Principles of Managerial Finance

492 PART 4 Long-Term Financial Decisions

TABLE 11.4 Summary of Key Definitions and Formulas

for Cost of Capital

Definitions of variables

Cost of capital formulas

Before-tax cost of debt (approximation):

kd

I

[Eq. 11.1]

After-tax cost of debt: kikd(1T) [Eq. 11.2]

Cost of preferred stock: kp [Eq. 11.3]

Cost of common stock equity:

Using constant-growth

valuation model: ksg [Eq. 11.5]

Using CAPM: ksRF[b(kmRF)] [Eq. 11.6]

Cost of retained earnings: krks [Eq. 11.7]

Cost of new issues of common stock: kng [Eq. 11.8]

Weighted average cost of capital (WACC):

ka(wiki)(wpkp)(wskr or n) [Eq. 11.9]

Break point: BPjAFwj [Eq. 11.10]

j

D 1



Nn

D^1

P 0

Dp

Np

Nd$1,000

2

$1,000Nd

n

AFjamount of funds available from financing

source jat a given cost

bbeta coefficient or measure of nondiversi-

fiable risk

BPjbreak point for financing source j

D 1 per share dividend expectedat the end of

year 1

Dpannual preferred stock dividend (in

dollars)

gconstant rate of growth in dividends

Iannual interest in dollars

kaweighted average cost of capital

kdbefore-tax cost of debt

kiafter-tax cost of debt

kmrequired return on the market portfolio

kncost of a new issue of common stock

kpcost of preferred stock

krcost of retained earnings

ksrequired return on common stock

nnumber of years to the bond’s maturity

Ndnet proceeds from the sale of debt

(bond)

Nnnet proceeds from the sale of new common

stock

Npnet proceeds from the sale of preferred

stock

P 0 value of common stock

RFrisk-free rate of return

Tfirm’s tax rate

wiproportion of long-term debt in capital

structure

wjcapital structure proportion (historical or

target, stated in decimal form) for financing

source j

wpproportion of preferred stock in capital

structure

wsproportion of common stock equity in

capital structure