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Retained Earnings
Cost of capital
It is the minimum required rate of return from the capital expenditures
Business riskrisk inherent in firms operations Financial riskrisk inherent in using debt
=
Where
The cost of capital provides a benchmark against which to evaluate investment returns Rule is equivalent to
Projects should not be undertaken unless they return more than the cost of the funds invested in them => the cost of capital. Project IRR exceeds the cost of capital Project NPV > 0 when calculated at the cost of capital
Cost of Debt
Debt Issued at Par
INT kd i B0
Tax adjustment
X ltd. issues Rs. 50,000 8% debentures at par. The tax rate applicable to the company is 50%. Compute the cost of debt capital
7
Example
cost of RE = ke
What is WACC?
WACC is the cost of capital for a business that raises capital from more than one source Public companies raise money by selling
Debt Preferred stock Common Stock
Debt
Preferred Stock Common stock
$60,000
50,000 90,000 $200,000
9
11 14
Example
A: First calculate the capital structure weights based on the values given. For example the weight of debt is $60,000 $200,000 = 30%. Next, each components cost is multiplied by its weight and the results are summed as shown:
Capital Component
Debt Preferred Stock Common stock
Value
$60,000 50,000 90,000 $200,000
Weight
30% 25% 45% 100%
Cost
9 11 14 WACC = 2.70% 2.75% 6.30% 11.75 %