Class notes
Notes
- Course
- Institution
- Book
Lecturer notes on Financial Mana calculations, concepts and theories.
[Show more]
Connected book
Book Title:
Author(s):
- Edition:
- ISBN:
- Edition:
More summaries for
-
Notes
-
Notes
-
Notes
Seller
Follow
mainluxx
Content preview
STUDY UNIT 4 - COST OF CAPITAL3.1 Cost of Capital
The minimum return that investors require in order to invest in the organisation.
3.2 Sources of Finance
Equity: Through issuing of ordinary shares which gives the investor a stake
in the business
Debit: Contain carrying provisions with regards to interest rate, security
and repayment and may contain restrictive covenants which usually limit
level of risk to which the company is exposed
3.3 Relationship between Risk and Return
The choice between debt or equity depends on:
o Return: Debt is cheaper than equity
o Risk: Debt is riskier than equity
o Control: Debt has less impact on the control of a company than equity
Cost of finance is dependent on
o The prevailing risk-free rate of return (Rf)
o The reward investors demand for the risk they take in advancing funds
to the firm
Risk-Free Rate of Return (Rf)
• It is the minimum rate required by all investors whose returns are certain
and is also called the return on treasury bill or the return on government
gilts (gilt-edged securities)
• It includes compensation for inflation i.e. it is a nominal or money rate
1|Page
, Return on Risky Investments – Equities
• Equity shareholders are paid only after all other commitments have been
met, the order of priority is:
o Secured lenders
o Legally-protected creditors such as tax authorities
o Unsecured creditors
o Preference shareholders
o Ordinary shareholders
Equity shareholders face the greatest risk as level of risk depends on:
o The volatility of company earnings
o The extent of other binding financial commitments
Required Return = Risk-Free Return + Risk Premium
3.4 Components of the Cost of Capital
3.4.1 Cost of new debt (Kd)
• Refers to interest charged on loans
• Loans are of two categories:
o Term loans at a negotiated rate – the quoted rate is related to the
market rate currently charged for similar loans
o Debentures (bonds) at a coupon rate – the rate is determined in terms
of the discount or premium on par value at the time of sale
o Formula 𝑲𝒅 = I(1 –t)
Kd = the cost of capital
I = interest rate payable
t = the marginal tax rate
2|Page
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller mainluxx. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $16.55. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
64438 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now