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FIN 301 - F09 Lab9 WACC

# FIN 301 - F09 Lab9 WACC - Weighted Average Cost of Capital...

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Weighted Average Cost of Capital & Security Market Line Seminar 9

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2 Weighted Average Cost of Capital ( 29 E P C D R V E R V P T 1 R V D WACC × + × + - × × = D: Market value of debt E: Market value of common stock P: Market value of preferred stock V: Firm Value R D : Pre-tax cost  of debt R P : Cost of preferred stock  R E : Cost of common stock Firm Value (V) = D + P + E Weight of Debt Weight of  Preferred Stock Weight of  Common Stock WACC is used as the firm’s discount rate.
3 Example 1: Columbia Power Capital structure: Debt 4,000   10-year 8% semi-annual coupon  bonds  priced at par (face value = \$1,000) Common stock 50,000  shares outstanding, price =  \$62  and    = 1.1 β Preferred stock 9,000  shares of  4%  preferred stock  outstanding, price =  \$60  (stated value = \$100) Market risk premium:  5% Risk-free rate:  6% Tax rate:  35% Consider a  4-year  project. New equipment costs  \$100,000   and will be salvaged for  \$15,000 . The CCA rate is  25% Inventory will increase immediately by  \$10,000 (S – E)(1 – T C ) =  \$12,000 . Should project be accepted?

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4 Columbia Project - Roadmap    Determine cost of capital     to obtain discount rate      Estimate annual cash flows,      discount cash flows Determine PV  of tax shields  NPV (+ or - ?)
5 Cost of Capital First, we have to calculate relative weights of different  sources of capital    Debt         :

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FIN 301 - F09 Lab9 WACC - Weighted Average Cost of Capital...

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