Chapter 11 Cost of Capital

# Chapter 11 Cost of Capital - Chapter 11 Cost of Capit...

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Chapter 11: Cost of Capit al (ll2 and 212) Assignments: a. #l 1-3, 5, 7 , 17 on page 482 - 485 due on Thursd ay (1112012008\ b. #ll-29 (only b, c (1), d. e, f, B, h, j) on page 489 and 490 1. Cost of capital and its use Cost of capital is defined as the firm's average cost of funds, which is the average return required by the firm's investom. Hence, cost of.capital the firm's required rate of return. The cost of capital is computed by the weighted average cost of capital (WACC). Weighted average cost of capital (WACC) is a weighted average of the component costs of different types of capital, such as debt (bond), preferred stock, and common equity. : If there is no new common stock: Cost of capital: r =WACC =wa'/,t(t-f) +wp<.rps +ws.rs If there is new common stock: \: Cost of capital: r =WACC - wd.ro(l-T)+wnr.rps +ws '(r" + Flotation adjustment) t Cost of capital : The firm's required rate of return : the WACC Flotation cost is defined as the expenses incurred when selling new issues of securities. Capital structure is defined as the combination of different types of capital use by a firm. The different types of capitals include bonds, preferred stock, and common equity. Common equity includes retained earnings and new commons stock (if available).

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Return to investors Costs to firms Debt (Bond) ra =WM (or market interest rate) ro(-r) Preferred stock ,nr=? Common equity Retained earnings D. ,t =E+ g New common stock D. ,r= ,o*f fs= Caution: Investors' required rates of return * Firm's required rate of return (because of the following facts in the table) Retained earnings are the opportunity retain the earnings after payment of stockholders. Use of cost of capital (r: WACC): cost of common stock to a firm because if the firm does not the preferred dividends, they have to pay them to common a. The cost of capital (r:WACC) is used to discount CFs and compute the value of a firm () Don't worry about it) b. The cost of capital (r:WACC) is used to make investment decision. Specifically, If co\$ of capital ( r :WA_C=Q < IRResad so NFV > Q then aqqQp! the project. If cost of capital (r:WACC) > IRR, and so NPV < 0, then rejggl the project. -r. c. The cost of capital (r:WACC) is used to discount CFs and compute the net present value (NPV) ofa project. , CF* NPV:CE+ t\rY : #*GwACq* 1r**ruy +"'+ (Risk-adjusted) REVENUE (r+rucc)*
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## This note was uploaded on 09/08/2010 for the course BUS 170 at San Jose State.

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Chapter 11 Cost of Capital - Chapter 11 Cost of Capit...

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