EfficientMarkets (1)

EfficientMarkets (1) - Sessions 11 and 12 Risk and return...

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Sessions 11 and 12 Risk and return 6049 Corporate Finance Lecture Slides, Academic Year 2010/2011 Sessions 11 and 12: Capital Budgeting and Risk annes Wagner Hannes Wagner -1- 6049 Corporate Finance 1
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Sessions 11 and 12 Risk and return Topics Covered Cost of capital for projects and firms Measuring the cost of equity Setting discount rates when you do not know Beta Certainty equivalents Discount rates for international projects Expectations This material is closely tied to chapters 8 and 9 but less technical. terature Literature BMA Chapter 10 -2- 6049 Corporate Finance
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Sessions 11 and 12 Risk and return Company Cost of Capital A firm’s value can be stated as the sum of the value of its various assets You already knew this - recall value additivity of present values! V(B) V(A) V(AB) alue irm PV(B) PV(A) PV(AB) value Firm -3- 6049 Corporate Finance
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Sessions 11 and 12 Risk and return Company Cost of Capital A company’s cost of capital can be compared to the CAPM required return. Take Microsoft as an example: Required SML return Company Cost of apital 12.9 Capital 5.0 Project Beta .13 0 -4- 6049 Corporate Finance 1.13 ( Microsoft)
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Sessions 11 and 12 Risk and return Examples of Company Cost of Capital ategory Discount Rate Category Speculative ventures 30% New products 20% Expansion of existing business 15% (Company COC) Cost improvement, known technology 10% -5- 6049 Corporate Finance
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Sessions 11 and 12 Risk and return Debt and COC D and V are all market E, D, and V are all market values of Equity, Debt and Total Firm Value f m equity f equity OC r r r r ) ( assets portfolio r r COC Then, the return on the company’s assets is simply the weighted average of the expected returns on the firm’s securities: V E r V D r r WACC equity debt assets E r D r T WACC uity ebt x fter ) 1 ( -6- 6049 Corporate Finance V V equity debt c tax after
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Sessions 11 and 12 Risk and return Capital Structure & COC Expected Returns and Betas prior to refinancing 20 Expected return (%) R equity =15 R rdebt =8 R assets =12.2 0 0 0.2 0.8 1.2 -7- 6049 Corporate Finance debt assets equity
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Sessions 11 and 12 Risk and return Measuring Betas The SML shows the relationship between return and risk CAPM uses Beta as a proxy for risk Other methods can be employed to determine the slope of the SML and thus Beta Regression analysis can be used to find Beta E.g. monthly returns (60 months) for the firm and the market -8- 6049 Corporate Finance
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Sessions 11 and 12 Risk and return Measuring Betas tel Computer 40.00 Intel Computer Price data: July 1996 – June 2001 20.00 30.00 10.00 R 2 = .29 = 1.54 -10.00 0.00 -20.00 -10.00 0.00 10.00 20.00 Intel return, % Slope determined from plotting the ne of best fit 1.54 -30.00 -20.00 line of best fit.
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EfficientMarkets (1) - Sessions 11 and 12 Risk and return...

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