Week 11

Manajemen Keuangan
Prodi Administrasi Bisnis
 Basic Skills:
Time value of money, Financial Statements
 Investments:
Stocks, Bonds, Risk and Return
 Corporate Finance:
The Investment Decision - Capital Budgeting

2
Corporate Finance: (The Financing Decision)
 Cost of capital
 Leverage
 Capital Structure
 Dividends

3
Assets Liabilities & Equity
Current Assets Current Liabilities

Fixed Assets Long-term Debt

Preferred Stock
Common Equity

4
 The investment decision

Assets Liabilities & Equity

Current Assets Current Liabilities

Fixed Assets Long-term Debt

Preferred Stock
Common Equity

5
 The financing decision

Assets Liabilities & Equity

Current Assets Current Liabilities

Fixed Assets Long-term Debt

Preferred Stock
Common Equity

6
 Assets Liabilities & Equity
Current assets Current Liabilities

Long-term Debt
Capital Structure Preferred Stock
Common Equity

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 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.

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  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.

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Cost of
Debt

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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.

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 with stock with debt
EBIT 400,000 400,000
- interest expense 0 (50,000)
EBT 400,000 350,000
- taxes (34%) (136,000) (119,000)
EAT 264,000 231,000

Now, suppose the firm pays $50,000 in dividends to the

stockholders.

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 with stock with debt
EBIT 400,000 400,000
- interest expense 0 (50,000)
EBT 400,000 350,000
- taxes (34%) (136,000) (119,000)
EAT 264,000 231,000
- dividends (50,000) 0
Retained earnings 214,000 231,000

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Cost of Debt (before tax):

C = pembayaran coupon
M = nilai nominal obligasi
Nd = nilai pasar (nilai jual obligasi)
n = umur obligasi

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Cost of Debt (after tax):
After-tax Before-tax Marginal
% cost of
Debt
= % cost of
Debt
x
1- tax
rate

Kd = kd (1 - T)

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 Prescott Corporation issues a $1,000 par, 20 year bond
paying the market rate of 10%. The bond will sell for par
since it pays the market rate, but flotation costs amount to
$50 per bond. Tax rate 34%

 What is the pre-tax and after-tax cost of debt for Prescott

Corporation?

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 Pre-tax cost of debt:

So, a 10% bond

costs the firm
only 7% (with
 After-tax cost of debt: flotation costs)
Kd = kd (1 - T) since the interest
Kd = .1051 (1 - .34) is tax deductible.
Kd = .07 = 7%

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 Finding the cost of preferred
stock is similar to finding the
rate of return , except that we
have to consider the flotation
costs associated with issuing
preferred stock.

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Recall:

D Dividend
kp = Po = Price

From the firm’s point of view:

kp = D Dividend
NPo
= Net Price
NPo = price - flotation costs!
If Prescott Corporation issues preferred stock, it
will pay a dividend of $8 per year and should
be valued at $75 per share. If flotation costs
amount to $1 per share, what is the cost of
preferred stock for Prescott?

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 D Dividend
kp = =
NPo Net Price

8.00
= 74.00 = 10.81%

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There are two sources of
Common Equity:
1) Internal common equity
(retained earnings).
2) External common equity
(new common stock issue).

Do these two sources have

the same cost?

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 Since the stockholders own the firm’s retained
earnings, the cost is simply the stockholders’
required rate of return.
 Why?
 If managers are investing stockholders’ funds,
stockholders will expect to earn an acceptable rate
of return.

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Dividend Growth Model

D1
kc = Po +g

Kc = cost of internal equity

D1 = dividen akhir tahun
P0 = harga awal tahun
g = growth

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 Suatu perusahaan mendapatkan keuntungan sebesar $ 400
per lembar saham, dividen yang dibayarkan senilai $ 200.
Hasil neto penjualan saham adalah $ 4,000 per lembar.
Profit, dividen dan harga saham mempunyai growth 5% per
tahun dan diharapkan pertumbuhan ini akan berlangsung
terus.

 Maka Cost of Retained Earning adalah:

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Dividend Growth Model

D1
knc = +g
NPo

Net proceeds to the firm

after flotation costs!
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 The weighted cost of capital is just the
weighted average cost of all of the
financing sources.

Kwacc = (Wd x Kd (1-T)) + (Wps x Kps) + (Wcs x Kcs) + (Wncs + Kncs)

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Source Cost Capital Structure
debt 6% 20%
preferred 10% 10%
common 16% 70%

Weighted cost of capital

(20% debt, 10% preferred, 70% common)

= .20 (6%) + .10 (10%) + .70 (16%)

= 13.4%
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