FIN300 Lecture 8 - Cost of Capital

FIN300 Lecture 8 - Cost of Capital - FIN300 Cost of Capital...

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FIN300 Cost of Capital
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Cost of Capital The cost to borrow long-term funds The minimum acceptable return for a new asset cost of capital = required return
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What factors influence the cost of capital? 1) economy 2) business & financial risk 3) a firm’s capital structure (mix of debt & equity)
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Four sources of long-term funds 1. Bonds (Debt) Calculate the ‘YTM’ or “cost to maturity” K d = cost of debt K d = $ interest + Par-Net Proceeds Years Par + 2(Net) 3
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Ex: Builtrite will sell 9% coupon, 25 year, $1000 par value bonds to raise money. The bonds will sell at $20 discount and under-writing (flotation) costs will be $25. Builtrite’s tax rate is 40%. What is Builtrites ’ after tax cost of debt? 90 + 1000-955 K d = 25 1000 + 2 (955) 3 ATK d =
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2) Preferred Stock K p = Cost of preferred stock K p = Dividend = D p Net Proceeds N p
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Builtrite will issue a $40 par value preferred stock with an 8% coupon. The stock is expected to sell at $38. Flotation costs will be $3.50 per share.
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