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.
23-4: Suppose venture capital firm GSB partners raised $50 million of committed capital. Each year over the 12-year life of the
fund, 1.5% of this committed capital will be used to pay GSB’s
management fee. As is typical in the venture capital industry,
GSB will only invest $41 million (committed capital less lifetime
management fees). At the end of 12 years, the investments made
by the fund are worth $550 million. GSB also charges 30% carried
interest on the profits of the fund (net of management fees).
a. Assuming the $41 million of invested capital is invested immediately and all proceeds were received at the end of 12 years,
what is the IRR of the investments GSB partners made? That is,
compute IRR ignoring all management fees
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