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