FIGURE 15.4 Afirn's optimal level of RAD expenditures. The firm's optimal level of R&D expenditures ($60 million) occurs where its expected rate of return equals the interest-rate cost of funds, as shown in both the table and the graph At $60 milion of R&D spending, the firm has taken advantage of all RAD opportunties for which the expected rate of return, r, exceeds or equals the 8 percent interest cost of borrowing 20 16 20 40 60 80 100 Research and development expenditures (millions of dollars) Еxpoctod Rate of Roturn, % R&D, Intorost-Rate Millions Cost-of-Funds, % 18 $10 8 16 20 14 30 12 40 8 10 50 8 8 GO 8 70 80 Expected rate of return, r, and Interest rate, (percent
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Consider the effect that corporate profit taxes have on investing. Look back at Figure 15.4. Suppose that the r line is the
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