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Unformatted text preview: 350-09a_note, 11S Page 1 of 6 TOPIC 9: COST OF CAPITAL (CHAPTER 10) I.Outline A.Sources of capital: Capital components B.Weighted average cost of capital (WACC) C.Component costs: 1.Cost of Debt 2.Cost of preferred stock 3.Cost of Retained Earnings a)CAPM b)DCF Approach c)Bond-Yield-plus-Risk-Premium Approach 4.Cost of New Common Stock 5.WACC D.Adjusting for flotation costs II.Homework Assignment Chapter10Question1, 2, 5Problem1, 2, 5-9, 11-13Class Notes I.Sources of capital A.What sources of long-term capital do Firms use? Long-Term CapitalLong-Term Debt Preferred StockCommon Stock Retained Earnings New Common Stock 350-09a_note, 11S Page 2 of 6 II.WACC (Case A) A.What is weighted average cost of capital (WACC)? scppddrWrWTrWWACC11.w = the firms capital structure weights. 2.r = the cost of each component B.Should our analysis focus on before-tax or after-tax capital costs? 1.Stockholders focus on A-T CFs. Therefore, we should focus on A-T capital costs, i.e. use A-T costs of capital in WACC. Only rdneeds adjustment, because interest is tax deductible. C.Should our analysis focus on historical (embedded) costs or new (marginal) costs? 1.The cost of capital is used primarily to make decisions that involve raising new capital. Focus on todays marginal costs (for WACC). D.How are the weights determined? 1.Use accounting numbers or market value (book vs. market weights)? 2.Use actual numbers or target capital structure? III.Component Costs A.Cost of Debt (Case B) scppddrWrWTrWWACC11.Basic: a)rd= the marginal cost of debt capital. b)The yield to maturity on outstanding L-T debt is often used as a measure of rd....
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