ch%2015%20(Cost%20of%20Capital)[1] - 15 Cost of Capital Key...

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15 Cost of Capital Slide 15 - 1 Key Concepts and Skills Know how to determine a firm’s cost of equity capital Know how to determine a firm’s cost of debt Know how to determine a firm’s overall cost of capital Understand pitfalls of overall cost of capital and how to manage them Compute floatation costs
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Slide 15 - 2 Required Return and Cost of Capital The return earned on assets depends on the risk of those assets, which need to earn at least the return required to compensate the investors for the financing they have provided. z Required return is from an investor’s point of view, which, from the firm’s point of view, is the cost of capital. z The required return is the appropriate discount rate that we use in a PV calculation. Cost of capital, required return, and appropriate discount rate are different phrases that all refer to the opportunity cost of using capital in one way as opposed to alternative financial market investments of the same systematic risk. Cost of Capital: Concept Slide 15 - 3 Cost of Capital and Capital structure z Capital structure is the firm’s combination of debt and equity Major classes of financial assets (securities): ¾ Common stock: common shares of ownership ¾ Preferred stock: perpetual dividend payment ¾ Debt: coupon payment and face value z A firm’s cost of capital reflects the average riskiness of all of the securities it has issued, which may be less risky (e.g. bonds) or more risky (common stock) Cost of Capital: Concept
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