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The Cost
of Capital
Learning Goals
1. Understand the key assumptions, the basic
concept, and the specific sources of capital
associated with the cost of capital.
2. Determine the cost of long-term debt and the
cost of preferred stock.
3. Calculate the cost of common stock equity and
convert it into the cost of retained earnings
and the cost of new issues of commons stock.
Copyright 2006 Pearson Addison-
11-2
11-3
11-4
11-5
11-6
11-9
11-10
11-11
11-12
11-13
11-14
11-15
11-16
11-17
11-18
11-19
11-20
11-21
11-22
11-23
11-24
11-25
11-26
11-27
11-28
11-29
11-31
11-32
11-33
11-34
11-35
11-36
11-37
11-38
11-39
= $2,000,000/.50 = $4,000,000
BPdebt
= $1,000,000/.40 = $2,500,000
11-40
Source of
New Financing
Capital
$0 to $2.5 million
Weighted
Weight
Cost
Cost
Debt
40%
5.67%
2.268%
Preferred
10%
9.62%
0.962%
Common
50%
15.80%
7.900%
WACC
11.130%
Debt
40%
7.00%
2.800%
Preferred
10%
9.62%
0.962%
Common
50%
15.80%
7.900%
WACC
11.662%
Debt
40%
7.00%
2.800%
Preferred
10%
9.62%
0.962%
Common
50%
16.00%
8.000%
WACC
11.762%
11-41
11.76%
11.75%
11.66%
11.50%
11.25%
11.13%
Total Financing
(millions) 11-42
Copyright 2006 Pearson Addison$2.5
$4.0
Cumulative
Ivestment
Investment
Project
IRR
13.0%
1,000,000
1,000,000
12.0%
1,000,000
2,000,000
11.5%
1,000,000
3,000,000
11.0%
1,000,000
4,000,000
10.0%
1,000,000
5,000,000
11-43
WMCC
B
11.66%
This indicates
that the firm can
accept only
Projects A & B.
11.5%
C
11.13%
11.0%
Total Financing
Copyright 2006 Pearson Addison- (millions) 11-44
$1.0 $2.0 $2.5 $3.0 $4.0