Article
David Durand, “The Cost of Capital, Corporation Finance, and the Theory of Investment: Comment”, American Economic Association, Vol. 49, No. 4 (Sep., 1959), pp. 639-655. Purpose of the paper
The focus of this paper is to contradict the results of [Franco Modigliani; Merton H. Miller, “The Cost of Capital, Corporation Finance, and the Theory of Investment: Comment”, American Economic Review, June 1958, 48,261-97] (hereafter MM) assumptions in related to cost of capital theory. Foundations

This paper starts with creating unrealistic four foundations that can’t be found anywhere in the real market, but they are in need to backup the possibility of the main example in this paper, which illustrates MM’s assumptions about Propositions I, and the assumptions are: 1. Arbitrage is possible between securities in an equivalent return class. 2. We have a “Hybrid Firm” that doesn’t fill in the will known company categories; it has marketable securities like a corporation, proration of income like a partnership and allocation of financial responsibility like neither. 3. Exclude risk.

4. Long-run equilibrium.
Petrolease, Leverfund Example
The example starts by presenting two companies, Petrolease which is a fictitious corporation whose business consists in leasing oil properties; it earns $10 per share on the average, all of which it pays out in dividends. Leverfund is a fictitious open-end investment trust, whose assets consist solely of Petrolease shares and operates under the following conditions: 1. Assets consist solely of Petrolease shares

2. 1 share of Petrolease = 1 Share of Stock and $100 bond at Interest rate 0.05 (Enforce the arbitrage). 3. Incurs no expenses and pays out all earnings (No additional costs or any kind of risk) 4. open-end fund (Leverfund assets are tradable in open market) a. Issue 1 share + 1 bond = adding 1 share Petrolease

b. Demand 1 share + 1 bond = subtract 1 share Petrolease 5. No...

...Chapter 10
The Cost of Capital
LEARNING OBJECTIVES
After reading this chapter, students should be able to:
• Explain what is meant by a firm’s weighted average cost of capital.
• Define and calculate the component costs of debt and preferred stock.
• Explain why retained earnings are not free and use three approaches to estimate the component cost of retained earnings.
• Briefly explain why the cost of new equity is higher than the cost of retained earnings, calculate the cost of new equity, and calculate the retained earnings breakpoint--which is the point where new equity would have to be issued.
• Briefly explain the two alternative approaches that can be used to account for flotation costs.
• Calculate the firm’s composite, or weighted average, cost of capital.
• Identify some of the factors that affect the overall, composite cost of capital.
• Briefly explain how firms should evaluate projects with different risks, and the problems encountered when divisions within the same firm all use the firm’s composite WACC when considering capital budgeting projects.
• List and briefly explain the three separate and distinct types of risk that can be identified, and explain the procedure many firms use when developing subjective...

...The Oceanic Corporation
(Determining the Cost of Capital)
Larry Stone wants to estimate the firm’s hurdle rate because it is a benchmark for how well the company needs to do on a project in order to at least break even. The higher the hurdle rate, the riskier the project will have to be and the lower the hurdle rate is, the safer the project will be for a company. A company should strive for a financing mix that minimizes the hurdle rate and matches the assets being financed. If there are not enough investments that earn the hurdle rate or better, then the cash should be given as dividends to the stockholders.
As long as the risk is roughly the same for all divisions and there are no outliers, then it doesn’t matter if Larry uses the weighted average cost of capital or divisional cost of capital. The weighted average cost of capital is an average that reflects each division’s importance to the average by multiplying by a factor.
The cost of debt can be calculated by using the yield to maturity (YTM) as an approximation. Per my calculations, the firm’s cost of debt is 10.84%.
Stephanie’s assumptions are very safe. Her first assumption that new debt would cost about the same as the yield on outstanding debt and would have the same rating is not realistic. It has been five years...

...
The Cost of Capital
Benedict Amanor, Yolanda Brown-McCutchen, Edith Compean, Angel Longino
and Melissa Shea-Brooks
FIN/571
May 18, 2015
William Stokes
The Cost of Capital
In our fifth week of understanding the practices of Corporate Finance, we reviewed the Cost of Capital video. This video provided information on Pfizer, a researched based pharmaceutical company that makes products to help face health care challenges. Our goal is to highlight the cost of capital as described by Amit Singh regarding Pfizer's funds in terms of debt and equity along with using the Capital Asset Pricing Model (CAPM). The Weight Average Cost of Capital (WACC) and how Pfizer uses this method will be reviewed. Additionally, each phase of developing and creating new value added drugs role financially will be addressed.
According to Parrino, Kidwell and Bates (2012), the capital asset pricing model describes the relationship between an associated risk and the expected return on an asset. Pfizer uses the CAPM to determine its cost of capital or the weighted average of the costs of debt and equity held in a company’s capital base. Singh states “standard models for a company’s capital structure focus mainly on tax benefits...

