悉尼大学资本市场与公司财务课件Lecture7.ppt

1、PowerPoint to accompanyChapter 8Company cost of capitalOverview Valuing an entire company may be performed by:Estimating the value of equity and debt separately,or Calculating the present value of free cash flows These two techniques should produce the same result because free cash flows are eventua

2、lly distributed to equity holders and debtholders The value of a company is a function of:The return required by the providers of capital The companys future cash flowsFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaOverview(cont)The return required is known as the company

3、 cost of capital and is some combination of the cost of debt and cost of equityThe three broad steps in valuing a company are:1.Estimation of the company cost of capital2.Preparation of cash flow forecasts3.Discounting cash flows at the company cost of capitalFrino,Hill,Chen:Introduction to Corporat

4、e Finance,4e?2009 Pearson AustraliaOverview(cont)This lecture will discuss:The company cost of capital,with regard to:Calculation of the company cost of capital Estimation of the cost of debt capital Estimation of the cost of equity capital The impact of corporate tax on the company cost of capital

5、The calculation and forecasting of free cash flows,including:Cash flow reporting in financial statements Preparation of free cash flow forecastsFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaThe company cost of capital In Chapter 3,the following expression for the value o

6、f a company was presented:?V?Ftt?1?1?r?t(3.2)where:Ft=the net cash flows after tax generated by the company for itsowners(free cash flow)r=the company cost of capitalThe variable r is the focus of this lectureFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaThe company cost

7、 of capital(cont)ShareholdersDebtholders$2 million invested$8 million investedOpportunity cost=15%Interest rate=10%Annual cost=$0.3 millionAnnual cost=$0.8 millionCOMPANYCapital=$10 millionCOST OF CAPITAL=$1.1 million or 11%Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaT

8、he WACC Since the company cost of capital is a weighted average of the equity cost of capital and the debt cost of capital it is referred to as the weighted average cost of capital(WACC)The WACC is given by the expression:WACC?rD?D?E?rE?d?e?D?E?(8.1)where:re=the cost of equity capitalrd=the cost of

9、debt capitalD=the value of debt used by the companyE=the value of equity used by the companyFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaThe WACC(cont)Example 8.1Debtholders have contributed$8 million to a company and charge an interest rate of 10%p.a.Equity holders hav

10、e contributed$2 million and require a rate of return of 15%on their investment.What is the company cost of capital?_WACC?rD?E?d?D?E?re?D?E?8?2?0.10?8?2?0.15?8?2?0.10?0.80?0.15?0.20?0.11?11%p.a.Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaThe cost of debt capital In Chap

11、ter 3,the following expression was used to find the value of a debt security:nD?FBt?nt?1?1?rd?1?rd?(3.3)where:D=the market value of the debtn=the time to maturity of the debtF=the dollar interest paid on the debtB=the face value of the debtrd=the discount rate =THE COST OF DEBTFrino,Hill,Chen:Introd

12、uction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of debt In theory,if we substitute:The traded value of debt(its price)The face value,andThe interest paymentsinto Equation 3.3,the only unknown would be the cost of debt We could therefore imply the cost of debt applied by the

13、market In practice,however,corporate debt is rarely traded and hence the market value cannot usually be observedFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of debt(cont)There are several approaches:Assume the debt is risk-free,and use the 10-year go

14、vernment bond yieldAdd 100 200 basis points(1 2%)to the 10-year bond yield to allow for riskUse the following equation:rnet interestd?average net debt(8.2)where:net interest=interest paid-interest received average net debt=reported book value of debt cashOften,this model is used to find a risk premi

15、umFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of debt(cont)Example 8.2As at 30 June 2006 and 30 June 2007,10 year bond yields were 5.79%and 6.26%respectively.Use this information and the information below to estimate Tabcorp Holdings Ltd risk premiu

16、m on its debt and current cost of debt._?Interest paid during 2008=172.3m?Interest received during 2008=8.6m?Net interest2008=172.3 8.6=163.7m?Net debt at the end of 2006=2213.0m?Net debt at the end of 2007=2138.4m?Average net debt=(2213.0+2138.4)/2=2175.7mFrino,Hill,Chen:Introduction to Corporate F

17、inance,4e?2009 Pearson AustraliaEstimating the cost of debt(cont)Example 8.2(cont)As at 30 June 2006 and 30 June 2007,10 year bond yields were 5.79%and 6.26%respectively.Use this information and the information below to estimate Tabcorp Holdings Ltd risk premium on its debt and current cost of debt.

