Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
The Cost of Capital: Cost of New Common Stock
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected return is reduced so it may not meet the firm's hurdle rate for acceptance of the project. The second approach involves adjusting the cost of common equity as follows:
The difference between the flotation-adjusted
Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $1.80 and it expects dividends to grow at a constant rate g = 4.2%. The firm's current common stock price, P0, is $20.60. If it needs to issue new common stock, the firm will encounter a 5.2% flotation cost, F. Assume that the cost of equity calculated without the flotation adjustment is 12% and the cost of old common equity is 11.5%. What is the flotation cost adjustment that must be added to its cost of
%
What is the cost of new common equity considering the estimate made from the three estimation methodologies? Round your answer to 2 decimal places. Do not round intermediate calculations.
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