6.3 Cost of Capital-New

Question 1

Marginal Cost of Capital MCC

Definition

Answer 1

The WEIGHTED AVERAGE cost to the firm of the NEXT dollar of NEW capital after Internal Sources

*Each dollar RAISED becomes more expensive as investors demand higher returns to compensate for Risk

Question 2

Cost of NEW CAPITAL (External Capital)

definition

Answer 2

Ratio of what firm must pay to what firm gets

Debt:
Annual Interest / NET Issue Proceeds
* as taxes rises, makes debt more attractive

PREFERRED STOCK:
NEW issues involve FLOTATION COSTS which reduce NET PROCEEDS. Raising cost of capital.
NEXT DIVIDEND/ NET issue Proceeds.

COMMON STOCK:
(NEXT DIVIDEND/NET ISSUE PROCEEDS0 + Dividend growth RATE
* stockholders will demand increasing dividends over time.
*mostly young, growing issue new stock. Not Mature because of issue costs and depressing influence on stock’s price.