Weighted average - generally used in finding the required rate of return since firms

seldom use equal amounts of debt and equity capital resources

Capital components investor-supplied items like debt, preferred share, and

ordinary shares

Minimum rate of return required cost of debt required by the suppliers of debt

Before-tax cost of debt interest rate a firm must pay on its new debt

After-tax cost of debt should be used to calculate the WACC; interest rate on new
debt less the tax savings that result because interest is tax deductible

Yield to maturity on outstanding debt reflects current market condition; better

measure of the cost of debt than the coupon rate

Before-tax cost of debt issue rate of return that equates the present value of the
future interest payments and principal payment with the net proceeds from the sale
of bond

Before-tax cost of a bond issue cost to maturity or yield to maturity

Preferred share hybrid security that has characteristics of both debt and equity

Ordinary equity share does not represent a contractual obligation to make specific
payments

Retained earnings portion of accumulated after-tax profits that the firm has not
distributed and therefore is reinvested in itself

CAPM most widely used method for estimating the cost of ordinary equity

Bond yield plus risk premium approach closely held companies where reliable
inputs for CAPM are not available

Bond yield plus risk premium generalized risk premium

Base rate rate on treasury bonds or the rate of the firms own bonds

Dividend yield plus growth rate approach both the price and the expected rate of
return on an ordinary equity share depend ultimately on the shares expected cash
flows

Discounted cash flow approach considers not only the dividend yield but also a
capital gain for a total expected return

Earnings-price ratio method simplistic technique used to estimate the cost of

ordinary equity
Constant growth model for new ordinary equity shares generally used in
measuring cost of ordinary equity shares; dividends grow at constant annual rate

Underpricing occurs when new ordinary equity share sells below the current
market price of outstanding ordinary equity share

Underwriting fee covers the cost of marketing the new issue

Historical growth rates estimates of g are based on

Retained earnings breakpoint total amount of capital that can be raised before
new shares must be issued

Historical weights based on the firms existing capital structure

Optimal capital structure combination of debt and equity that simultaneously

maximizes the firms market value and minimizes WACC

Book value weights book value weights measure the actual proportion of each
type of permanent capital based on the firms balance sheet; may misstate the
WACC

Market value weights measure the actual proportion of each of permanent capital
in the firms structure at current market price

Target weights based on the firms desired capital structure

Both to help identify the discount rate to be used in evaluating capital budgeting
projects and to help establish the firms optimal capital structure The cost of
capital may be used to _

Short-term debt Which of the following is generally excluded in estimating WACC

Debt the source capital that has a special tax advantage to the firm

Ordinary equity share which of a firms sources of new capital has the highest
after-tax cost

All of the given choices specific costs of capital may vary over time due to
changes in

The preferred share dividend divided by the net proceeds the cost of new
preferred share is equal to

The current market price plus expected growth rate in dividends when the
constant dividend growth model is used, the cost of retained earnings equals _

All of the given choices which of the following can be used to estimate the cost of
ordinary equity
Break point in developing a weighted marginal cost of capital schedule, the levels
at which a specific cost of capital increases are called

All the projects typify the firms overall or average risk using the intersection rate
of IOS and WMCC schedules as the discount rate for all proposed capital budgeted
projects is approporate if _

Ch 28