Chapter 10 Powerpoint

Chapter 10 Powerpoint - CHAPTER 10 The Cost of Capital Cos...

Info iconThis preview shows pages 1–16. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: CHAPTER 10 The Cost of Capital Cos t of Cap ital FIN 3403- Busi ness Financ e Other Topi cs Com pone nt Cos ts WA CC / MCC Deb t Preferred Equi ty Basi cs Cal culations Divisional Screen ing Rat es Type s of Risk Break points Component Costs of Capital When calculating component costs of capital, should we be concerned with before-tax or after-tax costs? Stockholders are concerned about after-tax cash flows. Therefore, our component costs should be on an after-tax basis. Component Costs of Capital Should we focus on historical (embedded) costs of capital or new (marginal) costs of capital? Our investment decisions will involve the raising of new capital. Therefore, concern should be on marginal costs (WACC). Component Costs of Capital What is the relationship between the return required by investors and the return the firm must earn? In general, because of flotation costs, the firm must earn a return higher than what is required by the investors. Cost of Debt A firm can issue debt with10- years to maturity and paying $50 in interest every 6 months. Flotation costs are negligible and the firm believes that it can net $940.25 per bond. The tax rate is 46%. 940.25 [50][PVIFA r D ,20 2 ] + [1,000][PVIF r D 11% r D (1-T) (.11)(1-.46) 5.94% r D ,20 2 ] Cost of Debt Debt and Leverage Assumptions : Firm A: Stock equals 200 Debt equals Firm B: Stock equals 150 Debt equals 50 r D 11% Debt and Leverage Income Firm A Firm B Change Revenue $120.00 $120.00 $0.00 Expense-$70.00-$70.00 $0.00 Interest $0.00-$5.50 $5.50 EBT $50.00 $44.50-$5.50 Taxes (46%)-$23.00-$20.47 $2.53 Net Income $27.00 $24.03-$2.97 Debt and Leverage Interest = $5.50 Taxes = - $2.53 Net Income = - $2.97 AT r D = ($5.50 - $2.53) / ($50.00) AT r D = ($2.97) / ($50.00) AT r D = 5.94% AT r = (11.0%)(1-.46) = 5.94% Debt and Leverage Firm A : r S = $27.00 / $200.00 = 13.50% Firm B : r D = $ 5.50 / $ 50.00 = 11.00% r S = $24.03 / $150.00 = 16.02% Debt and Leverage r S = ROA (unlevered) + Leverage effect + Tax shield on debt 16.02% = .1350 + (.1350-.1100)(50/150) + (.1100-.0594)(50/150) 16.02% = .1350 + .0083 + .0169 Cost of Preferred A firm can issue preferred stock that will pay a $10 dividend. Investors are willing to pay $130 for each share but, because of flotation costs, the firm will only net $125 per share. What are the costs (investor and firm) of preferred stock? Cost of Preferred r P = D P / P or D P / P N Investor : r P = $10 / $130 = 7.69% Firm : r P = $10 / $125 = 8.00% Preferred and Leverage Assumptions : Firm A: Stock equals 200 Preferred equals Firm B: Stock equals 150 Preferred equals 50 r P 8% Preferred and Leverage...
View Full Document

Page1 / 63

Chapter 10 Powerpoint - CHAPTER 10 The Cost of Capital Cos...

This preview shows document pages 1 - 16. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online