Weighted Average Cost of Capital: Capital Budgeting Decisions

Chapter 9 Cost of Capital 1. What is the WACC? a. Weighted Average Cost of Capital- most firms employ different types of capital, and because of their differences in risk, the difference securities have different required rates of return. Typically=debt, preferred stock and common equity. 2. What precautions must we take when measuring the WACC to use for capital budgeting decisions (future investment)? b. The company’s current and recent past book and market value structures. As well as rates of returns. 3. What do we mean by "target capital structure"? (this is in the Web appendix to Ch. 11) 4. What is the "marginal cost of capital"? 5. Know how to calculate the cost of debt, before and after taxes, and then also including flotation costs. 6. Know how to calculate the cost of common stock using the Gordon growth model (the DCF method) and the CAPM, and how to adjust the Gordon model for flotation costs. 7. Know how to calculate the cost of preferred stock, with and without flotation costs. 8. Know how to calculate the market value weights for the WACC. 9. Explain how we adjust a project's WACC for risk. 10. Understand the issues which arise when using the CAPM for calculating the cost of equity. 11. Be able to measure the cost of retained earning, and also be able to explain why retained earnings have a cost. 12. Understand the relationship between asymmetric information and flotation costs. 13. Understand the "Optimal Capital Structure" discussion in Web Extension 11B from the 12th Edition, posted on WebCT for everyone 14. Calculate the retention growth rate. 15. Understand how the WACC is used for analyzing different divisions and projects within a firm. 16. 13th Edition: be able to work problems 1-8 and 10-17 in the chapter.

Basics of Capital Budgeting
(Chapter 10 in 13th Edition; Ch. 11 in 12th) 1. Be able to explain and calculate the following capital budgeting