CF2-Ch-09-The-Cost-of-Capital-公司财务与金融-课件

CHAPTER9TheCostofCapital1CHAPTER9TheCostofCapital1TopicsCostofCapitalComponentsDebtPreferredCommonEquityWACC2TopicsCostofCapitalComponenWhattypesoflong-termcapitaldofirmsuse?Long-termdebtPreferredstockCommonequity3Whattypesoflong-termcapitaCapitalComponentsCapitalcomponentsaresourcesoffundingthatcomefrominvestors.Accountspayable,accruals,anddeferredtaxesarenotsourcesoffundingthatcomefrominvestors,sotheyarenotincludedinthecalculationofthecostofcapital.Wedoadjustfortheseitemswhencalculatingthecashflowsofaproject,butnotwhencalculatingthecostofcapital.4CapitalComponentsCapitalcompBefore-taxvs.After-taxCapitalCostsTaxeffectsassociatedwithfinancingcanbeincorporatedeitherincapitalbudgetingcashflowsorincostofcapital.Mostfirmsincorporatetaxeffectsinthecostofcapital.Therefore,focusonafter-taxcosts.Onlycostofdebtisaffected.5Before-taxvs.After-taxCapitHistorical(Embedded)Costsvs.New(Marginal)CostsThecostofcapitalisusedprimarilytomakedecisionswhichinvolveraisingandinvestingnewcapital.So,weshouldfocusonmarginalcosts.6Historical(Embedded)CostsvsCostofDebtMethod1:Askaninvestmentbankerwhatthecouponratewouldbeonnewdebt.Method2:Findthebondratingforthecompanyandusetheyieldonotherbondswithasimilarrating.Method3:Findtheyieldonthecompany’sdebt,ifithasany.7CostofDebtMethod1:AskaniA15-year,12%semiannualbondsellsfor$1,153.72.What’srd?

6060+1,0006001230i=?-1,153.72... 30 -1153.72601000

5.0%x2=rd=10% NI/YRPVFVPMTINPUTSOUTPUT8A15-year,12%semiannualbondComponentCostofDebtInterestistaxdeductible,sotheaftertax(AT)costofdebtis:rdAT =rdBT(1-T) rdAT =10%(1-0.40)=6%.Usenominalrate.Flotationcostssmall,soignore.9ComponentCostofDebtInterestCostofpreferredstock:PP=$113.10;10%Q;Par=$100;F=$2.Usethisformula:rps=DpsPn=0.1($100)$113.10-$2.00=$10$111.10=0.090=9.0%10Costofpreferredstock:PP=TimeLineofPreferred2.502.502.50012∞rps=?-111.1...$111.10=DQrPer=$2.50rPerrPer=$2.50$111.10=2.25%;rps(Nom)=2.25%(4)=9%11TimeLineofPreferred2.502.50Note:Flotationcostsforpreferredaresignificant,soarereflected.Usenetprice.Preferreddividendsarenotdeductible,sonotaxadjustment.Justrps.Nominalrpsisused.12Note:FlotationcostsforprefeIspreferredstockmoreorlessriskytoinvestorsthandebt?Morerisky;companynotrequiredtopaypreferreddividend.However,firmswanttopaypreferreddividend.Otherwise,(1)cannotpaycommondividend,(2)difficulttoraiseadditionalfunds,and(3)preferredstockholdersmaygaincontroloffirm.13IspreferredstockmoreorlesWhyisyieldonpreferred

lowerthanrd?Corporationsownmostpreferredstock,because70%ofpreferreddividendsarenontaxabletocorporations.Therefore,preferredoftenhasalower

