Cost-of-Capital課件

1、Cost of Capital11Chapter 11 - OutlineCost of CapitalCost of DebtCost of Preferred StockCost of Common Equity:Common StockRetained EarningsOptimum Capital StructureMarginal Cost of CapitalThe Security of Market LineSummary and ConclusionsPPT 11-22Cost of CapitalThe cost of capital represents the over

2、all cost of future financing to the firmThe cost of capital is normally the relevant discount rate to use in analyzing an investmentIt represents the minimal acceptable return from the investmentIf your cost of funds is 10%, you must earn at least 10% on your investments to break even!The cost of ca

3、pital is a weighted average of the various sources of funds in the form of debt and equityWACC = Weighted Average Cost of CapitalPPT 11-33Steps in measuring a firms cost of capital1. Compute the cost of each source of capital.2. Assign weights to each source. Conversion of historical cost of capital

4、 structure to market values may be required.3. Compute the weighted average of the component costs.4Cost of Capital Baker Corporation5Cost of DebtMeasured by interest rate, or yield, paid to bondholdersExample: $1,000 bond paying $100 annual interest 10% yieldCalculation is complex discount rate or

5、premium from par value bondsTo determine the cost of a new debt in the marketplace:The firm will compute the yield on its currently outstanding debt6Approximate Yield to Maturity (Y) Annual interest payment + Number of years to maturity 0.6 (Price of the bond) + 0.4 (Principal payment)Assuming: Y =

6、$101. 50 + 20 .6 ($940) + .4 ($1,000) = $101.50 + 20 $564 + $400 Y = $101.50 + 3 = $104.50 = 10.84% $964 $964Principal payment Price of the bond$1,000 - $940607Tax and flotation cost consideration Market-determined yields on various financial instruments will equal the cost of those instruments to t

7、he firm with adjustment tax and flotation cost consideration8Adjusting Yield for Tax ConsiderationsYield to maturity indicates how much the firm has to pay on a before-tax basisInterest payment on a debt is a tax-deductible expenseDue to this, the true cost is less than the stated cost9Adjusting Yie

8、ld for Tax Considerations (contd)The after-tax cost of debt is calculated as shown below:Assuming:10Yield of Preferred StockPreferred stock:has a fixed dividend (similar to debt)has no maturity datedividends are not tax deductible and are expected to be perpetual or infiniteYield of preferred stock

9、= annual dividend price of stockYield of new preferred stock = annual dividend price-flotation costsFlotation costs: selling and distribution costs (such as sales commissions) for the new securitiesPPT 11-611Cost of Preferred Stock (contd)The cost of preferred stock is as follows:Where, = Cost of pr

10、eferred stock; = Annual dividend on preferred stock; = Price of preferred stock; F = Floatation, or selling costAssuming annual dividend as $10.50, preferred stock is $100, and flotation, or selling cost is $4. Effective cost is: = $10.50 = $10.50 = 10.94% $100 - $4 $9612Cost of Common Equity Valuat

11、ion ApproachIn determining the cost of common stock, the firm must be sensitive to pricing and performance demands of current and future stockholdersDividend valuation model:Where, = Price of the stock today; = Dividend at the end of the year (or period); = Required rate of return; g = Constant grow

12、th rate in dividendsAssuming = $2; = $40 and g = 7%, equals 12 percent = $2 + 7% = 5% + 7% = 12% $4013Alternate Calculation of the Required Return on Common StockCapital asset pricing model (CAPM)Where: = Required return on common stock; = Risk-free rate of return, usually the current rate on Treasu

13、ry bill securities; = Beta coefficient (measures the historical volatility of an individual stocks return relative to a stock market index; = return in the market as measured by an approximate indexAssuming = 5.5%, = 12%, = 1.0, would be: = 5.5% + 1.0 (12% - 5.5%) = 5.5% + 1.0 (6.5%) = 5.5% + 6.5% =

14、 12% 14Cost of Retained EarningsSources of capital for common stock equity: Purchaser of the new shares external sourceRetained earnings internal sourceRepresent the present and past earnings of the firm minus previously distributed dividendsBelong to the current stockholders may be paid in the form

15、 of dividends or reinvested in the firmReinvestments represent a source of equity capital supplied by the current stockholdersAn opportunity cost is involved15Cost of Retained Earnings (contd)The cost of retained earnings is equivalent to the rate of return on the firms common cost representing the

16、opportunity cost represents both the required rate of return on common stock, and the cost of equity in the form of retained earningsFor ease of reference, = Cost of common equity in the form of retained earnings = Dividend at the end of the first year, $2 = Price of stock today, $40 g = Constant gr

