大学课件：公司金融学ch06.ppt

1、6-1CHAPTER 6The Cost of CapitalnCost of Capital ComponentslDebtlPreferredlCommon EquitynWACC6-2What types of long-term capital do firms use?nLong-term debtnPreferred stocknCommon equity6-3Capital components are sources of funding that come from investors.Accounts payable,accruals,and deferred taxes

2、are not sources of funding that come from investors,so they are not included in the calculation of the cost of capital.We do adjust for these items when calculating the cash flows of a project,but not when calculating the cost of capital.6-4Should we focus on before-tax or after-tax capital costs?nT

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.6-5Should we focus on historical(embedded)costs or new(ma

4、rginal)costs?The cost of capital is used primarily to make decisions which involve raising and investing new capital.So,we should focus on marginal costs.6-6Cost 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

5、 the yield on other bonds with a similar rating.nMethod 3:Find the yield on the companys debt,if it has any.6-7A 15-year,12%semiannual bond sells for$1,153.72.Whats rd?6060+1,0006001230i=?30 -1153.72 60 1000 5.0%x 2=rd=10%NI/YRPVFVPMT-1,153.72.INPUTSOUTPUT6-8Component Cost of DebtnInterest is tax de

6、ductible,so the after tax(AT)cost of debt is:rd AT=rd BT(1-T)=10%(1-0.40)=6%.nUse nominal rate.nFlotation costs small,so ignore.6-9Whats the cost of preferred stock?PP=$113.10;10%Q;Par=$100;F=$2.%.0.9090.010.111$10$00.2$10.113$100$1.0 npspsPDrUse this formula:6-10Picture of Preferred2.502.50012rps=?

7、-111.1.2.50.50.2$10.111$PerPerQrrD%.9)4%(25.2%;25.210.111$50.2$)(NompsPerrr6-11Note: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.6-12Is preferred stock more or less risky to in

8、vestors than debt?nMore 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.6-13Why is yield on preferred lower than rd?

9、nCorporations own most preferred 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

10、 higher risk of preferred.6-14Example: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%6-15nDirectly,by issuing new shares of common stock.nIndirectly,by reinvesting earnings that are not paid out as dividends(i.e.,retain

11、ing earnings).What are the two ways that companies can raise common equity?6-16nEarnings 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.Why is there a cost for reinvested earnings?6-17nOppor

12、tunity 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.6-18Three ways to determine the cost of equit

13、y,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+RP.6-19Whats the cost of equity based on the CAPM?rRF=7%,RPM=6%,b=1.2.rs=rRF+(rM-rRF)b.=7.0%+(6.0%)1.2 =14.2%.6-20Issues in Using CAPMnMost analysts use the rate on a long-term(10 to 20 years)government

14、 bond as an estimate of rRF.For a current estimate,go to ,select“U.S.Treasuries”from the section on the left under the heading“Market.”More6-21Issues 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 ha

15、ve a wide confidence interval).For an estimate of beta,go to and enter the ticker symbol for STOCK QUOTES.6-22Whats the DCF cost of equity,rs?Given:D0=$4.19;P0=$50;g=5%.gPgDgPDrs00011$4.$50.19 1050 050 0880 0513 8%.6-23Estimating the Growth RatenUse the historical growth rate if you believe the futu

16、re will be like the past.nObtain analysts estimates:Value Line,Zacks,Yahoo!.Finance.nUse the earnings retention model,illustrated on next slide.6-24Suppose the company has been earning 15%on equity(ROE=15%)and retaining 35%(dividend payout=65%),and this situation is expected to continue.Whats the ex

17、pected future g?6-25Retention 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%,what is g?6-26Could DCF methodology be appliedif g is not constant?nYES,n

18、onconstant g stocks are expected to have constant g at some point,generally in 5 to 10 years.nBut calculations get complicated.See“Ch 6 Tool Kit.xls”.6-27Find rs using the own-bond-yield-plus-risk-premium method.(rd=10%,RP=4%.)n This RP CAPM RPM.n Produces ballpark estimate of rs.Useful check.rs=rd+

19、RP=10.0%+4.0%=14.0%6-28Whats a reasonable final estimateof rs?MethodEstimateCAPM14.2%DCF13.8%rd+RP14.0%Average14.0%6-29Determining the Weights for the WACCnThe weights are the percentages of the firm that will be financed by each component.nIf possible,always use the target weights for the percentag

20、es of the firm that will be financed with the various types of capital.6-30Estimating 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 you dont know the market value of debt,then it is usually

21、 reasonable to use the book values of debt,especially if the debt is short-term.(More.)6-31Estimating 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 of debt.(More.)6-32nVce=$50(3 million)=$150 million.nVp

22、s=$25 million.nVd=$75 million.nTotal value=$150+$25+$75=$250 million.nwce=$150/$250=0.6nwps=$25/$250=0.1nwd=$75/$250=0.36-33Whats the WACC?WACC=wdrd(1-T)+wpsrps+wcers=0.3(10%)(0.6)+0.1(9%)+0.6(14%)=1.8%+0.9%+8.4%=11.1%.6-34WACC Estimates for Some Large U.S.CorporationsCompany WACCGeneral Electric(GE

