#Types of Financing
#Equity financing
Equity financing uses retained earnings or funds raised from an issuance of stock to finance a capital.
#Debt financing
Debt financing uses money raised through loans or by an issuance of bonds to finance a capital investment.
#Cost of Capital
Weighted average of Cost of Equity($i_e$) and Cost of Debt($i_d$)
#Cost of Equity
$i _ { e } = r _ { f } + \beta \left[ r _ { M } - r _ { f } \right]$
- $r_f$ = risk free interest rate (commonly referenced to U.S. Treasury bond yield)
- $r_M$ = market rate of return (commonly referenced to average return on S&P 500 stock index funds)
- $\beta$ = A number greater than one (β > 1) means that the stock is more volatile than the market on average; a number less than one (β < 1) means that the stock is less volatile than the market on average.
#the after-tax Cost of Debt
$i _ { d } = \left( c _ { s } / c _ { d } \right) k _ { s } \left( 1 - t _ { m } \right) + \left( c _ { b } / c _ { d } \right) k _ { b } \left( 1 - t _ { m } \right)$
- $c_s$ = the amount of the term loan
- $c_b$ = the amount of bond financing
- $k_s$ = the before-tax interest rate on the term loan
- $k_b$ = the before-tax interest rate on the bond
- $t_m$ = the firm's marginal tax rate
- $c_d$ = $c _ { s } + c _ { b }$
#Cost of Capital
$k = \frac { i _ { d } c _ { d } } { V } + \frac { i _ { e } c _ { e } } { V }$
- $c_d$ = Total debt capital(such as bonds) in dollars
- $c_e$ =Total equity capital in dollars
- $V$ = $c_d+c_e$
- $i_e$ = Average equity interest rate per period considering all equity sources
- $i_d$ = After-tax average borrowing interest rate per period considering all debt sources
- $k$ = Tax-adjusted weighted-average cost of capital