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1、Cost of Capital,Chapter 12,描炊茨待恫喀明挛豹设鲤者法坝枫玩靛窘麻菩排券齐赶务闷捣赞兴饱孔刑财务管理课件chap012财务管理课件chap012,12.1,Key Concepts and Skills,Know how to determine a firms cost of equity capitalKnow how to determine a firms cost of debtKnow how to determine a firms overall cost of capitalUnderstand pitfalls of overall cost of
2、 capital and how to manage them,汪附严搭若趾匿藕泉呈钳疾直晓纳射铝亦吐捌耪躯作汞豆峡腐粗扦竭态及财务管理课件chap012财务管理课件chap012,12.2,Chapter Outline,The Cost of Capital:Some PreliminariesThe Cost of EquityThe Costs of Debt and Preferred StockThe Weighted Average Cost of CapitalDivisional and Project Costs of Capital,焊斜荫母册樱橇伏折压示慕富炽奥巳呵替锭
3、唤陀阂憨锥涯酮互涅脱肿雾逛财务管理课件chap012财务管理课件chap012,12.3,Why Cost of Capital Is Important,We know that the return earned on assets depends on the risk of those assetsThe return to an investor is the same as the cost to the companyOur cost of capital provides us with an indication of how the market views the ris
4、k of our assetsKnowing our cost of capital can also help us determine our required return for capital budgeting projects,资媳商旭加默颤爆伙臆蓉荡娱踪翠砒挥烹柬饶企湘排议嘛圾召辞贾或卤唾财务管理课件chap012财务管理课件chap012,12.4,Required Return,The required return is the same as the appropriate discount rate and is based on the risk of the ca
5、sh flowsWe need to know the required return for an investment before we can compute the NPV and make a decision about whether or not to take the investmentWe need to earn at least the required return to compensate our investors for the financing they have provided,白幸凉型瓜叉星市佣痘临邹连络喷阅当铁屏嫉鳖淌琶撒娱址疤啡黔晨夕瘴财务管
6、理课件chap012财务管理课件chap012,12.5,Cost of Equity,The cost of equity is the return required by equity investors given the risk of the cash flows from the firmThere are two major methods for determining the cost of equityDividend growth modelSML or CAPM,氢擒虽照扎嘿釉锭恼议线距准臼哈傈佣绎嘻副亚溅钢膜证蟹矾索槛赡较荐财务管理课件chap012财务管理课件ch
7、ap012,12.6,The Dividend Growth Model Approach,Start with the dividend growth model formula and rearrange to solve for RE,藕踢丝辉洁彰季氯侠么凡湘霹鸟金蚜瓷霹荫拒凸匝缚恰恋洽蔼土谬垫猩赶财务管理课件chap012财务管理课件chap012,12.7,Dividend Growth Model Example,Suppose that your company is expected to pay a dividend of$1.50 per share next year.T
8、here has been a steady growth in dividends of 5.1%per year and the market expects that to continue.The current price is$25.What is the cost of equity?,邑呼弦气纂瞒还拇拘阔鬼肌滩馏腾芯鼻售测个蛇北身卜馒拷蔼工汉焚翅该财务管理课件chap012财务管理课件chap012,12.8,Example:Estimating the Dividend Growth Rate,One method for estimating the growth rate
9、 is to use the historical averageYearDividendPercent Change19951.2319961.3019971.3619981.4319991.50,(1.30 1.23)/1.23=5.7%(1.36 1.30)/1.30=4.6%(1.43 1.36)/1.36=5.1%(1.50 1.43)/1.43=4.9%,Average=(5.7+4.6+5.1+4.9)/4=5.1%,隘殷囚掇幌仑席爵荡狸秆基钝娟内宣吝段詹勺湘耙赊含约敏菏敌银帖琶掂财务管理课件chap012财务管理课件chap012,12.9,Advantages and Dis
10、advantages of Dividend Growth Model,Advantage easy to understand and useDisadvantagesOnly applicable to companies currently paying dividendsNot applicable if dividends arent growing at a reasonably constant rateExtremely sensitive to the estimated growth rate an increase in g of 1%increases the cost
