Topic10_capbud_risk[1]

Topic10_capbud_risk[1] - Thomas Moeller FINA 30153:...

Info iconThis preview shows pages 1–6. Sign up to view the full content.

View Full Document Right Arrow Icon
Thomas Moeller FINA 30153: Financial Management 1 Topic 10 Risk, cost of capital, and capital budgeting Objectives 1. Understand the concept of cost of equity capital 2. Learn how to estimate beta 3. Discuss the determinants of beta 4. Discuss the relation between capital budgeting and project risk 5. Discuss the concept of weighted average cost of capital
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Thomas Moeller FINA 30153: Financial Management 2 1. Cost of equity capital A firm with excess cash can either pay a dividend or make a capital investment. Since stockholders can reinvest the dividend in risky financial assets, the expected return on a capital-budgeting project should be at least as great as the expected return on a financial asset of comparable risk. From the firm’s perspective, the expected return is the cost of equity capital: E(r )=r i E(r )-r if m f + β []
Background image of page 2
Thomas Moeller FINA 30153: Financial Management 3 We can use the security market line (SML) to determine the proper discount rate to use for capital budgeting analysis. Rf IRR E(Rm) 1.0 Beta An all-equity firm should accept projects when IRRs exceed the cost of equity capital and reject projects when IRRs fall short of the cost of capital.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Thomas Moeller FINA 30153: Financial Management 4 2. Estimation of beta To estimate the cost of equity capital, we need to calculate the equity beta. Theoretically, the calculation of beta is straightforward: ( ) () m m i i r r r var , cov = β Problems: 1. Betas may vary over time. 2. Betas are influenced by changing financial leverage and business risk. 3. The equity of the firm is not publicly traded.
Background image of page 4
Thomas Moeller FINA 30153: Financial Management 5 Solutions: 1. Problem 1 can be moderated by more sophisticated statistical techniques or ad hoc adjustments.
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 6
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 04/21/2008 for the course FINA 30153 taught by Professor Moeller during the Spring '08 term at TCU.

Page1 / 19

Topic10_capbud_risk[1] - Thomas Moeller FINA 30153:...

This preview shows document pages 1 - 6. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online