Chapter 12 Flashcards
cost of capital
The firm’s average cost of funds, which is the average return required by the firm’s investors– what must be paid to attract funds.
required rate of return
The return that must be earned on invested funds to cover the cost of financing such investments; also called the opportunity cost rate.
capital components
The particular types of capital used by the firm– that is, its debt, preferred stock, and common equity.
capital structure
The combination or mix of different types of capital used by a firm.
after-tax cost of debt (rdT)
The relevant cost of new debt, taking into account the tax deductibility of interest.
cost of preferred stock (rps)
The rate of return investors require on the firm’s preferred stock. It’s calculated as the preferred dividend (Dps) divided by the net issuing price (NP).
cost of retained earnings (rs)
The rate of return required by stockholders on a firm’s existing common stock.
cost of new common equity (re)
The cost of external equity; based on the cost of retained earnings but increased for flotation costs.
flotation costs
The expenses incurred when selling new issues of securities.
target (optimal) capital structure
The combination (percentages) of debt, preferred stock, and common equity that maximizes the price of the firm’s stock.
weighted average cost of capital (WACC)
A weighted average of the component costs of debt, preferred stock, and common equity.
marginal cost of capital (MCC)
The cost of obtaining another dollar of new capital; the weighted average cost of the last dollar of new capital raised.
MCC (marginal cost of capital) schedule
A graph that relates the firm’s weighted average cost of each dollar of capital to the total amount of new capital raised.
break point (BP)
The dollar value of new capital that can be raised before an increase in the firm’s weighted average cost of capital occurs.
investment opportunity schedule (IOS)
A graph of the firm’s investment opportunities ranked in order of the projects’ expected rates of return.
