Aswath damodaran 22 capitalizing r d the effects rd

This preview shows page 22 - 30 out of 73 pages.

Aswath Damodaran 22 Capitalizing R& D: The Effects R&D expensed R&D capitalized Effect EBIT = $ 6,009 mil $6,710 mil Increase $ 701 EBIT (1-t) $ 3,906 mil $4,607 mil Increase $ 701 Capital spending = $1,505 mil $ 3,444 mil Increase $1939 Depreciation = $ 801 mil $ 2,039 mil Increase $ 1238 Net Cap Ex $ 704mil $1,405 mil Increase $ 701 Non-cash WC Chg = $ 79 mil $ 79 mil Unchanged Reinvestment Rate 20.04% 32.21% Increase BV of Equity $ 10,105 mil $ 18,320 mil Increase ROC 38.65% 25.21% Decrease
Image of page 22

Subscribe to view the full document.

Aswath Damodaran 23 Current Cashflow to Firm EBIT(1-t) : 4,607 - Nt CpX 1,405 - Chg WC 79 = FCFF 3,123 Reinvestment Rate =32.21% Expected Growth in EBIT (1-t) .3221*.2515= .081 8.10 % Stable Growth g = 5%; Beta = 0.90; ROC= 15% Reinvestment Rate=33.33% Terminal Value 5 = 4760/(.0861-.05) = 131,716 Cost of Equity 8.42% Cost of Debt (5.1%+0.75%)(1-.35) = 3.80% Weights E =98.34% D = 1.66% Discount at Cost of Capital (WACC) = 8.42% (.9834) + 3.80% (0.0166) = 8.34% Oper. Assets: 103,742 + Cash 3,385 - Debt: 1,885 =Equity 105,241 -Options 2,300 Value/Share $ 52.97 Riskfree Rate : Riskfree rate = 5.1% (10-year T.Bond rate) + Beta 0.83 X Risk Premium 4.00% Unlevered Beta for Sectors: 0.82 Firm’s D/E Ratio: 1.69% Mature risk premium 4% Country Risk Premium 0% Bristol Myers: Status Quo Reinvestment Rate 32.21% Return on Capital 25.15% Term Yr 7140 2380 4760 Synthetic rating = AAA EBIT (1-t) $4,980 $5,383 $5,819 $6,290 $6,800 - Reinvestment $1,604 $1,734 $1,874 $2,026 $2,190 FCFF $3,376 $3,649 $3,945 $4,264 $4,610
Image of page 23
Aswath Damodaran 24 Why does the cost of capital matter? n Value of a Firm = Present Value of Cash Flows to the Firm, discounted back at the cost of capital. n If the cash flows to the firm are held constant, and the cost of capital is minimized, the value of the firm will be maximized.
Image of page 24

Subscribe to view the full document.

Aswath Damodaran 25 Firm Value, Cost of Capital and Debt Ratios: A Simple Example n Strunks Inc., a leading manufacturer of chocolates and other candies, has cash flows to the firm of $200 million. n Strunks is in a relatively stable market, and these cash flows are expected to grow at 6% forever, and to be unaffected by the debt ratio of the firm. n The value of the firm at any cost of capital can be written as: Firm Value = Cash flow to the firm (1+g)/(Cost of capital - g) = 200 (1.06)/(Cost of capital - .06)
Image of page 25
Aswath Damodaran 26 Cost of Capital and Firm Value D/(D+E) Cost of Equity Cost of Debt WACC Firm Value 0 10.50% 4.80% 10.50% $4,711 10% 11.00% 5.10% 10.41% $4,807 20% 11.60% 5.40% 10.36% $4,862 30% 12.30% 5.52% 10.27% $4,970 40% 13.10% 5.70% 10.14% $5,121 50% 14.00% 6.30% 10.15% $5,108 60% 15.00% 7.20% 10.32% $4,907 70% 16.10% 8.10% 10.50% $4,711 80% 17.20% 9.00% 10.64% $4,569 90% 18.40% 10.20% 11.02% $4,223 100% 19.70% 11.40% 11.40% $3,926
Image of page 26

Subscribe to view the full document.

Aswath Damodaran 27 A Pictorial View Figure 19.2: Cost of Capital and Firm Value 9.40% 9.60% 9.80% 10.00% 10.20% 10.40% 10.60% 10.80% 11.00% 11.20% 11.40% 11.60% 0 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Debt Ratio $0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000 WACC Firm Value
Image of page 27
Aswath Damodaran 28 Current Cost of Capital: Boeing n The beta for Boeing's stock in March 1999was 1.01. The treasury bond rate at that time was 5%. Using an estimated market risk premium of 5.5%, we estimated the cost of equity for Boeing to be 10.58%: Cost of Equity = Riskfree rate + Beta * (Market Premium) =5.00% + 1.01 (5.5%) = 10.58% n Boeing's senior debt was rated AA;, the estimated pre-tax cost of debt for Boeing is 5.50%. The tax rate used for the analysis is 35%. After-tax Cost of debt = Pre-tax interest rate (1- tax rate) = 5.50% (1- 0.35) = 3.58% n Cost of Capital = Cost of Equity (Equity/(Equity + Debt)) + After-tax Cost of Debt (Debt/(Debt +Equity)) = 10.58% [32,595/(32595+8194)] + 3.58% [8,194 /(32595+8194)] = 9.17%
Image of page 28

Subscribe to view the full document.

Aswath Damodaran 29 Mechanics of Cost of Capital Estimation 1. Estimate the Cost of Equity at different levels of debt: Equity will become riskier -> Beta will increase -> Cost of Equity will increase.
Image of page 29
Image of page 30
You've reached the end of this preview.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    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.

    Student Picture

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

  • Left Quote Icon

    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.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    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.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern