Topic 12_cost of capital - Topic 12 Cost of Capital...

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Topic 12 Cost of Capital Readings: Chap 12 ( 12.1-12.5)
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1 2 0 1 2 ... (1 ) (1 ) (1 ) t t CF CF CF NPV CF r r r = + + + + + + + How do we figure out discount rate (cost of capital)?
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Assets Debt Equity Back to the portfolio theory Total Assets=Debt+Equity Assets Equity Equity Debt Debt r r W r W = ⋅ + ⋅ Assets Equity Debt Equity Debt r r r Debt Equity Debt Equity = ⋅ + ⋅ + +
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Cost of Equity Start with equity financing Capital Asset Pricing Model (CAPM) E ( ) p f p m f r r r r β   = + -  
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Example Suppose the stock of Stansfield Enterprises, a publisher of PowerPoint presentations, has a beta of 2.5. The firm is 100% equity financed. Assume a risk-free rate of 5% and a market return of 12%. What is the appropriate discount rate for an expansion of this firm?
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Estimation of Beta Using Historical returns Characteristic Line -30 -20 -10 0 10 20 30 40 -15 -10 -5 0 5 10 15 20 25 Market Return, % Stock Return, % Using industry beta
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Determinants of Equity Beta Business risk Cyclicality of revenues Operating leverage
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The degree of operating leverage measures how sensitive a firm (or project) is to its fixed costs. The degree of operating leverage is given by:
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This note was uploaded on 06/07/2011 for the course FINANCE 103 taught by Professor None during the Spring '11 term at University of Illinois, Urbana Champaign.

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Topic 12_cost of capital - Topic 12 Cost of Capital...

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