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4. Defining the Cost of Capital Differences Between Required Return and the Cost of Capital Relationship Between Financial Policy and the Cost of Capital The Basics of the Cost of Capital Introduction to the Cost of Capital > The Basics of the Cost of Capital Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance?campaign_content=book_192_section_87&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=dir ect&utm_source=boundless

5. If a project is of similar risk to a company's average business activities, it is reasonable to use the company's average cost of capital as a basis for project evaluation. A company's securities typically include both debt and equity; therefore, one must calculate both the cost of debt and the cost of equity to determine a company's cost of capital. Weighted average cost of capital takes into account the amount of financing that comes through the use of debt and the use of equity. IRR is the rate of return that makes the net present value of all cash flows from an investment equal zero. Defining the Cost of Capital Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-the-cost-of-capital-10/the-basics-of-the-cost-of-capital- 87/defining-the-cost-of-capital-372- 8286?campaign_content=book_192_section_87&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Net Present Value Equation View on Boundless.com Introduction to the Cost of Capital > The Basics of the Cost of Capital

6. Cost of capital refers to the expected returns on all of the various securities issued by a company, often expressed as a weighted average. Required refers to the rate of return necessary to achieve in order to compensate investors for taking on the risk of the individual investment. The risk premium can be established by understanding business risk and financial risk. Differences Between Required Return and the Cost of Capital Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-the-cost-of-capital-10/the-basics-of-the-cost-of-capital- 87/differences-between-required-return-and-the-cost-of-capital-373- 3448?campaign_content=book_192_section_87&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Obtaining Required Return View on Boundless.com Introduction to the Cost of Capital > The Basics of the Cost of Capital

7. As opposed to strictly using cost of capital, decisions must be made using opportunity cost of capital. Opportunity cost of capital is the amount of money foregone by investing in one asset compared to another. Facets of financial policy include valuation, portfolio theory, hedging, and capital structure. Relationship Between Financial Policy and the Cost of Capital Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-the-cost-of-capital-10/the-basics-of-the-cost-of-capital- 87/relationship-between-financial-policy-and-the-cost-of-capital-374- 3449?campaign_content=book_192_section_87&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Oil Prices View on Boundless.com Introduction to the Cost of Capital > The Basics of the Cost of Capital

8. Free to share, print, make copies and changes. Get yours at www.boundless.com Appendix

9. Key terms benchmark A standard by which something is evaluated or measured. capital Money and wealth; the means to acquire goods and services, especially in a non-barter system. leverage The use of borrowed funds with a contractually determined return to increase the ability of a business to invest and earn an expected higher return (usually at high risk). Opportunity cost The cost of an opportunity forgone (and the loss of the benefits that could be received from that opportunity); the most valuable forgone alternative. required return the minimum gain expected by investors Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to the Cost of Capital

10. Net Present Value Equation Equation used to determine net present value, and therefore internal rate of return. DPV = discounted net present value, N = total number of periods in which a cash flow occurs, t = the specific period of the cash flow, FV = the value of the future cash flow, and i = internal rate of return. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Discounted cash flow." GNU FDL http://en.wikipedia.org/wiki/Discounted_cash_flow View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Discounted_cash_flowView on Boundless.com Introduction to the Cost of Capital

11. Oil Prices Companies often use hedging techniques to offset price fluctuations for commodities. The fluctuation of oil prices can be seen in the above graph. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikimedia. "Oil.2001-2005jpg.smaller." CC BY-SA http://commons.wikimedia.org/wiki/File:Oil.2001-2005jpg.smaller.jpg View on Boundless.comCC BY-SAhttp://commons.wikimedia.org/wiki/File:Oil.2001-2005jpg.smaller.jpgView on Boundless.com Introduction to the Cost of Capital

12. Obtaining Required Return The capital asset pricing model is a good representation of how to obtain required return. It adds the risk-free rate to the risk premium of the market adjusted to an investment's beta. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Capital asset pricing model." GNU FDL http://en.wikipedia.org/wiki/Capital_asset_pricing_model View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Capital_asset_pricing_modelView on Boundless.com Introduction to the Cost of Capital

13. IRR Investment Comparison A graph showing the decision between two exclusive investments based on IRR. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Internal rate of return." GNU FDL http://en.wikipedia.org/wiki/Internal_rate_of_return View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Internal_rate_of_returnView on Boundless.com Introduction to the Cost of Capital

14. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to the Cost of Capital The average cost of capital is: A) fixed through time B) the same for all companies C) a benchmark for accepting or rejecting projects. D) all of these

15. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors." CC BY 3.0 http://www.saylor.org/majors/Business/CC BY 3.0http://www.saylor.org/majors/Business/ Introduction to the Cost of Capital The average cost of capital is: A) fixed through time B) the same for all companies C) a benchmark for accepting or rejecting projects. D) all of these

16. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to the Cost of Capital Which of the following explains the differences between a company's required return and its cost of capital? A) Required return measures business risk; cost of capital measures financial risk. B) Required return measures financial risk; cost of capital measures business risk. C) Required return is from the investor's perspective; cost of capital from the company's. D) Required return is from the company's perspective; cost of capital from the investor's.

17. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ Introduction to the Cost of Capital Which of the following explains the differences between a company's required return and its cost of capital? A) Required return measures business risk; cost of capital measures financial risk. B) Required return measures financial risk; cost of capital measures business risk. C) Required return is from the investor's perspective; cost of capital from the company's. D) Required return is from the company's perspective; cost of capital from the investor's.

18. Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to the Cost of Capital A company's cost of capital is used as a tool in relation to which aspect of financial policy? A) Diversifying a company's porfolio B) Hedging a company's investments. C) Evaluating a company's capital structure. D) Valuing projects by discounting cash flows, and then selecting projects with the highest return.

19. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ Introduction to the Cost of Capital A company's cost of capital is used as a tool in relation to which aspect of financial policy? A) Diversifying a company's porfolio B) Hedging a company's investments. C) Evaluating a company's capital structure. D) Valuing projects by discounting cash flows, and then selecting projects with the highest return.

20. Attribution OER Commons. CC BY http://www.oercommons.org/courses/15-414-financial-management-summer-2003/viewCC BYhttp://www.oercommons.org/courses/15-414-financial-management-summer-2003/view Wikipedia. "Cost of capital." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Cost_of_capitalCC BY-SA 3.0http://en.wikipedia.org/wiki/Cost_of_capital OER Commons. CC BY http://www.oercommons.org/courses/management-of-capital/viewCC BYhttp://www.oercommons.org/courses/management-of-capital/view Wikipedia. "Required rate of return." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Required_rate_of_returnCC BY-SA 3.0http://en.wikipedia.org/wiki/Required_rate_of_return Wiktionary. "Opportunity cost." CC BY-SA 3.0 http://en.wiktionary.org/wiki/Opportunity+costCC BY-SA 3.0http://en.wiktionary.org/wiki/Opportunity+cost Wiktionary. "capital." CC BY-SA 3.0 http://en.wiktionary.org/wiki/capitalCC BY-SA 3.0http://en.wiktionary.org/wiki/capital Wikipedia. "Portfolio theory." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Portfolio_theoryCC BY-SA 3.0http://en.wikipedia.org/wiki/Portfolio_theory Wikipedia. "Managerial finance." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Managerial_financeCC BY-SA 3.0http://en.wikipedia.org/wiki/Managerial_finance Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/Opportunity Cost." CC BY-SA 3.0 http://en.wikibooks.org/wiki/Principles_of_Finance/Section_1/Chapter_2/Time_Value_of_Money/Opportunity_CostCC BY-SA 3.0 http://en.wikibooks.org/wiki/Principles_of_Finance/Section_1/Chapter_2/Time_Value_of_Money/Opportunity_Cost Wikipedia. "Hedge (finance) - Wikipedia, the free encyclopedia." CC BY-SA 3.0 http://en.wikipedia.org/w/index.php?title=Hedge_(finance)&printable=yesCC BY-SA 3.0 http://en.wikipedia.org/w/index.php?title=Hedge_(finance)&printable=yes Wikipedia. "Capital structure - Wikipedia, the free encyclopedia." CC BY-SA 3.0 http://en.wikipedia.org/w/index.php?title=Capital_structure&printable=yesCC BY-SA 3.0 http://en.wikipedia.org/w/index.php?title=Capital_structure&printable=yes Wiktionary. "leverage." CC BY-SA 3.0 http://en.wiktionary.org/wiki/leverageCC BY-SA 3.0http://en.wiktionary.org/wiki/leverage Wikipedia. "Internal rate of return." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Internal_rate_of_returnCC BY-SA 3.0http://en.wikipedia.org/wiki/Internal_rate_of_return Wikipedia. "Cost of capital." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Cost_of_capitalCC BY-SA 3.0http://en.wikipedia.org/wiki/Cost_of_capital Wiktionary. "benchmark." CC BY-SA 3.0 http://en.wiktionary.org/wiki/benchmarkCC BY-SA 3.0http://en.wiktionary.org/wiki/benchmark Wiktionary. "capital." CC BY-SA 3.0 http://en.wiktionary.org/wiki/capitalCC BY-SA 3.0http://en.wiktionary.org/wiki/capital OER Commons. CC BY http://www.oercommons.org/courses/15-414-financial-management-summer-2003/viewCC BYhttp://www.oercommons.org/courses/15-414-financial-management-summer-2003/view Free to share, print, make copies and changes. Get yours at www.boundless.com Introduction to the Cost of Capital