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08-Cost-of-capital-FIN6406 - The Cost of Capital n Cost of...

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Cost of Capital 11 The Cost of Capital n Cost of capital components l Debt l Preferred l Common equity n WACC n MCC n IOS
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Cost of Capital 22 What sources of capital should be included in a firm’s WACC? n Long-term debt n Preferred stock n Common equity (including): l Retained earnings l New common stock
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Cost of Capital 33 Stockholders focus on after-tax cash flows. Thus, focus on A-T capital costs , i.e., use A-T costs in WACC. Only Rd needs adjustment. Should we focus on before-tax or after-tax capital costs?
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Cost of Capital 44 Should we focus on historical (embedded) costs or new (marginal) costs? The cost of capital is used primarily to make decisions which involve raising new capital. So, focus on today’s marginal costs .
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Cost of Capital 55 Cost of debt (Rd)? Coupon = 12% semi Price = $1,153.72; 15 years. 60 60 + 1,000 60 0 1 2 30 i = ? 30 -1153.72 60 1000 5.0% periodic x 2 = Rd = 10% N I/YR PV FV PMT -1,153.72 INPUTS OUTPUT
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Cost of Capital 66 Component cost of Debt n Interest is tax deductible , so Rd AT = Rd BT(1 - T) = 10%(1 - 0.40) = 6% n Debt flotation costs small. Ignore. n May need to incorporate yield curve differences.
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Cost of Capital 77 What’s the cost of preferred stock (Rps)? Pps = $113.10; 10%Q; Par = $100; F = $2 Use this formula: Rps = = = = 0.090 = 9.0% 0.1($100) $113.10 - $2.00 Dps Pnet $10 $111.10
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Cost of Capital 88 Note n Flotation costs for pfd. are significant , so are reflected. Use net price . n Preferred dividends are not deductible , so no tax adjustment. Just Rps. n Nominal Rps is used. l Capital budgeting CFs are nominal . l Use nominal values for component costs.
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Cost of Capital 99 Is preferred stock more or less risky to investors than debt? n More risky ; company not required to pay preferred dividend n However, firms try to pay preferred dividends. Otherwise: l cannot pay common dividends l difficult to raise new capital l preferred stockholders may gain some control of firm
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Cost of Capital 1010
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