CHAPTER 3

COST OF CAPITAL

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

- Calculate and interpret the weighted average cost of capital (WACC) of a company.
- Describe how taxes affect the cost of capital from different capital sources.
- Explain alternative methods of calculating the weights used in the WACC, including the use of the company’s target capital structure.
- Explain how the marginal cost of capital and the investment opportunity schedule are used to determine the optimal capital budget.
- Explain the marginal cost of capital’s role in determining the net present value of a project.
- Calculate and interpret the cost of fixed rate debt capital using the yield-to-maturity approach and the debt-rating approach.
- Calculate and interpret the cost of noncallable, nonconvertible preferred stock.
- Calculate and interpret the cost of equity capital using the capital asset pricing model approach, the dividend discount approach, and the bond yield plus risk premium approach.
- Calculate and interpret the beta and cost of capital for a project.
- Explain the country equity risk premium in the estimation of the cost of equity for a company located in a developing market.
- Describe the marginal cost of capital schedule, explain why it may be upward sloping with respect to additional capital, and calculate and interpret its break points.
- Explain and demonstrate the correct treatment of flotation costs.

SUMMARY OVERVIEW

- The weighted average cost of capital ...