17、owth rate in dividends, 7% = $2 + 7% = 5% + 7% = 12% $4016Cost of New Common StockA slightly higher return than , representing the required rate of return of present stockholders, is expectedNeeded to cover the distribution costs of the new securities Common stock New common stock17Cost of New Commo

18、n Stock (contd)Assuming = $2, = $40, F (Flotation or selling costs) = $4 and g = 7%; = $2 + 7% $40 - $4 = $2 + 7% $36 = 5.6% + 7% = 12.6%18Overview of Common Stock Costs19Optimum Capital StructureThe optimum (best) situation is associated with the minimum overall cost of capital:Optimum capital stru

19、cture means the lowest WACCUsually occurs with 40-70% debt in a firms capital structureWACC is also referred to as the required rate of return or the discount rateBased upon the market value rather than the book value of the firms debt and equityPPT 11-820Optimal Capital Structure Weighting Costs (c

20、ontd)Assessment of different plans (next slide):Firm is able to initially reduce weighted average cost of capital with debt financingBeyond Plan B, continued use of debt becomes unattractive and greatly increases costs of sources of financing21Optimal Capital Structure Weighting Costs (contd) Cost (

21、After-tax) Weights Weighted CostFinancial Plan A:Debt 6.5% 20% 1.3%Equity. 12.0 80 9.6 10.9%Financial Plan B:Debt 7.0% 40% 2.8%Equity. 12.5 60 7.5 10.3%Financial Plan C:Debt 9.0% 60% 5.4%Equity. 15.0 40 6.0 11.4%22Cost of Capital Curve23Debt as a Percentage of Total Assets (2006)24Capital acquisitio

22、n and investment decision makingThe discount rate used in evaluating capital projects should be the weighted average cost of capital.If the cost of capital is earned on all projects, the residual claimants of the earnings stream, the owners, will receive their required rate of return. If the overall

23、 return of the firm is less than the cost of capital, the owners will receive less than their desired rate of return because providers of debt capital must be paid.For most firms, the cost of capital is fairly constant within a reasonable range of debt-equity mixes. Changes in money and capital mark

24、et conditions (supply and demand for money), however, cause the cost of capital for all firms to vary upward and downward over time.25Cost of capital over timeCost of capital (Ka)xyDebt-equity mix (percent)KatKat + 1Kat + 226Investment Projects Available to the Baker Corporation27Cost of capital and

25、 investment projects for the Baker Corporation16.014.012.010.08.06.04.0 2.00.0Percent10 15 195039Amount of capital ($ millions)10.41%70 8595Weighted average cost of capitalKaABCDEFGH-28The Marginal Cost of CapitalThe market may demand a higher cost of capital for each amount of fund required if a la

26、rge amount of financing is requiredEquity (ownership) capital is represented by retained earningsRetained earnings cannot grow indefinitely as the firms capital needs to expandRetained earnings is limited to the amount of past and present earnings that can be redeployed into investments29The Margina

27、l Cost of Capital (contd)Assumptions:60% is the amount of equity capital a firm must maintain to keep a balance between fixed income securities and ownership interestBaker Corporation has $23.40 million of retained earning available for investmentThere is adequate retained earning to support the cap

28、ital structure as shown below:Assuming: X = Retained earnings ; Percent of retained earnings in the capital structureWhere X represents the size of the capital structure that retained earnings will support X = $23.40 million = $39 million .60 30Costs of Capital for Different Amounts of Financing31In

29、creasing Marginal Cost of CapitalBoth and represent the cost of capitalThe mc subscript after K indicates the increase in cost of capitalIncrease is because common equity is now in the form of new common stock rather than retained earningsThe aftertax cost of the new common stock is more expensive t

30、han retained earnings because of flotation costs32Increasing Marginal Cost of Capital (contd)Equation for the cost of new common stock: = $2 + 7% = $2 + 7% = 5.6% + 7% = 12.6% $40 - $4 $36 The $50 million figure can be derived thus: Z = Amount of lower-cost debt ; Percent of debt in the capital stru

31、cture Z = $15 million = $50 million .30Where Z represents the size of the capital structure in which lower-cost debt can be used33Cost of Capital for Increasing Amounts of Financing34Changes in the Marginal Costs of Capital35PPT 11-16Marginal cost of capital and Baker Corporation investment alternat

32、ives16.014.012.010.08.06.04.0 2.00.0Percent10 15 195039Amount of capital ($ millions)11.23%70 8595Marginal cost of capitalKmcABCDEFGH10.77%10.41%-36Cost of Components in the Capital Structure37Basic form of the CAPMThe basic form of the CAPM is a linear relationship between returns on individual sto

