FIN+4414+-+Cost+of+Capital+-+Chapter+10-1

FIN+4414+-+Cost+of+Capital+-+Chapter+10-1 - Cost of Capital...

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Cost of Capital
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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%.
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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
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Debt and Leverage Assumptions : Firm A: Stock equals 200 Debt equals 0 Firm B: Stock equals 150 Debt equals 50 r D 11%
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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
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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%
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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%
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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
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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?
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Cost of Preferred r P = D P / P 0 or D P / P N Investor : r P = $10 / $130 = 7.69% Firm : r P = $10 / $125 = 8.00%
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Preferred and Leverage Assumptions : Firm A: Stock equals 200 Preferred equals 0 Firm B: Stock equals 150 Preferred equals 50 r P 8%
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Preferred and Leverage Income Firm A Firm B Revenue $120.00 $120.00 Expense -$70.00 -$70.00 EBT $50.00 $50.00 Taxes (46%) -$23.00 -$23.00 Net Income $27.00 $27.00 Preferred Dividend $0.00 -$4.00 Available to Common $27.00 $23.00
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Preferred and Leverage Firm A : r S = $27.00 / $200.00 = 13.50% Firm B : r P = $ 4.00 / $ 50.00 = 8.00% r S = $23.00 / $150.00 = 15.33%
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Preferred and Leverage r S = ROA (unlevered) + Leverage effect 15.33% = .1350 + (.1350-.0800)(50/150) 15.33% = .1350 + .0183
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Cost of Equity Distinction must be made between Retained earnings External (new issues) of equity
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Cost of Equity Methods to determine equity costs CAPM Discounted cash flow
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Cost of RE: CAPM r S = r RF + [r M - r RF ][ß E ] This is the standard CAPM equation with which you are already familiar, but let’s look more closely at what this beta risk is comprised of.
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FIN+4414+-+Cost+of+Capital+-+Chapter+10-1 - Cost of Capital...

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