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Chapter 10 Cost of Capital

Chapter 10 Cost of Capital. Liabilities & Equity Assets Debt Preferred Stock $ Bank 14% Common Stock 5% R.O.I. (cost of $) Total Liabilities = Total Assets & Equity.

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Chapter 10 Cost of Capital

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  1. Chapter 10 Cost of Capital • Liabilities & Equity Assets • Debt • Preferred Stock $ Bank 14% • Common Stock 5% R.O.I. • (cost of $) • Total Liabilities = Total Assets • & Equity

  2. Chapter 10 Cost of Capital • Capital Structure • $ % • Debt $50 50% • Preferred 30 30% • Common 20 20% • Total $100 100%

  3. Chapter 10 Cost of Capital • Cost of $ • $ % k (given) • Debt $50 50% 10% • Preferred 30 30% 12% • Common 20 20% 14% • Total $100 100%

  4. Chapter 10 Cost of Capital • Wt’d Avg Cost • Cost of $ of Capital • $ % k (given) tax 40% • Debt $50 50% 10% 0.5(10%)x(1-tax)=3% • Preferred 30 30% 12% 0.3(12%) =3.6% • Common 20 20% 14% 0.2(14%) =2.8% • Total $100 100% WACC =9.4%

  5. (1) Cost of Old Debt (Kd) • Kd= interest = 10 =10% • principal 100 • (2) Cost of Old Preferred Stock (Kps) • Kps= Dividend to P.S. = 12 = 12% • P.S. price 100 • (3) Cost of Old Common Stock (Ks) • Ks= D1+ g = 2 + 4% = 14% • P0 20 • Ks = Risk Free Rate + Risk Premium

  6. For the following example... • FLOTATION COST • f = Flotation Cost = 5%

  7. (1) Cost of New Debt (Kd) • Kd= interest =10 = 10.53% • principal(1-f) 100(1-.05) • (2) Cost of New Preferred Stock (Kps) • Ks=Dividend to P.S. = 12 = 12.63% • P.S. price (1-f) 100(1-.05) • (3) Cost of New Common Stock (Ks) • Ks= D1 + g = 2 + 4% = 14.53% • P0 (1-f) 20(1-.05) • Ks = Risk Free Rate + Risk Premium

  8. Chapter 10 Cost of Capital • Wt’d Ave. Cost • Cost of $ of Capital • $ % k (given) & tax @ 40% • Debt $50 50% 10.53% 0.5(.1053)x(1-tax)=3.16% • Pref. 30 30% 12.63% 0.3(.1263) =3.79% • Comm. 20 20% 14.53% 0.2(.1453) =2.91% • Total $100 100% WACC =9.86% • Marginal Cost of Capital (MCC) = 9.86%

  9. WACC=weighted cost of capital MCC=marginal cost of capital IOS=investment opportunity schedule Percent a = 16% b = 14% c = 12% WACC = 9.86% MCC WACC = 9.50% WACC = 9.40% d = 8% IOS New capital raised & invested during the year Optimal Capital Budget

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