[專業(yè)課]【西南財大金融經(jīng)濟學】lecture3-costofcapitalppt課件

1、Cost of Capitaland Investment decisionsWACCWACC(*) )1 (IBTIEBITTIVCCLCorporate Finance3Under 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:BTEBITTBTVVCCCUL)1 (WACCThe new investment is financed with debt or

2、 equity or bothThe change in value can also be seen from the liability side:Corporate Finance4nnBSIIBIBISISIVnonoLWACCIf Bo = 0, and using the fact that I Sn BnThe project adds value for the shareholders ifCorporate Finance51ISIBSISIVonnoL(*) 1010IVIVISISLLooWACCUsing (*) in (*):If we assume that th

3、ere is a target capital structure and therefore that B/I = D/(D+E), the termis the WACCCorporate Finance6IBTIEBITTIBTIEBITTIVCCCCL1)1 (1)1 (IBTC1Derivation:Corporate Finance7DEDTrMPEDDTMPrEDDTrMPEDDTMPEDDMPEDErEDDTrEDErEDDMPEDTEDEMPEDErEDErEDDTrEDDMPEDTrEDErTEDDMPrEDErTEDDrEDErTEDDwaccUUUffUUUfffUUf

4、ffUffEffEf1)1 ()1 (1 ()1 ()()1 ()1 (WACC lessonsNotice that the standard WACC is a by product of MM, and therefore is relies on 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 targ

5、et debt ratioWhen the debt ratio is assumed constant, the WACC formula ought to be differentCorporate Finance8Miles-Ezzel WACC: dynamic debtIf we assume the debt ratio is constant, the WACC formula isAnd the formula for relevering betas isCorporate Finance9CDTrEDDWACC 1VSSDCost of equity: CAPMThe di

6、scount rate for risky investments (expected return) covers:The time value of moneyA risk premiumE(ri) = rf +i(E(rm) - rf)This is the most used method to calculate costs of equityAlternative: APT (see book for details if interested)Corporate Finance10Alternative: Dividend Growth ModelGordons growth m

7、odel:Thus: Corporate Finance11grdivEPPdivgrEApplying 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 Corporate Finance12PitfallsThe d-growth model makes a num

8、ber of assumptions:constant growth rateconstant dividend yield The validity of the model depends on the validity of these assumptionsCorporate Finance13Cost of DebtThe rate of return that debt-holders demand to hold the debtRemember: it is the expected return and not the promised oneFor high-rated b

9、onds, promised is probably a good proxyCorporate Finance14Discount 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

10、x EAD x LGDThese are the terms used by Basel IICorporate Finance15Discount 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%

11、 Corporate Finance16Discount rate for debtAlternative ways:CAPM: if there is little debt, assume D =0if debt is risky, use proxies based on empirical research:Corporate Finance17TypeBeta1-5 years.086-10 years.13Government BondsTypeBetaAaa.20Aa .20A.21Baa.23Lower Grade.31Corporate BondsExampleCompany

12、 XYZ wants to issue a 30-year bond, coupon 5%No bonds outstanding, credit risk 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?Corporate Finance18Example1. Direct comparison:Co

13、rporate Finance19%23. 6)(0)1 (1060.)1 (60160970302yieldIRRIRRIRRIRRExample2. CAPM: A bond:Beta of an A-bond is 0.21Using CAPM, and a market premium of 6%:E(rD) = 5.0% + .21 x 6% = 6.26%Corporate Finance20Capital budgetingCapital BudgetingThe CB problem amounts to deciding which projects a firm shoul

14、d undertakeNPV is the most sound rule for CBA project should be undertaken if NPV 0To implement NPV one needs:cash flow estimatescost of capital estimateCorporate Finance22A fresh look at NPVNPV = PV investmentPV = value of a tracking portfolio that replicates the projects payoffsNPV 0 same payoffs

15、can be obtained in a cheaper way in the (financial) marketsThus positive NPV projects are “arbitrage opportunities”Q: Why do they not disappear immediately?Corporate Finance23Risk-free project: NPVCorporate Finance24Month0612Project-200100120T-Bill-97100T-Bond-90100Replicating portfolio (NPV)T Bill1

16、T Bond1.2Payoff rep. portf.100120Risk-free project: NPV (cont)The NPV is thus the difference, the arbitrage opportunityCorporate Finance25 = 90 x 1.2 + 97CostsRepl. Port.-205Project-200Projects NPV5Risk-free project: DCF3.09% (11.11%) is the yield on the 6-month (12-month) T Bill:Corporate Finance26

