Cost_of_capital___handout

Cost_of_capital___handout - Cost of Capital Cost of Capital...

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Unformatted text preview: Cost of Capital Cost of Capital • For Investors the rate of return on an asset is the benefit of investing. • For Financial Managers that same rate of return is a cost of raising funds that are needed to operate the firm. • In other words, the cost of raising funds is the firm’s cost of capital. How can the firm raise capital? How can the firm raise capital? • Bonds • Preferred Stock • Equity • Each of these offers a rate of return to investors. • This return is a cost to the firm. • “Cost of capital ” refers to the weighted cost of capital (WACC)- a weighted average cost of financing sources. The Weighted Cost of Capital The Weighted Cost of Capital • To calculate the firm’s weighted cost of capital, we must first calculate the costs of the individual financing sources. Let’s look at: • Cost of Debt • Cost of Common Stock Cost of Debt Cost of Debt For the issuing firm, the cost of debt is the rate of return required by investors, adjusted for: • 1) flotation costs (any costs associated with issuing new bonds), and • 2) taxes . Example: Tax effects Example: Tax effects of financing with debt of financing with debt with stock with debt EBIT 400,000 400,000- interest expense (50,000) EBT 400,000 350,000- taxes (34%) (136,000) (119,000) EAT 264,000 231,000 Example:...
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This note was uploaded on 03/06/2012 for the course BUS M 201 taught by Professor Mcgregor during the Fall '11 term at BYU.

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Cost_of_capital___handout - Cost of Capital Cost of Capital...

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