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Lecture on Cost of Capital

Lecture on Cost of Capital. www.AssignmentPoint.com. Cost of Capital. The rate of return required by the market suppliers of capital to attract their funds to the firm Used to decide whether a proposed corporate investment will increase or decrease the firm’s stock price.

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Lecture on Cost of Capital

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  1. Lecture on Cost of Capital www.AssignmentPoint.com www.assignmentpoint.com

  2. Cost of Capital The rate of return required by the market suppliers of capital to attract their funds to the firm Used to decide whether a proposed corporate investment will increase or decrease the firm’s stock price. Investments that are expected to increase : NPV>0 or IRR>Cost of Capital www.assignmentpoint.com

  3. www.assignmentpoint.com Key Assumptions

  4. Sources of Capital www.assignmentpoint.com

  5. Cost of long-term debt • Before –tax, • Kd= • After-tax, • Ka=Kd×(1-T) • Example, Kd= Ka=9.4%×(1-.40)=5.6% www.assignmentpoint.com

  6. Cost of Preferred tock • Kp = • DP= Annual preferred stock dividend • Np= Net proceeds from the sale of the preferred stock www.assignmentpoint.com

  7. Cost of Common Stock Constant growth Valuation Model Capital Asset Pricing Model (CAPM) • Ke = kf + (km-kf) b • Kf = Risk free rate of return • Km = Market return • b = Beta coefficient • Ke= (D1/P0) + g Po= value of common stock D1 = per share dividend expected at the end of year g = constant rate of growth in dividends www.assignmentpoint.com

  8. Cost of New Issue of Common Stock • Kn = (D1/Nn) + g • D1 = per share dividend expected at the end of year • Nn = Market price of equity – flotation cost - underpricing www.assignmentpoint.com

  9. Cost of Retained Earnings • Kr = Ke =(D1/P0) + g • Kr=Cost of retained earnings www.assignmentpoint.com

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