B-TyieldthantheB-Tyieldondebt.TheA-TyieldtoinvestorsandA-Tcosttotheissuerarehigheronpreferredthanondebt,whichisconsistentwiththehigherriskofpreferred.14Whyisyieldonpreferred

lowExample:rps=9% rd=10% T=40%rps,AT=rps-rps(1-0.7)(T)=9%-9%(0.3)(0.4)=7.92%rd,AT=10%-10%(0.4) =6.00%A-TRiskPremiumonPreferred=1.92%15Example:rps=9% rdWhatarethetwowaysthatcompaniescanraisecommonequity?Directly,byissuingnewsharesofcommonstock.Indirectly,byreinvestingearningsthatarenotpaidoutasdividends(i.e.,retainingearnings).16WhatarethetwowaysthatcomWhyisthereacostforreinvestedearnings?Earningscanbereinvestedorpaidoutasdividends.Investorscouldbuyothersecurities,earnareturn.Thus,thereisanopportunitycostifearningsarereinvested.17WhyisthereacostforreinveCostforReinvestedEarnings(Continued)Opportunitycost:Thereturnstockholderscouldearnonalternativeinvestmentsofequalrisk.Theycouldbuysimilarstocksandearnrs,orcompanycouldrepurchaseitsownstockandearnrs.So,rs,isthecostofreinvestedearningsanditisthecostofequity.18CostforReinvestedEarnings(Threewaystodetermine

thecostofequity,rs:1. CAPM:rs =rRF+(rM-rRF)b =rRF+(RPM)b.2. DCF:rs=D1/P0+g.3. Own-Bond-Yield-Plus-Risk Premium: rs=rd+BondRP.19Threewaystodetermine

thecCAPMCostofEquity:rRF=7%,RPM=6%,b=1.2.rs=rRF+(rM-rRF)b.=7.0%+(6.0%)1.2=14.2%.20CAPMCostofEquity:rRF=7%IssuesinUsingCAPMMostanalystsusetherateonalong-term(10to20years)governmentbondasanestimateofrRF.Foracurrentestimate,goto,select“U.S.Treasuries”fromthesectionontheleftundertheheading“Market.”More…21IssuesinUsingCAPMMostanalyIssuesinUsingCAPM(Continued)Mostanalystsusearateof5%to6.5%forthemarketriskpremium(RPM)Estimatesofbetavary,andestimatesare“noisy”(theyhaveawideconfidenceinterval).Foranestimateofbeta,gotoThomsonONE—BusinessSchoolEdition,enteratickersymbol,thenlookunderKeyFundamentals.22IssuesinUsingCAPM(ContinueDCFCostofEquity,rs:D0=$4.19;P0=$50;g=5%.rs=D1P0+g=D0(1+g)P0+g=$4.19(1.05)$50+0.05=0.088+0.05=13.8%23DCFCostofEquity,rs:D0=$EstimatingtheGrowthRateUsethehistoricalgrowthrateifyoubelievethefuturewillbelikethepast.Obtainanalysts’estimates:ValueLine,Zack’s,Yahoo.Finance.Usetheearningsretentionmodel,illustratedonnextslide.24EstimatingtheGrowthRateUseEarningsRetentionModelSupposethecompanyhasbeenearning15%onequity(ROE=15%)andretaining35%(dividendpayout=65%),andthissituationisexpectedtocontinue.

What’stheexpectedfutureg?25EarningsRetentionModelSupposEarningsRetentionModel(Continued)Retentiongrowthrate:

g=ROE(Retentionrate)

g=0.35(15%)=5.25%.

