BFIN620_PPT_CH12_sp09-9

BFIN620_PPT_CH12_sp09-9 - 12- 1The Cost of CapitalThe Cost...

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Unformatted text preview: 12- 1The Cost of CapitalThe Cost of CapitalChapter 12Brealey-Myers-Marcus5thEditionBusiness Finance 62012- 2Cost of Capital In A NutshellFirms grow by running investment projects.To the extent a project generates more revenue than it costs, the project adds value to the firm, increasing the wealth of shareholders and causing the firm to grow.Investment projects require assets.Managers use some combination of debt and equity to purchase assets required by the firms projects.Providers of debt and equity financing expect a return on their invested funds.Returns depend upon profits from investment projects.The return investors require on their debt and equity financing is the firms cost of capital. 12- 3Understanding Cost of CapitalFor the All-Equity FirmConsider a firm financed entirely with equity.No debt, no funds borrowed.Owning the stock of this firm would be the same thing as owning the firms assets.THUS, the return required by investors in the stock must also be the cost of the funds used to purchase the firms assets (the firms cost of capital).What about a firm financed using a mix of debt and equity?Few firms are financed entirely with equity.The mix of debt and equity is a firms capital structure.12- 4Understanding Cost of CapitalFor the Firm Financed with Debt and EquityThe firm viewed as a portfolio of securities:Just as the all-equity-financed firm is a portfolio of the firms stock, the firm financed with a mix of debt and equity is a portfolio of debt and equity securities.Just as the return required by investors in the stock of the all-equity firm is the cost of the equity used to buy the firms assets, the return required by investors in a firm financed with a mix of debt andequity is the cost...
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BFIN620_PPT_CH12_sp09-9 - 12- 1The Cost of CapitalThe Cost...

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