Fin 515

Fin 515 Week 4 Discussion part 2

Cost of capital is the return required to make a capital budget project investment worthwhile. Cost of capital is the total cost of debt and cost of equity for a particular capital budget project (i.e. building a new factory). Cost of capital allows for the comparison of different ways to raise funds and the rate of return that would be expected if it invested in something else with a similar risk.

http://www.investopedia.com/terms/c/costofcapital.asp#axzz2JBNhRaZ5

The possible capital components are target proportions of debt, preferred stock, and common equity, along with the component costs of capital (p.359). The components include all the capital invested in the business and also the capital from debtors.

Retained Earnings - Profit the company makes, but does not give to the shareholders in the form of dividends.

Common Stock - A security that represents ownership in a corporation.

Preferred Stock - A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock.

Bonds (debt)

http://financeunleashed.blogspot.com/2007/12/cost-of-capital.html

The WACC is the weighted average of the after-tax component costs of capital --debt, preferred stock, and common equity. Each factor is the proportion of that type of capital in the optimal,, or target, capital structure (p.1111). The Weighted Average Cost of Capital (WACC) is one of the most important measures in corporate finance. The rate that a company is expected to pay on average to all its security holders to finance its assets.

WACC is calculated by the cost of each capital component multiplied by its proportional weight. This also requires that you know a firm's cost of debt (rD), corporate tax rate (Tc), total Debt and Equity, the firm's cost of equity (rE) - which in turn requires that you know a firm's Beta (β) and the risk-free (rf) and market return (rM) rates.

WACC = E/V × Re + D/V × Rd × (1 - Tc)

where:

Re =...