ch09 - CHAPTER9 TheCostofCapital Sourcesofcapital...

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    9-1 CHAPTER 9 The Cost of Capital Sources of capital Component costs WACC Adjusting for flotation costs Adjusting for risk
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9-2 What sources of long-term  capital do firms use? Long-Term Capital Long-Term Capital Long-Term Debt Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Retained Earnings Retained Earnings New Common Stock New Common Stock
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9-3 Calculating the weighted  average cost of capital WACC = w d k d (1-T) + w p k p  + w c k s   The w’s refer to the firm’s capital  structure weights. The k’s refer to the cost of each  component.
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9-4 Should our analysis focus on  before-tax or after-tax capital costs? 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 k d  needs  adjustment, because interest is tax  deductible.
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9-5 Should our analysis focus on  historical (embedded) costs or new  (marginal) costs? The cost of capital is used primarily to  make decisions that involve raising new  capital.  So, focus on today’s marginal  costs (for WACC).
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9-6 How are the weights determined? WACC =  w d k d (1-T) +  w p k p  +  w c k s   Use accounting numbers or market  value (book vs. market weights)? Use actual numbers or target capital  structure?
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9-7 Component cost of debt  WACC = w d k d (1-T)  + w p k p  + w c k s   k d  is the marginal cost of debt capital. The yield to maturity on outstanding L- T debt is often used as a measure of  k d . Why tax-adjust, i.e. why k d (1-T)?
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9-8 A 15-year, 12% semiannual coupon  bond sells for $1,153.72.  What is  the cost of debt (k d )? Remember, the bond pays a semiannual  coupon, so k d  = 5.0% x 2 = 10%. INPUTS OUTPUT N I/YR PMT PV FV 30 5 60 1000 -1153.72
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9-9 Component cost of debt Interest is tax deductible, so  A-T k d  = B-T k d  (1-T)           = 10% (1 - 0.40) = 6% Use nominal rate. Flotation costs are small, so ignore  them.
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Component cost of preferred  stock  WACC = w d k d (1-T) + w p k p  + w c k s   k p  is the marginal cost of preferred  stock. The rate of return investors require on 
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This note was uploaded on 11/18/2011 for the course ECON 351 taught by Professor Westbrook during the Fall '08 term at Rutgers.

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ch09 - CHAPTER9 TheCostofCapital Sourcesofcapital...

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