II.%20Wacc%20and%20CAPM

II.%20Wacc%20and%20CAPM - II. WACC and CAPM We review basic...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
1 II. WACC and CAPM We review basic valuation inputs. A. The cost of capital: r A B. FCFF C. Using r A to find the optimal capital structure D. More general cost of capital E. Using the CAPM to account for risk F. Measuring Beta; b , the risk free interest rate; r F , the equity market rate; r M G. Divisional betas
Background image of page 1

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

View Full DocumentRight Arrow Icon
2 A. The cost of capital, r A The cost of capital is the minimum rate of return that must be earned on the new project so providers of capital, equity and debt, just earn their respective required rates of return. FCFF is the free cash flow to the firm . A B S B S r r (1 T) r V V ± ± = - + ² ³ ² ³ L l L l
Background image of page 2
3 The balance sheet ________ Firm value is the sum of V B market value of debt and S market value of equity V = B + S Each having a required rate of return r A = the firm s required rate of return r B = bondholder s required rate of return r S = stockholder s required rate of return
Background image of page 3

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

View Full DocumentRight Arrow Icon
4 Example II.1, Cost of capital The value of THE CO. s debt is $375, and equity is $525. The debt is priced to yield the risk f ree rate of interest, 8%. The expected return on equity is 16%. If the corporate tax rate is 30%, what is the cost capital? A V=B+S=$375+$525=$900 so 375 525 r 8.0(1 .30) 16.0 =11.67% 900 900 ± ± = - + ² ³ ² ³ L l L l
Background image of page 4
5 The balance sheet looks like. THE CO. V = $900 B = $375 ( r A = 11.67%) (r B = 8.0%) S = $525 (r S = 16.0%) Example II.1, Cost of capital
Background image of page 5

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

View Full DocumentRight Arrow Icon
6 Example II.1, Cost of capital If THE CO. takes a new project costing $450, and earns exactly the above W ACC in perpetuity, and the project is financed at the current debt/equity ratio, what must the project s Pro Forma Income look like?
Background image of page 6
7 Example II.1, Cost of capital B/V = 375/900 = .417 S/V = 525/900 = .583 new debt and equity f inancing are B = (.417)$450 = $188 S = (.583)$450 = $262 Net income; (.16)$262 = $42 Interest expense; (.08)$188 = $15 EBT = NI/(1-T); $42/(1-.3) = $60
Background image of page 7

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

View Full DocumentRight Arrow Icon
8 Example II.1, Cost of capital The Project Income Statement, 200x _____________________________________ _____________________________________________________________________________________________________________________ EBIT $75 Interest (r B B) 15 EBT $60 Taxes (TEBT) 18 NI $42
Background image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 37

II.%20Wacc%20and%20CAPM - II. WACC and CAPM We review basic...

This preview shows document pages 1 - 9. Sign up to view the full document.

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