韩山师范学院财务管理课件第十一章 Cost of Capital.ppt

Chapter 11 Cost of Capital Chapter 11 - Outline LT 11-1 Cost of Capital Cost of Debt Cost of Preferred Stock Cost of Common Equity: – Retained Earnings – New Common Stock Optimum Capital Structure Cost of Capital LT 11-2 The cost of capital represents the overall cost of financing to the firm The cost of capital is normally the relevant discount rate to use in analyzing an investment The overall cost of capital is a weighted average of the various sources, including debt, preferred stock, and common equity (retained earnings): WACC = Weighted Average Cost of Capital WACC = After-tax cost x weights Cost of Debt LT 11-3 The cost of debt to the firm is the effective yield to maturity (or interest rate) paid to its bondholders Since interest is tax deductible to the firm, the actual cost of debt is less than the yield to maturity: After-tax cost of debt = yield x (1 - tax rate) Cost of Preferred Stock LT 11-4 Preferred stock: – has a fixed dividend (similar to debt) – has no maturity date – dividends are not tax deductible to the firm and are expected to be perpetual or infinite Cost of preferred stock = dividend price-flotation cost Cost of Common Equity: Retained Earnings LT 11-5 Common stock equity is available through retained earnings (R/E) or by issuing new common stock: Common equity = R/E + New common stock The cost of common equity in the form of retained earnings is equal to the required rate of return on the firm’s common stock (this is the opportunity cost) Cost of Common Equity: New Common Stock LT 11-6 The cost of new common stock is higher than the cost of retained earnings because of flotation costs Flotation costs: selling and distribution costs (such as sales commissions) for the new securities Optimum Capital Structure LT 11-7 The optimal (best) situation is associated with the minimum overall cost of capital: Opti