CF2-Ch-09-The-Cost-of-Capital-公司财务与金融-课件.ppt

1、1CHAPTER 9The Cost of Capital2TopicsnCost of Capital ComponentsnDebtnPreferrednCommon EquitynWACC3What types of long-term capital do firms use?nLong-term debtnPreferred stocknCommon equity4Capital ComponentsnCapital components are sources of funding that come from investors.nAccounts payable,accrual

2、s,and deferred taxes are not sources of funding that come from investors,so they are not included in the calculation of the cost of capital.nWe do adjust for these items when calculating the cash flows of a project,but not when calculating the cost of capital.5Before-tax vs.After-tax Capital CostsnT

3、ax effects associated with financing can be incorporated either in capital budgeting cash flows or in cost of capital.nMost firms incorporate tax effects in the cost of capital.Therefore,focus on after-tax costs.nOnly cost of debt is affected.6Historical(Embedded)Costs vs.New(Marginal)CostsnThe cost

4、 of capital is used primarily to make decisions which involve raising and investing new capital.So,we should focus on marginal costs.7Cost of DebtnMethod 1:Ask an investment banker what the coupon rate would be on new debt.nMethod 2:Find the bond rating for the company and use the yield on other bon

5、ds with a similar rating.nMethod 3:Find the yield on the companys debt,if it has any.8A 15-year,12%semiannual bond sells for$1,153.72.Whats rd?6060+1,0006001230i=?-1,153.72.30 -1153.72 60 1000 5.0%x 2=rd=10%NI/YRPVFVPMTINPUTSOUTPUT9Component Cost of DebtnInterest is tax deductible,so the after tax(A

6、T)cost of debt is:n rd AT=rd BT(1-T)n rd AT=10%(1-0.40)=6%.nUse nominal rate.nFlotation costs small,so ignore.10Cost of preferred stock:PP=$113.10;10%Q;Par=$100;F=$2.Use this formula:rps=DpsPn=0.1($100)$113.10-$2.00=$10$111.10=0.090=9.0%11Time Line of Preferred2.502.502.50012rps=?-111.1.$111.10=DQrP

7、er=$2.50rPerrPer=$2.50$111.10=2.25%;rps(Nom)=2.25%(4)=9%12Note:nFlotation costs for preferred are significant,so are reflected.Use net price.nPreferred dividends are not deductible,so no tax adjustment.Just rps.nNominal rps is used.13Is preferred stock more or less risky to investors than debt?nMore

8、 risky;company not required to pay preferred dividend.nHowever,firms want to pay preferred dividend.Otherwise,(1)cannot pay common dividend,(2)difficult to raise additional funds,and(3)preferred stockholders may gain control of firm.14Why is yield on preferred lower than rd?nCorporations own most pr

9、eferred stock,because 70%of preferred dividends are nontaxable to corporations.nTherefore,preferred often has a lower B-T yield than the B-T yield on debt.nThe A-T yield to investors and A-T cost to the issuer are higher on preferred than on debt,which is consistent with the higher risk of preferred

10、.15Example:rps =9%rd =10%T =40%rps,AT =rps-rps(1-0.7)(T)=9%-9%(0.3)(0.4)=7.92%rd,AT =10%-10%(0.4)=6.00%A-T Risk Premium on Preferred =1.92%16What are the two ways that companies can raise common equity?nDirectly,by issuing new shares of common stock.nIndirectly,by reinvesting earnings that are not p

11、aid out as dividends(i.e.,retaining earnings).17Why is there a cost for reinvested earnings?nEarnings can be reinvested or paid out as dividends.nInvestors could buy other securities,earn a return.nThus,there is an opportunity cost if earnings are reinvested.18Cost for Reinvested Earnings(Continued)

12、nOpportunity cost:The return stockholders could earn on alternative investments of equal risk.nThey could buy similar stocks and earn rs,or company could repurchase its own stock and earn rs.So,rs,is the cost of reinvested earnings and it is the cost of equity.19Three ways to determine the cost of e

