HO 9 Where we’ve been...

Cost of Capital
„ Financial Performance
„ Time value of money
„ Stocks and Bonds
„ The Investment Decision
(Capital Budgeting)

The investment decision

Where we’
we’re going...

„ The financing decision

Assets Liabilities & Equity Cost of capital
Current assets Current Liabilities
Leverage
Capital Structure
Fixed assets Long-
Long-term debt
Preferred Stock The Dividend Decision
Common Equity Working Capital

The financing decision

Assets Liabilities & Equity Assets Liabilities & Equity

Current assets Current Liabilities Current assets Current Liabilities

Fixed assets Long-

Long-term debt } Long-
Long-term debt
Preferred Stock Capital Structure Preferred Stock
Common Equity Common Equity

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 Cost of Capital How can the firm raise capital?

„ For Investors the rate of return on „ Bonds

a security is a benefit of investing. „ Preferred Stock

„ For Financial Managers that same „ Common Stock

rate of return is a cost of raising „ Each of these offers a rate of return to

funds that are needed to operate investors.

the firm. „ This return is a cost to the firm.
„ “Cost of capital”
capital” actually refers to the
„ In other words, the cost of raising
weighted cost of capital - a weighted
funds is the firm’
firm’s cost of capital.
capital.
average cost of financing sources.

The Weighted Cost of Capital Cost of Debt

„ To calculate the firm’

firm’s weighted
For the issuing firm, the cost of debt is:
cost of capital, we must first
„ the rate of return required by
calculate the costs of the individual
financing sources: investors,
„ adjusted for flotation costs (any costs
„ Cost of Debt
associated with issuing new bonds),
„ Cost of Preferred Stock
and
„ Cost of Common Stock
„ adjusted for taxes.

Example: Tax effects Example: Tax effects

of financing with debt of financing with debt
with stock with debt with stock with debt
EBIT 400,000 400,000 EBIT 400,000 400,000
- interest expense 0 (50,000) - interest expense 0 (50,000)
EBT 400,000 350,000 EBT 400,000 350,000
- taxes (34%) (136,000) (119,000) - taxes (34%) (136,000) (119,000)
EAT 264,000 231,000 EAT 264,000 231,000
- dividends (50,000) 0
„ Now, suppose the firm pays $50,000 in dividends Retained earnings 214,000 231,000
to the stockholders.

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 After-
After-tax cost Before-
Before-tax cost Tax After-
After-tax Before-
Before-tax Marginal
= -
of Debt of Debt Savings
Savings % cost of =
Debt
% cost of
Debt
x 1- tax
rate

33,000 = 50,000 - 17,000

OR Kd = kd (1 - T)
33,000 = 50,000 ( 1 - .34)
.066 = .10 (1 - .34)
Or, if we want to look at percentage costs:

Example: Cost of Debt „ Pre-

Pre-tax cost of debt:
debt:
„ Prescott Corporation issues a $1,000
950 = 100(PVIFA 20, kd) + 1000(PVIF 20, kd)
par, 20 year bond paying the market using the calculator,
rate of 10%. Coupons are annual. The kd = 10.61%. So, a 10% bond
bond will sell for par since it pays the costs the firm
market rate, but flotation costs amount
„ After-
After-tax cost of debt:
debt: only 7% (with
to $50 per bond.
Kd = kd (1 - T) flotation costs)
„ What is the pre-
pre-tax and after-
after-tax cost of Kd = .1061 (1 - .34) since the interest
debt for Prescott Corporation? Kd = .07 = 7% is tax deductible.
deductible.

Cost of Preferred Stock Cost of Preferred Stock

„ Recall:

„ Finding the cost of preferred stock is D Dividend

similar to finding the rate of return, kp = =
Po Price
except that we have to consider the
flotation costs associated with issuing „ From the firm’
firm’s point of view:
preferred stock.
D Dividend
kp = =
NPo Net Price

NPo = price - flotation costs!

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 Example: Cost of Preferred Cost of Preferred Stock

„ If Prescott Corporation issues

D Dividend
preferred stock, it will pay a kp = =
NPo Net Price
dividend of $8 per year and should
be valued at $75 per share. If
flotation costs amount to $1 per 8.00
= 74.00 = 10.81%
share, what is the cost of preferred
stock for Prescott?

Cost of Common Stock Cost of Internal Equity

„ There are 2 sources of Common Equity:
1) Internal common equity (retained
earnings), and
2) External common equity (new
common stock issue)
„ Since the stockholders own the firm’
firm’s
retained earnings, the cost is simply the
stockholders’
stockholders’ required rate of return.
„ Why?
„ If managers are investing stockholders’
stockholders’
funds, stockholders will expect to earn
an acceptable rate of return.

Do these 2 sources have the same cost?

Cost of Internal Equity Cost of External Equity

1) Dividend Growth Model Dividend Growth Model

D1 D1
Kc = +g knc = +g
Po NPo

2) Capital Asset Pricing Model (CAPM) Net proceeds to the firm

after flotation costs!
kc = krf + B ( km - krf )

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 Weighted Cost of Capital
Weighted Cost of Capital

„ The weighted cost of capital is just

the weighted average cost of all of
the financing sources. Capital
Source Cost Structure
debt 6% 20%
preferred 10% 10%
common 16% 70%

Weighted Cost of Capital

(20% debt, 10% preferred, 70% common)
Schedule Marginal Cost of Capital
„ MCC Æbiaya memperoleh rupiah tambahan sebagai modal
baru.
baru. Umumnya , biaya marginal modal akan meningkat
„ Weighted cost of capital = sejalan dengan meningkatnya penggunaan modal
.20 (6%) + .10 (10%) + .70 (16) „ karena menggunakan saham biasa baru lebih mahal,
mahal,
perusahaan pada umumnya menggunakan laba di tahan
= 13.4% sebanyak mungkin.
mungkin. Jika kurnag baru menggunakan saham
biasa baru
„ Titik dimana MCC naik disebut Break Point
BP = Jumlah Laba ditahan
Bag. modal sendiri dlm struktur modal
„ Selain Laba di tahan dan saham biasa baru,
baru, perusahan juga
dapat memanfaatkan cadangan depresiasi

Contoh Soal Jawab :

„ Suatu perusahaan membutuhkan modal baru sebanyak 500 jt.
Struktur modalyang hendak dicapai adalah 60% modal sendiri
dari common equity, 30% bond dan 10% prefered stock, Tarif
pajak 40%. Cost of debt before tax 14% dan cost of prefered
stock 12,6%. Perusahaan berharap dapat menahan laba sebesar
100 jt. Cost of internal equity 16%, cost of external equity
16,8%.

Hitung :
- WACC
- Bagaimana cara pemenuhan modal perusahaan?
perusahaan? Apakah
semua modal sendiri dapat dibiayai dari internal equity?
- gambarkan schedule of MCC
- gambarkan schedule of MCC jika diperkirakan bahwa biaya
depresiasi untuk periode yang direncanakan adalah 15 jt

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