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chapter 12

chapter 12 - Chapter 12 The weighted average cost of...

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COPYRIGHT©ZHULI 1 Chapter 12 The weighted average cost of capital and company valuation

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COPYRIGHT©ZHULI 2 Objectives 1. Calculate a firm’s capital structure 2. Estimate the required rates of return on the securities issued by the firm 3. Calculate the weighted-average cost of capital 4. Understand when the weighted-average cost of capital is – or isn’t – the appropriate discount rate for a new project 5. Use the weighted-average cost of capital to value a business given forecasts of its future cash flows
COPYRIGHT©ZHULI 3 Content Geothermal’s cost of capital The weighted-average cost of capital Measuring capital structure Calculating required rates of return Calculating the weighted-average cost of capital Interpreting the weighted-average cost of capital Valuing entire businesses

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COPYRIGHT©ZHULI 4 Assume the debt’s yielding 8%, and tax rate is 35%, equity investors want 14% Capital structure : the mix of long-term debt and equity financing
COPYRIGHT©ZHULI 5 Capital structure: h ° ° ° Long-term debt financing: ¤ t j ¶ “ 3 Equity financing: h° ° °

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COPYRIGHT©ZHULI 6 Content Geothermal’s cost of capital The weighted-average cost of capital Measuring capital structure Calculating required rates of return Calculating the weighted-average cost of capital Interpreting the weighted-average cost of capital Valuing entire businesses
COPYRIGHT©ZHULI 7 Calculating company cost of capital as a weighted average The company cost of capital is a weighted average of the returns demanded by debt and equity investors. The weighted average is the expected rate of return investors would demand on a portfolio of all the firm’s outstanding securities

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COPYRIGHT©ZHULI 9 Debtholders need income of (r debt × D), and the equity investors need expected income of (r equity × E). The total income that is needed is (r debt × D) + (r equity × E). The amount of their combined existing investment in the company is V. (ignoring taxes)

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COPYRIGHT©ZHULI 10 Market versus book weights The cost of capital must be based on what investors are actually willing to pay for the company’s outstanding securities—that is, based on the securities’ market values Financial managers use book debt-to-value ratios for
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chapter 12 - Chapter 12 The weighted average cost of...

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