PPT_Cost of Capital.pptx - THE COST OF CAPITAL INTRODUCTION The project\u2019s cost of capital is the minimum required rate of return on funds committed to

PPT_Cost of Capital.pptx - THE COST OF CAPITAL INTRODUCTION...

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THE COST OF CAPITAL
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INTRODUCTIONThe project’s cost of capitalis the minimum required rate of return on funds committed to the project, which depends on the riskiness of its cash flows. The firm’s cost of capitalwill be the overall, or average, required rate of return on the aggregate of investment projects 2
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COST OF CAPITALThe cost of capital of any investment (project, business, or company) is the rate of return the suppliers of capital would expect to receive if the capital were invested elsewhere in an investment (project, business, or company) of comparable riskThe cost of capital reflects expected returnThe cost of capital represents an opportunity costThe Opportunity Cost is the rate of return foregone on the next best alternative investment opportunity of comparable risk.
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SIGNIFICANCE OF THE COST OF CAPITALEvaluating investment decisionsDesigning a firm’s debt policyAppraising the financial performance of top management4
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WEIGHTED AVERAGE COST OF CAPITAL (WACC)WACC = wErE+ wprp+ wDrDwE= proportion of equityrE= cost of equitywp= proportion of preferencerp= cost of preferencewD= proportion of debtrD= Post-tax cost of debttc= corporate tax rate
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KEY POINTSOnly three types of capital (equity; nonconvertible, noncallable preference; and nonconvertible, noncallable debt) are considered.
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