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Chapter 15
The Cost of Capital and Taxation Issues in Project Evaluation
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 15–1
Prepared by Dr Buly Cardak
Learning Objectives
• Understand the concept of the cost of capital.
• Understand the effect of risk on the cost of capital.
• Understand how the cost of capital can be measured under the imputation tax system.
• Understand why the cost of capital for a company is expressed as a weighted average of the costs of all of the company’s sources of capital.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 15–2
Prepared by Dr Buly Cardak
Learning Objectives (cont.)
• Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company.
• Explain how to treat issue costs in project evaluation.
• Understand the distinction between the cost of capital for a project and a company’s weighted average cost of capital.
• Estimate the cost of capital for a division of a diversified company.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 15–3
Prepared by Dr Buly Cardak
Learning Objectives (cont.)
• Understand the advantages and disadvantages of using the weighted average cost of capital in project evaluation.
• Understand the effects of taxes on project cash flows.
• Understand the application of the certainty equivalent method of incorporating risk into project evaluation.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 15–4
Prepared by Dr Buly Cardak
Net Present Value Analysis
• Calculation requires: – Net cash flows.
– Required rate of return/cost of capital.
– Consistency in the definition of cash flows and the discount rate applied to the cash flows.
• Required rate of return = opportunity cost.
• Opportunity cost of capital: rate of return that could be earned on another investment of similar risk.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 15–5
Prepared by Dr Buly Cardak
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