Financial Management: Principles and Applications, 13/e

14.3 Estimating the Cost of Individual Sources of Capital

The second step in our three-step procedure for calculating the overall cost of capital calls for us to estimate the opportunity cost for each of the sources of financing, including both debt and equity. Before returning to our Templeton Extended Care example, let’s look at how a company measures its costs of debt, preferred equity, and common equity. As you will notice, in extracting investor-required rates of return from observed market prices, we use techniques that have their roots in Principle 1: Money Has a Time Value and Principle 3: Cash Flows Are the Source of Value.

The Cost ...