FIN 370 Week 4 DQ 8 -
The cost of capital for a firm is a weighted average of the required returns of the securities that are used to finance the firm. Determining the weighted average cost of capital for a firm involves a three-step process. First, the firm's capital structure is defined. Second, the cost of each component's sources of financing is estimated. Third, the cost of each component is weighted by its percent in the firm's capital structure. If a firm has multiple divisions with different risk level, the weighted-average cost of capital is adjusted to reflect the risk characteristics of each particular unit.
A. The Weighted-Average Cost of Capital (WACC) is a weighted average of the required returns of the securities that are used to finance the firm.
B. A three-step procedure is used to estimate the WACC.
1. Define the firm's capital structure.
2. Estimate the opportunity cost of each of the sources of financing.
3. Calculate the weighted average of the costs of each source of financing.
How do we estimate the Cost of Individual Sources of Capital? i.e. What are the individual sources of capital? i.e. preferred stock dividends are not tax deductible.........