MD. FARHADUL ISLAM

ID : 16-066

WELCOME TO THE PRESENTATION

Cost of Capital

T h e r a t e o f re t u r n re q u i re d b y t h e m a r k e t s u p p l i e r s o f c a p i t a l t o a t t r a c t t h e i r f u n d s t o t h e f i r m

U s e d t o d e c i d e w h e t h e r a p ro p o s e d c o r p o r a t e i n v e s t m e n t w i l l i n c re a s e o r d e c re a s e t h e f i r m ’s s t o c k p r i c e .

I n v e s t m e n t s t h a t a re e x p e c t e d t o i n c re a s e : N P V > 0 o r I R R > C o s t o f C a p i t a l

Cost of Capital

Key Assumptions

•Being unable to cover operating costs.

Business Risk

•Being unable to cover required financial obligations.

Financial Risk

•Net cash outflow resulting from a tax deductible cash expense after income tax effects have been considered.

After tax costs

Sources of Capital

Long-term debt

Preferred stock

Common stock

Retained earnings

Cost of long-term debt

Before –tax,

Kd=

After-tax,

Ka=Kd×(1-T)

Example,

Kd=

Ka=9.4%×(1-.40)=5.6%

Cost of Preferred tock

Kp =

DP= Annual preferred stock dividendNp= Net proceeds from the sale of the

preferred stock

Constant growth Valuation Model

Capital Asset Pricing Model (CAPM)

Ke = kf + (km-kf) b

Kf = Risk free rate of return

Km = Market returnb = Beta coefficient

Cost of Common Stock

Ke= (D1/P0) + g

Po= value of common stock

D1 = per share dividend expected at the end of year

g = constant rate of growth in dividends

Cost of New Issue of Common Stock

Kn = (D1/Nn) + g

D1 = per share dividend expected at the end of year

Nn = Market price of equity – flotation cost - underpricing

Cost of Retained Earnings

Kr = Ke

=(D1/P0) + g

Kr=Cost of retained earnings

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