COST OF CAPITAL FORMULAS

Before-tax cost of debt

(approximation):

$ 1,000N d
2
rd =
N d + $ 1,000
2

After-tax cost of debt:

r i=r d (1T )

I+

r p=

Dp
Np

Cost of common stock

equity:
Using constantgrowth valuation
model:
Using CAPM:

rs =

D1
+g
P0

Cost of retained earnings:

r r =r s

Cost of new issues of

common stock:

r n=

Cost of preferred stock:

Weighted average cost of

capital (WACC):
Break point:

b (r mR F )
r s =RF +

D1
+g
Nn

r a= ( wi r i ) + ( w p r p ) +( ws r r n)
BP j=

AF j
wj

Definitions of Variables
AFi = amount of funds available
from financing source j at a given
cost
b = beta coefficient or a measure
of nondiversifiable
BPj = break point for financing
source j
D1 = per-share dividend expected
at the end of year 1
Dp = annual preferred stock
dividend (in dollars)

g = constant rate of growth in

dividends
I = annual interest in dollars
n = number of years to the
bonds maturity
Nd = net proceeds from the sale
of debt (bond)
Nn represent the net proceeds
from the sale of new common
stock
Np = net proceeds from the sale
of the stock

P0 = value of common stock

rr = cost of retained earnings

rs = required return on common
stock

RF = risk-free rate of return

ra= weighted average cost of
capital
rd = before-tax cost of debt

T = firms tax rate

wp = proportion of preferred
stock in capital structure

ri =after-tax cost of debt

rm = market return; return on the
market portfolio of assets

wi = proportion of long-term debt

in capital structure
ws = proportion of common stock
equity in capital structure
wi + wp + ws = 1.0

rn = cost of a new issue of

common stock
rp = cost of preferred stock

WORKING CAPITAL MANAGEMENT

FORMULAS
Net working capital = Current assets (Payables+ Accruals)
Inventory Conversion Period + Average Collection Period
Payable Deferral Period = Cash Conversion Cycle
Inventory + Accounts receivable - Accounts payable =
Resources invested
Inventory conversion period=

Inventory
Cost of Goods Sold per day

Cost of short-term financing + Cost of long-term financing Earnings on surplus balances = Total cost of aggressive
strategy
Mathematical Development of EOQ
Order cost = O x (S Q)
Carrying cost = C x (Q 2)
Total cost = [O x (S Q)] + [C x (Q 2)]
ECQ=

S = usage in units per period

O = order cost per order

2 S Q
C

Q = order quantity in units

C = carrying cost per unit

per period

EOQ = order quantity that

minimizes the total inventory
cost.

Reorder point = Days of lead time X Daily usage

ACCOUNTS RECEIVABLE
Total variable cost
of annual sales
Average investment accounts receivable=
Turnover of
accounts receivable
Turnover of accounts receivable=
Average collection period=

365
Average collection period

Accounts Receivable
Sales per day

Average investment under proposed plan - Average investment

under present plan =
Marginal investment in accounts receivable X Cost of funds tied
up in receivables =
Cost of marginal investment in A/R
Under proposed plan - Under present plan =Cost of marginal
bad debts
ACCOUNTS PAYABLE
Payablesdeferral period=

Cost of givingup cash discount=

Payables
Payables
=
Purchases per day Cost of goods sold /365

CD
365

100 CD N

CD = stated cash discount in

percentage terms

N =number of days that

payment can be delayed by
giving up the cash discount

Approximate cost of giving up cash discount =CD

Nominal annual cost of trade credit=

Effective Annual Rate=

365
N

Discount
x
100Discount

365
Days credit is
outstanding
D iscount Period

Interest
Amount borrowed

Effective Annual Ratefor a discount loan=

Simple Interest Rate per day =

Approximate Annual Rate=

Interest
Amount borrowed
Interest

Nominal Rate
DaysYear

Interest paid
Amount received/2

(Daysmonth)
( perRateday )( Amount
of loan )

Interest charge for month=

CAPITAL ASSET PRICING METHOD