Cost of Capital Components - Flashcard set - Corporate Finance

Still learning

Cost of Debt

The cost of debt is the effective interest rate that a company pays on its borrowed funds from external sources. It's calculated after tax savings due to interest tax shield.

Cost\,of\,Debt = \frac{Interest\,Expense\,(1 - Tax\,Rate)}{Total\,Debt}

Cost of Preferred Stock

The cost of preferred stock is the dividend expected by preferred stockholders. It's calculated by dividing the preferred stock dividend by the market price of the preferred shares.

Cost\,of\,Preferred\,Stock = \frac{Preferred\,Dividend}{Market\,Price\,of\,Preferred\,Stock}

Cost of Equity

The cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership. It's often calculated using the Capital Asset Pricing Model (CAPM).

Cost\,of\,Equity = Risk\,Free\,Rate + Beta\times(Market\,Rate - Risk\,Free\,Rate)

Weighted Average Cost of Capital (WACC)

WACC is the average rate of return a company is expected to pay its security holders to finance its assets. It's calculated by weighting the cost of each capital component by its proportional weight in the total capital structure.

WACC = \frac{E}{V}\times Re + \frac{D}{V}\times Rd \times (1 - Tc)

Where

E

is the market value of equity,

D

is the market value of debt,

Re

is the cost of equity,

Rd

is the cost of debt,

V

is the total market value (E+D), and

Tc

is the corporate tax rate.

After-Tax Cost of Debt

The after-tax cost of debt takes into account the tax shield provided by interest payments, as interest expense reduces taxable income.

After-Tax\,Cost\,of\,Debt = Rd\times(1-Tc)

Where

Rd

is the cost of debt and

Tc

is the corporate tax rate.

Cost of Retained Earnings

The cost of retained earnings is the return that shareholders expect from the earnings that are retained by the company instead of being paid out as dividends.

Cost\,of\,Retained\,Earnings = Cost\,of\,Equity

Cost of New Equity

The cost of new equity is the return that new shareholders require to invest in the company's equity. It is higher than the cost of retained earnings due to flotation costs.

Cost\,of\,New\,Equity = \frac{D_1}{P_0(1-f)} + g

Where

D_1

is the expected dividend per share next year,

P_0

is the current price per share,

f

is the flotation cost as a percentage of

P_0

, and

g

is the growth rate of dividends.

Marginal Cost of Capital

The marginal cost of capital is the cost of obtaining an additional dollar of new capital, and it typically increases as more and more capital is raised over time.

MCC = \frac{\Delta Total\,Cost\,of\,Capital}{\Delta Capital\,Raised}

Cost of Convertible Bonds

The cost of convertible bonds is the effective rate that the company pays for such debt, considering the option to convert into equity. It's calculated similarly to other bonds but may include a premium for the conversion feature.

Cost\,of\,Convertible\,Bonds = \frac{Annual\,Interest\,(1 - Tax\,Rate)}{Market\,Value\,of\,Convertible\,Bonds}

Cost of Warrants and Options

The cost of warrants and options is the theoretical cost associated with issuing these instruments, as they potentially dilute existing shareholders' value.

Cost\,of\,Warrants\,and\,Options = (Potential\,Dilution\,Effect) \times (Cost\,of\,Equity)

Cost of Non-Convertible Debt

The cost of non-convertible debt is the interest rate paid on debt securities without a conversion feature. It's the yield required by the market for assuming the risk of the debt instrument.

Cost\,of\,Non-Convertible\,Debt = \frac{Annual\,Interest\,(1 - Tax\,Rate)}{Net\,Proceeds\,from\,Debt}

Cost of Term Loans

The cost of term loans is the annual interest rate paid on bank loans or other long-term loans. The after-tax cost is used given the tax deductibility of interest payments.

Cost\,of\,Term\,Loans = \frac{Annual\,Interest\,(1 - Tax\,Rate)}{Amount\,Borrowed}

Cost of Bond Debt

The cost of bond debt is the interest rate paid on long-term bond issuances. It's determined by the coupon rate, market price and the yield to maturity of the bond.

Cost\,of\,Bond\,Debt = Yield\,to\,Maturity\,\times\,(1 - Tax\,Rate)

Cost of Short-Term Debt

The cost of short-term debt refers to the interest rate applied to short-term borrowing like commercial paper or a credit line. The cost adjusts for taxes as interest is tax deductible.

Cost\,of\,Short-Term\,Debt = \frac{Annual\,Interest\,(1 - Tax\,Rate)}{Proceeds\,from\,Short-Term\,Debt}

Cost of Leases

The cost of leases is the implicit interest rate in lease agreements. Leasing is an alternative to buying assets and often represents a fixed financial obligation similar to debt.

Cost\,of\,Leases = Implied\,Interest\,Rate\,in\,Lease\,Payments

Cost of Accounts Payable and Accruals

The cost of accounts payable and accruals often is considered zero since they are a form of spontaneous, interest-free financing, although opportunity costs or discounts for early payment might imply an implicit cost.

Cost\,of\,Accounts\,Payable\,and\,Accruals = 0

In some cases, an implicit cost is calculated based on missed discounts or terms of payments.

Cost of Factoring Receivables

The cost of factoring receivables is the cost associated with selling accounts receivable to a factor at a discount from their face value.

Cost\,of\,Factoring\,Receivables = \frac{Annual\,Cost}{Net\,Proceeds\,from\,Factored\,Receivables}

Cost of Commercial Paper

The cost of commercial paper involves the interest rate or discount at which it is issued. It represents short-term unsecured debt issued by corporations.

Cost\,of\,Commercial\,Paper = \frac{Face\,Value - Issued\,Price}{Issued\,Price} \times \frac{365}{Term\,of\,Paper}

Cost of Mezzanine Financing

The cost of mezzanine financing, which combines debt and equity characteristics, is usually higher than senior debt due to its higher risk and subordinated position in the event of liquidation.

Cost\,of\,Mezzanine\,Financing = \frac{Annual\,Interest\,\plus\,Potential\,Equity\,Upside}{Total\,Mezzanine\,Capital\,Provided}

Cost of Asset-Backed Securities

The cost of asset-backed securities (ABS) involves interest and other expenses related to the securitization of assets like receivables, loans, or other financial assets.

Cost\,of\,Asset-Backed\,Securities = \frac{Annual\,Interest\,Expense}{Net\,Proceeds\,from\,Securitization}

Cost of Project Financing

Project financing cost reflects the required return for investors on funds used to finance a specific project. It often includes a risk premium due to the project's unique risks.

Cost\,of\,Project\,Financing = Project\,Specific\,Discount\,Rate

Cost of Crowdfunding

The cost of crowdfunding includes not just the monetary cost but also the cost of rewards or equity given away as part of the fundraising effort.

Cost\,of\,Crowdfunding = \frac{Total\,Rewards\,or\,Equity\,Given}{Amount\,Raised}

Know

Discover published sets by community