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Cost of Capital
MBA ZG521: Financial Management
BITS Pilani Instructor: Prof. Mahalakshmi Mudliar
Cost of Capital - Introduction
Decided to redeem ₹600 crs. maturing in 2019. This was issued in 2014
& company was paying interest of 11.5% on them.
Financing Investment
Cost of capital
Decisions Decisions
Hurdle rate
Firms required rate of return
Reflects investors Firms opportunity cost of funds
required rate of return Discount rate –evaluating new projects
(ROR)
Minimum rate of Is ROR = COC ???
return to attract an 3. Flotation costs on new
Not exactly issues (debt or stock)
investor to buy or hold
If a firm sells new shares of common
1. Taxes on 2. Issue /Market price stock for $25 per share & incurs $5
interest payments different from par value per share as flotation costs. Investors
Consider a firm borrows @ If 10 year debenture with ROR @15%
9% & deducts interest from face value of $1000 is issued
its revenues before paying for $980 with coupon rate
tax at a rate of 34% of 10%
BITS Pilani, Deemed to be University under Section 3, UGC Act
rate= 10.33%
Year Amount PVFactor Amount
1 100 0.90637 90.64
2 100 0.82151 82.15
3 100 0.74459 74.46
4 100 0.67488 67.49
5 100 0.61169 61.17
6 100 0.55442 55.44
7 100 0.50251 50.25
8 100 0.45546 45.55
9 100 0.41282 41.28
10 1100 0.37417 411.58
Value of bond= 980.0
WACC
Cost of
Cost of Debt
Equity
Cost of Cost of
Preference Common
Stock Stock
Retained
New Issue
Earnings
BITS Pilani, Deemed to be University under Section 3, UGC Act
Compute the cost for the following
sources of financing:
P.P-1 A $1000 par value bond with a market price of $970 and a coupon interest rate
of 10 percent. Flotation costs for a new issue would be approximately 5
percent. The bonds mature in 10 years and the corporate tax rate is 34 percent.
P.P-2 A preferred stock selling for $100 with an annual dividend payment of $8. If the
company sells a new issue, the flotation cost will be $9 per share. The
company’s marginal tax rate is 30 percent.
P.P-3 Internally generated common stock totalling $4.8 million. The price of the
common stock is $75 per share, and the dividend per share was $9.80 last
year. The dividend is not expected to change in the future.
P.P-4 New common stock where the most recent dividend was $2.8. The company’s
dividends per share should continue to increase at an 8 percent growth rate
into the indefinite future. The market price of the stock is currently $53;
however, flotation costs of $6 per share are expected if the new stock is issued.
What is the current cost of debt for a firm that has a 9% coupon bond with 5
years to maturity and a current price of $962?
What is the after tax cost if it is in the 40% tax bracket?
The company has 1 million shares of 8% preferred stock selling for $120 today.
What is rP?
Internally generated common stock totalling $4.8 million. The price of the common
stock is $75 per share, and the dividend per share was $9.80 last year. The dividend is
not expected to change in the future. Compute the cost of retained earnings.
New common stock where the most recent dividend was $2.8. The company’s dividends
per share should continue to increase at an 8 percent growth rate into the indefinite
future. The market price of the stock is currently $53; however, flotation costs of $6 per
share are expected if the new stock is issued. Compute the cost of new common stock.
Thank you