ch 10_IM - Chapter 10 The Cost of Capital Learning...

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Unformatted text preview: Chapter 10 The Cost of Capital Learning Objectives After reading this chapter, students should be able to: Explain why the weighted average cost of capital (WACC) is used in capital budgeting. Estimate the costs of different capital componentsdebt, preferred stock, retained earnings, and common stock. Combine the different component costs to determine the firms WACC. Chapter 10: The Cost of Capital Learning Objectives 241 Lecture Suggestions Chapter 10 uses the rate of return concepts covered in previous chapters, along with the concept of the weighted average cost of capital (WACC), to develop a corporate cost of capital for use in capital budgeting. We begin by describing the logic of the WACC, and why it should be used in capital budgeting. We next explain how to estimate the cost of each component of capital, and how to put the components together to determine the WACC. We go on to discuss factors that affect the WACC and how to adjust the cost of capital for risk. We conclude the chapter with a discussion on some problems with cost of capital estimates. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 10, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the Lecture Suggestions in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER: 3 OF 58 DAYS (50-minute periods) 242 Lecture Suggestions Chapter 10: The Cost of Capital Answers to End-Of-Chapter Questions 10-1 Probable Effect on r d (1 T) r s WACC a. The corporate tax rate is lowered. + + b. The Federal Reserve tightens credit. + + + c. The firm uses more debt; that is, it increases its debt/assets ratio. + + d. The dividend payout ratio is increased. e. The firm doubles the amount of capital it raises during the year. 0 or + 0 or + 0 or + f. The firm expands into a risky new area. + + + g. The firm merges with another firm whose earnings are counter-cyclical both to those of the first firm and...
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ch 10_IM - Chapter 10 The Cost of Capital Learning...

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