acca p4課件、真題及其他chp7a

1、Chapter 7aImpact of financing on investment decisions and APVStudy guideAssess the appropriateness and price of sources finance availableCost of capital: cost of debt, cost of equityMacaulay duration method, the benefits and limitations of durationAssess the exposure of credit riskImpact of financin

2、g upon investment decisions of:Pecking order theoryStatic trade-off theoryAgency effects and capital structureAdjusted present value (APV) techniqueAssess the impact of significant capital investment upon financial position1. Sources of financeShort-term debt Overdrafts & short-term loansLong-term d

3、ebtEquity financeVenture capitalBusiness angelsLease financePrivate equityAsset securitisationTechnical article: toxic assetsIslamic finance (p206 table)hybridsConsider the appropriateness for different organizations and relative costs: p206 Q&ASources of finance available depend on:Financial positi

4、on of the companyFinancial risk of the companyValue of the company2. Cost of capitalDividend growth modelEstimation of growth ratePast growth in dividendGordons growth model CAPMProblems with applying CAPM in practiceDeterminants of betaCAPM and portfoliosProject specific cost of capitalCost of debt

5、Cost of preferred shares (p212)WACC Problems with CAPM (p209)Assumptions not all realistic p215 3.5Its just a single period model p215 4.1(b)Can not explain some market anomalies Ignores some other risk factorsThe total risk may be important p215 3.5(c)Need to determine all the parameters such as ri

6、sk-free rate and excess return of market p215 4.1(a c)Problems in beta value calculationStatistical errorsHistorical data as basis for future predictionMay change overtimeSubject to statistical errors p215 4.1(d)Factors affecting beta valuep210 Q&A (b) Beta of a company is the weighted average of it

7、s equity beta and its debt beta.Beta of a companys equity is affected by:Sensitivity of cash flow to economic factorsCompanys operating gearing: high level of fixed costs in cost structure will cause high operating gearing Companys financial gearing: high level of debt in capital structure will caus

8、e high financial gearing3. CAPM and portfoliosThe beta factor of an investors portfolio is the weighted average of the beta factor of the securities in the portfolio.Then, expected return of a portfolio can be calculated using CAPM. (p213 3.1.1 example)Portfolio manager should decide the portfolio b

9、eta factor he likes to have, and seek to invest low-beta shares in bear market and invest high-beta shares in bull market.Investors can benefit from maximum diversification by investing in the world market portfolio.In practice, the international market is between completely integrated and completel

10、y segment, so a multinational cost of capital is between the local cost of equity and world cost of equity. (2006/06-5)4. Project specific cost of capitalStep 1: obtain published beta values for companies in the same industryStep 2: ungear beta (adjust published beta to allow for quoted companys gea

11、ring level)Step 3: regear beta (convert ungeared beta to a geared beta, reflecting companys own gearing ratio)Step 4: use the CAPM to estimate cost of equity and then WACCCalculations: p216 4.1.3 example + p218 Q&AWeaknesses in the formulaDifficult to identify firms with identical operating characte

12、risticsEstimates of beta are not wholly accurateOpportunities for growth affect its equity betaThere may be differences in beta values between firms caused by cost structure, and sizeIts assumed that debt is risk-free, but debt may have default risk*2008-6-1(a)2.3 Cost of debtIrredeemable debtRedeem

13、able debtConvertible debtIf conversion not expected: redeemable debt If conversion expected:Bond valuation and bond yieldtechnical article by examiner1.2.1 Bond valuation Use the coupon rate to get interest per period use the required rate of return to discount the interests and redeemable value and

14、 get the bond valueP202 Example1.2.3 Yield to maturity (YTM/GRY)Use the current price of a bond, together with coupons and redemption value and date to compute YTM just like the calculation of IRRBond valuation and bond yieldtechnical article by examiner1.2.2 Term structure and yield curveMarket dem

15、and different annual returns or yield on bonds with differing lengths of time before their redemptionTerm structure can be represented by yield curveNormally, the yield cure is upward sloping downward sloping may also be possible (chp17)YTM is a weighted average of the term structure of interest rat

16、es.Bond valuation and bond yieldtechnical article by examinerLogic Estimate the government bond yield curve Use credit rating of individual corporate bond to get the relevant spread Individual yield curve can be estimated based on government bond yield and spreadUse these rates as discount rate (req

17、uired rate of return) to estimate value or price of individual bondP252 Q&ABond valuation and bond yieldtechnical article by examinerWACCFormulaUsing WACC in investment appraisalFORProject being appraised is small relative to the companyExisting capital structure is maintained (same financial risk)P

18、roject has the same business risk as the company (same business risk)AGAINSTProject might have different business riskThe finance for the project might change the capital structure and financial riskCompany might raise floating rate debt capital5. DurationDuration is the weighted average length of t

19、ime to receipt of a bonds benefits, the weights being PV of benefits involved.It is a composite measure of risk expressed in years.Duration depends on factors:Longer-dated bonds have longer durationLower-coupon bonds have longer durationLower yield will give longer durationThe duration will shorten

20、as the life span of the bond decaysModified durationModified duration is a means of expressing the sensitivity of a bond to movements in the interest rate.The higher the modified duration, the greater sensitivity of the bond to a change in yield.The modified duration shares the same properties with

21、Macaulay duration.Benefits and limitations of durationBenefitsAllows different bonds to be comparedPossible to determine a bond portfolio value change to interest rate changeManagement can modify interest rate risk by changing duration of bond portfolioLimitationsIt assumes a linear relationship bet

22、ween interest rates and priceActually, the relationship is convex*Duration should be treated with caution in prediction of interest rate/price relationship, possibly combined with convexity6. Credit riskCredit risk= default riskIs the risk undertaken by the lender that borrower will default either o

23、n interest payments or (and) on the repayment of principal on the due dateCredit risk of a loan or bond is determined by:The probability of default (PD)The recovery rateCredit risk measurementThis assignment of credit risk rating is done by credit rating companies such as S&P and Moodys. (P224)Using

24、 financial and other information on the borrowers and assign a rating that reflects the expected loss from investing in the particular bond.Criteria for establishing credit ratings: 6.3 2011-12-3(C)Usually, probability of default is inversely related to credit rating, and positively related to durat

25、ion of the bond.Credit migrationThe credit rating of a borrower may change after a bond is issued. This is referred to as credit migration.Default probabilities can vary quite substantially over the years.The assignment of lower credit rating will decrease the market value of the corporate bond.Cred

26、it enhancementThe process of reducing credit risk, is a key part of securitization transaction.Internal credit enhancementExcess spread: surplus interest cash flowsOver-collateralization: ratio of assets supporting a debt to debt is greater than 1External credit enhancementSurety bond: contract of g

27、uarantee to compensate for any losses incurred Letter of credit: financial institution obliged to reimburse any losses incurred,often used in international tradeCash collateral account: an account used to secure and service a loan7. Credit spreads and cost of debt capitalCredit spread is the premium

28、 required by an investor in a corporate bond to compensate for the credit risk of the bond.For investor of the bond:For the borrower:Impact of credit spreads on bond valuesThe general formula for the value of a bond:P228 use the spreads table to do computations: 3 examplesThe impact of credit migrat

29、ion on bond valuesPredicting credit ratingKaplan-Urwitz model produces a numerical value which is used to classify a company into a credit rating category.For quoted companiesFor unquoted companiesScore (Y) and corresponding rating category8. Theories of capital structureTraditional view and MM theo

30、ryTraditional viewMM viewMM theory adjusted for taxationAlternative theoriesStatic trade-off theoryAgency theoryPecking order theoryFinancing mix and cost of capitalMM theory of capital structure (1958)The value of a levered firm is the same as the value of an unlevered firm.The WACC is fixed and eq

31、ual to the unleveraged cost of equity.Leverage increases the risk of equity, the cost of equity capital for a levered firm equals the constant overall cost of capital plus a risk premium.Traditional theory of capital structureMM theory with corporate taxes (1963)The value of a levered firm equals th

32、e value of an equivalent unlevered firm plus the value of tax savings due to interest deductibility from taxes.The WACC is reduced as the level of debt increases.The cost of equity capital isCost of Capital (%)262014 8020406080100Debt/Value Ratio (%)keWACCkd(1 - T)As the level of debt increases: the

33、 cost of debt remains the same, the cost of equity increases, the WACC decreases,the value of the leveraged company increases.Value of Firm, V (%)432100.51.01.52.02.5Debt(Millions of $)VLVUUnder MM with corporate taxes, the firms value increases continuously as more and more debt is used.TDProblems

34、with M-M theoryModels are derived based on perfect market assumptions, not considering the following:Bankruptcy risks ignoredAgency costs ignoredTransaction costsIrrational behavior of investorsIn practice, the capital structure will depend on factors such as stage of company in its life cycle, stab

35、ility of CF and financial distress cost, etc.9. Alternative explanations of capital structureThe static trade-off theoryAn increase in debt will result in an increase in the chances of the firm going bankrupt, thus an increase in the bankruptcy and financial distress costs.Direct financial distress

36、costsIndirect financial distress costsThe value of the firm:There exists a certain combination of debt and equity financing that will enable a firm to minimize its cost of capital and to maximize its value.The company should lever up to take advantage of any tax benefits, but only to the extent that

37、 the marginal benefits exceed the marginal costs of financial distress.Alternative explanations of capital structureAgency theoryAgency costs of debt arise when there is a risk of default, and will increase as the level of debt increases.Agency cost also exist in relation to the new share issues.The

38、 optimal capital structure of the firm will be formed at the particular level of debt and equity where the benefits of the debt that can be received by the shareholders balance with the costs of debt imposed by the debt holders.Relationships between capital costs and leverage when financial distress

39、 and agency costs are considered.Cost of Capital (%)14 4Debt ($)ksWACCkd(1 - T)D*WACC schedule is U-shaped when plotted against leverage.Relationship between value and leverage.Value of Firm ($)Debt ($)4321D*Company market value schedule is an inverted U-shape.Pecking order hypothesisAs a result of

40、information asymmetry, shareholders use directors actions as a signal to indicate their superior information.The stock issue is an adverse signal to investors, depressing stock price, leading to underinvestment.Firms can avoid underinvestment by financing the investment with security not so heavily

41、undervalued by the market.The theory predicts that firms tend to finance investment first internally, then with risky debt and finally with external equity. A single optimal debt-equity ratio does not exist.Alternative explanations of capital structure10. Adjusted present value (APV)APV approach:Ste

42、p 1: Estimate the project with no leverage:Use to ungear cost of equityUse NPV method to calculate “base case NPV”Step 2: make adjustments to the effect of financing.P240 10.3If the investment will not change the companys WACC, the NPV method is better;If the investment will change the companys exis

43、ting capital structure, the APV method is betterElements in APV calculationTax shield of debt:Only when the tax shield is perpetuity and paid in current yearGenerally, the tax relief should be discounted at the risk-free rate or cost of debt.Issue cost:If issue cost are x% of the amount raised:If is

44、sue costs are allowable for tax:(Spare debt capacity): tax shield effect of the increased debt financeSubsidy: government loan at favorable rateTax shield in favorable rateBenefits of paying lower interest rateElements in APV calculationAdv. and disadv. of APVAdvantages:Can be used to evaluate all the effects of financing a project, inclu