Lecturenotes-chap10

# Lecturenotes-chap10 - CHAPTER10 1 Whattypesoflongterm...

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1 CHAPTER 10 Determining the Cost of Capital

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2 What types of long-term  capital do firms use? Long-term debt Preferred stock Common equity
3 Cost of Debt Method 1: Ask an investment banker  what the coupon rate would be on new  debt. Method 2: Find the bond rating for the  company and use the yield on other  bonds with a similar rating. Method 3: Find the yield on the  company’s debt, if it has any.

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4 A 15-year, 12% semiannual bond  sells for \$1,153.72.  What’s r d ?    60 60 + 1,000 60 0 1 2 30 i = ? -1,153.72 ... 30 -1153.72 60 1000 5.0% x 2 = r d = 10% N I/YR PV FV PMT INPUTS OUTPUT
5 Component Cost of Debt Interest is tax deductible, so the after  tax (AT) cost of debt is:    r AT= r d  BT(1 - T)  r AT = 10%(1 - 0.40) = 6%. Use nominal rate. Flotation costs small, so ignore.

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6 Cost of preferred stock: P P  =  \$113.10; 10%Q; Par = \$100; F = \$2. Use this formula: r ps = D ps P n = 0.1(\$100) \$113.10 - \$2.00 = \$10 \$111.10 = 0.090=9.0 %
7 Time Line of Preferred 2.50 2.50 2.50 0 1 2 r ps =? -111.1 ... \$111.10= D Q r Per = \$2.50 r Per r Per = \$2.50 \$111.10 = 2.25%; r ps(Nom) = 2.25%(4) = 9%

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8 Is preferred stock more or less  risky to investors than debt? More risky; company not required to pay  preferred dividend. However, firms want to pay preferred  dividend.  Otherwise, (1) cannot pay  common dividend, (2) difficult to raise  additional funds, and (3) preferred  stockholders may gain control of firm.
9 What are the two ways that  companies can raise common  equity? Directly, by issuing new shares of

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Lecturenotes-chap10 - CHAPTER10 1 Whattypesoflongterm...

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