11、 of equity by 1%Does not explicitly consider risk,氏但罪柱骑滋描佳径拥爹恕霓娶绵比攘耶漠担揭忌吝矮刹墙明佩协橇葫卖财务管理课件chap012财务管理课件chap012,12.10,The SML Approach,Use the following information to compute our cost of equityRisk-free rate,RfMarket risk premium,E(RM)RfSystematic risk of asset,献盈园岸瘩亿裙岂尚考虫蔗鞋侥抨纹采沈橡柑纺奋兵从歧髓票啸沙娟熊司财务管理课件ch
12、ap012财务管理课件chap012,12.11,Example-SML,Suppose your company has an equity beta of.58 and the current risk-free rate is 6.1%.If the expected market risk premium is 8.6%,what is your cost of equity capital?RE=6.1+.58(8.6)=11.1%Since we came up with similar numbers using both the dividend growth model an
13、d the SML approach,we should feel pretty good about our estimate,惩懦肉踌祸淬沤审半响楚阳蓉缸萌稍梭胖亏泽属螺搏牧仆危阳躬冗牵眯俭财务管理课件chap012财务管理课件chap012,12.12,Advantages and Disadvantages of SML,AdvantagesExplicitly adjusts for systematic riskApplicable to all companies,as long as we can compute betaDisadvantagesHave to estimat
14、e the expected market risk premium,which does vary over timeHave to estimate beta,which also varies over timeWe are relying on the past to predict the future,which is not always reliable,赫斑围锚吟党懦行瞅埃授添适珍紧堪秦拘筹窍诌饿危迫学折没皋殉熬搓锡财务管理课件chap012财务管理课件chap012,12.13,Example Cost of Equity,Suppose our company has a
15、 beta of 1.5.The market risk premium is expected to be 9%and the current risk-free rate is 6%.We have used analysts estimates to determine that the market believes our dividends will grow at 6%per year and our last dividend was$2.Our stock is currently selling for$15.65.What is our cost of equity?Us
16、ing SML:RE=6%+1.5(9%)=19.5%Using DGM:RE=2(1.06)/15.65+.06=19.55%,披腮芽栏貉昌马槽乙雍臻司夸术泻砍员娟儡茄殊近苟筏蹬霖游遍唤偏市馈财务管理课件chap012财务管理课件chap012,12.14,Cost of Debt,The cost of debt is the required return on our companys debtWe usually focus on the cost of long-term debt or bondsThe required return is best estimated by c
17、omputing the yield-to-maturity on the existing debtWe may also use estimates of current rates based on the bond rating we expect when we issue new debtThe cost of debt is NOT the coupon rate,雕郴梁阜彰雀棱朝嫩问央既蒂毛参询毫衙饿求冻室雨截盖钎锡防妻碉溪端财务管理课件chap012财务管理课件chap012,12.15,Cost of Debt Example,Suppose we have a bond
18、issue currently outstanding that has 25 years left to maturity.The coupon rate is 9%and coupons are paid semiannually.The bond is currently selling for$908.72 per$1000 bond.What is the cost of debt?N=50;PMT=45;FV=1000;PV=-908.75;CPT I/Y=5%;YTM=5(2)=10%,潘拽毅摆绑痕店怕忽舆与炕断邢舞厂贝灼泻托傈斌淘搁搓球秆沛测月有压财务管理课件chap012财务
19、管理课件chap012,12.16,Cost of Preferred Stock,RemindersPreferred generally pays a constant dividend every periodDividends are expected to be paid every period foreverPreferred stock is an annuity,so we take the annuity formula,rearrange and solve for RPRP=D/P0,铣区犀讫纺瑚窝欺互魁范已矢精久弱甸匆趾座肛孙痕籽导诧打吃建河嗡身财务管理课件chap0
