Lect 11 Fin 221 web

Lect 11 Fin 221 web - Autumn 2011 Managerial Finance...

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Autumn 2011 1 Managerial Finance Lecture 11 Valuation: Valuation: FCFs and Discount Rates CAPM: The final frontier ) ] [ ( * ] [ , f market market i f i r R E r R E Three key components: 1. The risk free ( r f ) 2. The project specific (project i ) beta 3. The expected excess return of the market portfolio or expected market risk premium market i , ) ] [ ( f market r R E
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Autumn 2011 2 Finding beta 1. Find comparables 2. Estimate equity betas 3. Estimate debt betas 4. Estimate the market value of debt and equity 5. Find unlevered asset beta for each comparable 6. Compute the average and use the CAPM! 3 ) ) ( ( * ) ( f market omps unleveredc f Ameritrade r R E r r E ) ) ( ( * ) ( f market Ameritrade f Ameritrade r R E r r E Steps (1) List of comparables and (2 equity betas (2) equity betas: Firm Name Equity Beta Comparable? AG Edwards 1.45 Bear Stearns 1.69 Charles Schwab 2.30 Yes Merrill Lynch 1.82 4 Morgan Stanley Dean Witter 2.09 PaineWebber 1.76 Quick & Reilly 2.20 Raymond James 1.45 Waterhouse 3.19 2.09 1.76 2.20 Yes 1.45 3.19 Yes
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Autumn 2011 3 Steps (3) Debt betas (assume β Debt =0): for now! (4) Estimate market value of D/(D+E), E/(D+E) (given Exh4) (5) Get unlevered betas Equity Debt Unlevered E D E E D D Charles Schwab 230 Yes 80% 92 0% Firm Name Equity Beta Comparable? Debt/Value Equity/Value Unlevered Beta AG Edwards 1.45 Bear Stearns 1.69 Charles Schwab 2.30 Yes 8.0% 92.0% 2.12 ) ) ( ( * ) ( f market omps unleveredc f Ameritrade r R E r r E 5 Charles Schwab 2.30 Yes 8.0% Merrill Lynch 1.82 Morgan Stanley Dean Witter 2.09 PaineWebber 1.76 Quick & Reilly 2.20 Yes 0.0% Raymond James 1.45 Waterhouse 3.19 Yes 38.0% 2.30 8.0% 92.0% Merrill Lynch 1.82 Morgan Stanley Dean Witter 2.09 PaineWebber 1.76 Quick & Reilly 2.20 Yes 0.0% 100.0% Raymond James 1.45 Waterhouse 3.19 Yes 38.0% 62.0% Merrill Lynch 1.82 Morgan Stanley Dean Witter 2.09 PaineWebber 1.76 Quick & Reilly 2.20 Yes 0.0% 100.0% 2.20 Raymond James 1.45 Waterhouse 3.19 Yes 38.0% 62.0% 1.98 Average 2.10 Unlevered Ameritrade’s Cost of Capital (6) CAPM: ) ) ( ( * ) ( f market Ameritrade f Ameritrade r R E r r E ) ) ( ( * 1 . 2 ) ( f market f Ameritrade r R E r r E ) ) ( ( * 1 . 2 0661 . 0 ) ( f market Ameritrade r R E r E 065 0 * 1 2 0661 0 E 6 . . . ) ( Ameritrade r % 2 . 20 ) ( Ameritrade r E
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Autumn 2011 4 Summary: Project Cost of Capital The cost of capital is given by the opportunity cost of funds (CAPM): Return offered to equivalent investment alternatives in the capital market ) ) ( ( * ) ( f market unlevered f unlevered r R E r R E Select r f to match the economic life of the project: common to use the current T-bond yield that matches the maturity of the project
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Lect 11 Fin 221 web - Autumn 2011 Managerial Finance...

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