Cost of Capital

Chapter 11- Block and Hurt

 Scenario 1: Suppose you wish to borrow $10,000 through
issuing bond @8 % annual interest rate to purchase a “kN95
mask machine”.
So here your total cost is 8% (In terms of percentage)
So we can also say, cost of debt is 8%

Scenario 2: Suppose you wish get same $10,000 to buy the

same “kN95 mask machine” though issuing common share.
Assume, your current cost from common share rate is 14%
yearly.
So here your total cost is 14% (In terms of percentage)
So we can also say, cost of equity is 14%
Scenario 3: Suppose you wish borrow same $10,000 to buy the
same “kN95 mask machine”. But $4,000 through bond @ 8% yearly
rate and $6,000 though issuing common share. Assume, your current
cost from common share rate is 14% yearly.
So what is you total cost here?

Wd = 4000/ 10,000 =
40%
We = 6000/ 10,000 =
60%
 3.2 % 8.4 %
11.6 %
What Is Weighted Average Cost of Capital –
WACC?
The weighted average cost of capital (WACC) is a
calculation of a firm's cost of capital in which each
category of capital is proportionately weighted.
- All sources of capital, including common stock,
preferred stock, bonds, and any other long-term debt,
are included in a WACC calculation.

*Also we can restate to say that Cost of capital is

the required return necessary to make a capital
budgeting project, such as building a new machine.
 [1] [2] [1] [2]

[1] [2]

Components Cost Weight ( % ) Weighted avg.

[1] [ 2] cost of capital
( W.A.C.C )
[1*2]
Cost of debt (Kd) 8% [4,000/ 10,000] = 40% **
/ 0.08
Cost of preferred share 9% [1,000/ 10,000 ]= 10% **
/ 0.09
(kp)
Cost of common share 14% [5,000/ 10,000 ]= 50% **
/ 0.14
(ke)
/ cost of equity
Total cost / WACC = ** %
After tax cost of debt (Kd) = Yield to Maturity (Y.T.M) * (1 - Tax rate )

 
Do (present)= Last year dividend / Dividend paid / Current dividend

D1 (future)= Next year dividend / Dividend will be paid / expected dividend

   

Assume dividend paid is $100 and growth is 5%.

Do /(pv) = $ 100 and g = 5%, D1 / (fv) = ?
D1(Fv) = Do(pv) * (1 + g ) ^1
= 100 * ( 1 + 0.05 )^1
D1 = 105 ans
 

Weighted
Cost Weight ( % ) avg. cost of
Alternatives [1] [ 2] capital
Components ( W.A.C.C )
[1*2]
Cost of debt (Kd) % **
Cost of preferred share % **
(kp)
Cost of common share % **
(ke)
/ cost of equity
Total cost / WACC ** %
=
 Math 19
Global technology

 
 Math 19
Alternative

Weighted
Cost Weight ( % ) avg. cost of
Components capital
[1] [ 2]
( W.A.C.C )
[1*2]
6.5%/ 0.065 0.35 0.02275
Cost of debt (Kd)
Cost of preferred share 10% / 0.10 0.15 0.015
(kp)
0.50 0.0675
Cost of common share 13.5%/0.135

(ke)
/ cost of equity 0.1053 /
10.53%
Total cost of
Capital / WACC =
Check list Math's 22/ Hamilton Corp. Line
Yield to Maturity (Y.T.M) 9%  
Tax rate 25 %
Dividend of preferred stock (Dp) $ 12
Price of preferred stock (Pp) $ 106
 
Floating cost of preferred stock (F)$ 4.50
Expected Dividend of common stock (D1)
$5
Price of common stock (Po)
$ 60
Ke = 0.1433 or
Growth (g) 14.33% ans
6%

After tax cost of debt (Kd) =Yield to Maturity (Y.T.M) * (1- Tax rate )
= 0.09 * (1 – 0.25 )
= 0.0675 or 6.75%
    Kp = 0.1182 or
11.82% ans
 Math 22
Hamilton Corp. Line
Weighted Average Cost of Capital (WACC)

 
 Math 22
Hamilton Corp. Line
23 H. W
Alternative

Weighted
Cost Weight ( % ) avg. cost of
Components capital
[1] [ 2]
( W.A.C.C )
[1*2]
0.0675 35% / 0.35 0.023625
Cost of debt (Kd)
Cost of preferred share 0.1182 20% / 0.20 0.02364
(kp)
0.1433 45% / 0.45 0.064485
Cost of common share
(ke)
/ cost of equity 0.11175 /
11.18%
Total cost of
Capital / WACC =
Check list Math's 24 / Brook window
Yield to Maturity (Y.T.M) 13.4%  
Tax rate 25 %
Dividend of preferred stock (Dp) $ 6.75
Price of preferred stock (Pp) $ 54
 
Floating cost of preferred stock (F) $ 2.10
Expected Dividend of common stock (D1)
5.30
Price of common stock (Po)
$ 58
Growth (g) Ke = ? % ans
7%

After tax cost of debt (Kd) =Yield to Maturity (Y.T.M) * (1- Tax rate )
= 0.134 * (1 – 0.25 )
= 0.1005 or 10.05%
   
Kp = ? % ans
 Math 24
 
The END