23、)12.5Coca-Cola(KO)12.3Intel(INTC)12.2Motorola(MOT)11.7Wal-Mart(WMT)11.0Walt Disney(DIS)9.3AT&T(T)9.2Exxon Mobil(XOM)8.2H.J.Heinz(HNZ)7.8BellSouth(BLS)7.46-35What factors influence a companys WACC?nMarket conditions,especially interest rates and tax rates.nThe firms capital structure and dividend pol

24、icy.nThe firms investment policy.Firms with riskier projects generally have a higher WACC.6-36Should the company use the composite WACC as the hurdle rate for each of its divisions?nNO!The composite WACC reflects the risk of an average project undertaken by the firm.nDifferent divisions may have dif

25、ferent risks.The divisions WACC should be adjusted to reflect the divisions risk and capital structure.6-37nEstimate 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.What procedures are used

26、 to determine the risk-adjusted cost of capital for a particular division?6-38Methods for Estimating Beta for a Division or a Project1.Pure play.Find several publicly traded companies exclusively in projects business.Use average of their betas as proxy for projects beta.Hard to find such companies.6

27、-392.Accounting beta.Run regression between projects ROA and S&P index ROA.Accounting betas are correlated(0.5 0.6)with market betas.But normally cant get data on new projects ROAs before the capital budgeting decision has been made.6-40Find the divisions market risk and cost of capital based on the

28、 CAPM,given these inputs:nTarget debt ratio=10%.nrd=12%.nrRF=7%.nTax rate=40%.nbetaDivision=1.7.nMarket risk premium=6%.6-41nBeta=1.7,so division has more market risk than average.nDivisions required return on equity:rs=rRF+(rM rRF)bDiv.=7%+(6%)1.7=17.2%.WACCDiv.=wdrd(1 T)+wcrs =0.1(12%)(0.6)+0.9(17

29、.2%)=16.2%.6-42How does the divisions WACC compare with the 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%.6-43Divisional Risk and the Cost of Capital R ate of R eturn(%)W AC C R ejection R e

30、gion A cceptan ce R egion R isk L B A H W AC CH W AC CL W AC CA 0 R iskL R iskA R iskH 6-44What are the three types of project risk?nStand-alone risknCorporate risknMarket risk6-45How is each type of risk used?nStand-alone risk is easiest to calculate.nMarket risk is theoretically best in most situa

31、tions.nHowever,creditors,customers,suppliers,and employees are more affected by corporate risk.nTherefore,corporate risk is also relevant.6-46A Project-Specific,Risk-Adjusted Cost of CapitalnStart by calculating a divisional cost of capital.nEstimate the risk of the project using the techniques in C

32、hapter 8.nUse judgment to scale up or down the cost of capital for an individual project relative to the divisional cost of capital.6-471.When a company issues new common stock they also have to pay flotation costs to the underwriter.2.Issuing new common stock may send a negative signal to the capit

33、al markets,which may depress stock price.Why is the cost of internal equity from reinvested earnings cheaper than the cost of issuing new common stock?6-48Estimate the cost of new common equity:P0=$50,D0=$4.19,g=5%,and F=15%.gFPgDre )1()1(00%.4.15%0.550.42$40.4$%0.515.0150$05.119.4$6-49Estimate the

34、cost of new 30-year debt:Par=$1,000,Coupon=10%paid annually,and F=2%.nUsing a financial calculator:lN=30lPV=1000(1-.02)=980lPMT=-(.10)(1000)(1-.4)=-60lFV=-1000nSolving for I:6.15%6-50Comments about flotation costs:nFlotation costs depend on the risk of the firm and the type of capital being raised.n

35、The flotation costs are highest for common equity.However,since most firms issue equity infrequently,the per-project cost is fairly small.nWe will frequently ignore flotation costs when calculating the WACC.6-51Four Mistakes to Avoid1.When estimating the cost of debt,dont use the coupon rate on exis

36、ting debt.Use the current interest rate on new debt.2.When estimating the risk premium for the CAPM approach,dont subtract the current long-term T-bond rate from the historical average return on common stocks.(More.)6-52For example,if the historical rM has been about 12.7%and inflation drives the cu

37、rrent rRF up to 10%,the current market risk premium is not 12.7%-10%=2.7%!(More.)6-533.Dont use book weights to estimate the weights for the capital structure.Use the target capital structure to determine the weights.If you dont know the target weights,then use the current market value of equity,and

38、 never the book value of equity.If you dont know the market value of debt,then the book value of debt often is a reasonable approximation,especially for short-term debt.(More.)6-544.Always remember that capital components are sources of funding that come from investors.Accounts 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.We do adjust for these items when calculating the cash flows of the project,but not when calculating the WACC.