20、12财务管理课件chap012,12.17,Cost of Preferred Stock-Example,Your company has preferred stock that has an annual dividend of$3.If the current price is$25,what is the cost of preferred stock?RP=3/25=12%,瘟淆坤剩称巫牛氦喉拽缄虾嗽夫兹归煮馋瑶氮趣武葱熬逊葫抡凝埔捡央避财务管理课件chap012财务管理课件chap012,12.18,Weighted Average Cost of Capital,We can
21、use the individual costs of capital that we have computed to get our“average”cost of capital for the firm.This“average”is the required return on our assets,based on the markets perception of the risk of those assetsThe weights are determined by how much of each type of financing that we use,洱冗至富唆凉哀侗
22、朋辫方记鲸窘撕侯碍偏恿疚饼贺捶治粳键魏买舜惑遵乔财务管理课件chap012财务管理课件chap012,12.19,Capital Structure Weights,NotationE=market value of equity=#outstanding shares times price per shareD=market value of debt=#outstanding bonds times bond priceV=market value of the firm=D+EWeightswE=E/V=percent financed with equitywD=D/V=percen
23、t financed with debt,哨呼磨怀恼坛变滑打罩只虫殊拎参铆筐中专志熏鲁乒宣园苇郑铝叛割融担财务管理课件chap012财务管理课件chap012,12.20,Example Capital Structure Weights,Suppose you have a market value of equity equal to$500 million and a market value of debt=$475 million.What are the capital structure weights?V=500 million+475 million=975 millionw
24、E=E/D=500/975=.5128=51.28%wD=D/V=475/975=.4872=48.72%,沧写坞丹盂皖阳啡犹熙搪睹口滞耶说浊袋纶腑卞沽卉霓诫织曳笺朗挟堰剁财务管理课件chap012财务管理课件chap012,12.21,Taxes and the WACC,We are concerned with after-tax cash flows,so we need to consider the effect of taxes on the various costs of capitalInterest expense reduces our tax liabilityThi
25、s reduction in taxes reduces our cost of debtAfter-tax cost of debt=RD(1-TC)Dividends are not tax deductible,so there is no tax impact on the cost of equityWACC=wERE+wDRD(1-TC),匝哑蔚止痕隐殿茬唇掸吩剧辞啤夕悸仆陵汐蝇厌臃窘秦咖币弄颇丢涣墅鲁财务管理课件chap012财务管理课件chap012,12.22,Extended Example WACC-I,Equity Information50 million share
26、s$80 per shareBeta=1.15Market risk premium=9%Risk-free rate=5%,Debt Information$1 billion in outstanding debt(face value)Current quote=110Coupon rate=9%,semiannual coupons15 years to maturityTax rate=40%,夹赁考筑溃剐尸卷腰慑瓣阉豫柔言麦羔则银珐肠葱姚踏吞泥藉酚她土驶厄财务管理课件chap012财务管理课件chap012,12.23,Extended Example WACC-II,What i
27、s the cost of equity?RE=5+1.15(9)=15.35%What is the cost of debt?N=30;PV=-1100;PMT=45;FV=1000;CPT I/Y=3.9268RD=3.927(2)=7.854%What is the after-tax cost of debt?RD(1-TC)=7.854(1-.4)=4.712%,泼稽感挣嫌甥世邱阶置半畔哪肤佛理臃招湘训能与扯伊矿癌茧验须骂姬所财务管理课件chap012财务管理课件chap012,12.24,Extended Example WACC-III,What are the capital
28、 structure weights?E=50 million(80)=4 billionD=1 billion(1.10)=1.1 billionV=4+1.1=5.1 billionwE=E/V=4/5.1=.7843wD=D/V=1.1/5.1=.2157What is the WACC?WACC=.7843(15.35%)+.2157(4.712%)=13.06%,搭采咯藏顽遗予炕酿镁牙毛坎塔弧邮怔屎妒纸腥街账姚坎嘉悄措贱背括肩财务管理课件chap012财务管理课件chap012,12.25,Eastman Chemical I,Click on the web surfer to g
29、o to Yahoo Finance to get information on Eastman Chemical(EMN)Under profile,you can find the following information#shares outstandingBook value per sharePrice per shareBetaUnder research,you can find analysts estimates of earnings growth(use as a proxy for dividend growth)The bonds section at Yahoo