Thisisclosetog=5%givenearlier.Thinkofbankaccountpaying15%withretentionratio=0.Whatisgofaccountbalance?Ifretentionratiois100%,whatisg?26EarningsRetentionModel(ContCouldDCFmethodologybeappliedifgisnotconstant?YES,nonconstantgstocksareexpectedtohaveconstantgatsomepoint,generallyin5to10years.Butcalculationsgetcomplicated.See“FM11Ch9ToolKit.xls”.27CouldDCFmethodologybeappliTheOwn-Bond-Yield-Plus-Risk-PremiumMethod:rd=10%,RP=4%.rs =rd+RPrs =10.0%+4.0%=14.0%ThisRPCAPMRPM.Producesballparkestimateofrs.Usefulcheck.28TheOwn-Bond-Yield-Plus-Risk-PWhat’sareasonablefinalestimateofrs?MethodEstimateCAPM14.2%DCF13.8%rd+RP14.0%Average14.0%29What’sareasonablefinalestiDeterminingtheWeightsfortheWACCTheweightsarethepercentagesofthefirmthatwillbefinancedbyeachcomponent.Ifpossible,alwaysusethetargetweightsforthepercentagesofthefirmthatwillbefinancedwiththevarioustypesofcapital.30DeterminingtheWeightsforthEstimatingWeightsfortheCapitalStructureIfyoudon’tknowthetargets,itisbettertoestimatetheweightsusingcurrentmarketvaluesthancurrentbookvalues.Ifyoudon’tknowthemarketvalueofdebt,thenitisusuallyreasonabletousethebookvaluesofdebt,especiallyifthedebtisshort-term.(More...)31EstimatingWeightsfortheCapEstimatingWeights(Continued)Supposethestockpriceis$50,thereare3millionsharesofstock,thefirmhas$25millionofpreferredstock,and$75millionofdebt.(More...)32EstimatingWeights(Continued)EstimatingWeights(Continued)Vce=$50(3million)=$150million.Vps=$25million.Vd=$75million.Totalvalue=$150+$25+$75=$250million.33EstimatingWeights(Continued)EstimatingWeights(Continued)wce=$150/$250=0.6wps=$25/$250=0.1wd=$75/$250=0.334EstimatingWeights(Continued)What’stheWACC?WACC=wdrd(1-T)+wpsrps+wcersWACC=0.3(10%)(0.6)+0.1(9%)+0.6(14%)WACC=1.8%+0.9%+8.4%=11.1%. 35What’stheWACC?WACC=wdrd(1Whatfactorsinfluenceacompany’sWACC?Marketconditions,especiallyinterestratesandtaxrates.Thefirm’scapitalstructureanddividendpolicy.Thefirm’sinvestmentpolicy.FirmswithriskierprojectsgenerallyhaveahigherWACC.36WhatfactorsinfluenceacompaIsthefirm’sWACCcorrectforeachofitsdivisions?NO!ThecompositeWACCreflectstheriskofanaverageprojectundertakenbythefirm.Differentdivisionsmayhavedifferentrisks.Thedivision’sWACCshouldbeadjustedtoreflectthedivision’sriskandcapitalstructure.37Isthefirm’sWACCcorrectforTheRisk-AdjustedDivisionalCostofCapitalEstimatethecostofcapitalthatthedivisionwouldhaveifitwereastand-alonefirm.Thisrequiresestimatingthedivision’sbeta,costofdebt,andcapitalstructure.38TheRisk-AdjustedDivisionalCPurePlayMethodforEstimatingBetaforaDivisionoraProjectFindseveralpubliclytradedcompaniesexclusivelyinproject’sbusiness.Useaverageoftheirbetasasproxyforproject’sbeta.Hardtofindsuchcompanies.39PurePlayMethodforEstimatinAccountingBetaMethodforEstimatingBetaRunregressionbetweenproject’sROAandS&PindexROA.Accountingbetasarecorrelated(0.5–0.6)withmarketbetas.Butnormallycan’tgetdataonnewprojects’ROAsbeforethecapitalbudgetingdecisionhasbeenmade.40AccountingBetaMethodforEstDivisionalCostofCapitalUsingCAPMTargetdebtratio=10%.rd=12%.rRF=7%.Taxrate=40%.betaDivision=1.7.Marketriskpremium=6%.41DivisionalCostofCapitalUsiDivisionalCostofCapitalUsingCAPM(Continued)Division’srequiredreturnonequity:rs =rRF+(rM–rRF)bDiv.rs=7%+(6%)1.7=17.2%.WACCDiv. =wdrd(1–T)+wcrs =0.1(12%)(0.6)+0.9(17.2%) =16.2%.42DivisionalCostofCapitalUsiDivision’sWACCvs.Firm’sOverallWACC?DivisionWACC=16.2%versuscompanyWACC=11.1%.“Typical”projectswithinthisdivisionwouldbeacceptediftheirreturnsareabove16.2%.43Division’sWACCvs.Firm’sOveDivisionalRiskandtheCostofCapital

RateofReturn

(%)

