Cost of Capital

# Cost of Capital - THE COST OF THE CAPITAL CAPITAL Stony...

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1 THE COST OF THE COST OF CAPITAL CAPITAL Stony Brook College of Business BUS 330 V. Giardini

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2 COST OF CAPITAL CONCEPTS COST OF CAPITAL CONCEPTS Capital Components Components of a firm’s capital … debt, Capital Structure Mix of the three capital components Return on Investment The return earned by investors on the security underlying a capital component is its unadjusted cost.
3 CAPITAL STRUCTURE CAPITAL STRUCTURE The mix of capital components in use Component \$000 % Debt \$30,000 30% Preferred Stock \$10,000 10% Equity \$60,000 60% Total Capital \$100,000 100%. RELATED CONCEPTS RELATED CONCEPTS The Target Capital Structure Raising Money in the Proportions of the Capital Structure

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4 THE WEIGHTED AVERAGE CALCULATION THE WEIGHTED AVERAGE CALCULATION - THE WACC - THE WACC A firm's overall cost of capital is the average of the costs of its separate sources weighted by the proportion of each source used Example of Calculation Capital Component Value Weight Cost Debt \$60,000 .30 x 9% = 2.70% Preferred Stock \$50,000 .25 x 11% = 2.75% Common Stock \$90,000 .45 x 14% = 6.30% \$200,000 1.00 WACC = 11.75%
5 CAPITAL STRUCTURE AND COST - BOOK CAPITAL STRUCTURE AND COST - BOOK VS MARKET VALUES VS MARKET VALUES A Source of Confusion: Both capital structure and component costs can be viewed in terms of either the book or market values of the underlying capital 1. CAPITAL STRUCTURE 1. CAPITAL STRUCTURE Initial Capital Structure - Book and Market Values Equal \$ % Equity

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## This note was uploaded on 02/15/2012 for the course GERM 200 taught by Professor Kuhmar during the Spring '10 term at SUNY Albany.

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Cost of Capital - THE COST OF THE CAPITAL CAPITAL Stony...

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