FIN 300 - Ch. 14 Cost of Capital

the cost of capital depends primarily on the use of the funds, not the source. - depends on the risk of that investment

*this is really important, just remember

two approaches to determining cost of equity

1. dividend growth model approach 2. security market line (SML) approach

weighted average cost of capital (WACC)

cost of capital for the firm as a whole, and it can be interpreted as the required return on the overall firm

cost of capital

minimum required return = required return new project will have a positive NPV only if its return exceeds what the financial markets offer on investments of similar risk

capital structure weights

percentages that can be interpreted just like portfolio weights

cost of equity

the return that equity investors require on their investment in the firm

cost of debt

the return that lenders require on the firm's debt

pure play approach

the use of a WACC that is unique to a particular project, based on companies in similar lines of business

WACC weighted average cost of capital

the weighted average of the cost of equity and the aftertax cost of debt