33、cks and the market over time. Using least squares regression analysis, the return Kj = + Rm + e Where: Kj = return on individual common stock of company = Alpha, the intercept on the y-axis = Beta, the coefficient Rm = Return on the stock market e = Error term of the regression equation38 Rate of Re

34、turn on Stock Year PAI Market1 . . . . . . . . . . . .12.0%10.0%2 . . . . . . . . . . . .16.018.03 . . . . . . . . . . . . 20.016.04 . . . . . . . . . . . .16.010.05 . . . . . . . . . . . . 6.08.0Mean return14.0%12.4%Standard deviation4.73%3.87%PPT 11-18Table 11A-1Performance of PAI and the market39

35、Percent21.015.09.0 3.0Return on PAI common stock Kj3.09.015.021.0Rm Kj = j Rm + ej = 2.8 + .9 (Rm ) + ejReturn on the market Rm (x) 2.8.9Beta = j = Slope of the line(5)(1)(4)(3)(2)(y)Linear regression of returns between PAI and the market40YearKj Rm1. . . . .12%10%2. . . . .16%18%3. . . . .20%16%4.

36、. . . .16%10%5. . . . . 6% 8%70%62%Kj Rm Kj Rm Rm2( Rm )2 936 4,340 844 3,844n Kj Rm Kj Rm 5(936) - 4,340j n Rm2 ( Rm )2 5(844) - 3,844Kj Rm 70 - 0.9 (62)n 5PPT 11-20Linear regression of returns between PAI and the market 41Linear regression of returns between PAI and the marketCalculatorMode: StatI

37、nput 10 (x,y) 12 Data 18 (x,y) 16 Data 16 (x,y) 20 Data 10 (x,y) 16 Data 8 (x,y) 6 Data2ndF a gives 2.792ndF b gives .902ndF r gives .74Note that the values for the x axis(Rm) are input firstThis is the alpha coefficientThis is the beta coefficientThis is the correlation coefficient, a measure of ho

38、w well the formula describes the relationship. The closer to 1.00, the better the fitPPT 11-2142Improved CAPM (risk premium model)Investors expect higher returns if higher risks are taken Kj = Rf + (Rm-Rf) Where: Kj= Required return on Common Stock Rf = Risk-free rate of return = Beta coefficient. T

39、he beta measures the historical volatility of an individual stocks return relative to a stock market index. A beta greater than 1 indicates greater volatility (price movements) than the market, while the reverse would be true for a beta less than 1.Rm-Rf _= Premium or excess return of the market ver

40、sus the risk-free rate. (Rm-Rf) = Expect return above the risk-free rate for the stock of company j, given the level of risk.43The security market line (SML) K.5 Required rates of return Percent0.51.01.52.0SML = Rf + (Rm Rf)Beta (risk)6.5 % market risk premium20.018.016.014.012.010.08.05.5K2K1Rf44Re

41、quired rates of return (percent)0.51.01.52.020.018.016.014.012.010.07.55.5Rf1Rf0SML1Beta (risk)Rf increased 2%SML0The security market line and changing interest rates450.51.01.52.0RfRequired rates of return (percent)SML1Beta (risk)More risk aversion22.020.018.016.014.012.010.08.05.5SML0 PPT 11-24The

42、 security market line and changing investor expectations46Net income (NI) approachCost of capital (percent)Debt/value ratio (percent)Value of the firm ($)Debt/value ratio (percent)Ke = Cost of Equity: Kd = Cost of debt; Ka = Cost of capitalValue is the market value of the firm01000100KdKeKa47Net ope

43、rating income (NOI) approachCost of capital (percent)Value of the firm ($)Debt/value ratio (percent)Debt/value ratio (percent) 00 100 100KeKaKd48Traditional approach as described by DurandCost of capital (percent)Debt/value ratio (percent)Value of the firm ($)Debt/value ratio (percent) KeKaKd0100010

44、049Modigliani and Miller with corporate taxesCost of capital (percent)Value of the firm ($)Debt/value ratio (percent)Debt/value ratio (percent)01000100Cost of debtadjusted for the tax effect of interestKeKaKdVLVU50Combined impact of the corporate tax effect and bankruptcy effect on valuation and cos

45、t of capitalA. Cost of capital (percent)0Debt/value ratio (percent)100Ka (M +M with tax effect and bankruptcy effect)Ka (original M + M)Ka (M + M with tax effect)51Combined impact of the corporate tax effect and bankruptcy effect on valuation and cost of capitalB. Value of the firm ($)0Debt/value ra