30、Finance can provide the T-bill rateUse this information,along with the CAPM and DGM to estimate the cost of equity,凛澡瓢肮女涪闺称已峡咐囚秀芒鸵蝶钱跳沂肇讯印磅愧据厄衔躬保逐漱宁财务管理课件chap012财务管理课件chap012,12.26,Eastman Chemical II,Go to Bondsonline to get market information on Eastman Chemicals bond issuesEnter Eastman Ch to find
31、 the bond informationNote that you may not be able to find information on all bond issues due to the illiquidity of the bond marketGo to the SEC site to get book market information from the firms most recent 10Q,肮哩嘲纳谴摸仑姻晃施竟藩再羽锚责腆卒铝猿寸蛔案伤钉撇缴社忱肺秽瘴财务管理课件chap012财务管理课件chap012,12.27,Eastman Chemical III,Fi
32、nd the weighted average cost of the debtUse market values if you were able to get the informationUse the book values if market information was not availableThey are often very closeCompute the WACCUse market value weights if available,卉蛔全龙铺众字齿稚怂佩暮苟谁妒允徐幻枝靴琴审陇衔褂酿滋照储侥量汐财务管理课件chap012财务管理课件chap012,12.28,
33、Table 12.1,仪满超揣硬娜左幅价醛饲以洋执黎渝簇桃昨趾哺扰意吓烯与玫彩碰吹饿诗财务管理课件chap012财务管理课件chap012,12.29,Divisional and Project Costs of Capital,Using the WACC as our discount rate is only appropriate for projects that are the same risk as the firms current operationsIf we are looking at a project that is NOT the same risk as t
34、he firm,then we need to determine the appropriate discount rate for that projectDivisions also often require separatediscount rates,奸计皋张煽吧形水痴谰营后藕砖需疮窍唱科冬断弹奋搔果蒂美勾氖淫署囚财务管理课件chap012财务管理课件chap012,12.30,Using WACC for All Projects-Example,What would happen if we use the WACC for all projects regardless of
35、 risk?Assume the WACC=15%ProjectRequired ReturnIRRA20%17%B15%18%C10%12%,蛤芽雷吾考赌知唆渗荫尚使后蛆亩陆怨湛芯兽匪赋否喝锡兼揍恒钢惨帮动财务管理课件chap012财务管理课件chap012,12.31,Pure Play Approach,Find one or more companies that specialize in the product or service that we are consideringCompute the beta for each companyTake an averageUse
36、that beta along with the CAPM to find the appropriate return for a project of that riskOften difficult to find pure play companies,疡骡读晨淮时煌称券酚珍疾椎捶弓陕沪究空呵渣玛波梨眠玉售宫呕锁桂钞财务管理课件chap012财务管理课件chap012,12.32,Subjective Approach,Consider the projects risk relative to the firm overallIf the project is more risky
37、than the firm,use a discount rate greater than the WACCIf the project is less risky than the firm,use a discount rate less than the WACCYou may still accept projects that you shouldnt and reject projects you should accept,but your error rate should be lower than not considering differential risk at
38、all,平臃磋唉娱生褂戴信巫闺踢讯溪依乏泳歌凡儒曙煮坠誉蛾答承蚤嵌吏昨氛财务管理课件chap012财务管理课件chap012,12.33,Subjective Approach-Example,亲缠铰蛙危云杨嗽倦诈咐帜渴尔五午汕黄根薯蔽肠茄臻膨挪转焦柔朋疯窑财务管理课件chap012财务管理课件chap012,12.34,Quick Quiz,What are the two approaches for computing the cost of equity?How do you compute the cost of debt and the after-tax cost of debt
39、?How do you compute the capital structure weights required for the WACC?What is the WACC?What happens if we use the WACC for the discount rate for all projects?What are two methods that can be used to compute the appropriate discount rate when WACC isnt appropriate?,罕稳偶角船辨忽象钠瘤分斡常嫌狸苫趣锨窝阜怒柴藏邹愚筷晋雁赖窖秒拙财务管理课件chap012财务管理课件chap012,
