Lecture9_Slides_6perpage - FINS1613 BUSINESSFINANCE...

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1 FINS 1613 BUSINESS FINANCE Dr. Gloria Y. Tian School of Banking & Finance y.tian@unsw.edu.au Recap: Capital Asset Pricing Model (CAPM) Lecture 09 Diversification and Risks o Two types of risks o Diversification benefit: risk reduction (which risk can be diversified away?) 3 Portfolio expected return and risk Portfolio return depends on each individual security’s weight and its expected return Portfolio risk depends on each individual security’s weight and its systematic risk CAPM: E[Ri] = Rf + β i × (E[R M ] – Rf) Security Market Line (SML) 4 C OST OF C APITAL R AISING C APITAL RTBWJ Chapters 12 & 15 Cost of Capital & Raising Capital 6
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2 CONTENTS Cost of Capital 1.1 Definition 1.2 Cost of capital & required rate of return Weighted Average Cost of Capital (WACC) Lecture 09 2.1 Sources of financing 2.2 Costs: debt, preference shares and common equity 2.3 Weighted average cost of capital Other Issues to Consider 3.1 Cost of raising new equity capital 3.2 WACC & capital budgeting 3.3 Impact of imputation tax (later …) 7 Capital of Capital: Definition What is the Cost of Capital? o Most companies raise finance using a combination of debt and equity. o It is not possible to raise finance without paying 8 It is not possible to raise finance without paying some costs every source of finance available to a company has some costs attached to it. o These costs are known as the cost of capital Capital of Capital & Required Rate of Return The returns received by investors must be provided by the issuing firms of those securities and, from the issuer’s viewpoint, the return demanded by investors is effectively a cost (of using capital) 9 cost (of using capital). We can thus interchange the term ‘ cost of capital ’ with the term ‘ required return ’. The cost of capital for a project is critically determined by the risk of the project . Sources of Financing Two main types of (long-term) capital a company can use to finance its investment projects: Long-Term Capital Long-Term Debt Preferred Stock Common Stock Retained Earnings New Common Stock 10 Weighted Average Cost of Capital (WACC) Weighted average of the returns required by investors on the various securities issued by the firm: E R D R WACC E D 11 where: R E = the cost of equity capital R D = the cost of debt capital V = (D + E), the market value of debt financing and equity financing respectively. ... V V Cost of Debt: R D Savings Tax Rate Interest debt of t tax After cos c D D T R R debt of t tax After cos 12  c D T R debt of t tax After 1 cos Interest rate on new borrowing Firm marginal tax rate
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3 Cost of Debt: Estimating R D Lecture 09 Definition: The rate of return required by the firm’s creditors on new borrowing.
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This note was uploaded on 10/20/2011 for the course COMMERCE 3502 taught by Professor All during the One '11 term at University of New South Wales.

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Lecture9_Slides_6perpage - FINS1613 BUSINESSFINANCE...

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