WACC

RejectionRegion

AcceptanceRegion

Risk

L

B

A

H

WACCH

WACCL

WACCA

0

RiskL

RiskA

RiskH

44DivisionalRiskandtheCostoWhatarethethreetypesofprojectrisk?Stand-aloneriskCorporateriskMarketrisk45WhatarethethreetypesofprHowiseachtypeofriskused?Stand-aloneriskiseasiesttocalculate.Marketriskistheoreticallybestinmostsituations.However,creditors,customers,suppliers,andemployeesaremoreaffectedbycorporaterisk.Therefore,corporateriskisalsorelevant.46Howiseachtypeofriskused?AProject-Specific,Risk-Adjusted

CostofCapitalStartbycalculatingadivisionalcostofcapital.EstimatetheriskoftheprojectusingthetechniquesinChapter11.Usejudgmenttoscaleupordownthecostofcapitalforanindividualprojectrelativetothedivisionalcostofcapital.47AProject-Specific,Risk-AdjusCostsofIssuingNewCommonStockWhenacompanyissuesnewcommonstocktheyalsohavetopayflotationcoststotheunderwriter.Issuingnewcommonstockmaysendanegativesignaltothecapitalmarkets,whichmaydepressstockprice.48CostsofIssuingNewCommonStCostofNewCommonEquity:P0=$50,D0=$4.19,g=5%,andF=15%.re=D0(1+g)P0(1-F)+g=$4.19(1.05)$50(1–0.15)+5.0%=$4.40$42.50+5.0%=15.4%49CostofNewCommonEquity:P0=CostofNew30-YearDebt:Par=$1,000,Coupon=10%paidannually,andF=2%.Usingafinancialcalculator:N=30PV=1000(1-.02)=980PMT=-(.10)(1000)(1-.4)=-60FV=-1000SolvingforI:6.15%50CostofNew30-YearDebt:Par=Commentsaboutflotationcosts:Flotationcostsdependontheriskofthefirmandthetypeofcapitalbeingraised.Theflotationcostsarehighestforcommonequity.However,sincemostfirmsissueequityinfrequently,theper-projectcostisfairlysmall.WewillfrequentlyignoreflotationcostswhencalculatingtheWACC.51CommentsaboutflotationcostsFourMistakestoAvoidCurrentvs.historicalcostofdebtMixingcurrentandhistoricalmeasurestoestimatethemarketriskpremiumBookweightsvs.MarketWeightsIncorrectcostofcapitalcomponentsSeenextslidesfordetails.(More...)52FourMistakestoAvoidCurrentCurrentvs.HistoricalCostofDebtWhenestimatingthecostofdebt,don’tusethecouponrateonexistingdebt.Usethecurrentinterestrateonnewdebt.(More...)53Currentvs.HistoricalCostofEstimatingtheMarketRiskPremiumWhenestimatingtheriskpremiumfortheCAPMapproach,don’tsubtractthecurrentlong-termT-bondratefromthehistoricalaveragereturnoncommonstocks.Forexample,ifthehistoricalrMhasbeenabout12.2%andinflationdrivesthecurrentrRFupto10%,thecurrentmarketriskpremiumisnot12.2%-10%=2.2%!(More...)54EstimatingtheMarketRiskPre(More...)EstimatingWeightsUsethetargetcapitalstructuretodeterminetheweights.Ifyoudon’tknowthetargetweights,thenusethecurrentmarketvalueofequity,andneverthebookvalueofequity.Ifyoudon’tknowthemarketvalueofdebt,thenthebookvalueofdebtoftenisareasonableapproximation,especiallyforshort-termdebt.55(More...)EstimatingWeightsUseCapitalcomponentsaresourcesoffundingthatcomefrominvestors.Accountspayable,accruals,anddeferredtaxesarenotsourcesoffundingthatcomefrominvestors,sotheyarenotincludedinthecalculationoftheWACC.Wedoadjustfortheseitemswhencalculatingthecashflowsoftheproject,butnotwhencalculatingtheWACC.56CapitalcomponentsaresourcesCHAPTER9TheCostofCapital57CHAPTER9TheCostofCapital1TopicsCostofCapitalComponentsDebtPreferredCommonEquityWACC58TopicsCostofCapitalComponenWhattypesoflong-termcapitaldofirmsuse?Long-termdebtPreferredstockCommonequity59Whattypesoflong-termcapitaCapitalComponentsCapitalcomponentsaresourcesoffundingthatcomefrominvestors.Accountspayable,accruals,anddeferredtaxesarenotsourcesoffundingthatcomefrominvestors,sotheyarenotincludedinthecalculationofthecostofcapital.Wedoadjustfortheseitemswhencalculatingthecashflowsofaproject,butnotwhencalculatingthecostofcapital.60CapitalComponentsCapitalcompBefore-taxvs.After-taxCapitalCostsTaxeffectsassociatedwithfinancingcanbeincorporatedeitherincapitalbudgetingcashflowsorincostofcapital.Mostfirmsincorporatetaxeffectsinthecostofcapital.Therefore,focusonafter-taxcosts.Onlycostofdebtisaffected.61Before-taxvs.After-taxCapitHistorical(Embedded)Costsvs.New(Marginal)CostsThecostofcapitalisusedprimarilytomakedecisionswhichinvolveraisingandinvestingnewcapital.So,weshouldfocusonmarginalcosts.62Historical(Embedded)CostsvsCostofDebtMethod1:Askaninvestmentbankerwhatthecouponratewouldbeonnewdebt.Method2:Findthebondratingforthecompanyandusetheyieldonotherbondswithasimilarrating.Method3:Findtheyieldonthecompany’sdebt,ifithasany.63CostofDebtMethod1:AskaniA15-year,12%semiannualbondsellsfor$1,153.72.What’srd?