...Solutions to Chapter 12
The Cost of Capital
1. The yield to maturity for the bonds (since maturity is now 19 years) is the interest rate (r) that is the solution to the following equation:
[$80 annuity factor(r, 19 years)] + [$1,000/(1 + r)19] = $1,050
Using a financial calculator, enter: n = 19, FV = 1000, PV = (-)1050, PMT = 90, and then compute i = 7.50%
Therefore, the after-tax cost of debt is: 7.50% (1 – 0.35) = 4.88%
2. r = DIV/P0 = $4/$40 = 0.10 = 10%
3.
= [0.3 7.50% (1 – 0.35)] + [0.2 10%] + [0.5 12.0%] = 9.46%
4.
5. The total value of the firm is $80 million. The weights for each security class are as follows:
Debt: D/V = 20/80 = 0.250
Preferred: P/V = 10/80 = 0.125
Common: E/V = 50/80 = 0.625
= [0.250 6% (1 – 0.35)] + [0.125 8%] + [0.625 12.0%] = 9.475%
6. Executive Fruit should use the WACC of Geothermal, not its own WACC, when evaluating an investment in geothermal power production. The risk of the project determines the discount rate, and in this case, Geothermal’s WACC is more reflective of the risk of the project in question. The proper discount rate, therefore, is not 12.3%. It is more likely to be 11.4%.
7. The flotation costs reduce the NPV of the project by $1.2 million. Even so, project NPV is still positive, so the project should be undertaken.
8. The rate on Buildwell’s debt is 5 percent. The cost of equity...

...Caleb Johnson
Capital Structure Theory
Working Capital Management
Dr. Woodward
10/14/14
Capital Structure Theory
Part a. (Capital Structure)
Capital structure is very important. Not only does it influence the return a company earns for its shareholders but can also be a determining factor on whether or not a firm survives a recession. A company’s capital structure is a mix of their short-term debt, long-term debt, and equity. A firm’s capital structure is the way the firm finances all of its operations, investments, and growth. When a firm’s debt-to-equity ratio maximizes its value and minimizes the firm’s weighted average cost of capital (WACC), it is said to be at the “target” or “optimal capital structure”. Debt usually offers a lower cost of capital because of the ability to deduct tax from interest, but the company’s risk increases as debt increases.
Part b. (Business Risk)
Business risk refers to the risk brought upon the firm by its operations. This can be influenced by many factors such as, cost of production, sales volume, unit price, competition, demand, government regulations, etc. A company with higher business risk should operate with a capital structure that has a lower debt ration to safeguard its...

...is the WACC for Marriott Corporation?
Cost of Debt
Tax Rate
We determined this number by taking income taxes paid/EBITDA = 175.9/398.9 = 44.1%
Return on debt
There are two clear components of debt: fixed and floating.
In order to get the fixed debt rate we took the interest rates on fixed-rate government securities and added the premium above the government rate.
The floating aspect is priced into the premium above the government rate.
We used the 30-year maturity for the cost of debt on Marriott Corp and the Lodging division. We did this because both the Lodging division’s assets and the company have long useful lives.
We used a 10-year maturity for the cost of debt on the Restaurant division. We did this because the useful life of the assets in a restaurant are not as long-term as those in Lodging, but are also not extremely short-term.
We used a 1-year maturity for the cost of debt on the Contract Services division. We did this because the useful life of the assets in this division is very short.
COST OF DEBT | | | | |
Fixed-rate US Government Securities | |
Maturity | Rate | | | | |
30 year | 8.95% | | | | |
10 year | 8.72% | | | | |
1 year | 6.90% | | | | |
| | | |...

...HBR Case #1
Marriott Corporation: The Cost of Capital
Group 16—Tutorial Mon 11:30am
Group members
LIU Ying, Chloe | 1155019350 |
LUO Yingying, Irika | 1155020931 |
TIAN Tian, Sarah | 1155019114 |
WU Jiajie, Jesse | 1155019061 |
17 September 2012
Executive Summary
By 1987, Marriott Corporation had grown into a large multi-dimensional company with over $5 billion assets in lodging, contract services and restaurants. The company enjoyed fast growth in both sales and assets at around 16% per year from 1984 to 1987 and aimed to continue this trend into the near future. The management was determined to develop the company into top players in each line of business and hence an aggressive growth objective has been set. Its financial strategies are in general consistent with its goal and would facilitate fast development in the near future. Company and divisional hurdle rates are computed in this report with various assumptions and references. Below is a table summarizing the financial data.
| Lodging | Contract Services | Restaurant | Marriott Corp. |
Risk-Free Rate (Rf) | 8.72% | 8.72% | 8.72% | 8.72% |
Market Risk Premium (MRP) | 7.43% | 7.43% | 7.43% | 7.43% |
Target D/V | 74% | 40% | 42% | 60% |
Current D/V | - | - | - | 41% |
β leveraged | 0.92 | - | 1.04 | 0.97 |
β unlevered (βu) | 0.53 | - | 0.90 | 0.70 |
β relevered (βl) | 1.37 | 1.09 | 1.27 | 1.29 |
Cost of equity...

...Case #3 “Marriott Corporation” The Cost of Capital”
What is the weighted average cost of capital for the Marriott Corporation and cost of capital for each of its divisions?
– What risk-free rate and risk premium did you use to calculate the cost of equity?
– How did you measure the cost of debt?
– How did you measure the beta for each division?
Solution
What risk-free rate and risk premium did you use to calculate the cost of equity?
– Risk-free rate proxy
The risk-free rate is determined using the yields of U.S. Treasury securities, which are risk-free from default risk. U.S. Treasuries are subject to interest rate risk, therefore, the selected maturity should correspond to an investment horizon[1].
– Investment horizon
According to the cost-of-capital calculation methodology used by Marriott Corporation, lodging division was treated as long-term, while restaurant and contract services divisions were treated as short-term because those assets had shorter useful lives.
– Expected return proxy
Arithmetic average return is more suitable than geometric mean as it is better in estimating an investment’s expected return over a future horizon based on its past performance (geometric mean is a better description of...

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