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Taylor’s University Dual Degree Program Introduction to Finance Topic 9 Financial Issues: Cost of Capital 1 Acknowledgement Ross et al, 2008, Essentials of Corporate Finance, 6 th Ed, McGraw-Hill 1-212-2 Learning Outcomes At the end of the lesson, students should be able to: •determine a firm’s cost of equity capital •determine a firm’s cost of debt •calculate a firm’s overall cost of capital 2 1-312-3 Chapter Outline • • • • The Cost of Capital: Some Preliminaries The Cost of Equity The Costs of Debt and Preferred Stock The Weighted Average Cost of Capital (WACC) • Divisional and Project Costs of Capital 3 1-412-4 Why Cost of Capital is Important • We know that the return earned on assets depends on the risk of those assets • The return to an investor is the same as the cost to the company • Also, knowing our cost of capital helps us determine our required return for capital budgeting projects 4 1-512-5 Required Return • The required return is the same as the appropriate discount rate and is based on the risk of the cash flows • We need to know the required return for an investment before we can compute the NPV and make a decision about whether or not to take the investment • We need to earn at least the required return to compensate our investors for the financing they have provided 5 1-612-6 Cost of Equity • The cost of equity is the return required by equity investors given the risk of the cash flows from the firm ...
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