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Long-term Debts

Common Stock Retained Earnings


Weighted Average Cost of Capital

Preferred Stock

Overall Cost of Capital

Weighted Marginal Cost of Capital

Investment Opportunities Schedule

Long-term Debts

Common Stock Retained Earnings


Weighted Average Cost of Capital

Preferred Stock

Overall Cost of Capital

Weighted Marginal Cost of Capital

Investment Opportunities Schedule

ka = (wi xaverage Expected ki) + (wp of p) future cost x kfunds over + (ws x kr or kn) the long run
Weighting the cost of each specific type of capital by its proportion in the firms capital structure

Weighted

Average
Cost of Capital
k = cost of capital w = proportion in the capital structure

ka =

(wi x ki) + (wp x kp) + (ws x kr or kn)

Cost of W retained d eighte earnings e A v e r a g (kr) C o s tof new Cost o f C common apital stock (kn)
k = cost of capital w = proportion in the capital structure

p = long-termstock i = preferred stock s common debt

Type of Capital Long-term debt Preferred stock Retained New common earnings stock TOTAL Retained earnings

Cost 5.6% 10.6% 13.0% 14.0% 13.0%

Weight .40 .10 .50 1.00

Weighted Cost 2.2% 1.1% 6.5% 9.8%

WACC

Accounting values

Book Value Weights

Weighting Schemes Market Value Weights


Approximate the actual dollars to be received from a sale

Based on actual capital structure proportions

Historical Weights

Weighting Schemes Market Target Weights Value


Based on desired capital structure proportions

Market Value Weights Weighting Schemes


Target Weights

Long-term Debts

Common Stock Retained Earnings


Weighted Average Cost of Capital

Preferred Stock

Overall Cost of Capital

Weighted Marginal Cost of Capital

Investment Opportunities Schedule

The firms WACC associated with its next dollar of total new financing volume of financing

W eighted M arginal C ost of C apital

WACC

cost of financing

Afj
Amount of funds available from Reflect the level of financing source j total new financing at a given cost at which the cost of one of the wj financing Weight of the components rises capital structure weight for financing source j

BPj = Afj wj

Retained earnings, $300,000, is exhausted at kr = 13%. The more expensive new common stock financing must be used at kn = 14%. Long-term debt, $400,000 is exhausted at 5.6% cost. Additional debt has an after-tax cost (ki) of 8.4%.

BPcommon equity

= $300,000 0.50 = $600,000

BP long-term debt

= $400,000 0.40 = $1,000,000

BPj = Afj wj

Long-term Debts

Common Stock Retained Earnings


Weighted Average Cost of Capital

Preferred Stock

Overall Cost of Capital

Weighted Marginal Cost of Capital

Investment Opportunities Schedule

Internal Rate of Best (highest return) Return

>

Worst WMCC (lowest return)

Investment Opportunity Schedule

Investment Opportunity A B

IRR
15.0% 14.5

Initial Investment $100,000 200,000

Cumulative Investment $100,000 300,000

C D E F G

14.0 13.0 12.0 11.0 10.0

400,000 100,000 300,000 200,000 100,000

700,000 800,000 1,100,000 1,300,000 1,400,000