CHAPTER 9 The Cost of Capital
What types of long-term capital do firms use?
Should we focus on before-tax or after-tax capital costs?
Should we focus on historical (embedded) costs or new (marginal) costs?
A 15-year, 12% semiannual bond sells for $1,153.72. Whatís kd?
Component Cost of Debt
Whatís the cost of preferred stock? PP = $113.10; 10%Q; Par = $100; F = $2.
Picture of Preferred
Note:
Is preferred stock more or less risky to investors than debt?
Why is yield on preferred lower than kd?
Example:
Why is there a cost for retained earnings?
PPT Slide
Three ways to determine cost of retained earnings, ks:
Whatís the cost of retained earnings based on the CAPM? kRF = 7%, MRP = 6%, b = 1.2.
Whatís the DCF cost of retained earnings, ks? Given: D0 = $4.19; P0 = $50; g = 5%.
Suppose the company has been earning 15% on equity (ROE = 15%) and retaining 35% (dividend payout = 65%), and this situation is expected to continue. Whatís the expected future g?
Retention growth rate: g = b(ROE) = 0.35(15%) = 5.25%. Here b = Fraction retained. Close to g = 5% given earlier. Think of bank account paying 10% with b = 0, b = 1.0, and b = 0.5. Whatís g?
Could DCF methodology be applied if g is not constant?
Find ks using the own-bond-yield-plus-risk-premium method. (kd = 10%, RP = 4%.)
Whatís a reasonable final estimate of ks?
How do we find the cost of new common stock, ke?
Why is ke > ks?
Whatís WACC using only retained earnings for equity component of WACC1?
WACC with New CS
Summary to this Point
MCC Schedule Definition
How large will capital budget be before must issue new CS?
Find Retained Earnings Break Point
Investment Opportunities (Capital Budgeting Projects)
Would the MCC remain constant beyond $2 million?
Email: wsullivan@csus.edu
Home Page: hhtp://www.csus/indiv/s/sullivanw
Other information: MGNT 133 Chapter 9 lecture slides.
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