FIL 240 Lecture15Outline of Current Lecture I. Component Costs of Capitala. Debtb. Preferred Stockc. Common StockII. Marginal Cost of Capital (MCC)a. Optimal Capital Structureb. WACC GraphCurrent LectureThe Cost of CapitalI. Component Costs of Capitala. Debti. Tier 1, Tier 2… ii. Interest is a tax shieldiii. DATk = dk(1-T) iv. T=tax ratev. Bank wants 8%; your company is in the 20% marginal tax bracket. 1. DAT = 8% (1-.20) = 6.4%vi. Megacorp is in the 35% marginal tax bracket1. DAT = 8% (1-35) = 5.2%vii. Bigger companies are taxed less than smaller companies1. Wealthy family – dAT = 6.99% (1-.34) = 4.61%2. Poor family – dAT = 6.99% (1-.15) = 5.94%b. Preferred Stocki. Discount rate for preferred stock: Pp = D/Kpii. Cost of preferred stock – Kp = D/Ppc. Common Stocki. Cost of existing common stock: Ks = (D1/P) + gii. Cost of new common stock: KN = (D1/(P-F)) + giii. F = Float (How much they’ll charge to sell the stock)1. 15% - $8mil2. 16% - $2mil3. 12% - $5milThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.4. 10% - $5mil capital5. 12% - $4mil capital6. 17% - $Unlimited capitaliv. If the last dollar costs more than the return on the whole project, you don’t start the project. The last dollar is all that matters. II. MMC – Marginal Cost of Capital (step graph)a. Optimal Capital Structure – combination of debt & equity with the lowest weighted average cost of capital
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