COC.pptx
- 1. Cost of Capital What is capital? 1
- 2. 2 Capital Components A firm’s Capital Components are ○ Debt • Borrowed money, either loans or bonds ○ Common equity • Ownership interest ○ Preferred stock • A hybrid security, a cross between debt and equity Capital structure is the mix of the three capital components - generally expressed in percentages
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- 4. What is cost of Capital 4
- 5. 5 The cost of capital is the average rate paid for the use of the firm’s capital funds The cost of capital provides a benchmark against which to evaluate investment returns
- 6. 6 Returns on Investments and the Costs of Capital Components Investors provide capital by purchasing securities ○ Returns paid to investors adjusted for taxes and administrative expenses are the firm’s costs The risk levels of Capital Component securities differ ○ Leads to different investor returns for each component • And different costs to the issuing firm for each component ○ Equity is the riskiest investment, earns the highest return, and has the highest cost ○ Debt is the safest investment, earns the lowest return, and costs the firm least ○ Preferred Stock offers investors intermediate risk and return levels and has a cost between that of equity and debt
- 7. Computation of overall cost of Capital involves : 1. Computation of cost of Specific source of finance 2. Computation of Weighted cost of capital 7
- 8. 8 The Weighted Average Calculation—The WACC A firm’s cost of capital is a weighted average of the costs of the three capital components where the weights reflect the $ amounts of each component in use Referred to in two ways ○ k, the cost of capital ○ WACC, for weighted average cost of capital
- 9. Cost of Debt It is the rate of interest payable on debt. 9
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- 11. Example 11
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- 15. Cost of Preference share capital 15
- 16. Computation of cost of Preference share capital 16