商业财务学英文版教学课件：Chap011 Risk,Cost of Capital,and Capital Budgeting

Risk,CostofCapital,andCapitalBudgetingChapter11Copyright©2011byTheMcGraw-HillCompanies,Inc.Allrightsreserved.McGraw-Hill/IrwinMeasureafirm’scostofequitycapitalGraspandinterprettheimpactofbetaindeterminingthefirm’scostofequitycapitalComprehendandcalculatethefirm’soverallcostofcapitalIncorporatetheimpactofflotationcostsoncapitalbudgetingKeyConceptsandSkills11.1 TheCostofEquityCapital11.2 EstimatingtheCostofEquityCapitalwiththeCAPM11.3 EstimationofBeta11.4 BetaandCovariance11.5 DeterminantsofBeta11.6 DividendDiscountModel11.7 CostofCapitalforDivisionsandProjects11.8 CostofFixedIncomeSecurities11.9 TheWeightedAverageCostofCapital11.10 EstimatingEastmanChemical’sCostofCapital11.11 FlotationCostsandtheWeightedAverageCostofCapitalChapterOutlineEarlierchaptersoncapitalbudgetingfocusedontheappropriatesizeandtimingofcashflows.Thischapterdiscussestheappropriatediscountratewhencashflowsarerisky.WhereDoWeStand?Investinproject11.1TheCostofEquityCapitalFirmwith

excesscashShareholder’sTerminalValuePaycashdividendShareholderinvestsinfinancialassetBecausestockholderscanreinvestthedividendinriskyfinancialassets,theexpectedreturnonacapital-budgetingprojectshouldbeatleastasgreatastheexpectedreturnonafinancialassetofcomparablerisk.AfirmwithexcesscashcaneitherpayadividendormakeacapitalinvestmentFromthefirm’sperspective,theexpectedreturnistheCostofEquityCapital:11.2TheCostofEquityCapital–CAPMModelToestimateafirm’scostofequitycapital,weneedtoknowthreethings:Therisk-freerate,RFThemarketriskpremium,Thecompanybeta,SupposethestockofStansfieldEnterprises,apublisherofPowerPointpresentations,hasabetaof2.5.Thefirmis100%equityfinanced.Assumearisk-freerateof5%andamarketriskpremiumof10%.Whatistheappropriatediscountrateforanexpansionofthisfirm?Example:Calculating“R”usingCAPMSupposeStansfieldEnterprisesisevaluatingthefollowingindependentprojects.Eachcosts$100andlastsoneyear.Example:UsingRSandtheSMLtoEvaluateProjectsProjectProjectbProject’sEstimatedCashFlowsNextYearIRRNPVat30%A2.5$15050%$15.38B2.5$13030%$0C2.5$11010%-$15.38

Anall-equityfirmshouldacceptprojectswhoseIRRsexceedthecostofequitycapitalandrejectprojectswhoseIRRsfallshortofthecostofcapital.Application:UsingtheSMLforProjectSelectionProjectIRRFirm’srisk(beta)5%GoodprojectBadproject30%2.5ABCTreasurysecuritiesarecloseproxiesfortherisk-freerate.TheCAPMisaperiodmodel.However,projectsarelong-lived.So,averageperiod(short-term)ratesneedtobeused.Asapracticalmatter,theoneyearTreasuryBillratewillbeassumedasanaccurateestimateofshorttermratesCAPMsuggeststhatweshoulduseaTreasurysecuritywhosematuritymatchesthetimehorizonofinvestors:Nooneagreesonwhatthathorizonis!TheRisk-freeRateMethod1:UsehistoricaldataMethod2:UsetheDividendDiscountModelMarketdataandanalystforecastscanbeusedtoimplementtheDDMapproachonamarket-widebasisTheMarketRiskPremiumMarketPortfolio-Portfolioofallassetsintheeconomy.Inpractice,abroadstockmarketindex,suchastheS&P500,isusedtorepresentthemarket.Beta-Sensitivityofastock’sreturntothereturnonthemarketportfolio.

