(BQ) Part 2 book "Corporate finance - Principles and practice" has contents: Investment appraisal - applications and risk, portfolio theory and the capital asset pricing model, the cost of capital and capital structure, dividend policy, mergers and takeovers, risk management. | 10/18/06 9:51 PM Page 241 Chapter 9 The cost of capital and capital structure Learning objectives After studying this chapter, you should have achieved the following learning objectives: ■ a firm understanding of how to calculate a company’s cost of capital and how to apply it appropriately in the investment appraisal process; ■ the ability to calculate the costs of different sources of finance used by a company and to calculate the weighted average cost of capital of a company; ■ an appreciation of why, when calculating the weighted average cost of capital, it is better to use market values than book values; ■ an understanding of how the capital asset pricing model can be used to calculate risk-adjusted discount rates for use in investment appraisal; ■ the ability to discuss critically whether or not a company can, by adopting a particular capital structure, influence its cost of capital. 241 10/18/06 9:51 PM Page 242 Chapter 9 The cost of capital and capital structure Introduction The concept of the cost of capital, which is the rate of return required on invested funds, plays an important role in corporate finance theory and practice. A company’s cost of capital is (or could be) used as the discount rate in the investment appraisal process when using techniques such as net present value and internal rate of return. If we assume that a company is rational, it will seek to raise capital by the cheapest and most efficient methods, thereby minimising its average cost of capital. This will have the effect of increasing the net present value of the company’s projects and hence its market value. For a company to try to minimise its average cost of capital, it first requires information on the costs associated with the different sources of finance available to it. Second, it needs to know how to combine these different sources of finance in order to reach its optimal capital structure. The importance of a company’s capital .
