Versalife has built up a strong balance sheet due to immunology related drugs and nanotechnology products such as Ambrosia, which have made investors generally optimistic about it's prospects. It has strong access to fixed income markets and can borrow fixed rate debt at 3.14% per annum and floating rate debt at LIBOR +0.98% per annum. By contrast, The 'Ton Hotel has seen a significant drop in revenue in recent times. It is able to borrow at a fixed interest rate of 7.7% per annum and a floating rate of LIBOR + 1.8% per annum. Suppose The 'Ton Hotel needs fixed rate debt due to its financial situation, and Versalife is willing to lend in the floating rate market. Suppose also they into an interest rate swap and agree to split the savings equally. How much would Hilton pay for the fixed rate funds?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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