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.
2. Consider Higgins Production which has the following information about its capital structures:
Debt - 1,500, 5 percent coupon bonds outstanding, $1,000 par value, 7 years to maturity, selling for 80 percent of par, the bonds make semi-annual payments
Common Stock - 100,000 shares outstanding, selling for $45 per share; the beta is 0.80
Market Information - 6 percent market risk premium and 4 percent risk-free rate.
Required: Calculate the following if the company has a tax rate of 36 percent.
iii.
iv. Cost of Preferred Stock
v. Weighted Average Cost of Capital
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