6060+1,0006001230i=?-1,153.72... 30 -1153.72601000

5.0%x2=rd=10% NI/YRPVFVPMTINPUTSOUTPUT64A15-year,12%semiannualbondComponentCostofDebtInterestistaxdeductible,sotheaftertax(AT)costofdebtis:rdAT =rdBT(1-T) rdAT =10%(1-0.40)=6%.Usenominalrate.Flotationcostssmall,soignore.65ComponentCostofDebtInterestCostofpreferredstock:PP=$113.10;10%Q;Par=$100;F=$2.Usethisformula:rps=DpsPn=0.1($100)$113.10-$2.00=$10$111.10=0.090=9.0%66Costofpreferredstock:PP=TimeLineofPreferred2.502.502.50012∞rps=?-111.1...$111.10=DQrPer=$2.50rPerrPer=$2.50$111.10=2.25%;rps(Nom)=2.25%(4)=9%67TimeLineofPreferred2.502.50Note:Flotationcostsforpreferredaresignificant,soarereflected.Usenetprice.Preferreddividendsarenotdeductible,sonotaxadjustment.Justrps.Nominalrpsisused.68Note:FlotationcostsforprefeIspreferredstockmoreorlessriskytoinvestorsthandebt?Morerisky;companynotrequiredtopaypreferreddividend.However,firmswanttopaypreferreddividend.Otherwise,(1)cannotpaycommondividend,(2)difficulttoraiseadditionalfunds,and(3)preferredstockholdersmaygaincontroloffirm.69IspreferredstockmoreorlesWhyisyieldonpreferred

lowerthanrd?Corporationsownmostpreferredstock,because70%ofpreferreddividendsarenontaxabletocorporations.Therefore,preferredoftenhasalower

B-TyieldthantheB-Tyieldondebt.TheA-TyieldtoinvestorsandA-Tcosttotheissuerarehigheronpreferredthanondebt,whichisconsistentwiththehigherriskofpreferred.70Whyisyieldonpreferred

lowExample:rps=9% rd=10% T=40%rps,AT=rps-rps(1-0.7)(T)=9%-9%(0.3)(0.4)=7.92%rd,AT=10%-10%(0.4) =6.00%A-TRiskPremiumonPreferred=1.92%71Example:rps=9% rdWhatarethetwowaysthatcompaniescanraisecommonequity?Directly,byissuingnewsharesofcommonstock.Indirectly,byreinvestingearningsthatarenotpaidoutasdividends(i.e.,retainingearnings).72WhatarethetwowaysthatcomWhyisthereacostforreinvestedearnings?Earningscanbereinvestedorpaidoutasdividends.Investorscouldbuyothersecurities,earnareturn.Thus,thereisanopportunitycostifearningsarereinvested.73WhyisthereacostforreinveCostforReinvestedEarnings(Continued)Opportunitycost:Thereturnstockholderscouldearnonalternativeinvestmentsofequalrisk.Theycouldbuysimilarstocksandearnrs,orcompanycouldrepurchaseitsownstockandearnrs.So,rs,isthecostofreinvestedearningsanditisthecostofequity.74CostforReinvestedEarnings(Threewaystodetermine

