Professional Documents
Culture Documents
Financial management
Chienlin Lu
2
Learning Objectives
9.1 Understand the concepts underlying the firm’s cost of
capital.
9.2 Evaluate the costs of the individual sources of capital
9.3 Calculate a firm’s weighted average cost of capital.
9.4 Estimate divisional costs of capital.
3
Capital Structure
Capital
• Capital represents the funds used to finance a firm’s
assets and operations. Capital constitutes all items on the
right hand side of balance sheet, i.e., liabilities and
common equity.
• Main sources: Debt, preferred stock, retained earnings,
and common stock.
Capital
4
Debt
TSMC ( 台積
電)
Equity
Total assets
Equity
6
Debt
YANGMING ( 陽
明)
Equity
Total assets
Equity
7
×$50.00 = $7.5
0.15×
$7.5
k= = 0.1667 or16.67% rather than 15%
$45.00
Or P.317
10
11
Financial Policy
• A firm’s financial policy indicates the desired sources of
financing and the particular mix in which it will be used.
• For example, a firm may choose to raise capital by issuing
stocks and bonds in the ratio of 6:4 (60 percent stocks
and 40 percent bonds). The choice of mix will impact the
cost of capital.
Weight
Costs of capital
Example of WACC
• Case 1
• Suppose you collect $100 from bonds.
• Weight of bonds: 100% (or 1).
• Costs of bonds: 4% (or 0.04).
• Then your WACC will be . $4 per year.
• Case 2
• Suppose you collect $50 from bonds and $50 from stocks.
• Weight of bonds: 50%; Weight of stocks: 50%.
• Costs of bonds: 4%; Costs of stocks: 6%.
• Then your WACC will be .
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$4.25
Cost = = 0.074 or 7.44%
58.50 -1.375
19
kc = rf + β rm rf
rf = Risk-free rate
β = Beta
Cost of common
= rf + β (rm rf ) = 0.0275 + 1.4(0.10 0.0275) = 0.129 or 12.9%
stock (kcs )
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WACC Example
• A firm borrows money at 6 percent interest after taxes and
pays 10 percent for equity. The company raises capital in
equal proportions, i.e., 50 percent debt and 50 percent
equity.
• WACC = (0.06 × 0.5) + (0.10 × 0.5)
= 0.08 or 8.0%
30
Study problems
• 9-3.
• 9-5.
• 9-6.
• 9-11.
• 9-16.