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10 Cards in this Set
- Front
- Back
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What sources of long-term capital do firms use?
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Long term debt, preferred stock, common stock (retained earnings or new common stock)
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Weighted Average Cost of Capital (WACC)
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WACC = wdrd(1 – T) + wprp + wcrs
The w’s refer to the firm’s capital structure weights. The r’s refer to the cost of each component. |
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Should our analysis focus on before-tax or after-tax capital costs?
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After-tax. Stockholders focus on After-tax. Only rd needs adjustment, because interest is tax deductible.
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Use accounting numbers or market value (book vs. market weights)?
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Market Value. Accounting is historical and not helpful for forecasting and budgeting.
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Use actual numbers or target capital structure?
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Target capital structure.
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Component Cost of Debt
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rd (1-T)
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What is Rd?
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The marginal cost of debt. The yield to maturity on outstanding L-T debt is often used as a measure of rd.
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Why tax-adjust; i.e., why rd(1 – T)?
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The higher the tax rate, the more we can discount/lower debt.
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What is Rp?
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the marginal cost of preferred stock, which is the return investors require on a firm’s preferred stock.
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What is the Rp formula?
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Dp/Pp
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