13、quity,rs:1.CAPM:rs=rRF+(rM-rRF)b=rRF+(RPM)b.2.DCF:rs=D1/P0+g.3.Own-Bond-Yield-Plus-Risk Premium:rs=rd+Bond RP.20CAPM Cost of Equity:rRF=7%,RPM=6%,b=1.2.rs=rRF+(rM-rRF)b.=7.0%+(6.0%)1.2 =14.2%.21Issues in Using CAPMnMost analysts use the rate on a long-term(10 to 20 years)government bond as an estima

14、te of rRF.For a current estimate,go to ,select“U.S.Treasuries”from the section on the left under the heading“Market.”More22Issues in Using CAPM(Continued)nMost analysts use a rate of 5%to 6.5%for the market risk premium(RPM)nEstimates of beta vary,and estimates are“noisy”(they have a wide confidence

15、 interval).nFor an estimate of beta,go to Thomson ONEBusiness School Edition,enter a ticker symbol,then look under Key Fundamentals.23DCF Cost of Equity,rs:D0=$4.19;P0=$50;g=5%.rs=D1P0+g=D0(1+g)P0+g=$4.19(1.05)$50+0.05=0.088+0.05=13.8%24Estimating the Growth RatenUse the historical growth rate if yo

16、u believe the future will be like the past.nObtain analysts estimates:Value Line,Zacks,Yahoo.Finance.nUse the earnings retention model,illustrated on next slide.25Earnings Retention ModelnSuppose the company has been earning 15%on equity(ROE=15%)and retaining 35%(dividend payout=65%),and this situat

17、ion is expected to continue.Whats the expected future g?26Earnings Retention Model(Continued)nRetention growth rate:g=ROE(Retention rate)g=0.35(15%)=5.25%.This is close to g=5%given earlier.Think of bank account paying 15%with retention ratio=0.What is g of account balance?If retention ratio is 100%

18、,what is g?27Could DCF methodology be applied if g is not constant?nYES,nonconstant g stocks are expected to have constant g at some point,generally in 5 to 10 years.nBut calculations get complicated.See“FM11 Ch 9 Tool Kit.xls”.28The Own-Bond-Yield-Plus-Risk-Premium Method:rd=10%,RP=4%.nrs=rd+RPn rs

19、=10.0%+4.0%=14.0%nThis RP CAPM RPM.nProduces ballpark estimate of rs.Useful check.29Whats a reasonable final estimate of rs?MethodEstimateCAPM14.2%DCF13.8%rd+RP14.0%Average14.0%30Determining the Weights for the WACCnThe weights are the percentages of the firm that will be financed by each component.

20、nIf possible,always use the target weights for the percentages of the firm that will be financed with the various types of capital.31Estimating Weights for the Capital StructurenIf you dont know the targets,it is better to estimate the weights using current market values than current book values.nIf

21、 you dont know the market value of debt,then it is usually reasonable to use the book values of debt,especially if the debt is short-term.(More.)32Estimating Weights(Continued)nSuppose the stock price is$50,there are 3 million shares of stock,the firm has$25 million of preferred stock,and$75 million

22、 of debt.(More.)33Estimating Weights(Continued)nVce=$50(3 million)=$150 million.nVps=$25 million.nVd=$75 million.nTotal value=$150+$25+$75=$250 million.34Estimating Weights(Continued)nwce=$150/$250=0.6nwps=$25/$250=0.1nwd=$75/$250=0.335Whats the WACC?WACC=wdrd(1-T)+wpsrps+wcersWACC=0.3(10%)(0.6)+0.1

23、(9%)+0.6(14%)WACC=1.8%+0.9%+8.4%=11.1%.36What factors influence a companys WACC?nMarket conditions,especially interest rates and tax rates.nThe firms capital structure and dividend policy.nThe firms investment policy.Firms with riskier projects generally have a higher WACC.37Is the firms WACC correc

24、t for each of its divisions?nNO!The composite WACC reflects the risk of an average project undertaken by the firm.nDifferent divisions may have different risks.The divisions WACC should be adjusted to reflect the divisions risk and capital structure.38The Risk-Adjusted Divisional Cost of CapitalnEst

25、imate the cost of capital that the division would have if it were a stand-alone firm.nThis requires estimating the divisions beta,cost of debt,and capital structure.39Pure Play Method for Estimating Beta for a Division or a ProjectnFind several publicly traded companies exclusively in projects busin

