CHTheCostofCapital(财务管理,英文版)

1、CHAPTER 10The Cost of CapitalCost of capital componentsAccounting for flotation costsWACCAdjusting cost of capital for riskEstimating project riskWhat types of capital do firms use?DebtPreferred stockCommon equity: Retained earnings New common stockStockholders focus on A-T CFs.Therefore, we should

2、focus on A-T capital costs, i.e., use A-T costs in WACC. Only kd needs adjustment.Should we focus on before-tax or after-tax capital costs?The cost of capital is used primarily to make decisions that involve raising new capital. So, focus on todays marginal costs (for WACC).Should we focus on histor

3、ical (embedded) costs or new (marginal) costs?A 15-year, 12% semiannual bond sells for $1,153.72. Whats kd? 6060 + 1,0006001230i = ?30 -1153.72 60 1000 5.0% x 2 = kd = 10% NI/YRPVFVPMT-1,153.72.INPUTSOUTPUTComponent Cost of DebtInterest is tax deductible, sokd AT = kd BT(1 T) = 10%(1 0.40) = 6%.Use

4、nominal rate.Flotation costs small.Ignore.Whats the cost of preferred stock? Pp = $111.10; 10%Q; Par = $100.Use this formula:Picture of Preferred Stock2.502.50012kp = ?-0$111.10 = = .kPer = = 2.25%; kp(Nom) = 2.25%(4) = 9%.DQkPer$2.50kPer$2.50$111.10Note:Preferred dividends are not tax dedu

5、ctible, so no tax adjustment. Just kp.Nominal kp is used.Our calculation ignores flotation costs.Is preferred stock more or less risky to investors than debt?More risky; company not required to pay preferred dividend.However, firms try to pay preferred dividend. Otherwise, (1) cannot pay common divi

6、dend, (2) difficult to raise additional funds, (3) preferred stockholders may gain control of firm.Why is yield on preferred lower than kd?Corporations own most preferred stock, because 70% of preferred dividends are nontaxable to corporations.Therefore, preferred often has a lower B-T yield than th

7、e B-T yield on debt.The A-T yield to an investor, and the A-T cost to the issuer, are higher on preferred than on debt. Consistent with higher risk of preferred.Example:kp = 9% kd = 10% T = 40%kp, AT = kp kp (1 0.7)(T)= 9% 9%(0.3)(0.4) = 7.92%.kd, AT = 10% 10%(0.4) = 6.00%. A-T Risk Premium on Prefe

8、rred = 1.92%.Why is there a cost for retained earnings?Earnings can be reinvested or paid out as dividends.Investors could buy other securities, earn a return.Thus, there is an opportunity cost if earnings are retained.Opportunity cost: The return stockholders could earn on alternative investments o

9、f equal risk.They could buy similar stocks and earn ks, or company could repurchase its own stock and earn ks. So, ks is the cost of retained earnings.Three ways to determine cost of common equity, ks: 1.CAPM: ks = kRF + (kM kRF)b.2.DCF: ks = D1/P0 + g.3.Own-Bond-Yield-Plus-Risk Premium: ks = kd + R

10、P.Whats the cost of common equity based on the CAPM?kRF = 7%, RPM = 6%, b = 1.2.ks = kRF + (kM kRF )b.= 7.0% + (6.0%)1.2 = 14.2%.Whats the DCF cost of commonequity, ks? Given: D0 = $4.19;P0 = $50; g = 5%.D1P0D0(1 + g)P0$4.19(1.05)$50ks= + g = + g= + 0.05= 0.088 + 0.05= 13.8%.Suppose the company has

11、been earning 15% on equity (ROE = 15%) and retaining 35% (dividend payout = 65%), and this situation is expected to continue.Whats the expected future g?Retention growth rate:g = (1 Payout)(ROE)= 0.35(15%) = 5.25%.Here (1 Payout) = Fraction retained.Close to g = 5% given earlier. Think of bank accou

12、nt paying 10% with payout = 100%, payout = 0%, and payout = 50%. Whats g?Could DCF methodology be applied if g is not constant?YES, nonconstant g stocks are expected to have constant g at some point, generally in 5 to 10 years.But calculations get complicated.Find ks using the own-bond-yield-plus-ri

13、sk-premium method. (kd = 10%, RP = 4%.)This RP CAPM RP.Produces ballpark estimate of ks. Useful check.ks = kd + RP = 10.0% + 4.0% = 14.0%Whats a reasonable final estimate of ks?MethodEstimateCAPM 14.2%DCF 13.8%kd + RP 14.0%Average 14.0%1.When a company issues new common stock they also have to pay f

14、lotation costs to the underwriter.2.Issuing new common stock may send a negative signal to the capital markets, which may depress stock price.Why is the cost of retained earnings cheaper than the cost of issuing new common stock? Two approaches that can be used to account for flotation costs:Include

15、 the flotation costs as part of the projects up-front cost. This reduces the projects estimated return.Adjust the cost of capital to include flotation costs. This is most commonly done by incorporating flotation costs in the DCF model.New common, F = 15%:Comments about flotation costs:Flotation cost

16、s depend on the risk of the firm and the type of capital being raised.The flotation costs are highest for common equity. However, since most firms issue equity infrequently, the per-project cost is fairly small.We will frequently ignore flotation costs when calculating the WACC.Whats the firms WACC

17、(ignoring flotation costs)?WACC = wdkd(1 T) + wpkp + wcks = 0.3(10%)(0.6) + 0.1(9%) + 0.6(14%) = 1.8% + 0.9% + 8.4% = 11.1%.What factors influence a companys composite WACC?Market conditions.The firms capital structure and dividend policy.The firms investment policy. Firms with riskier projects gene

18、rally have a higher WACC.WACC Estimates for Some Large U. S. Corporations, Nov. 1999CompanyWACCIntel12.9%General Electric11.9Motorola11.3Coca-Cola11.2Walt Disney10.0 AT&T 9.8Wal-Mart 9.8Exxon 8.8H. J. Heinz 8.5BellSouth 8.2Should the company use the composite WACC as the hurdle rate for each of its

19、projects?NO! The composite WACC reflects the risk of an average project undertaken by the firm. Therefore, the WACC only represents the “hurdle rate” for a typical project with average risk.Different projects have different risks. The projects WACC should be adjusted to reflect the projects risk.Ris

20、k and the Cost of CapitalDivisional Cost of CapitalWhat are the three types of project risk?Stand-alone riskCorporate riskMarket riskHow is each type of risk used?Market risk is theoretically best in most situations.However, creditors, customers, suppliers, and employees are more affected by corpora

21、te risk.Therefore, corporate risk is also relevant.Subjective adjustments to the firms composite WACC.Attempt to estimate what the cost of capital would be if the project/division were a stand-alone firm. This requires estimating the projects beta.What procedures are used to determine the risk-adjus

22、ted cost of capital for a particular project or division?Methods for Estimating a Projects Beta1.Pure play. Find several publicly traded companies exclusively in projects business.Use average of their betas as proxy for projects beta.Hard to find such companies.2.Accounting beta. Run regression between projects ROA and S&P index ROA.Accounting betas are correlated (0.5 0.6) with market betas.But normally cant get data on new projects