Notes 4-30-08 (CH11)

Notes 4-30-08 (CH11) - Capital Structure mix of long term...

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4/30/08 Notes CH11 Risk Return and capital budging Beta – measures the sensitivity of the stock return compared to the overall market Beta for the overall market is 1 T-bills have a beta of 0 Overall market – rm Market risk premium = rm – rf Return on a given stock – r Risk premium (on given stock) - r – rf = B ( Rm – Rf) Capital Asset Pricing Model – theory of the relationship between risk and return which states that the expected risk premium on any security equals its beta times the market risk premium R = rf + B ( rm – rf) Securities market line – visual representation of the CAPM R = dividends + capital +/- Po Treasury bill is a short term note CH12 Cost of Capital – The return that a company’s investors could expect to receive if they invested in securities (D, E) of similar degrees of risk.
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Unformatted text preview: Capital Structure mix of long term debt (D) and equity (E) D + E = V (value) Geo (or geo thermal) pays 8% for debt (cost of debt) Pays 14% for equity (cost of equity) Market value of debt - $194 = 30% Market value of equity - $453 = 70% V = $647 Company return = (30%)(8%) + (70%)(14) Company return = 12.2% Debt is issued out as a bond and it is tax deductable. Tax rate of 35% The cost of debt after tax 8% * (1-tax rate) = 8%(.65) = 5.2% Company return = (30%)(5.2%) + (70%)(14%) Company return = 11.4% WACC weighted average cost of capital -expected rate of return on a portfolio of all the firms securities WACC = (D/V) * (r debt) * (1-tax rate) + (E/V) * (r equity)...
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Notes 4-30-08 (CH11) - Capital Structure mix of long term...

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