The Cost of Capital: Introduction
Companies issue bonds, preferred stock, and common equity to raise capital to invest in capital budgeting projects. Capital is a necessary factor of production, and like any other factor, it has a cost. This cost is equal to the -Select-security analyst'smarginal investor'scompany vendor'sItem 1 required return on the applicable security. The rates of return that investors require on bonds, preferred stocks, and common equity represent the costs of those securities to the firm. Companies estimate the required returns on their securities, calculate a weighted average of the costs of their different types of capital, and use this average cost for capital budgeting purposes.
The firm's primary financial objective is to -Select-minimizemaintain the initial level ofmaximizeItem 2 shareholder value. To do this, companies invest in projects that earn -Select-more thanless thanequal toItem 3 their cost of capital. So, the cost of capital is often referred to as the -Select-crossoverhurdleindifferenceItem 4 rate: When calculating the weighted average cost of capital (WACC), our concern is with capital that must be provided by -Select-managersvendorsinvestorsItem 5 —interest-bearing debt, preferred stock, and common equity. -Select-Notes payableAccounts payableLong-term debtItem 6 and accruals, which arise spontaneously from operations when capital budgeting projects are undertaken, are not included as part of total invested capital because they do not come directly from investors.
Which of the following would be included in the calculation of total invested capital? Choose the response that is most correct.
a) Notes payable
b) Taxes payable
c) Retained earnings
d) Responses a and c would be included in the calculation of total invested capital.
e) None of the above would be included in the calculation of total invested capital.