11.3DefinitionofBetaEstimationofBetaProblemsBetasmayvaryovertime.Thesamplesizemaybeinadequate.Betasareinfluencedbychangingfinancialleverageandbusinessrisk.SolutionsProblems1and2canbemoderatedbymoresophisticatedstatisticaltechniques.Problem3canbelessenedbyadjustingforchangesinbusinessandfinancialrisk.Lookataveragebetaestimatesofcomparablefirmsintheindustry.Mostanalystsarguethatbetasaregenerallystableforfirmsremaininginthesameindustry.Thatisnottosaythatafirm’sbetacannotchange.ChangesinproductlineChangesintechnologyDeregulationChangesinfinancialleverageStabilityofBetaItisfrequentlyarguedthatonecanbetterestimateafirm’sbetabyinvolvingthewholeindustry.Ifyoubelievethattheoperationsofthefirmaresimilartotheoperationsoftherestoftheindustry,youshouldusetheindustrybeta.Ifyoubelievethattheoperationsofthefirmarefundamentallydifferentfromtheoperationsoftherestoftheindustry,youshouldusethefirm’sbeta.Donotforgetaboutadjustmentsforfinancialleverage.UsinganIndustryBeta11.4BetaandCovarianceBetaisqualitativelysimilartothecovariancesincethedenominator(marketvariance)isaconstant.Wheneverasetofvaluesaredividedbyaconstant,therelativepositionofeachvalueremainsthesame.Betameasuresresponsivenessofasinglestocktothemarketasawhole.Sincebetaisatransformationofcovariance,covariancemeasurethesameBusinessRiskCyclicalityofRevenuesOperatingLeverageFinancialRiskFinancialLeverage11.5DeterminantsofBetaHighlycyclicalstockshavehigherbetas.SuchfirmsdowellintheexpansionphaseoftheeconomiccycleandmorepoorlyinthecontractionphaseCyclicalindustriesincluderetailandautomotiveNon-cyclicalindustriesincludetransportationNotethatcyclicalityisnotthesameasvariabilityStockswithhighstandarddeviationsneednothavehighbetas.PricemovementofsuchstocksismoredependentonqualityofperformancethanmarketmovementExample:Moviestudiohitsandflops.CyclicalityofRevenuesThedegreeofoperatingleveragemeasureshowsensitiveafirm(orproject)istoitsfixedcosts.Operatingleverageincreasesasfixedcostsriseandvariablecostsfall.Operatingleveragemagnifiestheeffectofcyclicalityonbeta.Thedegreeofoperatingleverageisgivenby:OperatingLeverageDOL=EBITDSalesSalesDEBIT×OperatingLeverageSales$FixedcostsTotalcostsEBITSalesOperatingleverageincreasesasfixedcostsriseandvariablecostsfall.FixedcostsTotalcostsOperatingleveragereferstothesensitivitytothefirm’sfixedcostsofproduction.Financialleverageisthesensitivitytoafirm’sfixedcostsoffinancing.Therelationshipbetweenthebetasofthefirm’sdebt,equity,andassetsisgivenby:FinancialLeverageandBetaFinancialleveragealwaysincreasestheequitybetarelativetotheassetbeta.bAsset=Debt+EquityDebt×bDebt+Debt+EquityEquity×bEquityConsiderGrandSport,Inc.,whichiscurrentlyall-equityfinancedandhasabetaof0.90.Thefirmhasdecidedtoleveruptoacapitalstructureof1partdebtto1partequity.Sincethefirmwillremaininthesameindustry,itsassetbetashouldremain0.90.However,assumingazerobetaforitsdebt,itsequitybetawouldbecometwiceaslarge:ExamplebAsset=0.90=1+11×bEquitybEquity=2×0.90=1.8011.6DividendDiscountModelTheDDMisanalternativetotheCAPMforcalculatingafirm’scostofequity.TheDDMandCAPMareinternallyconsistent,butacademicsgenerallyfavortheCAPMandcompaniesseemtousetheCAPMmoreconsistently.Thismaybeduetothemeasurementerrorassociatedwithestimatingcompanygrowth.Afirmthatusesonediscountrateforallprojectsmayovertimeincreasetheriskofthefirmwhiledecreasingitsvalue.11.7CapitalBudgeting&ProjectRiskProjectIRRFirm’srisk(beta)rfbFIRMIncorrectlyrejectedpositiveNPVprojectsIncorrectlyacceptednegativeNPVprojectsHurdlerateTheSMLcantelluswhy:SupposetheConglomerateCompanyhasacostofcapital,basedontheCAPM,of17%.Therisk-freerateis4%,themarketriskpremiumis10%,andthefirm’sbetais1.3.17%=4%+1.3×10%Thisisabreakdownofthecompany’sinvestmentprojects:1/3AutomotiveRetailerb=2.01/3ComputerHardDriveManufacturerb=1.31/3ElectricUtilityb=0.6averagebofassets=1.3Whenevaluatinganewelectricalgenerationinvestment,whichcostofcapitalshouldbeused?CapitalBudgeting&ProjectRiskCapitalBudgeting&ProjectRiskProjectIRRProject’srisk(b)17%1.32.00.6R=4%+0.6×(14%–4%)=10%10%reflectstheopportunitycostofcapitalonaninvestmentinelectricalgeneration,giventheuniqueriskoftheproject.10%24%Investmentsinharddrivesorautoretailingshouldhavehigherdiscountrates.SMLInterestraterequiredonnewdebtissuance(i.e.,yieldtomaturityonoutstandingdebt)Adjustforthetaxdeductibilityofinterestexpense11.8CostofDebtPreferredstockisaperpetuity,soitspriceisequaltothecouponpaiddividedbythecurrentrequiredreturn.Rearranging,thecostofpreferredstockis:RP=C/PVCostofPreferredStockTheWeightedAverageCostofCapitalisgivenby:11.9TheWeightedAverageCostofCapitalBecauseinterestexpenseistax-deductible,wemultiplythelasttermby(1–

TC).RWACC=Equity+DebtEquity×REquity+Equity+Debt

Debt×RDebt×(1–TC)RWACC=S+BS×RS+S+BB×RB×(1–TC)First,weestimatethecostofequityandthecostofdebt.Weestimateanequitybetatoestimatethecostofequity.WecanoftenestimatethecostofdebtbyobservingtheYTMofthefirm’sdebt.Second,wedeterminetheWACCbyweightingthesetwocostsappropriately.11.10Example:EastmanChemicalEastman’sbetaonReutersis2.01,theriskfreerateis.75%,andthemarketriskpremiumis7%.Thus,thecostofequitycapitalis:Example:EastmanChemicalRS=RF+bi×(RM–RF)=.75%+2.01×7%=14.82%Theyieldonthecompany’sdebtis6.03%,andthefirmhasa35%marginaltaxrate.Thedebttovalueratiois25.8%Example:EastmanChemic