Cost of Capital: Applications and Examples, + Website, 5th Edition

CHAPTER 20

Other Components of a Business's Capital Structure

Introduction

Debt Capital

Estimating Current Market Yields on Debt

Duration

Tax Shield

Leases Are Debt

Debt Guarantees

Risky Debt

Deferred Income Taxes

Preferred Equity Capital

Convertible Debt and Convertible Preferred Equity Capital

Employee Stock Options

Obligations That Are Subtracted in a Valuation

Postretirement Obligations

Contingent Liabilities

Summary

Additional Reading

INTRODUCTION

The capital structure of many businesses includes two or more components, each of which has its own cost of capital. Companies whose capital structure includes many components may be said to have a complex capital structure. The major components commonly comprising a business's capital structure are:

• Debt capital
• Preferred equity capital
• Common equity capital

Similarly, a project being considered in a capital budgeting decision may be financed by multiple components of capital.

In a complex capital structure, each of these general components may have subcomponents, and each subcomponent may have a different cost of capital. In addition, there may be hybrid or special securities, such as convertible debt or preferred stock, warrants, options, or leases.

Ultimately, a business's or project's overall cost of capital is a result of the blending of the individual costs of each of these components. This chapter briefly discusses each of the capital structure components, and Chapter 22 shows the process of blending them into a business's ...