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CHAPTER 10
The Cost of Capital
Sources of capital
Component costs
WACC
Adjusting for flotation costs
Adjusting for risk
Long-Term
Capital
Dp $10
kp = = = 0.090 = 9.0%.
Pp $111 .10
0
kp = ?
1 2
...
-111.1 2.50 2.50 2.50
DQ $2.50
$111.10 = = .
kPer kPer
Note:
D1 D0(1 + g)
ks = +g= +g
P0 P0
= $4.19(1.05) + 0.05
$50
= 0.088 + 0.05
= 13.8%.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
10 - 19
ks = kd + RP
Method Estimate
CAPM 14.2%
DCF 13.8%
kd + RP 14.0%
Average 14.0%
D0(1 + g)
ke = +g
P0(1 – F)
$4.19(1.05)
= + 5.0%
$50(1 – 0.15)
$4.40
= + 5.0% = 15.4%.
$42.50
Copyright © 2002 by Harcourt, Inc. All rights reserved.
10 - 24
Market conditions.
The firm’s capital structure and
dividend policy.
The firm’s investment policy. Firms
with riskier projects generally have a
higher WACC.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
10 - 26
Company WACC
Intel 12.19%
General Electric 12.47
Motorola 11.65
Coca-Cola 12.31
Walt Disney 9.28
AT&T 9.22
Wal-Mart 10.99
Exxon Mobil 8.16
H. J. Heinz 7.78
BellSouth 7.41
Copyright © 2002 by Harcourt, Inc. All rights reserved.
10 - 27
Stand-alone risk
Corporate risk
Market risk