UNIT 7: CORPORATE VALUATION COST OF CAPITAL
INTRODUCTION
In Unit Five, we discussed the discounting of a company's expected cash flows or the cash
flows of a potential project a company is considering. We showed how the discount rate is
used to discount the cash flows and arrive at their present value. This discount rate is often
called the required rate of return for the project or the opportunity cost for the funds that
may be used to invest in the company or project. In Unit Six, you also learned how to adjust
rates of return according to the risk involved in the investment. The cost of capital
represents the required rate of return. In this unit, you will learn how to calculate the cost
of each source of capital and the overall cost of capital for a company.
UNIT OBJECTIVES
After you successfully complete this unit, you will be able to:
·
Calculate the cost of debt, preferred stock, and common stock (equity)
·
Calculate the weighted average cost of capital
SOURCES OF CAPITAL AND THEIR COSTS
Three major
sources
There are three major sources of capital available for financing a
project or investment:
·
Debt
·
Preferred stock
·
Common stock