Chap. 11
The cost of Capital
MA0N0239
Yu Muramatsu
Cost of capital
The rate of return that a firm must
earn on the projects in which it
invests to maintain the market value
of its stock
The rate of return required by the
market suppliers of capital to
attract their funds to the firm
Key assumptions
1.Business Risk
the firm’s acceptance of a given project does not
affect its ability to meet operating cost
2.Financial Risk
projects are financed in such a way that the firm’s
ability to meet required financing cost is unchanged
3.After-tax costs are considered relevant
measured on an after-tax basis
United Airlines
 Because of terrorist attack in Sep. 2001 and
economic difficulties, UAL lost $2.14 billion in
2001.
 UAL Corporation filed for Chapter 11
bankruptcy protection in Dec. 2002.
United Airlines (Cont.)
 Restructuring
UAL received offers of subscription for
more than twice the capital necessary to
support the $3 billion it sought.
UAL was able to reduce its financing
costs by 75 basis points(0.75%)
United Airlines (Cont.)
 UAL was able to restructure its $3 billion debt
 Because of oversubscription of the refinancing,
UAL made its financing costs lower
 The new loan was set at 200 basis points (2.00%)
over LIBOR , a reduction of 175 basis points (1.75%)
from the original financing cost
 The lower pricing is expected to result in net pretax savings of approximately $70 million per year
Conclusion
 UAL was able to meet its capital needs
primarily from operating activities and
the issuance of debt
 Companies will strive to meet some
desired mix of debt and equity capital
financing to raise its capital
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