Cost of capital chapter 10
Download
1 / 10

COST OF CAPITAL CHAPTER 10 - PowerPoint PPT Presentation


  • 146 Views
  • Uploaded on

COST OF CAPITAL CHAPTER 10. Weighted Average Cost of Capital Cost of Capital Components. Types of Capital. SOURCES OF LONG-TERM CAPITAL . From Most to Least Used Sources Retained Earnings Sale of Corporate Bonds Sale of Common Stock Sale of Preferred Stock

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' COST OF CAPITAL CHAPTER 10' - rae


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Cost of capital chapter 10

COST OF CAPITALCHAPTER 10

Weighted Average Cost of Capital

Cost of Capital Components



Sources of long term capital
SOURCES OF LONG-TERM CAPITAL

  • From Most to Least Used Sources

    • Retained Earnings

    • Sale of Corporate Bonds

    • Sale of Common Stock

    • Sale of Preferred Stock

  • Cost of capital determined by firm's capital structure (RHS of B/S).

    Capital consists of:

    • Debt (bonds)

    • Equity (preferred and common stocks)

    • Retained Earnings


Sources of long term capital1
SOURCES OF LONG-TERM CAPITAL

  • Market-based weighted-average of these costs (WACC) is also termed the hurdle rate.

    WACC = Wd Kd (1-t) + Wp Kp + We Ke

  • How are the weights Wi determined?

    • Use accounting numbers (easiest – uses book values)

    • Use market value of issued securities (preferred method)

    • Firm’s cost of capital is set by market forces via investor pricing activity [implied risk assessment]

      • High risk: lower prices (low P/E ratios)

      • Low risk: higher prices (high P/E ratios)


Hurdle rate wacc or k a
HURDLE RATE [WACC or ka]

  • Some Observations:

    • Approximately 80% of all investment projects are financed internally (from retained earnings and tax-shielded cash flows such as depreciation).

    • Approximately 15% are financed by selling debt.

    • Approximately 5% are financed by selling stock.


Cost of new capital
COST OF NEW CAPITAL

  • The Cost of New Debt: Kd

    • Kd = [YTM / (1 - F)] (1 - T)

    • Where:

      • YTM = current market yields to maturity for seasoned bonds.

      • F = flotation costs as a decimal (percentage).

      • T = the marginal tax rate of the firm


Cost of new capital1
COST OF NEW CAPITAL

B. The cost of Preferred Stock; Kpfd

  • Kpfd = Dpfd / [Ppfd * (1 - F)]

  • Where:

    • Dp = the dividend (to be) paid on the preferred stock.

    • Pp = the (current) market price of preferred.

    • F = Flotation costs as a percentage.


Cost of new capital2
COST OF NEW CAPITAL

C. Cost of Equity (common & ret’d earns); Ke

Ke = D1 / (Po - F) + g

  • Where:

    • D1 = the expected dividend at the end of year 1.

    • Po = the current price of common.

    • F = Flotation cost in dollars per share.

    • g = the anticipated rate of growth in dividends.


Hurdle rate wacc or k a1
HURDLE RATE [WACC or ka]

  • Hurdle rate; minimum rate of return a project must earn. Ceteris paribus….

    • If just the hurdle rate is earned, then value of firm is maintained.

    • If less that the hurdle rate is earned, then value of firm declines.

    • If more that the hurdle rate is earned, then value of firm increases.


Homework chapter 10
HOMEWORK CHAPTER 10

  • Questions You Should Be Able To Answer

    • Why is the hurdle rate an important concept in capital budgeting?

    • What important considerations must we make when computing the cost of capital?

    • What factors should managers consider when planning a capital structure strategy?

  • Homework Assignment

    • Self-test: ST-1, parts b, e, f

    • Questions: 10-1, parts a, b, h, i

    • Problems: 10-1, 10-3, 10-11


ad