013 and 014 session_30017 - Sessions 13 and 14 Risk and the...

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Sessions 13 and 14 Risk and the cost of capital - 1 - Corporate Finance 30017 Corporate Finance Lecture Slides, Academic Year 2015/2016 Sessions 13 and 14: Risk and the cost of capital Hannes Wagner
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Sessions 13 and 14 Risk and the cost of capital - 2 - 30017 Corporate Finance Topics Cost of capital and cost of equity How to determine project risk? Toolbox: Certainty equivalents Reading BMA 9 Expectations This material is closely tied to chapters 7 and 8, but less technical.
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Sessions 13 and 14 Risk and the cost of capital - 3 - 30017 Corporate Finance Company Cost of Capital A company’s cost of capital can be compared to the CAPM required return Required return Project Beta 1.13 (Microsoft) Company Cost of Capital 12.9 5.0 0 SML
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Sessions 13 and 14 Risk and the cost of capital - 4 - 30017 Corporate Finance 0 20 0 0.2 0.8 1.2 Capital Structure & Cost of Capital Expected return (%) β debt β assets β equity R rdebt =8 R assets =12.2 R equity =15 How to think about beta(s) and cost(s) of capital? Consider this example:
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Sessions 13 and 14 Risk and the cost of capital - 5 - 30017 Corporate Finance Debt and COC IMPORTANT E, D, and V are all market values of Equity, Debt and Total Firm Value ( ) equity f equity m f r r r r β = + Portfolio Assets COC r r = Assets debt equity D E r WACC r r V V = = (1 ) AfterTax c debt equity D E WACC T r r V V = + Capital Structure - the mix of debt & equity within a company
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Sessions 13 and 14 Risk and the cost of capital - 6 - 30017 Corporate Finance Measuring Betas The SML shows the relationship between return and risk CAPM uses Beta as a proxy for risk Other methods can be employed to determine the slope of the SML and thus Beta Regression analysis can be used to find Beta E.g. monthly returns (60 months) for the firm and the market
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