Finance a Business by kuc14840

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									   FINC3131
Business Finance

    Chapter 10:
 The Cost of Capital




                       1
Capital Components




                     2
   weighted average cost of
       capital (WACC)

   WACC = wdrd(1-T) + were

1. The w’s refer to the firm’s capital
   structure weights.
2. The r’s refer to the cost of each
   component.
  Component cost of debt

   WACC = wdrd(1-T) + were

1. rd is the cost of debt capital.
2. The yield to maturity on outstanding
   L-T debt is often used as a measure
   of rd.
3. Why tax-adjust, i.e. why rd(1-T)?
   focus on after-tax capital costs
Because interest is tax deductible.
A 15-year, $1000 face value,12% semiannual
coupon bond sells for $1,153.72. What is the
              cost of debt (rd)?

 Remember, the bond pays a semiannual
   coupon, so rd = 5.0% x 2 = 10%.



   INPUTS    30           -1153.72   60    1000
              N    I/YR     PV       PMT   FV
   OUTPUT           5
Component cost of equity

   WACC = wdrd(1-T) + were

1. re is the cost of common equity
Two ways to determine the cost
    of common equity, re
1. re = rRF + bx(rM – rRF)

2. re = (D1 / P0) + g
If the rRF = 7%, RPM = 6%, and the firm’s
  beta is 1.2, what’s the cost of common
      equity based upon the CAPM?


  re = rRF + (rM – rRF) b
       = 7.0% + (6.0%)1.2 = 14.2%
     If D0 = $4.19, P0 = $50, and g = 5%,
      what’s the cost of common equity ?
D1 = D0 (1 + g)
D1 = $4.19 (1 + .05)
D1 = $4.3995

re = (D1 / P0) + g
   = ($4.3995 / $50) + 0.05
   = 13.8%
       what is the firm’s WACC?
If weight of debt =40%, weight of equity =60%,
    cost of debt=10%, cost of equity=14%, tax
    rate=30%,

WACC = wdrd(1-T) + were
     = 0.4(10%)(1-0.3) + 0.6(14%)
     = 0.028 + 0.084
     = 0.112=11.2%
             Assignment
1. problems: 10-1 10-3 10-8 10-9




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