Chapter 9 FIN

Chapter 9 FIN - Chapter 9 Weighted average cost of capital...

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Chapter 9 Weighted average cost of capital: a composite of the individual costs of financing incurred by each capital source. A firm’s weighted cost of capital is a function of the individual costs of capital and the capital structure mix - The firm must earn at least this cost if it is to create value for its owners The Cost of Capital: Key Defnitions Opportunity Costs, Required Rates of Return, and the Cost of Capital Is the investor’s required rate of return the same thing as the cost of capital? Not exactly, there are two factors that drive a wedge between the investor’s required rate of return and the cost of capital to the firm 1. Taxes: When a firm borrows money to finance the purchase of an asset, the interest expense is deductible for federal income tax calculations. 2. Transaction Costs: The costs the firm incurs when it raises funds by issuing a particular type of security. The firm’s financial policy and the cost of capital Financial Policy: the firm’s policies regarding the sources of financing it plans to use and the particular mix (proportions) in which they will be used. Determining the Costs of the Individual Sources of Capital The Cost of Debt Since firms must pay flotation costs when they sell bonds, the net proceeds per bond received by the firm is less than the market price of the bond. Consequently, the cost of debt capital, kd, is higher than the bondholder’s required rate of return and is calculated using: *Look on pate 237 for equation* The Cost of Preferred Stock Once again, because flotation costs are usually incurred when new
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Chapter 9 FIN - Chapter 9 Weighted average cost of capital...

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