Unit 1287: Cost of Capital

1. Introduction to Cost of Capital

• Definition and significance
• Role in financial decision-making
• Sources of financing: equity, debt, and others
• Basic calculation principles

2. Weighted Average Cost of Capital (WACC)

• Definition and purpose
• Components of capital structure
• Formula for WACC calculation
• Importance of capital structure weights
• Examples and practice calculations

3. Cost of Equity

3.1 Capital Asset Pricing Model (CAPM)

• Concept and assumptions
• Formula: Cost of Equity = Risk-free rate + Beta × Market Risk Premium
• Interpretation of Beta
• Limitations and considerations

3.2 Dividend Discount Model (DDM)

• Concept and assumptions
• Formula: Cost of Equity = (Dividend / Current Share Price) + Growth Rate
• When to use DDM
• Limitations and practical examples

4. Cost of Debt

• Definition and significance
• Yield to Maturity (YTM) as a measure
• Calculation of after-tax cost of debt
• Impact of tax shield on cost of debt
• Examples illustrating cost of debt calculations

5. Risk and the Cost of Capital

• Types of risk: business risk, financial risk, market risk
• How risk affects required rate of return
• Risk-return tradeoff
• Adjusting cost of capital for risk factors
• Case examples

6. Marginal Cost of Capital

• Definition and concept
• Difference between marginal and average cost of capital
• Role in investment decisions and capital budgeting
• Graphical representation and interpretation

7. Optimal Capital Structure

• Definition and objectives
• Trade-off theory: balancing tax shields and financial distress costs
• Factors influencing optimal capital structure
• Impact on WACC and firm value
• Practical considerations and examples

8. Real-World Applications of Cost of Capital

• Investment appraisal and project evaluation
• Capital budgeting decisions
• Valuation of business and projects
• Case studies illustrating corporate use of cost of capital
• Strategic decision-making based on cost of capital

Summary and Review:

• Recap of key concepts
• Q&A session
• Practice exercises