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Corporate Finance

Topic:Cost of Capital

Presented To: Rizwan Hamid

Presented By: M.Hashaam

Roll No. : AM552381Class : MBA (B&F) 4thSemester

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AcknowledgmentFirst of all thanks of Allah who is most

beneficent and the most mercifulwhose blessings are abundant and

favors are unlimited.

It is my pleasure to acknowledge theguidance and support of my subject

Teacher: Mr. Rizwan Hamid for hisendless guidance.

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An AbstractCost of Capital is the marginal cost ofraising funds. This cost is important in

our investment decision making becausewe ultimately want to compare the cost

of funds with the benefits from

investing these funds.Cost of Capital is the companys cost ofusing funds provided by creditors and

shareholders.

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Introduction to Cost of Capital

Cost of Capital is the required rate ofreturn on the various types of

financing. The overall cost of capital isa weighted average of the individual

required rates of return (costs).

Cost of Capital= kx(Wx)x=1

Sn

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Source of Capital

The Cost of Debt

The Cost of Preferred Equity

The Cost of Common Equity

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Cost of Debt

Cost of Debt is the required rate of

return on investment of the lenders

of a company.

ki= kd( 1 - T )

P0=Ij+ Pj

(1 + kd)j

Sn

j =1

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Cost of Preferred Equity

Cost of Preferred Stock is the

required rate of return on

investment of the preferredshareholders of the company.

kP= DP/ P0

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Cost of Common Equity

The Cost of Common Equity, ke, is the

required rate of return on common

stock. Approaches are followings:Dividend Discount Model

Capital-Asset Pricing

Model

Before-Tax Cost of Debt plus Risk

Premium

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Dividend Discount Model

Thecost of equity capital, ke, is the

discount rate that equates the present

value of all expected future dividendswith the current market price of the

stock.

D1 D2 D

(1+ke)1 (1+ke)

2 (1+ke)+ . . . ++P0 =

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Capital Asset Pricing Model

The cost of equity capital, ke, is equated

to the required rate of return in market

equilibrium. The risk-returnrelationship is described by the

Security Market Line (SML).

ke = Rj= Rf+ (Rm- Rf)bj

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Before-Tax Cost of Debt Plus Risk

PremiumThe cost of equity capital, ke, is the sum of the

before-tax cost of debt and a risk premium in

expected return for common stock over debt.

* Risk premium is not the same as CAPM riskpremium

ke = kd+ Risk Premium*

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Conclusion

The cost of capital represents the

overall cost of future financingto the

firmIt is a weighted average of the costs of

the various source of funds available

It represents the minimum acceptable

returnfrom an investment

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RecommendationsI will recommend, That firms

should calculate betas relative to

the world market. If investorsthroughout the world held theworld portfolio, then they can

demand the same return from aninvestment in any where in world.

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Thank You