Cost of Capital - Weighted Average Cost of Capital WACC = w...

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Cost of Capital Cost Cost of Capital of Capital r S • common stock r D • retained earnings • preferred stock • debt Risk Capital capital components (1) Debt • r D = r RF + DRP i + LP i + MRP t r D = risk-free rate plus various risk premiums (2) Preferred Stock • r P = D P /P P P P = D P /r P (3) Common Equity • use an equity model to get r S , the cost of retained earnings • add the flotation costs of issuing new common stock • add a “dilution/risk premium” to the cost of retained earnings to get r e , the cost of new CS possibilities: (a) pure dilution (b) a new signal that new debt is "not available" (c) more risk if more debt is simultaneously being issued
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Unformatted text preview: Weighted Average Cost of Capital WACC = w D *r D (1 T) + w P *r P + w CE *r CE for common equity, the firm uses all retained earnings first since r S < r e actual WACC (WACC*) is the overall hurdle rate, i.e. the minimum required rate of return use the existing WACC for the discount rate for calculating present values for overall, general corporate decisions for individual projects and decisions, need to account for risk and calculate the project-specific cost of equity and WACC...
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This note was uploaded on 07/14/2010 for the course UGBA 18195 taught by Professor Johngonzales during the Summer '10 term at University of California, Berkeley.

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