lecture3-costofcapital - Cost of Capital and Investment...

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

View Full Document Right Arrow Icon
Cost of Capital and Investment decisions 18 September 2005
Background image of page 1

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

View Full DocumentRight Arrow Icon
WACC
Background image of page 2
Corporate Finance 3 WACC Under the assumptions of MM, If the company undertakes a new investment project with same risk as the rest of the company, the change in value is: (*) ) 1 ( I B T I EBIT T I V C C L + - = ρ B T EBIT T B T V V C C C U L + - = + = ) 1 (
Background image of page 3

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

View Full DocumentRight Arrow Icon
Corporate Finance 4 WACC The new investment is financed with debt or equity or both The change in value can also be seen from the liability side: n n B S I + = I B I B I S I S I V n o n o L + + + =
Background image of page 4
Corporate Finance 5 WACC If B o = 0, and using the fact that ∆Ι = S n +∆ B n The project adds value for the shareholders if 1 + = + + = I S I B S I S I V o n n o L (**) 1 0 1 0 - = I V I V I S I S L L o o
Background image of page 5

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

View Full DocumentRight Arrow Icon
Corporate Finance 6 WACC Using (**) in (*): If we assume that there is a target capital structure and therefore that B/ I = D/(D+E), the term is the WACC - - + - = I B T I EBIT T I B T I EBIT T I V C C C C L 1 ) 1 ( 1 ) 1 ( ρ - I B T C 1
Background image of page 6
Corporate Finance 7 Derivation: + - = + - + + - = = + - + + + + + - + + + = = - + + + + + + + - + = = - + + + + - + = + + + - + = = + + - + = D E D T r MP E D D T MP r E D D T r MP E D D T MP E D D MP E D E r E D D T r E D E r E D D MP E D T E D E MP E D E r E D E r E D D T r E D D MP E D T r E D E r T E D D MP r E D E r T E D D r E D E r T E D D wacc U U U f f U U U f f f U U f f f U f f E f f E f 1 ) 1 ( ) ) ) 1 ( 1 ( ( ) 1 ( ) ( ) 1 ( ) 1 ( β
Background image of page 7

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

View Full DocumentRight Arrow Icon
Corporate Finance 8 WACC – lessons Notice that the standard WACC is a by product of MM, and therefore is relies on the same assumptions Notice also there is something intrinsically contradictory in the way it is often applied: You start assuming a constant debt level Then you assume a target debt ratio When the debt ratio is assumed constant, the WACC formula ought to be different
Background image of page 8
Corporate Finance 9 Miles-Ezzel WACC: dynamic debt If we assume the debt ratio is constant, the WACC formula is And the formula for relevering betas is C D T r E D D WACC + - = ρ 1 V S S D β + =
Background image of page 9

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

View Full DocumentRight Arrow Icon
Corporate Finance 10 Cost of equity: CAPM The discount rate for risky investments (expected return) covers: The time value of money A risk premium E ( r i ) = r f + β i ( E ( r m ) - r f ) This is the most used method to calculate costs of equity Alternative: APT (see book for details if interested)
Background image of page 10
Corporate Finance 11 Alternative: Dividend Growth Model Gordon’s growth model: Thus: g r div E P - = P div g r E + =
Background image of page 11

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

View Full DocumentRight Arrow Icon
Corporate Finance 12 Applying it: Need dividend yield and growth rate:
Background image of page 12
Image of page 13
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 47

lecture3-costofcapital - Cost of Capital and Investment...

This preview shows document pages 1 - 13. Sign up to view the full document.

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