46、tio (percent)100VL (M + M with tax effect)VU (original M +M)(M + M with tax effect and bankruptcy effect)52The Capital Budgeting Decision12Chapter 12 - OutlineWhat is Capital Budgeting?5 Methods of Evaluating Investment ProposalsAverage Accounting ReturnPayback PeriodNet Present ValueInternal Rate o

47、f ReturnProfitability indexPPT 12-2Accept/Reject DecisionCapital RationingNet Present Value ProfileCapital Cost AllowanceDetermining Whether to Purchase a MachineSummary and Conclusions54What is Capital Budgeting?Capital Budgeting:represents a long-term investment decisionfor example, buy a new comp

48、uter system or build a new plantinvolves the planning of expenditures for a project with a life of 1 or more years emphasizes amounts and timing of cash flows and opportunity costs and benefitsinvestment usually requires a large initial cash outflow with the expectation of future cash inflowsconside

49、rs only those cash flows that will change as a result of the investmentall cash flows are calculated aftertaxPPT 12-355Administrative ConsiderationsSteps in the decision-making process:Search for and discovery of investment opportunitiesCollection of dataEvaluation and decision makingReevaluation an

50、d adjustment56Capital Budgeting Procedures57Accounting Flows versus Cash FlowThe capital budgeting process focuses on cash flows rather than income on an aftertax basis. Evaluation involves the incorporation of all incremental cash flows in the capital budgeting analysis. Sunk costs are ignored. Opp

51、ortunity costs included. Accounting flows are not totally disregarded in the capital budgeting process.Investors emphasis on EPS.Top management may elect to glean the short-term personal benefits of income effect.58Earnings before amortization and taxes (cash inflow) . $20,000Amortization (non-cash

52、expense). 5,000Earnings before taxes. 15,000Taxes (cash outflow) .7,500Earnings aftertaxes .7,500Amortization. + 5,000Cash flow .$12,500Alternative method of cash flow calculationCash inflow (EBAT) . $20,000Cash outflow (taxes) .- 7,500Cash flow .$12,500PPT 12-5Table 12-1Cash flow for Alston Corpora

53、tion59Earnings before amortization and taxes .$20,000Amortization .20,000Earnings before taxes. .0Taxes .0Earnings aftertaxes. 0Amortization . + 20,000Cash flow .$20,000PPT 12-6Revised cash flow for Alston Corporation605 Methods of Evaluating Investment ProposalsAverage Accounting Return (AAR)Paybac

54、k Period (PP)Internal Rate of Return (IRR)Net Present Value (NPV)Profitability Index (PI)PPT 12-761Average Accounting ReturnAAR Equals: Average Earnings Aftertax Average Book Value of InvestmentAdvantage:Relatively easy to calculateDisadvantages:Uses accounting earnings, not cash flowsIgnores the ti

55、ming of the earningsUses book value, not market value of investmentDoes not suggest an an evaluation yardstickPPT 12-862Payback PeriodPayback Period (PP):computes the amount of time required to recoup the initial investmenta cutoff period is establishedAdvantages:easy to use (“quick and dirty” appro

56、ach)emphasizes liquidityone measure of the risk of an investmentDisadvantages:ignores inflows after the cutoff period and fails to consider the time value of moneybetter measures of riskPPT 12-963Net Present ValueNet Present Value (NPV):the present value of the cash inflows minus the present value o

57、f the cash outflowsthe future cash flows are discounted back over the life of the investmentthe basic discount rate is usually the firms cost of capital (WACC)(assuming similar risk)PPT 12-1164Internal Rate of ReturnInternal Rate of Return (IRR):represents a yield on an investment or an interest rat

58、erequires calculating the discount rate that equates the initial cash outflow (cost) with the future cash inflows (benefits)is the discount rate where the cash outflows equal the cash inflows (or NPV = 0)PPT 12-1265Accept/Reject DecisionPayback Period (PP):if PP cutoff period, reject the projectInte

59、rnal Rate of Return (IRR):if IRR cost of capital, accept the projectif IRR 0, accept the projectif NPV =0 also means IRR or =cost of capital) A disagreement may arise between the NPV and IRR methods when a choice must be made from mutually exclusive proposals or all acceptable proposals cannot be ta

60、ken due to capital rationing.The primary cause of disagreement is the differing discounting assumptions. The NPV method of discounts cash flows at the cost of capital. The IRR method discounts of cash flows at the internal rate of return.The more conservative NPV technique is usually the recommended