Financial Management Accounting: Cost of Capital (Including WACC)

Introduction to Cost of Capital00:00:00

The session introduces the cost of capital in the context of long-term budgeting. It defines the cost of capital as the minimum rate of return a firm must earn on investments to satisfy its debt and equity providers.

Importance and Hurdle Rate00:03:19

Discusses the concept of the 'hurdle rate,' which is the minimum acceptable return on new investments. It explains how returns above this rate create value, while those below destroy it, and highlights why businesses must use current market costs for calculations.

Sources of Long-term Funds00:08:55

Covers the three primary sources of long-term funding: debt (K sub D), preferred stock (K sub P), and common equity (including retained earnings and new common stock). It explains the tax shield benefit associated specifically with debt.

Calculating Component Costs00:12:03

Detailed breakdown of calculating the cost of debt (after-tax), cost of preferred stock (including flotation costs), and cost of common equity using both the Dividend Growth Model and the Capital Asset Pricing Model (CAPM).

Weighted Average Cost of Capital (WACC)00:34:52

Explains how to calculate the WACC by assigning weights to different funding sources. It emphasizes that retained earnings should be exhausted before issuing new common stock because of the added flotation costs associated with new shares.

Practical Application and Examples00:38:14

Walkthrough of comprehensive examples illustrating how to determine the cost of capital for specific financing scenarios, calculate the WACC, and adjust calculations based on market value versus book value.