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# Chapter 10 - CHAPTER10 TheCostofCapital Sourcesofcapital...

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10-1 CHAPTER 10 The Cost of Capital Sources of capital Component costs WACC Adjusting for flotation costs Adjusting for risk

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10-2 The Gist of the Chapter WACC = w d r d (1-T)   + w p r p  + w c r s   Found using  bond formula Found using r p  = D p  / P p Found using CAPM:  r s  = r RF  + (r M  – r RF ) b DCF: r s  = (D 1  / P 0 ) + g Bond-Yield+RP: r s  = r d  + RP
10-3 What sources of long-term  capital do firms use? Long-Term Capital Long-Term Debt Preferred Stock Common Stock Retained Earnings New Common Stock

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10-4 WACC What would the cost  of funds be? WACC = Weighted  Average Cost of  Capital
10-5 Calculating the weighted  average cost of capital WACC = w d r d (1-T) + w p r p  + w c r s   The w’s refer to the firm’s capital  structure weights. The r’s refer to the cost of each  component.

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10-6 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 r d  needs  adjustment, because interest is tax  deductible.
10-7 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, should focus on  today’s   marginal costs (for WACC).

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10-8 How are the weights determined? WACC =  w d r d (1-T) +  w p r p  +  w c r s   Should use market value rather than  accounting numbers or (market vs. book  weights) Should use target capital structure  rather than actual numbers?
10-9 Component cost of debt  WACC = w d r d (1-T)  + w p r p  + w c r s   r d  is the marginal cost of debt capital.

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Chapter 10 - CHAPTER10 TheCostofCapital Sourcesofcapital...

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