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we shall have an example about cost of capital In the next video.

Yo welcome to my channel in this video we shall be talking about cost of capital cost of capital is the last sub-topic and the financing decision which is a sub-topic in financial management cost of capital refers to that required return necessary to make a capital budgeting project such as building a new factory it’s it refers to the cost of equity for

Is financed through equity or it refers to a cost of debt if a business is financed through a debt the cost of equities dividends it means that the return for equity is dividends and under equity we have things like ordinary shares or common stock then we have preference shares where we have both the redeemable and irredeemable preference shares then we have

Retained earnings or results and then the cost of debt the return to debt is interest and under that we have loan bond bonds bonds we have both the redeemable and irredeemable bonds when we are calculating cost of capital we need to first calculate for the specific cost of capital in order for us to know the cost of each source of capital the specific cost of

Each source of capital and let’s start with cost of equity under equity we said we have ordinary shares or common stock so the formula for specific cost of ordinary shares we have d out of into brackets p minus f plus g where d is the dividends p is the market value f is the flotation costs and g is the growth rate but where the growth rate is zero and the no

Flotation costs the formula for cost of ordinary shares is d out of p plus g under equity we also have retained earnings and the formula for calculating specific cost of retained earnings is d out of p naught plus g where d is dividends p note is the market value and g is the growth rate under eqt we have preference shares preference shares we shall start with

The irredeemable preference shares and the formula is b out of p note where id is dividends and p naught is the market value there is also redeemable preference shares and the formula for specific cost of redeemable preference shares is d plus one out of n into brackets f naught minus p naught out of a half into brackets f naught plus p naught where k p is the

Cost of redeemable preference shares and d is dividends n is period in years f naught is the first value and p naught is the market value then let’s look at the cost of debt and the cost of that we have bank loan and bank loan we have cost of debt the formula is cost of debt equals to interest into brackets one minus t whereby kd is the cost of debt for a bank

Loan and int is the interest rate and t is the tax rate and under cost of that we also have a bond and a bond is both irredeemable and redeemable so we shall first look at the irredeemable bond and the formula is kd equals to int out of p naught times 1 minus t where kd is the cost of debt for an irredeemable bond and and int is the interest rate p naught is

The market value and t is the tax rate then for a redeemable bond the formula is interest plus 1 out of n into brackets f not minus p naught out of a half into brackets f naught plus p naught times one minus t whereby k d is the cost of debt for that redeemable bond int is the interest rate n is period in years f naught is the first value or the nominal value

And p naught is the market value t is the tax rate when we are calculating for the cost of debt we always multiply by one minus t we subtract the tax rate because debt is not taxed it has that shield advantage the reason why we always multiply by one minus t after calculating for the specific cost of capital the next thing we shall do is to calculate for the

Overall cost of capital so we shall draw a table to help us get the overall cost of capital we shall have five columns the column of sources the sources of capital who like bonds ordinary shares preference shares reserves and then the total then we shall have the column of amount which shows that amount of each source of capital and then we shall have proportion

Proportion in order for us to get proportion we shall divide amount divided by the total in order for us to get a proportion for each source of capital we shall have the column for specific cost of capital it’s what we been looking at then we shall have the column of the weighted average cost of capital the overall cost of capital that we are looking for and we

Get it by multiplying proportion times the specific cost of capital thanks for watching don’t forget to subscribe like comment share with your friends and watch my next video we shall have one example about cost of capital

Transcribed from video

cost of capital, both debt and equity (financing decision, financial Management) By NAISHA ACADEMY