COST OF CAPITAL - COST OF CAPITAL Cost of capital acts as a...

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COST OF CAPITAL
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Cost of capital acts as a major link between the firm’s long-term investment decisions and the wealth of the owners as determined by investors in the market place. It is in effect the “magic number” that is used to decide whether a proposed corporate investment will increase or decrease the firm’s stock price.
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Clearly, only those investments that are expected to increase stock price (NPV>0 or IRR>k) would be recommended.
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Definitions The cost of capital is the rate of return that a firm must earn on its investments in order to maintain the market value of its stock. It can also be thought of as the rate of return required by the market suppliers of capital to provide their funds to the firm
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Calculation of Cost of Capital Identify and determine the cost of each capital component Calculate the weighted average cost of capital.
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Capital Components Long-term debt Preferred stock Equity
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Cost of Debt The cost of debt is the after-tax cost of raising long-term funds through borrowing.
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