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10 The Cost of Capital

# 10 The Cost of Capital - 10 1 CHAPTER 10 The Cost of...

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10 - 1 CHAPTER 10 The Cost of Capital Cost of Capital Components Debt Preferred Common Equity WACC

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10 - 2 What types of long-term capital do firms use? Long-term debt Preferred stock Common equity
10 - 3 Should we focus on before-tax or after-tax capital costs? Tax effects associated with financing can be incorporated either in capital budgeting cash flows or in cost of capital. Most firms incorporate tax effects in the cost of capital. Therefore, focus on after-tax costs. Only cost of debt is affected.

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10 - 4 Should we focus on historical (embedded) costs or new ( marginal ) costs? The cost of capital is used primarily to make decisions which involve raising and investing new capital. So, we should focus on marginal costs .
10 - 5 A 15-year, 12% semiannual bond sells for \$1,153.72. What’s k d ? 60 60 + 1,000 60 0 1 2 30 i = ? 30 -1153.72 60 1000 5.0% x 2 = k d = 10% N I/YR PV FV PMT -1,153.72 ... INPUTS OUTPUT

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10 - 6 Component Cost of Debt Interest is tax deductible, so k d AT = k d BT (1 - T) = 10%(1 - 0.40) = 6%. Use nominal rate. Flotation costs small, so ignore.
10 - 7 What’s the cost of preferred stock? P P = \$113.10; 10%Q; Par = \$100; F = \$2. ( 29 %. 0 . 9 090 . 0 10 . 111 \$ 10 \$ 00 . 2 \$ 10 . 113 \$ 100 \$ 1 . 0 = = = - = n ps ps P D k = Use this formula:

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10 - 8 Picture of Preferred 2.50 2.50 0 1 2 k ps = ? -111.1 ... 2.50 . k 50 . 2 \$ k D 10 . 111 \$ Per Per Q = = %. 9 ) 4 %( 25 . 2 k %; 25 . 2 10 . 111 \$ 50 . 2 \$ k ) Nom ( ps Per = = = =
Note: Flotation costs for preferred are significant, so are reflected. Use net price. Preferred dividends are not

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10 The Cost of Capital - 10 1 CHAPTER 10 The Cost of...

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