Chap. 11 The cost of Capital MA0N0239 Yu Muramatsu

 The rate of return that a firm must earn on the projects in which it invests to maintain the market value of its stock  The rate of return required by the market suppliers of capital to attract their funds to the firm Cost of capital

1.Business Risk the firm’s acceptance of a given project does not affect its ability to meet operating cost 2.Financial Risk projects are financed in such a way that the firm’s ability to meet required financing cost is unchanged 3.After-tax costs are considered relevant measured on an after-tax basis Key assumptions

 Because of terrorist attack in Sep and economic difficulties, UAL lost $2.14 billion in  UAL Corporation filed for Chapter 11 bankruptcy protection in Dec United Airlines

 Restructuring  UAL received offers of subscription for more than twice the capital necessary to support the $3 billion it sought.  UAL was able to reduce its financing costs by 75 basis points(0.75%) United Airlines (Cont.)

 UAL was able to restructure its $3 billion debt  Because of oversubscription of the refinancing, UAL made its financing costs lower  The new loan was set at 200 basis points (2.00%) over LIBOR, a reduction of 175 basis points (1.75%) from the original financing cost  The lower pricing is expected to result in net pre- tax savings of approximately $70 million per year United Airlines (Cont.)

 UAL was able to meet its capital needs primarily from operating activities and the issuance of debt  Companies will strive to meet some desired mix of debt and equity capital financing to raise its capital Conclusion

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