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Learning objectives of this chapter include: Know how to determine a firm’s cost of equity capital, know how to determine a firm’s cost of debt, know how to determine a firm’s overall cost of capital, understand pitfalls of overall cost of capital and how to manage them, understand the impact of an imputation tax system. | Cost of capital Chapter 12 Key concepts and skills Know how to determine a firm’s cost of equity capital Know how to determine a firm’s cost of debt Know how to determine a firm’s overall cost of capital Understand pitfalls of overall cost of capital and how to manage them 12- Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh Chapter outline The cost of capital: Some preliminaries The cost of equity The costs of debt and preferred stock The weighted average cost of capital Divisional and project costs of capital 12- Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh Why cost of capital is important? We know that the return earned on assets depends on the risk of those assets. The return to an investor is the same as the cost to the company. Our cost of capital provides us with an indication of how the market views the risk of our assets. Knowing our cost of capital can also help us determine our required return for capital budgeting projects. 12- Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh ‘We’ meaning the firm here. Required return The required return is the same as the appropriate discount rate and is based on the risk of the cash flows. We need to know the required return for an investment before we can compute the NPV and make a decision about whether or not to take the investment. We need to earn at least the required return to compensate our investors for the financing they have provided. 12- Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh Cost of equity The cost of equity is the return . | Cost of capital Chapter 12 Key concepts and skills Know how to determine a firm’s cost of equity capital Know how to determine a firm’s cost of debt Know how to determine a firm’s overall cost of capital Understand pitfalls of overall cost of capital and how to manage them 12- Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh Chapter outline The cost of capital: Some preliminaries The cost of equity The costs of debt and preferred stock The weighted average cost of capital Divisional and project costs of capital 12- Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh Why cost of capital is important? We know that the return earned on assets depends on the risk of those assets. The return to an investor is the same as the cost to the company. Our cost of