17、NoImage197100%09. 3= 120 / 1.1111= 100 / 1.0309DCFDiscount rates3.09%11.11%PV cash flows-20097108NPV5Risky ProjectsThe underlying principles are the same Replicating portfolioDiscount rates (now risk-adjusted)Corporate Finance27CAPMRewriting the CAPM formula we get:E(ri) = rf +i(E(rm) - rf) = rf (1

18、i) + i E(rm)ie the expected return on the project equals the expected return on a portfolio consisting of:A fraction of the investment in the market portfolio1 in the risk-free assetwhich is the tracking portfolio for the investment.Corporate Finance28Discount Rate for a ProjectIn theory, a projects

19、 discount rate:reflects the expected return investors require to hold financial assets (those in the replicating portfolio)whose cash flows are thus in the same risk class as the projectsApplying this principle:Estimate a beta for the projectUse CAPM to estimate the cost of capitalCorporate Finance2

20、9DR for a project (c)Normally there is no history to estimate beta (the project is yet to be undertaken)Way out: use the beta of a firm in the same line of business as the projectCorporate Finance30Betas and leverageBeta is a measure of risk, that reflects two types of it:Operational (asset) riskFin

21、ancial riskWe dont want the second one (which is firm-specific)We need an “asset beta” of the beta of the firms assetsWe need the formulas mentioned earlier to go from one to the otherCorporate Finance31ExampleMarriot identified 3 comparable firms for its restaurant division:Estimate the unlevered c

22、ost of capital for the restaurant division, assuming: rf = 4%, MP = 5%, Tc = 34%, comparables debt is risk-free, and debt is a constant known amountCorporate Finance32FirmEq. BetaDEChurchs Chiken.75.004.096McDonalds1.002.37.70Wendys1.08.210.790AnswerCorporate Finance33 .9279.21.66.108. 1)(.847 . 73

23、. 266.11)(.73096.004.66.175.)(WMDCCUUUMarriots OAs beta is thenWe can average those three, to getAnd its cost of capital (unlevered):Corporate Finance3483.392.84.73.% 15. 805.83.04.MPrrUfCash flows(Free) cash flow is:EBIT - Taxes on EBIT (=NOPLAT)+ Depreciation- Changes in working capital- Capital E

24、xpendituresCorporate Finance35Interest?We do not subtract interest because it is a financing cash flow:depends on the way the project is financednot on the projects assets themselvesCorporate Finance36Example: evaluate this projectCost of a new plant = 1,000New Sales (per year) = 50Save 100 in year

25、expensesOperating costs = 10 / yearOld plant fully depreciated, salvage value = 50 after taxNew plants salvage value = 200 after 10 years; linear depreciationTaxes = 34%, discount rate 10% Corporate Finance37Cash FlowsCorporate Finance38Year01234Sales50505050Savings100100100100O. Costs-10-10-10-10CA

26、PEX-1000Old Plant50Depreciation-80-80-80-80EBIT60606060Taxes20202020Net Cash Flow-9501201201201205678910505050505050100100100100100100-10-10-10-10-10-10200-80-80-80-80-80-80606060606060202020202020120120120120120320NPV(10%)=-235.5APV approachA project can have three sources of value to the sharehold

27、ers:NPV of the free cash flow from the real assetsNPV of subsidies etcNPV of financing effectsCorporate Finance39APV (b)APV decomposes the value in two parts:1. NPV assuming all equity financing2. PV of benefits and costs of debtDiscount rates:1. DR for unlevered assets2. DR for the firms debt, e.g.

28、: rD = rf + D MPThen: APV = NPV + B(D) - C(D)where D is the optimal debt levelCorporate Finance40ExampleInvestment = 100FCF = 20 / year (for 10 years)beta (OA) = 1rf = 5%the firm can borrow 80m on the assetrD = 8%No costs of financial distressTax = 30%Corporate Finance41AnswerNPV (13%) = 8.52Yearly

29、interest = .08 x 80 = 6.4Yearly tax shield = .30 x 6.4 = 1.92If the spread over the risk-free rate reflects the default risk, there is some probability the firm will default (and not enjoy the tax shield). Say that prob is 25%Then: expected yearly tax shield = .75 x 1.92 = 1.44Corporate Finance42AnswerDiscount rate = cost of debt = 8%PVTS = 9.6APV = NPV + B(D) = 8.52 + 9.6 = 18.12Corporate Finance43Assessing APVMain problem:How to estimate the optimal capital structureMore in general, how to estimate D, C(D) and B(D)