How can the firm raise capital? Bond Preferred stock Common stock Each of these offers a rate of return to investors This return is a cost to the firm “ Cost of capita” actually refers to the weighted cost of capital-a weighted average cost of financing sources
How can the firm raise capital? • Bonds • Preferred Stock • Common Stock • Each of these offers a rate of return to investors. • This return is a cost to the firm. • “Cost of capital” actually refers to the weighted cost of capital - a weighted average cost of financing sources
OAN DEPT Cost of Debt
Cost of Debt
Cost of Debt For the issuing firm, the cost of debt is: the rate of return required by investors, adjusted for flotation costs (any costs associated with issuing new bonds), and adiusted for taxes
Cost of Debt For the issuing firm, the cost of debt is: • the rate of return required by investors, • adjusted for flotation costs (any costs associated with issuing new bonds), and • adjusted for taxes
Example: Tax effects of' financing with debt with stock with debt EBIT 400,000 400,000 interest expense 0 50,000 EBT 400.000 350000 taxes (34%) (136,000119,000 EAT 264,000 231,000
Example: Tax effects of financing with debt with stock with debt EBIT 400,000 400,000 - interest expense 0 (50,000) EBT 400,000 350,000 - taxes (34%) (136,000) (119,000) EAT 264,000 231,000
Example: Tax effects of' financing with debt with stock with debt EBIT 400,000 400,000 interest expense 0 50,000 EBT 400.000 350000 taxes (34%) (136000(119,000 EAT 264,000 231,000 Now, suppose the firm pays $50,000 in dividends to the stockholders
Example: Tax effects of financing with debt with stock with debt EBIT 400,000 400,000 - interest expense 0 (50,000) EBT 400,000 350,000 - taxes (34%) (136,000) (119,000) EAT 264,000 231,000 • Now, suppose the firm pays $50,000 in dividends to the stockholders