Capital Structure and Budgeting

Paper Summary:

This paper examines a method for estimating targeted capital structure using data extracted from a firm's financial statements. The weighted cost of capital (WACC) with its components: debt, common and preferred stock are calculated. The cost of retained earnings is calculated and explained. Issues regarding the computation of net present value (NPV) and internal rate of return (IRR) are explored in relation to capital budget questions. Additional issues management should evaluate when considering capital expenditures are discussed.

From the Paper:

"For most firms the "average cost of capital" is the combined cost of capital raised from the sources that the firm uses (Brigham & Ehrhardt, 2002a, p. 421). Each capital component will have its own minimum rate of return, expected by the investors, who provide that form of capital (p. 421). This combined capital cost is termed the "weighted average cost of capital" or WACC (p. 421). Typically capital is obtained from the components of debt (preferred and common) and stock (p. 420)."

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