OEM 2009 ProgramThe Cost of CapitalPage 1CHAPTER 10The Cost of CapitalComponent Costs of CapitalWhen calculating componentcosts of capital, should we beconcerned with before-tax orafter-tax costs?after tax costs?Stockholders are concerned aboutafter-tax cash flows. Therefore,our component costs should beon an after-tax basis.Component Costs of CapitalShould we focus on historical(embedded) costs of capital ornew (marginal) costs of capital?Our investment decisions willinvolve the raising of new capital.Therefore, concern should be onmarginal costs (WACC).Component Costs of CapitalWhat is the relationship betweenthe return required by investorsand the return the firm must earn?In general, because of flotationcosts, the firm must earn a returnhigher than what is required bythe investors.Cost of DebtA firm can issue debt with10-yearsto maturity and paying $50 ininterest every 6 months. Flotationtli ibld thficosts are negligible and the firmbelieves that it can net $940.25per bond. The tax rate is 46%.What are the before-tax and after-tax costs of debt?940.25[PVIFArD,202]+ [1,000][PVIFrD,20]Cost of DebtrD11%rD(1-T)(.11)(1-.46)5.94%2
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