lecture10-350

lecture10-350 - Corporate Financing and Market Efficiency...

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Financial management: lecture 10 Corporate Financing and Market Efficiency Where to get money for good projects
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Financial management: lecture 10 Today’s plan Review WACC Investment Decision vs. Financing Decision Equity and debt financing Does the stock price follow a random walk? Three forms of Market Efficiency Weak form efficiency Semi-strong form efficiency Strong form efficiency
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Financial management: lecture 10 What have we learned in the last lecture ? Motivation for WACC How do we know that a project is worth taking? How do we find the cost of capital for a project ? What is the formula of WACC without tax? What is the formula of WACC with tax? Should we use the market value or book value of equity and debt in calculating WACC?
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Financial management: lecture 10 What have we learned in the last lecture (1)? WACC without tax WACC with tax d e r V D r V E WACC + = E D V where + = e V E d V D r + Tc)r - (1 = WACC
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Financial management: lecture 10 What have we learned in the last lecture (2)? The cost of bond It is the YTM, the expected return required by the investors. That is The expected return on a bond can also be calculated by using CAPM ( 29 ( 29 t d d d r principal cpn r cpn r cpn + + + + + + + = 1 1 1 P 2 bond ) ( f m d f d r R r r - β + =
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Financial management: lecture 10 What have we learned in the last lecture (2)? The cost of equity is calculated by using CAPM Dividend growth model ) r - (R + r = r f m f e e β g P DIV r g r DIV P e e + = - = 0 1 1 0
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Financial management: lecture 10 What have we learned in the last lecture (2)? Three steps in calculating WACC First step: Calculate the market value of each security and calculate its portfolio weight Second step: Determine the cost of capital on each security. Third step: Calculate a weighted average cost of capital on these securities.
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Financial management: lecture 10 A summary example John Cox, a recent MBA student of SFSU, was asked by his boss in Geothermal to decide whether the firm should take an expansion project: the cost of the project is $30 million, and the project is expected to generate a perpetual incremental cash flow of $4.5 million. Currently, Geothermal has 20 million shares of common stocks outstanding, with a market price of $22.65 per share. The Beta of the firm’s equity is 1.1. The risk free rate is 4% and the market risk premium is 5.6%. The firm also has long-term debt, with the YTM of 9%. John also got the following information from the firm’s balance sheet: Debt (12 years maturity, 8% coupon): $200 million Common stocks:$110 million If the tax rate is 35%, should John suggest to his boss to take the project or not?
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This note was uploaded on 10/05/2011 for the course FIN 350 taught by Professor Chen during the Spring '07 term at S.F. State.

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lecture10-350 - Corporate Financing and Market Efficiency...

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