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**Unformatted text preview: **Lecture 11: Cost of Capital: II BD Chapter 10 Topics Weighted Average Cost of Capital (WACC) Adjusting the cost of capital for risk Mini Case Weighted Average Cost of Capital (WACC) WACC = w d r d (1 - T) + w ps r ps + w ce r s Determine the weights The weights are the percentages of the firm that will be financed by each component. Use the target weights If you dont know the targets, estimate the weights using current market values than current book values. If you dont 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. Determine Weights NCCs stock price is $50. there are 3 million shares of stock, the firm has $25 million of preferred stock, and $75 million of debt. Tax rate is 40% V ce = $50 (3 million) = $150 million. V ps = $25 million. V d = $75 million. Total value = $150 + $25 + $75 = $250 million. Weights w ce = $150/$250 = 0.6 w ps = $25/$250 = 0.1 w d = $75/$250 = 0.3 Calculate WACC WACC = w d r d (1 - T) + w ps r ps + w ce r s WACC = 0.3(10%)(0.6) + 0.1(10.3%) + 0.6(14.2%) WACC = 11.35%. How is cost of capital determined?How is cost of capital determined?...

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