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    Chapter 10 PFD2123 Cost of Capital

    Uploaded by

    Maizatul Aqmal
    Finance

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    © All Rights Reserved
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    Chapter 10 PFD2123 Cost of Capital

    Uploaded by

    Maizatul Aqmal
    152 views21 pages
    Finance

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    © © All Rights Reserved

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    PPT, PDF, TXT or read online from Scribd

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    Finance

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    152 views21 pages

    Chapter 10 PFD2123 Cost of Capital

    Uploaded by

    Maizatul Aqmal
    Finance

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 21

    Financial Management SECOND EDITION All Rights Reserved

    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 1


    CHAPTER 10
    Cost of Capital

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 2
    Learning Objectives

    At the end of this chapter, you should be able


    to:
     Explain the breakdown and composition of a
    firm’s cost of capital
     Determine a firm’s cost of debt capital
     Determine a firm’s cost of equity capital
     Understand the impact of beta in determining
    the firm’s cost of equity capital
     Determine the firm’s overall cost of capital

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 3
    Introduction

     Investors’ required rate of return is the firm’s


    cost of capital.
     Cost of capital is the required rate of return that
    a firm must achieve to cover the cost of
    generating funds in the marketplace.

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 4
    Understanding Concepts of Cost
    of Capital
     Factors that impact the cost of capital:

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 5
    Weighted Average Cost of Capital

     The firm’s WACC—Cost of capital for the firm’s


    mixture of debt and stock (preferred and
    common stocks)
     Firms are usually geared/leveraged using a
    mixture of debt and equity.

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 6
    Computation of WACC

     See the illustration below:

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 7
    WACC Components

     Cost of Debt (Kd)—the level of return that must


    be provided for by a firm to meet the required
    return of debt holders.
     Cost of Preferred Stock (Kps)—has higher return
    than bonds, but is less costly than common
    stock.
     Cost of Equity (Common Stock & Retained
    Earnings)—the rate of return that investors
    require to make an equity investment in a firm

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 8
    Cost of debt

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 9
    Cost of Debt-interpolation

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 10
    Cost of debt after tax

     Cost of debt after tax (kd after tax)

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 11
    Cost of Preferred Share

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 12
    Cost of Common Shares

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    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 13
    Calculating WACC

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 14
    WACC – Breakpoints

    – TEXT
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    – TEXT

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 15
    Business Risk and Financial Risk

     Firm’s business risk is attributed to a firm


    business and investment decisions.
     Evaluating business risk—variability of EBIT
     Financial risk is a direct result of the firm’s
    financing decision—selection of financing mix of
    debt and equity

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 16
    Types of Leverage

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 17
    Operating Leverage

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 18
    Financial Leverage

     Degree of financial leverage =


     DOLs =% change in EPS/% change in EBIT

    or
     DFLs =% change in earnings attributable to
    common stockholders/% change in EBIT
     Refer to Example 10.13

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 19
    Implications of Financial Leverage

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 20
    Total Leverage

     Degree of combined leverage from the best


    sales level
     = DOLs =% change in EPS/% change in
    sales

    or
     DFLs =% change in earnings attributable to
    common stockholders/% change in Sales
     Refer to Example 10.14

    Financial Management SECOND EDITION All Rights Reserved


    © Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 21

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