thecostofequity,rs:1. CAPM:rs =rRF+(rM-rRF)b =rRF+(RPM)b.2. DCF:rs=D1/P0+g.3. Own-Bond-Yield-Plus-Risk Premium: rs=rd+BondRP.75Threewaystodetermine

thecCAPMCostofEquity:rRF=7%,RPM=6%,b=1.2.rs=rRF+(rM-rRF)b.=7.0%+(6.0%)1.2=14.2%.76CAPMCostofEquity:rRF=7%IssuesinUsingCAPMMostanalystsusetherateonalong-term(10to20years)governmentbondasanestimateofrRF.Foracurrentestimate,goto,select“U.S.Treasuries”fromthesectionontheleftundertheheading“Market.”More…77IssuesinUsingCAPMMostanalyIssuesinUsingCAPM(Continued)Mostanalystsusearateof5%to6.5%forthemarketriskpremium(RPM)Estimatesofbetavary,andestimatesare“noisy”(theyhaveawideconfidenceinterval).Foranestimateofbeta,gotoThomsonONE—BusinessSchoolEdition,enteratickersymbol,thenlookunderKeyFundamentals.78IssuesinUsingCAPM(ContinueDCFCostofEquity,rs:D0=$4.19;P0=$50;g=5%.rs=D1P0+g=D0(1+g)P0+g=$4.19(1.05)$50+0.05=0.088+0.05=13.8%79DCFCostofEquity,rs:D0=$EstimatingtheGrowthRateUsethehistoricalgrowthrateifyoubelievethefuturewillbelikethepast.Obtainanalysts’estimates:ValueLine,Zack’s,Yahoo.Finance.Usetheearningsretentionmodel,illustratedonnextslide.80EstimatingtheGrowthRateUseEarningsRetentionModelSupposethecompanyhasbeenearning15%onequity(ROE=15%)andretaining35%(dividendpayout=65%),andthissituationisexpectedtocontinue.

What’stheexpectedfutureg?81EarningsRetentionModelSupposEarningsRetentionModel(Continued)Retentiongrowthrate:

g=ROE(Retentionrate)

g=0.35(15%)=5.25%.