18、_?rd,2007=net interest/average net debt=163.7 2175.7=7.52%?Average 10-year bond yield2007=(5.79+6.26)2=6.03%?Tabcorp risk premium=7.52 6.03=1.49%?Tabcorps current cost of debt(rd)=10-yr bond yield+risk premium=6.26+1.49=7.75%p.a.Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson Austr

19、aliaThe cost of equity capital The cost of equity is the minimum rate of return required by a companys shareholders,given its risk The risk is derived from the business risk of the company There are two general ways of estimating the required return on shares:The required rate of return can be impli

20、ed from the stock price and fundamentals of the companyThe CAPM can be used to estimate the required rate of returnFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of equity We have previously shown that the value of a companys shares is given by the pre

21、sent value of future dividends,as follows:?P?dtt?1?1?rte?(3.5)where:P=the current price of sharesdt=the dividend paid in year tre=the required return on shares(cost of equity)Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of equity(cont)Since the price

22、 of a company can be observed in the share market,if the dividends can be forecast,the required rate of return can be implied from Equation 3.4 e.g.the following exampleThere are two reasons why this estimate might be flawed:1.The shares could be overpriced or underpriced2.The assumption that there

23、is a constant dividend,or a constantly growing dividend,might be inappropriateFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of equity(cont)Example 8.3On 31 December 2007,the following information was available for Tabcorp Holdings Ltd:?Forecast growth

24、 for next two years=11.4%?Dividend for year ended 30 June 2006=94 cents per share?Stock price=$14.78Calculate the implied cost of equity capital._Pdt?10.094?(1.114)t?r?g?14.78?r?0.114?r?0.1848?18.48%Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of equ

25、ity(cont)An alternative method of estimating the cost of equity is the CAPM:E?ri?rf?E?rm?rf?i(7.4)where:E(ri)=required return on the equity of stock iE(rm rf)=expected return on the market over and above therisk-free raterf=risk-free ratei=beta of stock iFrino,Hill,Chen:Introduction to Corporate Fin

26、ance,4e?2009 Pearson AustraliaEstimating the cost of equity(cont)Example 8.4Using one year of monthly data to June 2007,the beta of Tabcorp Holdings Ltd is estimated to be 0.94.The yield on 10-year bonds is 6.26%.The market risk premium is believed to be 6.3%p.a.What is the cost of equity for Tabcor

27、p Holdings Ltd?_E?ri?rf?E?rm?rf?i?0.0626?0.063?0.97?0.1237?12.37%Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating the cost of equity(cont)Using CAPM to estimate the cost of equity:1.Estimate the beta of the stock using historical data2.Determine the current risk-

28、free rate3.Determine the expected market risk premium(difficult-several approaches)4.Substitute these values into the CAPM equationFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating market risk premium There are 3 approaches to estimating market risk premium:1.Use

29、historical average returns on the stock market2.Imply from share prices and analysts forecasts3.Estimate the relationship between stock market volatility and stock market returnsFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating market risk premium(cont)1.Using his

30、torical average returns on the stock market Assumptions:Realised returns are equivalent to the returns expected by market participants for bearing risk in the future The market risk premium is constant over timeFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating mar

31、ket risk premium(cont)2.Using analysts forecasts of earnings and dividends:rdt?1,ie,i?P?git,i(Rearrangement of 3.7)where:re,i=the equity cost of capital for stock idt+1,i=the one-year-ahead forecast dividend for stock igi=the constant growth rate for stock iPt,i=the current price of stock i Assumpti

32、on:Analyst forecasts are accurateFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaEstimating market risk premium(cont)3.Estimating the relationship between stock market volatility and stock market returns(regression analysis)rm,t?rf,t?a?b?2?t?whererm,t=the market return ove

33、r period trf,t=the risk-free rate of return over period tb=reward-to-risk ratio2(t)=stock return volatility period tFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaTaxation and the company cost of capital How does taxation affect the calculation of a companys cost of capit

34、al?There are 2 widely used taxation systems1.The Classical System Companies pay company tax on net income and shareholders pay personal tax on the dividends paid out by the company2.The Imputation system Introduced into Australia in 1987 Shareholders receive franking credits with their dividends,equ

35、al to the corporate tax paid on the income from which the dividends are paidFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaTaxation and the company cost of capital(CONT)Under the imputation system:Companies pay tax on their net income at the corporate tax rateThey distrib

