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Corporate Financial Management 3e
Emery Finnerty Stowe
Cost of Capital
Learning Objectives
Understand the concept of cost of capital.
Understand the major determinants of ponents of the cost of capital.
Identify the important differences between operating and financial leverage.
Estimate the cost of capital for a capital budgeting project.
Chapter Outline
The Cost Capital
Corporate Valuation
Value and the Risk-Return Trade-off
Leverage
Leverage and Risk Bearing
Chapter Outline
The Weighted Average Cost of Capital
A Potential Misuse of the Weighted Average Cost of Capital
Financial Risk
A Practical Prescription for Estimating a Cost of Capital
Focus on Principles
Risk-Return Trade-Off
Consider the risk of the capital budgeting project when determining the project’s cost of capital.
Time-Value-of-Money
The value that a capital budgeting project will create—its NPV –depends on its cost of capital, its required return.
Valuable Ideas
Look for new ideas to use as a basis for capital budgeting projects will create value.
Focus on Principles
Comparative Advantage
Look for capital budgeting projects that exploit the firm’parative advantage to add value.
Incremental Benefits
Identify and estimate the incremental expected future cash flows for a capital budgeting project.
Focus on Principles
Options
Recognize the value of options, such as the options to expand, postpone, or abandon a capital budgeting project.
Two-Sided Transactions
Consider why others are willing to sell your firm the project.
Signaling
Consider the actions and products petitors.
The Cost of Capital
The Cost of Capital is often misinterpreted.
It is NOT the firm’s historical cost of funds that determines the cost of capital.
The relevant cost is the opportunity cost.
The Cost of Capital
The Cost of Capital is the required return for a capital budget.
It is the opportunity cost of funds tied up in the project.
It is the rate of return at which inv