# 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

12

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