Q. Average cost of capital?

Even though the director suggests that equity finance is appropriate given the amount of finance needed the amount alone doesn't rule out other financing methods. It would be sensible to go over the effect of the new finance on the company's capital structure and cost of capital to consider the relative issue costs of different sources of finance and to assess the effect on the company of any change in financial risk.

Cost of Capital

If Nespa is able to reduce its average cost of capital this will increase its overall value. The information that its interest cover is important than similar companies points to its competitors having proportionately more debt in their capital structures a view supported by Nespa's return on capital employed being close to the sector average.

It is as well worth noting that since Nespa's average cost of capital and hence its cost of equity is 10% and since equity is more expensive than debt the cost of debt finance is certain to be less than 10%. The tax effectiveness of debt will reduce the effective cost to Nespa even further implying that debt finance at a cost of 6% or less is available the cost will be even lower for secured debt. From this discussion it possibly concluded that an issue of debt may well be in the best interests of Nespa's shareholders.