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    Paciones - The Cost of Capital

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    Chema Paciones
    The document discusses the cost of capital and different methods for calculating it. It covers the cost of long-term debt, preferred stocks, and common equity using the dividend growth model and capital asset pricing model. It also explains how to calculate the weighted average cost of capital (WACC) using different capital sources and costs.

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    Paciones - The Cost of Capital

    Uploaded by

    Chema Paciones
    17 views15 pages
    The document discusses the cost of capital and different methods for calculating it. It covers the cost of long-term debt, preferred stocks, and common equity using the dividend growth model and capital asset pricing model. It also explains how to calculate the weighted average cost of capital (WACC) using different capital sources and costs.

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    The document discusses the cost of capital and different methods for calculating it. It covers the cost of long-term debt, preferred stocks, and common equity using the dividend growth model and capital asset pricing model. It also explains how to calculate the weighted average cost of capital (WACC) using different capital sources and costs.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    17 views15 pages

    Paciones - The Cost of Capital

    Uploaded by

    Chema Paciones
    The document discusses the cost of capital and different methods for calculating it. It covers the cost of long-term debt, preferred stocks, and common equity using the dividend growth model and capital asset pricing model. It also explains how to calculate the weighted average cost of capital (WACC) using different capital sources and costs.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 15

    FINANCIAL MANAGEMENT – MBA 206A

    THE COST OF
    CAPITAL
    Prepared by:
    CHEMA C. PACIONES

    Dr . Rubi Ana Saludario


    Professor
    TOPIC OUTLINE

    Basic concepts
    Cost of Long term Debt
    Cost of preferred stocks
    Cost of common equity – Dividend Growth
    Model
    Cost of common equity – capital asset pricing
    model
    Weighted Average Cost of the Capital (WACC)
    BASIC CONCEPTS
    Cost of Capital is all about:

    CAPITAL STRUCTURE

    Capital structure refers to the mix of debt, preferred


    stocks and common equity that the firm uses to finance
    its assets and resources.

    Accounting Equation

    Assets = Liability + Equity


    Objective

     To maximize the market value of


    the firm through an appropriate
    mix of long- term sources of
    funds
    BASIC CONCEPTS

    SOURCE CAPITAL COST OF CAPITAL

    Long-term Debt After-tax Cost of


    Creditors
    Debt

    Preferred
    Stockholders
    Preferred shares Dividend Per
    Share ÷ Net
    Issue price

    Common
    Stockholders Common
    CAPM or DGM
    Shares
    Preferred Stock vs Common Stock

     PS owners gets paid  Common Stock owners invited to


    dividend first. shareholders meetings.

     Are pain individuals after


     Less risk than common preferred stocks holders
    stock.
     Common stock holders have more
     No voting rights in potential to make money higher
    risk….higher earnings.
    corporation
    BASIC
    COSTCONCEPTS
    OF LONG-TERM DEBT

    The before-tax cost of debt is computed by using


    yield to maturity formula:

    + F– P
    C
    n
    Yield to Maturity =
    F+P
    2

    Yield to Maturity
    COST OF PREFERRED STOCKS

    The cost of preferred stock to a company is effectively the price it pays in return for
    the income it gets from issuing and selling the stock. In other words, it’s the amount
    of money the company pays out in a year, divided by the lump sum they got from
    issuing the stock.

    Cost of preferred shares is computed as:

    Dividend per share ÷ (Issue price –floatation cost)


    DIVIDEND GROWTH MODEL
    This is known as GORDON GROWTH MODEL name
    Myron Gordon

    This model assumes that dividends grow either at a stable rate in perpetuity or at
    different rate during the period.

    Cost of retained earnings:  Cost of new ordinary shares:

    Ke = (DI ÷ P0) + GR Kn = [D1 (P0-FC)] + GR

     How to convert D0 to D1

    D1 = {D0 x (1
    CAPITAL ASSET PRICING MODEL

    This model describes the relationship between systematic risk and expected
    return. This model assumes the expected return of a particular stock depends
    on its volatility (beta) relative to the overall stock market.

    Cost of capital

    Risk free rate + [ Beta x (market return – Risk free rate)]


    Weighted Average Cost of Capital (WACC)

    This is the calculation of the firm’s effective cost of capital, taking into
    account the portion of its capital that was obtained from various
    sources.

    To compute for the WACC, multiply the cost of each type of


    capital by their respective weights (percentage of each
    source to the firm’s total capital structure) and add up the
    individual weighted cost of capital.
    Weighted Average Cost of Capital (WACC)

    :SAMPLE OF EXERCISE

    XYZ corp’s capital structure is as follows:

    Debt 35%
    Preferred Stock 15%
    Common equity 50%

    The after –tax cost of debt is 6.5 percent; the cost of preferred stock is 10
    percent; and the cost of common equity (in the form of retained earnings)
    is 13.5 percent)

    Requirement : Calculate XYZ’s weighted average cost of capital.


    Weighted Average Cost of Capital (WACC)

    SOLUTION:

    SOURCE COST WEIGHT WACC

    DEBT 6.50% 35% 2.275%

    Preferred Stock 10.0% 15% 1.500%

    Common Stock 13.5% 50% 6.750%

    100% 10.525%
    SUMMARY

    The cost of capital is simply the return expected by


    those who provide capital for the business,”
    There are two groups of people who may put up the
    capital needed to run a business:

    1. investors who purchase stock


    2. debt holders who buy bonds or issues loans to the
    company
    THANK YOU!

    STAY SAFE.

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