Thisisclosetog=5%givenearlier.Thinkofbankaccountpaying15%withretentionratio=0.Whatisgofaccountbalance?Ifretentionratiois100%,whatisg?82EarningsRetentionModel(ContCouldDCFmethodologybeappliedifgisnotconstant?YES,nonconstantgstocksareexpectedtohaveconstantgatsomepoint,generallyin5to10years.Butcalculationsgetcomplicated.See“FM11Ch9ToolKit.xls”.83CouldDCFmethodologybeappliTheOwn-Bond-Yield-Plus-Risk-PremiumMethod:rd=10%,RP=4%.rs =rd+RPrs =10.0%+4.0%=14.0%ThisRPCAPMRPM.Producesballparkestimateofrs.Usefulcheck.84TheOwn-Bond-Yield-Plus-Risk-PWhat’sareasonablefinalestimateofrs?MethodEstimateCAPM14.2%DCF13.8%rd+RP14.0%Average14.0%85What’sareasonablefinalestiDeterminingtheWeightsfortheWACCTheweightsarethepercentagesofthefirmthatwillbefinancedbyeachcomponent.Ifpossible,alwaysusethetargetweightsforthepercentagesofthefirmthatwillbefinancedwiththevarioustypesofcapital.86DeterminingtheWeightsforthEstimatingWeightsfortheCapitalStructureIfyoudon’tknowthetargets,itisbettertoestimatetheweightsusingcurrentmarketvaluesthancurrentbookvalues.Ifyoudon’tknowthemarketvalueofdebt,thenitisusuallyreasonabletousethebookvaluesofdebt,especiallyifthedebtisshort-term.(More...)87EstimatingWeightsfortheCapEstimatingWeights(Continued)Supposethestockpriceis$50,thereare3millionsharesofstock,thefirmhas$25millionofpreferredstock,and$75millionofdebt.(More...)88EstimatingWeights(Continued)EstimatingWeights(Continued)Vce=$50(3million)=$150million.Vps=$25million.Vd=$75million.Totalvalue=$150+$25+$75=$250million.89EstimatingWeights(Continued)EstimatingWeights(Continued)wce=$150/$250=0.6wps=$25/$250=0.1wd=$75/$250=0.390EstimatingWeights(Continued)What’stheWACC?WACC=wdrd(1-T)+wpsrps+wcersWACC=0.3(10%)(0.6)+0.1(9%)+0.6(14%)WACC=1.8%+0.9%+8.4%=11.1%. 91What’stheWACC?WACC=wdrd(1Whatfactorsinfluenceacompany’sWACC?Marketconditions,especiallyinterestratesandtaxrates.Thefirm’scapitalstructureanddividendpolicy.Thefirm’sinvestmentpolicy.FirmswithriskierprojectsgenerallyhaveahigherWACC.92WhatfactorsinfluenceacompaIsthefirm’sWACCcorrectforeachofitsdivisions?NO!ThecompositeWACCreflectstheriskofanaverageprojectundertakenbythefirm.Differentdivisionsmayhavedifferentrisks.Thedivision’sWACCshouldbeadjustedtoreflectthedivision’sriskandcapitalstructure.93Isthefirm’sWACCcorrectforTheRisk-AdjustedDivisionalCostofCapitalEstimatethecostofcapitalthatthedivisionwouldhaveifitwereastand-alonefirm.Thisrequiresestimatingthedivision’sbeta,costofdebt,andcapitalstructure.94TheRisk-AdjustedDivisionalCPurePlayMethodforEstimatingBetaforaDivisionoraProjectFindseveralpubliclytradedcompaniesexclusivelyinproject’sbusiness.Useaverageoftheirbetasasproxyforproject’sbeta.Hardtofindsuchcompanies.95PurePlayMethodforEstimatinAccountingBetaMethodforEstimatingBetaRunregressionbetweenproject’sROAandS&PindexROA.Accountingbetasarecorrelated(0.5–0.6)withmarketbetas.Butnormallycan’tgetdataonnewprojects’ROAsbeforethecapitalbudgetingdecisionhasbeenmade.96AccountingBetaMethodforEstDivisionalCostofCapitalUsingCAPMTargetdebtratio=10%.rd=12%.rRF=7%.Taxrate=40%.betaDivision=1.7.Marketriskpremium=6%.97DivisionalCostofCapitalUsiDivisionalCostofCapitalUsingCAPM(Continued)Division’srequiredreturnonequity:rs =rRF+(rM–rRF)bDiv.rs=7%+(6%)1.7=17.2%.WACCDiv. =wdrd(1–T)+wcrs =0.1(12%)(0.6)+0.9(17.2%) =16.2%.98DivisionalCostofCapitalUsiDivision’sWACCvs.Firm’sOverallWACC?DivisionWACC=16.2%versuscompanyWACC=11.1%.“Typical”projectswithinthisdivisionwouldbeacceptediftheirreturnsareabove16.2%.99Division’sWACCvs.Firm’sOveDivisionalRiskandtheCostofCapital

RateofReturn

(%)

WACC

RejectionRegion

AcceptanceRegion

Risk

L

B

A

H

WACCH

WACCL

WACCA

0

RiskL

RiskA

RiskH

100DivisionalRiskandtheCostoWhatarethethreetypesofprojectrisk?Stand-aloneriskCorporateriskMarketrisk101WhatarethethreetypesofprHowiseachtypeofriskused?Stand-aloneriskiseasiesttocalculate.Marketriskistheoreticallybestinmostsituations.However,creditors,customers,suppliers,andemployeesaremoreaffectedbycorporaterisk.Therefore,corporateriskisalsorelevant.102Howiseachtypeofriskused?AProject-Specific,Risk-Adjusted

CostofCapitalStartbycalculatingadivisionalcostofcapital.EstimatetheriskoftheprojectusingthetechniquesinChapter11.Usejudgmenttoscaleup