Chapter+12_S

Chapter+12_S - Determining the Cost of Capital Chapter 12,...

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Determining the Cost of Capital Chapter 12, BDH
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Chapter Outline 12.1 A First Look at the Weighted Average Cost of Capital 12.2 The Firm’s Costs of Debt and Equity Capital 12.3 A Second Look at the Weighted Average Cost of Capital 12.4 Using the WACC to Value a Project 12.5 Project-Based Costs of Capital 12.6 When Raising External Capital Is Costly 1
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Learning Objectives Understand the drivers of the firm’s overall cost of capital. Measure the costs of debt, preferred stock, and common stock. Compute a firm’s overall , or weighted average, cost of capital. Apply the weighted average cost of capital to value projects . Adjust the cost of capital for the risk associated with the project. Account for the direct costs of raising external capital. 2
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12.1 A First Look at the Weighted Average Cost of Capital A firm’s sources of financing, which usually consist of debt and equity, represent its capital . The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure . When corporations raise funds from outside investors , they must choose which type of security to issue. The most common choices are financing through equity alone and financing through a combination of debt and equity . 3 12.1 A First Look at the Weighted Average Cost of Capital
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Figure 12.1 A Balance Sheet 4 12.1 A First Look at the Weighted Average Cost of Capital
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12.1 A First Look at the Weighted Average Cost of Capital Intuitively, the firm’s overall cost of capital should be a blend of the costs of the different sources of capital. In fact, we calculate the firm’s overall cost of capital as a weighted average of its equity and debt costs of capital, known as the firm’s weighted average cost of capital (WACC) . 5 12.1 A First Look at the Weighted Average Cost of Capital
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Dividends Weighted Average Cost of Capital 6 ‘Pool’ of Capital Debtholders Shareholders Investments Equity Debt Cost of Equity ( r E ) Cost of Debt ( r D ) Minimum return from investments Weighted Average Cost of Capital ( r wacc ) 12.1 A First Look at the Weighted Average Cost of Capital
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Weighted Average Cost of Capital Calculations Unlevered: a firm that does not have debt outstanding. Levered: a firm that has debt outstanding. Leverage: relative amount of debt on a firm’s balance sheet. Market-value balance sheet instead of their book values. Market Value of Equity + Market Value of Debt = Market Value of Assets (Eq. 12.1) 7 12.1 A First Look at the Weighted Average Cost of Capital
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Unlevered Firm With no debt, all of the free cash flows generated by its assets are ultimately paid out to its equity holders. The free cash flows to the equity holders are the same as the free cash flows from the assets.
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This note was uploaded on 07/30/2011 for the course FIN 111 taught by Professor Mark during the Spring '11 term at HKU.

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Chapter+12_S - Determining the Cost of Capital Chapter 12,...

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