Cost of Debt, Cost of Preferred Stock
This article deals with the estimation of the value of capital and its components. we'll find out how to estimate the value of debt, the value of preferred shares , and therefore the cost of common shares . we will also determine the way to compute the load of every cost of the capital component then they're going to estimate the general cost of capital. The cost of capital refers to the return rate that an organization gives to its investors. If an organization doesn’t provide enough return, economic process will decrease the costs of their stock and bonds to revive the balance. A firm’s long-run and short-run financial decisions are linked to every other by the assistance of the firm’s cost of capital.
Cost of Common Stock
Common stock is a type of security/instrument issued to Equity shareholders of the Company. These are commonly known as equity shares in India. It is also called ‘Common equity
The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm's capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital-budgeting analyst, therefore, is necessarily a detective who must winnow bad evidence from good. Much of the challenge is in knowing what quantitative analysis to generate in the first place.
Suppose you are a new capital-budgeting analyst fr a company considering investments in the eight projects listed in Exhibit 1. The CFO of your company has asked you to rank the projects and recommend the "four best" that the company should accept.
In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive.
All the projects required the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The firm's weighted average cost of capital has never been estimated. In the past, analysts have simply assumed that 10% was an appropriate discount rate (although certain officers of the company have recently asserted that the discount rate should be much higher.)
To stimulate your analysis, consider the following questions:
1.) Can you rank the projects simply by inspecting the cash flow?
| Exhibit 1 | |||||||||
| The Investment Detective | |||||||||
| Project number | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
| Initial investment | $2,000 | $2,000 | $2,000 | $2,000 | $2,000 | $2,000 | $2,000 | $2,000 | |
| Year | 1 | $330 | $1,666 | $160 | $280 | $2,200* | $1,200 | ($350) | |
| 2 | $330 | $334* | 200 | $280 | $900* | ($60) | |||
| 3 | $330 | 165 | 350 | $280 | 300 | $60 | |||
| 4 | $330 | 395 | $280 | 90 | $350 | ||||
| 5 | $330 | 432 | $280 | 70 | $700 | ||||
| 6 | $330 | $440* | $280 | $1,200 | |||||
| 7 | $330* | 442 | $280 | $2,250* | |||||
| 8 | $1,000 | 444 | $280* | ||||||
| 9 | 446 | $280 | |||||||
| 10 | 448 | $280 | |||||||
| 11 | 450 | $280 | |||||||
| 12 | 451 | $280 | |||||||
| 13 | 451 | $280 | |||||||
| 14 | 452 | $280 | |||||||
| 15 | $10,000 | $2,000 | $280 | ||||||
| Sum of cash flow | |||||||||
| benefits | $3,310 | $2,165 | $10,000 | $3,561 | $4,200 | $2,200 | $2,560 | $4,150 | |
| Excess of cash flow | |||||||||
| over initial investment | $1,310 | $165 | $8,000 | $1,561 | $2,200 | $200 | $560 | $2,150 | |
| *Indicates year in which payback was accomplished |
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