专业课西南财大金融经济学lecture3costofcapital.pptx
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1、WACC2WACCUnder the assumptions of MM,If the company undertakes a new investment project with same risk as the rest of the company,the change in value is:3WACCThe new investment is financed with debt or equity or bothThe change in value can also be seen from the liability side:4WACCIf DBo=0,and using
2、 the fact that DI=DSn+DBnThe project adds value for the shareholders if5WACCUsing(*)in(*):If we assume that there is a target capital structure and therefore that DB/DI=D/(D+E),the termis the WACC6Derivation:7WACC lessonsNotice that the standard WACC is a by product of MM,and therefore is relies on
3、the same assumptionsNotice also there is something intrinsically contradictory in the way it is often applied:You start assuming a constant debt levelThen you assume a target debt ratioWhen the debt ratio is assumed constant,the WACC formula ought to be different8Miles-Ezzel WACC:dynamic debtIf we a
4、ssume the debt ratio is constant,the WACC formula isAnd the formula for relevering betas is9Cost of equity:CAPMThe discount rate for risky investments(expected return)covers:The time value of moneyA risk premiumE(ri)=rf+bi(E(rm)-rf)This is the most used method to calculate costs of equityAlternative
5、:APT(see book for details if interested)10Alternative:Dividend Growth ModelGordons growth model:Thus:11Applying it:Need dividend yield and growth rate:use analysts forecastsuse the plowback ratio formula:g=b x ROE,where b is the retention ratioNote:this g is the so-called sustainable growth rate 12P
6、itfallsThe d-growth model makes a number of assumptions:constant growth rateconstant dividend yield The validity of the model depends on the validity of these assumptions13Cost of DebtThe rate of return that debt-holders demand to hold the debtRemember:it is the expected return and not the promised
7、oneFor high-rated bonds,promised is probably a good proxy14Discount Rate for DebtIn practice:Rate on new or recent borrowingsYield on comparable bondsBoth are measures of promised yieldExpected return depends on:Probability of defaultExposure at defaultLoss given defaultExpected loss on a loan is:PD
8、 x EAD x LGDThese are the terms used by Basel II15Discount Rate for DebtSame logic can be used to calculate expected returnsAssuming EAD=1:rD=(1 PD)x i+PD x LGDE.g.interest(i)is 14%,PD is 4%,recovery rate is 60%.Then,cost of debt is:rD=0.96 x 14%+0.04 x 40%=11.84%16Discount rate for debtAlternative
9、ways:CAPM:if there is little debt,assume bD=0if debt is risky,use proxies based on empirical research:TypeBeta1-5 years.086-10 years.13Government BondsTypeBetaAaa.20Aa.20A.21Baa.23Lower Grade.31Corporate Bonds17ExampleCompany XYZ wants to issue a 30-year bond,coupon 5%No bonds outstanding,credit ris
10、k similar to General Tool CompanyThe latter issued last year a 31-year bond,coupon 6.0%,selling today at 97%3-month T-bills pay 5%a yearWhich discount rate should be used?18Example1.Direct comparison:19Example2.CAPM:A bond:Beta of an A-bond is 0.21Using CAPM,and a market premium of 6%:E(rD)=5.0%+.21
11、 x 6%=6.26%Capital budgeting21Capital BudgetingThe CB problem amounts to deciding which projects a firm should undertakeNPV is the most sound rule for CBA project should be undertaken if NPV 0To implement NPV one needs:cash flow estimatescost of capital estimate22A fresh look at NPVNPV=PV investment
12、PV=value of a tracking portfolio that replicates the projects payoffsNPV 0 same payoffs can be obtained in a cheaper way in the(financial)marketsThus positive NPV projects are“arbitrage opportunities”Q:Why do they not disappear immediately?23Risk-free project:NPVMonth0612Project-200100120T-Bill-9710
13、0T-Bond-90100Replicating portfolio(NPV)T Bill1T Bond1.2Payoff rep.portf.10012024Risk-free project:NPV(cont)The NPV is thus the difference,the arbitrage opportunity=90 x 1.2+97CostsRepl.Port.-205Project-200Projects NPV525Risk-free project:DCF3.09%(11.11%)is the yield on the 6-month(12-month)T Bill:=1
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