FNCE 100 Ch. 12 - A risky dollar is worth more than a...

Info icon This preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
A risky dollar is worth more than a riskless dollar Application of NPV to risky cash flows. Discount rate computed from CAPM or APT Value a risky project: determined required return (rS) using SML rS = Cost of equity capital When use both debt and equity use rWACC 1. Cost of Equity Capital: Pay dividend with cash or invest in a project paying out future CFs of project as divs. Which do stockholders prefer? If holder can reinvest div in a financial assets with the same risk as that of the project, the stockholders would desire the alternative with the highest expected return. Thus … Project only undertaken if expected return is greater than that of a financial asset of comparable risk. RULE: Discount rate of project should be the expected return of a financial asset of comparable risk. But choose the project with the highest return Determine rs on a project by using SML. Rs = Equity Cost of Capital. From firm’s perspective: Expeted return is cost of equity capital. Using CAPM Expected return = Rbar = Rf + Beta x (RbarM – Rf) Rf = Risk-free rate RbarM - Rf = Market Risk Premium Bi = Co. Beta EX. Beta = 1.3 risk-free rate = Rf = .05 RbarM – Rf = .084 (Market Risk Premium) ***100% Equity Fianced B/c new projects are similar to the firm’s existing ones, Avg Beta on new projs = existing Beta What is the appropriate discount rate?
Image of page 1
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern