Prepared by:

Aquino, Karen Erika Nicole

Pimentel, Kristine Ann
Rosario, Jecelle
Timario, Hermie
32-BSA-01
SOURCE AND COST OF CAPITAL

Investors Expected returns

1. Long term creditors interest
2. Preference Shareholders dividends
3. Ordinary Shareholders dividends and
growth
COST OF LONG
TERM DEBT
 COST OF LONG TERM DEBT
Approximating the cost

rd =

Where: I = annual interest

Nd = Net proceeds from the sale of debt
n = number of years to the bond’s maturity
 COST OF LONG TERM DEBT
Example:
Duchness Corporation, a major thinware
manufacturer, is contemplating selling $10 million
worth of 20-year, 9% coupon (stated annual
interest rate) bonds, each with a par value of
$1000. Because bonds with similar risk earn
returns greater than 9, the firm must sell the
bonds for $980 to compensate for the lower
coupon interest rate. The flotation costs are 2%
of the par value of the bond.
 COST OF LONG TERM DEBT

After-tax Cost of Debt

= Before Tax Cost of Debt x (1-Tax rate)
 COST OF LONG TERM DEBT
Example:
English Corp. wants to calculate its after
tax cost of debt. The company's CFO has the
ff:
• The company's long term bonds currently offer
a yield to maturity of 12 percent
• The company's tax rate is 30 percent.
COST OF COMMON
STOCKS EQUITY
COST OF COMMON STOCKS EQUITY

 the return required on the stock by

investor in the marketplace.
COST OF COMMON STOCKS EQUITY
Two forms of common equity financing:

1. Retained Earnings

2. Issue of new common stocks

COST OF COMMON STOCKS EQUITY

The rate at which investors discount

the expected dividends of the firm
to determine its share value.
COST OF COMMON STOCKS EQUITY
Two Techniques Used to Measure the Cost of
Common Stock Equity

1. Constant Growth Valuation Model (Gordon

Model)

2. Capital Asset Pricing Model

COST OF COMMON STOCKS EQUITY
Constant Growth Valuation Model
 Used to determine the intrinsic value of a stock
based on a future series of dividends that grow at
a constant rate.

Cost of Equity = Dividends per share

+ Growth rate
Current MV of Stock
COST OF COMMON STOCKS EQUITY

Cost of Newly issued Stocks

Dividend per share

+ Growth Rate
MV of CS * (1-FC)
COST OF COMMON STOCKS EQUITY
Example:
The Global Advertising Company has a
marginal tax rate of 40%. The last dividend
paid by the company was P.90. Global
common stock is selling for P8.59 per share
and its expected growth rate in earnings and
dividends is 5%. What is the company’s cost of
common stock?
COST OF COMMON STOCKS EQUITY
Example:
• The company’s capital structure is 70% equity, 30% debt
• The yield to maturity on the company’s bonds is 9%
• The company’s year end dividend is forecasted to be P.80 a share
• The company expects that its divided will grow at a constant rate of
9%.
• The company’s stock price is P25
• The company’s tax rate is 40%
• The company anticipates that it will need to raise new common
stock this year. Its investment bankers anticipate that the total
flotation cost will equal to 10% of the amount issued. Assume the
company accounts for flotation costs by adjusting the cost of
capital
• Given this information, calculate the cost of newly issued stocks.
COST OF COMMON STOCKS EQUITY
Capital Asset Pricing Model

Capital Asset Pricing Model indicates that the cost

of common stock equity is the return required by
investors as compensation for the firm’s nondiversifiable
risk or systematic risk, measured by beta.
COST OF COMMON STOCKS EQUITY
Capital Asset Pricing Model

R = RF + Beta adjusted risk premium

R = RF + ß(MR-RF)

RF = risk free rate of return

MR = Market rate
ß = Beta Coefficient
COST OF COMMON STOCKS EQUITY
Example:

B Company’s stock has a beta coefficient

of 1.4 and its market rate is 12.5% with a risk
free rate of 9%. The company’s flotation cost is
7%. What is the company’s cost of using
ordinary equity in financing capital investment.
COST OF PREFERRED STOCKS

Dividend per share

Market price per share (net)
 COST OF PREFERRED STOCKS
Example:

Heidi Company plans to issue some P100

preferred stock, with an 11% dividend. The stock is
selling on the market for 97 and Heidi must pay
flotation costs of 5% of thee market price. The
company is under the 40% corporate tax rate.
 WEIGHTED
AVERAGE COST
OF CAPITAL
 WEIGHTED AVERAGE OF COST OF
CAPITAL
WACC= C(E)* W(E) + C(D) *
(1-t) * W(D)

C(E)= Cost Of Equity

W(E)= Weight Of Equity
C(D) * (1-t) = After Tax Cost Of Debt
W(D)= Weight Of Debt
WEIGHTED AVERAGE OF COST OF
CAPITAL
MV of Equity
Weight of Equity =
Total MV Of Firms Financing

MV Of Debt
Weight of Debt =
Total MV Of Firms Financing

Total MV Of Financing= MV of Equity +

MV of Debt
 WEIGHTED AVERAGE OF COST OF
CAPITAL
Example:
Nosebleed Corporation went public by issuing 1
million shares of common stock @P25 per share. The
shares are currently trading @P30 per share. Current
risk free rate is 4%, market risk premium is 8% and
the company has a beta coefficient of 1.2.
During last year, it issued 50, 000 bonds of 1, 000
par paying 10% coupon annually maturing 20 years.
The bonds has a yield to maturity of 10.61%. The
bonds are currently trading @P950. The tax rate is
30%. Compute for the WACC
 WEIGHTED AVERAGE OF COST OF
CAPITAL
Example:
• The company’s capital structure is 70% equity, 30% debt
• The yield to maturity on the company’s bonds is 9%
• The company’s year end dividend is forecasted to be P.80 a share
• The company expects that its divided will grow at a constant rate of
9%.
• The company’s stock price is P25
• The company’s tax rate is 40%
• The company anticipates that it will need to raise new common
stock this year. Its investment bankers anticipate that the total
flotation cost will equal to 10% of the amount issued. Assume the
company accounts for flotation costs by adjusting the cost of
capital
• Given this information, calculate the WACC.