26、ess.nUse average of their betas as proxy for projects beta.nHard to find such companies.40Accounting Beta Method for Estimating BetanRun regression between projects ROA and S&P index ROA.nAccounting betas are correlated(0.5 0.6)with market betas.nBut normally cant get data on new projects ROAs befor

27、e the capital budgeting decision has been made.41Divisional Cost of Capital Using CAPMnTarget debt ratio=10%.nrd=12%.nrRF=7%.nTax rate=40%.nbetaDivision=1.7.nMarket risk premium=6%.42Divisional Cost of Capital Using CAPM(Continued)Divisions required return on equity:rs=rRF+(rM rRF)bDiv.rs=7%+(6%)1.7

28、=17.2%.WACCDiv.=wd rd(1 T)+wc rs =0.1(12%)(0.6)+0.9(17.2%)=16.2%.43Divisions WACC vs.Firms Overall WACC?nDivision WACC=16.2%versus company WACC=11.1%.n“Typical”projects within this division would be accepted if their returns are above 16.2%.44Divisional Risk and the Cost of Capital Rate of Return(%)

29、WACC Rejection Region Acceptance Region Risk L B A H WACCH WACCL WACCA 0 RiskL RiskA RiskH 45What are the three types of project risk?nStand-alone risknCorporate risknMarket risk46How is each type of risk used?nStand-alone risk is easiest to calculate.nMarket risk is theoretically best in most situa

30、tions.nHowever,creditors,customers,suppliers,and employees are more affected by corporate risk.nTherefore,corporate risk is also relevant.47A Project-Specific,Risk-Adjusted Cost of CapitalnStart by calculating a divisional cost of capital.nEstimate the risk of the project using the techniques in Cha

31、pter 11.nUse judgment to scale up or down the cost of capital for an individual project relative to the divisional cost of capital.48Costs of Issuing New Common StocknWhen a company issues new common stock they also have to pay flotation costs to the underwriter.nIssuing new common stock may send a

32、negative signal to the capital markets,which may depress stock price.49Cost of New Common Equity:P0=$50,D0=$4.19,g=5%,and F=15%.re=D0(1+g)P0(1-F)+g=$4.19(1.05)$50(1 0.15)+5.0%=$4.40$42.50+5.0%=15.4%50Cost of New 30-Year Debt:Par=$1,000,Coupon=10%paid annually,and F=2%.nUsing a financial calculator:n

33、N=30nPV=1000(1-.02)=980nPMT=-(.10)(1000)(1-.4)=-60nFV=-1000nSolving for I:6.15%51Comments about flotation costs:nFlotation costs depend on the risk of the firm and the type of capital being raised.nThe flotation costs are highest for common equity.However,since most firms issue equity infrequently,t

34、he per-project cost is fairly small.nWe will frequently ignore flotation costs when calculating the WACC.52Four Mistakes to AvoidnCurrent vs.historical cost of debtnMixing current and historical measures to estimate the market risk premiumnBook weights vs.Market WeightsnIncorrect cost of capital com

35、ponentsnSee next slides for details.(More.)53Current vs.Historical Cost of DebtnWhen estimating the cost of debt,dont use the coupon rate on existing debt.nUse the current interest rate on new debt.(More.)54Estimating the Market Risk PremiumnWhen estimating the risk premium for the CAPM approach,don

36、t subtract the current long-term T-bond rate from the historical average return on common stocks.nFor example,if the historical rM has been about 12.2%and inflation drives the current rRF up to 10%,the current market risk premium is not 12.2%-10%=2.2%!(More.)55(More.)Estimating WeightsnUse the targe

37、t capital structure to determine the weights.nIf you dont know the target weights,then use the current market value of equity,and never the book value of equity.nIf you dont know the market value of debt,then the book value of debt often is a reasonable approximation,especially for short-term debt.5

38、6Capital components are sources of funding that come from investors.nAccounts payable,accruals,and deferred taxes are not sources of funding that come from investors,so they are not included in the calculation of the WACC.nWe do adjust for these items when calculating the cash flows of the project,but not when calculating the WACC.