, r, multiplied by 1 minus the firm’s marginal tax rate, t, or image0.jpg You’ve decided to finance a capital investment by issuing bonds that have a 6 percent annual interest rate. In addition, your company’s marginal tax rate is 35 percent. The cost of using debt to finance the project equals image1.jpg Firms commonly raise funds for capital investment from both internal and external sources. The composite cost of capital, kc, is a weighted average of the cost of equity capital and the cost of debt capital. Therefore, image2.jpg where we and wd are the weights or proportions of equity and debt capital you use to finance the project. You decide to fund a capital investment through a combination of equity and debt capital. You plan to fund 25 percent of your capital investment through equity and 75 percent through debt. To determine the composite cost of capital, start by separately calculating the cost of equity capital and the cost of debt capital. Assume your firm’s â coefficient is 2.1 and the average stock return is 6 percent. The return on U.S. Treasury bills is 1 percent, which is the risk-free rate of return. Your firm can borrow funds at 9-percent interest and its marginal tax rate is 34 percent. 1.Determine the cost of equity capital. This example uses the capital-asset-pricing method. image3.jpg 2.Determine the cost of debt by using the marginal tax rate. image4.jpg 3.Determine the composite cost of capital. Remember to weight each component by the percentage of funds raised through that method — equity or debt. image5.jpg Thus, the composite cost of capital is 7.33 percent.

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