Risk, Cost of Capital and Capital Budgeting Chapter 12 Cost of Debt Cost of Preferred Stock Cost of Retained Earnings Cost of Newly Issued Equity Weighted Average Cost of Capital (WACC) Factors that Affects WACC Adjusting the Cost of Capital for Risk Marginal Cost of Capital The cost of capital is an important issue for financial managers because: In order to maximize the value of the firm the financial manager must minimize all costs In order to make capital budgeting decisions, the financial manager must discount the cash flows of the project by a certain rate (the cost of capital), and Other investment decisions such as short term financing, bond refunding, etc., require the estimation of the cost of capital. Cost of CapitalAre the rates of return expected by those individuals or firms who contribute to the financial structure: preferred and common shareholders. Now, as we know, when it comes to financing a project, for example, a firm can finance it in many different ways. Some may choose to finance their projects through debt, others by issuing preferred stocks and others may use their retained earnings or any combination of them. Nevertheless, depending on their financing decision, the firm will have to discount the projects cash flows accordingly. For those who chose debt financing, they will have to use the cost of debt to discount their cash flows. For those who used preferred stocks will need to use the cost of preferred stocks. And for those who used a combination will have to use what is known as the Weighted Average of Capital. Let us look at the different cost of capitals in more detail. Cost of Retained Earning, rsCost of Retained Earnings- is the rate of return required by investors who own common stock.
has intentionally blurred sections.
Sign up to view the full version.