361-CH10Concise - CHAPTER10 TheCostofCapital...

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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 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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10-3 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 (should sum to 1). The r’s refer to the cost of capital for each  component (%).
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10-4 Should our analysis focus on before- tax (BT) or after-tax (AT) capital costs? Stockholders focus on A-T CFs (CFAT).   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. General Rule: Discount CFAT ($) with  A-T costs of capital (%)
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10-5 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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10-6 How are the weights determined? WACC =  w d r d (1-T) +  w p r p  +  w c r s   Use accounting numbers or market  value (book vs. market weights)? Use actual numbers or target capital  structure?
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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. The yield to maturity on outstanding L- T debt is often used as a measure of  r d . Why tax-adjust, i.e. why r
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This note was uploaded on 01/23/2012 for the course BUS 361 taught by Professor Staff during the Fall '11 term at University of Michigan.

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361-CH10Concise - CHAPTER10 TheCostofCapital...

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