ch.10 notes

# ch.10 notes - Chapter 10 The Cost of Capital E. Johnson FIN...

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Chapter 10 The Cost of Capital E. Johnson FIN 300

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Calculating the W eighted A verage C ost of C apital A weighted average of the component costs of debt, preferred stock, and common equity WACC = w d r d (1-T) + w p r p + w c r s The w’s refer to the firm’s capital structure weights. The r’s refer to the cost of each component. Optimal Capital Structure: the percentage of debt, preferred stock, and common equity that will maximize the firm’s stock price
Should our analysis focus on before- tax or After-Tax capital costs ? Stockholders focus on A-T CFs. Therefore, we should focus on A-T capital costs, i.e. use A-T costs of capital in WACC. Only r d needs adjustment, because interest is tax deductible.

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WACC = w d r d (1-T) + w p r p + w r Weighted Average Cost of Capital = WACC % of DEBT w d After Tax Cost of DEBT r d (1-T) % of PREFERRED Stock w p Cost of PREFERRED Stock r p c
Component cost of debt WACC = w d r d (1-T) + w p r p + w c r s r d is the marginal cost of debt capital. The yield to maturity (YTM) on outstanding L-T debt is often used as a measure of r d .

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, example: A 15-year, 12% semiannual coupon bond sells for \$1,153.72. What is the cost of debt (r d )? Remember, the bond pays a semiannual
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## This note was uploaded on 05/10/2008 for the course FIN 300 taught by Professor Cindychen during the Spring '07 term at CSU Long Beach.

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ch.10 notes - Chapter 10 The Cost of Capital E. Johnson FIN...

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