Cost of Capital

In: Business and Management

Submitted By alek
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The relationship between the method and assumptions made with respect to placing a value on a financial instrument and determining the capital cost for each of these instruments is intertwined. Similar factors are involved in both calculations. Issues surrounding estimating the future cost of capital and placing a value on a financial instrument are similar too. A WACC formula makes it clear that the problem of discount rate determination can be separated in the problem of determining the financial weights and the problem of determining the segment cost of capital (e.viaminvest.com). A company’s assets are generally financed by either debt or equity. The weighted average cost of capital is the average costs of these sources of financing, each of which is weighted by its respective use in the given situation. These sources of financing are financial instruments.
Similar to how a company’s assets are generally financed, preferred stock has characteristics of both equity and debt. Preferred shares generally have a dividend requirement that makes them appear similar to debt.
When placing the financial value on a bond, bond valuation includes calculating the present value of the bond’s future interest payments or cash flow, and the bond’s value upon maturity, also known as its face value (investopedia.com). A simplified stock valuation model is usually based on the general principle that the price of a common stock equals the present value of its future dividends (jstor.org).
The methods and assumptions made with respect to placing a value on a financial instrument, such as, preferred stock, bond valuation, common stock, etc., are all made focusing on similar characteristics used in determining the capital cost for each of these instruments. Most of these are financed through either debt or equity, or focus on cash flows for…...

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