Week09 Lecture - Cost of Capital & Raising Capital (Chapters 12 and 15)

Week09 Lecture - Cost of Capital & Raising Capital (Chapters 12 and 15)

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FINS1613 BUSINESS FINANCE Week 9 Co-Lecturer: Donald Winchester (Weeks 9, 10 and 11) Email: d.winchester@unsw.edu.au Consultation Days/Times – (room Quad 2117): Tuesday: 3 pm to 4 pm Wednesday: 5 pm to 6 pm
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House Keeping Final Exam = 60 multiple choice questions (of equal value) 20 MC questions come from chapters 12, 15, 13, and 14. Quiz 3 held in week 10 during normal tutorial time. Quiz 3 worth 10 marks – up to 5 marks come from today's lecture and/or week 10 tutorial questions based on textbook chapters 12 and 15. Remainder of marks set by co-lecturer. Quiz 4 held in week 12 during normal tutorial time. Quiz 4 marks split between chapters 13 and 14 most likely multiple choice questions (7-10) with question marks clearly labelled (probably of equal value). Quiz questions may be on lecture notes not in the textbook 2
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Cost of Capital (Chapter 12): Key Concepts and Skills Know how to determine a firm’s cost of equity capital Know how to determine a firm’s cost of debt Know how to determine a firm’s overall cost of capital Understand pitfalls of overall cost of capital and how to manage them Understand the impact of an imputation tax system (cf. classical system) 3
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Chapter Outline The Cost of Capital: Some Preliminaries The Cost of Equity The Costs of Debt and Preferred Stock The Weighted Average Cost of Capital Divisional and Project Costs of Capital 4
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Why Cost of Capital is Important We know that the return earned on assets depends on the risk of those assets The return to an investor is the same as the cost to the company Our cost of capital provides us with an indication of how the market views the risk of our assets Knowing our cost of capital can also help us determine our required return for capital budgeting projects 5
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Required Return The required return is the same as the appropriate discount rate and is based on the risk of the cash flows We need to know the required return for an investment before we can compute the NPV and make a decision about whether or not to take the investment We need to earn at least the required return to compensate our investors for the financing they have provided 6
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What is the Cost of Capital? The cost to a firm of obtaining capital to invest in long term assets. Rate of return required by capital suppliers to compensate them for committing their resources to the project. Cost depends on the use of the capital, not its source. 7
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Sources of Capital 8
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How to estimate the cost of capital? Weighted Average Cost of Capital (WACC) Weighted Average of the returns required by investors on the various securities issued by the firm where: R E = the cost of equity capital R D = the cost of debt capital V = (E + D), the market value of debt financing and equity financing respectively 9 ... + + × = V D R V E R WACC D E
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Estimating the Cost of Capital Steps: 1.Examine the WACC formula 2.Calculate the capital structure (D/V) and (E/V) [and/or Hybrid/V] 3.Calculate cost of equity 4.Calculate cost of debt 10
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Week09 Lecture - Cost of Capital & Raising Capital (Chapters 12 and 15)

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