36、ute profits after tax as dividends,together with franking credits equivalent to the amount of company tax paidThe shareholder is then charged income tax on the sum of the cash dividend and the franking credit,at their personal income tax rate Note that,unlike companies,individuals are subject to gra

37、duated,or marginal,tax rates on different levels of incomeFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaTaxation and the company cost of capital(CONT)Example 8.5A companys income of$1 is paid out as an after-tax dividend.What is the shareholders after-tax income if his t

38、ax rate is 45%?ClassicalImputationCorporate levelNet income$1.00$1.00Company tax0.300.30Cash dividend0.700.70Shareholder levelTaxable income0.701.00Personal tax liability0.320.45Franking creditn.a.0.30Tax paid0.320.15After-tax income0.390.55Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 P

39、earson AustraliaCompany taxation and the impact on shareholder returns The return on a share that pays a fully-franked dividend,before personal tax,can be stated as:rt?pt?pt?1?dt?g?ft?pt?1(8.3)where:rt?=after-company tax but before personal tax rate of returnpt=price of the share in period tdt=cash

40、dividend paid per shareft=dollar amount of tax(or franking)credits per share distributed at time tg=portion of the franking credit used to reduce personal taxFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaCompany taxation and the impact on shareholder returns(cont)Example

41、 8.7On 27 August 2007,Tabcorp Holdings Ltd paid a dividend of 47 cents per share(fully franked).If the share price was$15.92 and had decreased to$15.29 by the end of August,what is the gross return after company tax(but before personal tax)for a shareholder on the top marginal tax rate?_The grossed

42、up value of the dividend(i.e.including franking credit)is 0.47/0.70=0.6714=dt+ft.Hence:ft=0.6714 0.47=0.2014.Given a personal tax rate of 45%,the shareholder will use the full value of franking credits;hence,g=1.Thus:rt?pt?pt?1?dt?g?ft?pt?1?15.29?15.92?0.47?1?0.2014?15.92?0.0026?0.26%Frino,Hill,Chen

43、:Introduction to Corporate Finance,4e?2009 Pearson AustraliaIncorporating the effect of tax into the company cost of capital The WACC needs to be adjusted to reflect the effect of tax(formulas from Officer(1994)Under the classical system if discounting forecast cash flows estimated before tax:WACC?r

44、d?D V?re?1?tc?E V?(8.6)if discounting forecast cash flows estimated after tax:WACC?rd?1?tc?D V?re?E V?(8.7)where:tc=the corporate tax rateFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaIncorporating the effect of tax into the company cost of capital(cont)Under the imputat

45、ion system if discounting forecast cash flows estimated before tax:WACC?rd?D V?re?1?tc?1?g?E V?(8.8)if discounting forecast cash flows estimated after tax:WACC?r?1?T?EDe?1?T?1?g?V?rd?1?T?V(8.9)where:re,rd=expected return on equity and debt before taxE,D,V=market value of equity,debt&the firm,respect

46、ivelyT=effective rate of company tax on companies free cash flowg=proportion of franking credits valued by the companys shareholdersFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaIncorporating the effect of tax into the company cost of capital(cont)Example 8.8Using the fo

47、llowing information for Tabcorp Holdings Ltd estimate the company cost of capital Estimated required rate of return on equity=12.2%Estimated cost of debt=7.75%Net debt=$2138.4m _Number of shares=524.9 millionShare price=$17.15Assume:1)Market value of equity=524.9m x 17.15=$9002.04m2)Market value of

48、firm=9 002.04m+2138.4m=$11 140.44mWACC?r?1?T?EDE?1?T?1?g?V?rD?1?T?V?0.122?1?0.30?9002?1?0.30?1?1?.0411140.44?0.0775?1?0.30?2138.411140.44?0.07942?7.94%p.a.Frino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaCAPM under an imputation system of tax The CAPM also needs to be redef

49、ined so that the value of franking credits is included in returns on both the stock and on the market:rt?rft?E?rmt?tmt?rft?j(8.10)where:rt?=expected return on stock j before personal tax,including the value of franking credits usedrft=risk-free rate of return over period trmt=return on the market ov

50、er period ttmt=value of franking credits paid on stocks in the indexj=beta of stock jFrino,Hill,Chen:Introduction to Corporate Finance,4e?2009 Pearson AustraliaCAPM under an imputation system of tax The value of franking credits paid in the overall market is difficult to estimate,and there is no mar