{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Slide 11 Cost of Capital

Slide 11 Cost of Capital - Cost of Capital Outline The Cost...

Info icon This preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
Cost of Capital
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Outline The Cost of Capital: The Cost of Equity The Costs of Debt The Weighted Average Cost of Capital
Image of page 2
Cost of Capital-Motivation We look at the whole firm as an Asset. This asset generates income. How ? Then, ask the question “what is the return on investment in a firm” ?. There are two sources of raising capital: (1) borrowing (debt) – firm pays interest and (2) issuing stocks (equity) – firm pays dividends
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Why Cost of Capital Is Important Cost of Capital is the return required by investor to invest in a firm Or Firm’s overall cost of capital will reflect required return on the firm’s asset as a whole Cost of capital provides us with an indication of how the market views the risk of our assets, not set by firm
Image of page 4
Cost of Capital The return (cost of capital) specific to each investor - Returns to creditors (debt): Cost of Debt - Returns to stockholders: Cost of Equity So cost of capital reflects (or linear conbination of) both cost of debt capital and equity capital. Firm as asset is formed by two other different assets : debt and equity Cost of Capital should reflect the market opinion if firms are in the market, not set by the firm.
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
The Cost of Equity Cost of equity: The return that equity investors require (i.e., buying stocks) How to get Cost of Equity ? +Dividend growth model approach +Security Market Line Approach (beta) So, we need to know the market data to problem
Image of page 6
Cost of equity – Dividend Growth The formula is: So, R E is the return that shareholders require on equity or cost of equity capital. g P D R Therefore g R D g R g D P E E E + = - = - + = 0 1 1 0 0 , ) 1 (
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Example A stock currently sells for $60/share, dividend in last year is $4. The dividend grows at 6% (estimated). Then just apply the previous formula • R E = D 1 /P 0 +g= =($4*(1+.06))/60+.06 =13.07% So if an investor decides to finance the company in the form of equity, then he requires return of 13.07%. Note that this return is paired with “some level of risk”
Image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern