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Cost of Capital ¾The cost to borrow long-term funds ¾The minimum acceptable return for a new asset cost of capital = required return What factors influence the cost of capital? 1.economy 2.business & financial risk 3.a firm’s capital structure (mix of debt & equity) Four sources of long-term funds: 1.Bonds (Debt) •Calculate the ‘YTM’ or “cost to maturity” Kd= cost of debt $interest + Par – currentKd= ________________Years____Par + 2 (current)3 Ex: Builtrite will sell 9% coupon, 25 year, $1000 par value bonds to raise money. The
Bonds will sell at a $20 discount and under-writing (floatation) costs will be $25. Builtrite’s tax rate is 40%. What is Builtrites’ after tax cost of debt? 2. Preferred Stock Kp = cost of preferred stock Kp= Dividend = DNet Proceeds NBuiltrite will issue a $40 par value preferred stock with an 8% coupon. The stock is expected to sell at $38. Floatation costs will be $3.50 per share. What is Builtrite’s after after tax cost of preferred stock? pp
4. New Common Stock •a firm will need to sell new common stock when it uses up its retained earnings. KNC= Dl+ Net Proceeds ‘NNC’ (continue example #3) Floatation costs to sell common stock will be $0.50 per share and the expected selling price of the stock is $46.75. What is the after tax cost of selling new common stock? g