Basic Skills: (Time value of money, Financial Statements) Investments: (Stocks, Bonds, Risk and Return) Corporate Finance: (The Investment Decision - Capital Budgeting) For Investors, the rate of return on a security is a benefit of investing. For Financial Managers, that same rate of return is a cost of raising funds that are needed to operate the firm. In other words, the cost of raising funds is the firm’s cost of capital. | Ch. 12 Cost of Capital 2002, Prentice Hall, Inc. Basic Skills: (Time value of money, Financial Statements) Investments: (Stocks, Bonds, Risk and Return) Corporate Finance: (The Investment Decision - Capital Budgeting) Where we’ve been. Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity The investment decision Corporate Finance: (The Financing Decision) Cost of capital Leverage Capital Structure Dividends Where we’re going. Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity The financing decision Assets Liabilities & Equity Current assets Current Liabilities Long-term debt Preferred Stock Common Equity Assets Liabilities & Equity Current assets Current Liabilities Long-term debt Preferred Stock Common Equity } Capital Structure Ch. 12 - Cost of Capital For Investors, the rate of return on a security is a benefit of investing. For Financial Managers, that same rate of return is a cost of raising funds that are needed to operate the firm. In other words, the cost of raising funds is the firm’s cost of capital. How can the firm raise capital? Bonds Preferred Stock Common Stock Each of these offers a rate of return to investors. This return is a cost to the firm. “Cost of capital” actually refers to the weighted cost of capital - a weighted average cost of financing sources. Cost of Debt Cost of Debt For the issuing firm, the cost of debt is: the rate of return required by investors, adjusted for flotation costs (any costs associated with issuing new bonds), and adjusted for taxes. Example: Tax effects of financing with debt with stock with debt EBIT 400,000 400,000 - interest expense 0 . | Ch. 12 Cost of Capital 2002, Prentice Hall, Inc. Basic Skills: (Time value of money, Financial Statements) Investments: (Stocks, Bonds, Risk and Return) Corporate Finance: (The Investment Decision - Capital Budgeting) Where we’ve been. Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity The investment decision Corporate Finance: (The Financing Decision) Cost of capital Leverage Capital Structure Dividends Where we’re going. Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity Assets Liabilities & Equity Current assets Current Liabilities Fixed assets Long-term debt Preferred Stock Common Equity The financing decision Assets Liabilities & Equity Current assets Current Liabilities Long-term debt Preferred Stock Common Equity .
