Management Accounting Ch10 -Qs & As(stock holders Equity-Test Banx.doc.pdf

Section 1 Introduction to Cost of Capital 2Should We Concern About Short Term Obligations?  No!!!  Only non seasonal debts with explicit interest costs should be considered;  Payables, accruals and other obligations with similar nature are excluded;  In addition maturity hedging approach requires to achieve a match between duration of investment and the debt; 5Should We Consider Historical Costs  No!!!  Finance focuses on future cash flows;  The cost of each element in WACC is calculated based on their current market prices; 6Weighted Average Cost of Capital  Weighted average cost of capital is the average after-tax cost of a company’s various capital sources, including common stock, preferred stock, bonds and any other long-term debt;  Therefore, WACC in it’s more general terms is WACC=wdrd(1-t)+wprp+were where wd-proportion of debt rd-=cost of debt t-tax rate wp-proportion of preferred stock rp-cost of preferred stock we-proportion of equity re-cost of equity 7WACC Example Assume that ABC corporation has following capital structure;30% debt,10% preferred stock,60% equity.It’s before tax debt cost is 8%,preferred stock cost is 10% and equity cost is 15%.If tax rate is 40% calculate company’s WACC. Solution WACC=(0.3)(0.08)(1-0.4)+(0.1)(0.1)+(0.6)(0.15)= 11.44% 8