{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Lecture16_winter09

# Lecture16_winter09 - CAPITAL STRUCTURE AND COST OF CAPITAL...

This preview shows pages 1–11. Sign up to view the full content.

CAPITAL STRUCTURE AND COST OF CAPITAL

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
CORRECTION OF TYPO Last lecture the formula for the LEVERED BETA with Taxes was wrong. The correct is S B t asset S 1 1
EXAMPLE Consider Gecko Company. The Company specializes in making umbrellas. The Capital Structure of Gecko is composed by 25% in Debt and 75% in Equity. The required return of Bondholders is 5% The Beta f Gecko stock is 1.25. Also, you know that the risk-free rate is 5% and the Return of the Market Portfolio is 20% Gecko pays Corporate Taxes at a rate of 40%

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
EXAMPLE What is the Cost of Capital for Gecko? We need to calculate what is the required return by the Stockholders of Gecko. % 75 . 23 % 5 % 20 * 25 . 1 % 5 * S f M S f S R R R E R R
EXAMPLE Now we can calculate the WACC of Gecko % 56 . 18 ) 4 . 0 1 %( 5 4 1 % 75 . 23 4 3 1 wacc B S wacc R t R B S B R B S S R

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
EXAMPLE Now suppose Gecko decides to produce sunglasses. Gordon Company makes sunglasses. The Beta of Gordon is 1.5. Gordon has a mix of 20% Debt and 80% Equity. Gecko wants to finance its sunglasses business the same way it finances the umbrella business.
EXAMPLE What is the Cost of Capital for Gecko’s sunglasses business? There are a few things to consider: The risk of businesses is different. We should not use the Beta of Gecko stock for this calculation Gordon has a capital structure different than Gecko. We should not use the Beta of Gordon stock.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
EXAMPLE First we need to UNLEVER the BETA of Gordon stock. The aim is to discover what is the risk of making sunglasses. 3 . 1 8 . 0 2 . 0 4 . 0 1 1 5 . 1 4 . 0 1 1 sunglasses sunglasses gordon gordon sunglasses gordon S B
EXAMPLE Then, we need to discover what is the risk of the stock of Gecko when making sunglasses 56 . 1 75 . 0 25 . 0 4 . 0 1 1 3 . 1 4 . 0 1 1 gecko gecko gecko sunglasses gecko S B

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
EXAMPLE Now we can discover the cost of equity for Gecko, when making sunglasses We can now discover the WACC for Gecko when making sunglasses % 4 . 28 % 5 % 20 56 . 1 % 5 S R % 05 . 22 % 4 . 28 * 75 . 0 ) 4 . 0 1 %( 5 * 25 . 0
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern