Chapter-10

# Chapter-10 - Chapter 10 The Cost of Capital Sources of...

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The Cost of Capital Chapter 10 ± Sources of Capital ± Component Costs ± WACC ± Adjusting for Flotation Costs ± Adjusting for Risk 10-1 What sources of long-term capital do firms use? 10-2 Calculating the Weighted Average Cost of Capital WACC = w d r d (1 – T) + w p r p + w c r s ± The w’s refer to the firm’s capital structure weights. ± The r’s refer to the cost of each component. 10-3

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Should our analysis focus on before-tax or after-tax capital costs? ± Stockholders focus on A-T CFs. Therefore, we should focus on A-T capital costs, i.e. use A-T costs of capital in WACC. Only r d needs adjustment, because interest is tax deductible. 10-4 Should our analysis focus on historical (embedded) costs or new (marginal) costs? ± The cost of capital is used primarily to make decisions that involve raising new capital. So, focus on today’s marginal costs (for WACC). 10-5 How are the weights determined? WACC = w d r d (1 – T) + w p r p + w c r s 10-6 ± Use accounting numbers or market value (book vs. market weights)? ± Use actual numbers or target capital structure?
Component Cost of Debt WACC = w d r d (1 T) + w p r p + w c r s 10-7 ± r d is the marginal cost of debt capital. ± The yield to maturity on outstanding L-T debt is often used as a measure of r d . ± Why tax-adjust; i.e., why r d (1 – T)? A 15-year, 12% semiannual coupon bond sells for \$1,153.72. What is the cost of debt (r d )? ± Remember, the bond pays a semiannual

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Chapter-10 - Chapter 10 The Cost of Capital Sources of...

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