Cost of Capital

Our ultimate objective is to learn how to value firms and projects that firms may wish to do. However, before we do that, we now realize that all cash flows are risky and may require different returns. We also know that firms raise money for their various projects by using a mixture of stocks and bonds. So, we need a way to access the cost of capital of the firm or project we wish to evaluate. In Chapters 7 and 8, we assess the cost of capital of various stakeholders (shareholders, bondholders, and others) and estimate their expected returns based on the risk they face. We find that the uncertainty assumed by each stakeholder results in a corresponding reward in expected return. However, the riskiness of the firm and its expected return remain unchanged. This critical finding leads to the famous M&M theorem of a firm. As usual, we try to ease your learning by using several solved examples, exercises with answers, and numerous real-world exercises.