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Chapter 10 Part 2 notes

Chapter 10 Part 2 notes - CHAPTER10Part2 1 theWACC...

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1 CHAPTER 10 Part 2 Determining the Cost of Capital

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2 Determining the Weights for  the WACC The weights are the percentages of the  firm that will be financed by each  component. If possible, always use the ______  weights for the percentages of the firm  that will be financed with the various  types of capital.
3 Estimating Weights for the  Capital Structure If you don’t know the targets, it is better  to estimate the weights using current  _______ values than current _____  values. If you don’t know the market value of  debt, then it is usually reasonable to use  the book values of debt, especially if the  debt is short-term. (More...)

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4 Estimating Weights  (Continued) Suppose the stock price is \$50, there  are 3 million shares of stock, the firm  has \$25 million of preferred stock, and  \$75 million of debt. (More...)
5 Estimating Weights  (Continued) V ce  = \$50 (3 million) = \$150 million. V ps  = \$25 million. V = \$75 million. Total value = \$150 + \$25 + \$75 = \$250  million.

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6 Estimating Weights  (Continued) w ce  = \$150/\$250 = 0.6 w ps  = \$25/\$250 = 0.1 w d  = \$75/\$250 = 0.3
7 What’s the WACC? WACC = w d r d (1 - T) + w ps r ps  + w ce r s WACC = 0.3(10%)(0.6) + 0.1(9%) +  0.6(14%) WACC = 1.8% + 0.9% + 8.4% = 11.1%.

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8 What factors influence a  company’s WACC? Market conditions, especially ______  rates and ______ rates. The firm’s capital structure and dividend  policy. The firm’s investment policy.  Firms with  riskier projects generally have a  ________ WACC.
9 Is the firm’s WACC correct for  each of its divisions?

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