{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Chap012(WW-FIN357T)NT

# Chap012(WW-FIN357T)NT - Chapter 12 Risk Cost of Capital...

This preview shows pages 1–13. Sign up to view the full content.

Chapter 12 Risk, Cost of Capital, & Capital Budgeting

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

View Full Document
12-2 Chapter Outline 12.1 The Cost of Equity Capital 12.2 Estimation of Beta 12.3 Determinants of Beta 12.4 Extensions of the Basic Model 12.5 Estimating IP’s Cost of Capital
12-3 Key Concepts and Skills Know how to determine a firm’s cost of equity capital Understand the impact of beta in determining the firm’s cost of equity capital Know how to determine the firm’s overall cost of capital

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

View Full Document
12-4 Amount, Timing, and  Risk Earlier chapters on capital budgeting focused on the appropriate amount and timing of cash flows. This chapter discusses the appropriate discount rate when cash flows are risky.
12-5 Amount, Timing, and  Risk ? Because 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.

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

View Full Document
12-6 Invest in project 12.1 The Cost of Equity Capital Firm with excess cash Shareholder’s Terminal Value Pay cash dividend Shareholder invests in financial asset A firm with excess cash can either pay a dividend or m ake a capital investment
12-7 The Cost of Equity From the firm’s perspective, the expected return is the Cost of Equity Capital: ) ( F M i F i R R β R R - + = To estimate a firm’s cost of equity capital, we need to know: 1. The risk-free rate, R F F M R R - 1. The market risk premium, 2 , ) ( ) , ( M M i M M i i σ σ R Var R R Cov β = = 1. The company beta,

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

View Full Document
12-8 Example Suppose the stock of Stansfield Enterprises has a beta of 2.5. The firm is 100% equity financed. If the risk-free rate is 5% and the market risk premium is 10%, what is the correct discount rate for an expansion of this firm? ) ( F M i F R R β R R - + = % 10 5 . 2 % 5 × + = R % 30 = R
12-9 Example (continued) Suppose Stansfield Enterprises is evaluating the following non-mutually exclusive projects. Each costs \$100 and lasts one year. Project Project β Project’s Estimated Cash Flows Next Year IRR NPV at 30% A 2.5 \$150 50% \$15.38 B 2.5 \$130 30% \$0 C 2.5 \$110 10% -\$15.38

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

View Full Document
12-10 Risk-Adj. Discount Rate for Projects An all-equity firm should accept a project whose IRR exceeds the cost of equity capital and reject projects whose IRRs fall short of the cost of capital . Project IRR Firm’s risk (beta) SML 5% Good project Bad project 30% 2.5 A B C
12-11 12.2 Estimation of Beta Theoretically, the calculation of beta is straightforward: 2 , ) ( ) , ( M M i M M i σ σ R Var R R Cov β = = Potential problems 1. Betas may vary over time. 2. The sample size may be inadequate. 3. Betas are influenced by changing financial leverage and business risk.

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

View Full Document
12-12 12.2 Estimation of Beta Potential Solutions Problems 1 and 2 can be moderated by more sophisticated statistical techniques.
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}