Cost of Capital, Tool Kit Chapter The Weighted Average Cost of Capital The cost of capital is the weighted average cost of the debt, preferred stock, and common equity that the firm uses to finance...

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Cost of Capital, Tool Kit Chapter The Weighted Average Cost of Capital The cost of capital is the weighted average cost of the debt, preferred stock, and common equity that the firm uses to finance its assets, or its WACC. Definitions WACC =Weighted average cost of capital =wd rd(1 – T) + wps rps + ws rs rd =Cost of debt rps =Cost of preferred stock rs =Cost of stock (common equity) wd =Percent of target capital structure financed with debt wps =Percent of target capital structure financed with preferred stock ws =Percent of target capital structure financed with stock (common equity) T =Tax rate Choosing Weights for the Weighted Average Cost of Capital Investor-Supplied Capital Book Market Book Value Percent of TotalMarket Value Percent of Total DEBT?0??ERROR:#DIV/0!ERROR:#DIV/0! Preferred stock?0??ERROR:#DIV/0!ERROR:#DIV/0! Total common equity$?0??ERROR:#DIV/0!ERROR:#DIV/0! Total $0ERROR:#DIV/0!$0ERROR:#DIV/0! Other Data (Millions, except per share data): Number of common shares outstanding =? Price per share of common stock =? Number of preferred shares outstanding =? Price per share of preferred stock =? After-Tax Cost of Debt: rd (1 − T) and rstd (1 − T) The relevant cost of debt is the after-tax cost of new debt, taking account of the tax deductibility of interest. The after-tax cost is calculated by multiplying the interest rate (or the before-tax cost of debt) times one minus the tax rate. To estimate the cost of debt, use the RATE function to find the yield on the bonds: The After-Tax Cost of Debt Tax rate =? Long-term debt: rd = ? After-tax cost of debt = r (1 – T) Long-term debt: rd (1-T) =? Cost of Preferred Stock, rps The cost of preferred stock is simply the preferred dividend divided by the price the company will receive if it issues new preferred stock. No tax adjustment is necessary, as preferred dividends are not tax deductible. Pref. Dividend? Price? Flotation %2.0% Net preferred issue price? rps =DivPref÷Net Pref. Price rps =?÷?=? Using the CAPM to Estimate the Cost of Common Stock, rs rs = risk-free rate + (Market risk premium) (Beta) = rRF + (RPM) bi (Recall that: RPM is the expected return on the market minus the risk-free rate.) The Risk-Free Rate Yield on 10-year T-bond = rRF =? The Market Risk Premium The market risk premium is the return in excess of the risk-free rate that is required to induce investors to invest in the stock market. Assumed market risk premium = RPM =6.00% Estimating Beta Beta for Stock i = bi =? The same estimate for beta can be obtained as the estimated slope coefficient in a regression, with the company’s stock returns on the y-axis and market returns on the x-axis. Beta can also be obtained from many Web sources. Risk-free rate? Market risk premium? Beta? rs = rRF+(RPM)(bi) rs =?+6.0%? rs =? The Weighted Average Cost of Capital (WACC) The weighted average cost of capital (WACC) is calculated using the firm's target capital structure together with its after-tax cost of long-term debt, after-tax cost of short-term debt, cost of preferred stock, and cost of common equity. WACC =Weighted average cost of capital =wd rd(1 – T) + wstd(1 – T)rstd + wps rps + ws rs T =? wd =?rd =? wps =?rps =? ws =?rs =? WACC =?
Answered Same DayAug 13, 2021

Answer To: Cost of Capital, Tool Kit Chapter The Weighted Average Cost of Capital The cost of capital is the...

Sumit answered on Aug 13 2021
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Cost of Capital, Tool Kit
Chapter
     The Weighted Average Cost of Capital
    The cost of capital is
the weighted average cost of the debt, preferred stock, and common equity that the firm uses to finance its assets, or its WACC.
    Definitions
    WACC =    Weighted average cost of capital
    =    wd rd(1 – T) + wps rps + ws rs
    rd =    Cost of debt
    rps =    Cost of preferred stock
    rs =    Cost of stock (common equity)
    wd =    Percent of target capital structure financed with debt
    wps =    Percent of target capital structure financed with preferred stock
    ws =    Percent of target capital structure financed with stock (common equity)
    T =    Tax rate
    Choosing Weights for the Weighted Average Cost of Capital
                 Investor-Supplied Capital
                 Book         Market
                Book
Value     Percent
of Total    Market
Value     Percent
of Total
     DEBT            ?2,6,4,0,2??    51%    ?3,6,4,2,2??    58.8%
     Total common...
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