# Measure cost of capital for companies that issue

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Measure cost of capital for companies that issue different types of securities Adjusts the cost of capital for tax-deductibility of interest payments Use is restricted to certain types of projects Sometimes used as a company-wide benchmark discount rate Firms use it because they need a standard discount rate for average risk projects If a project is not a carbon copy of the firm, then WACC can be used as a benchmark Some points to note: What can companies do with excess cash? o Invest in project o Pay dividends to shareholders so they can reinvest \$ Beware of false precision – do not expect estimates of the cost of equity to be precise Remember that the constant growth formula in the DDM will give you poor results if it is applied to firms with unsustainably high current growth rates
York SOS: Students Offering Support 10 Chapter 14 Overview – How Corporations Issue Security Venture capital is provided by venture capital firms, financial and investment institutions, such as banks and pension funds, and by government institutions Angel investor is a wealthy individual who invests in early-stage ventures Initial Public Offering (IPO): o Once a firm decides to go public, the first task is to select the underwriters o Obtain approval from the Board of Directors o File preliminary prospectus (red herring) with OSC o Revise prospectus to meet OSC approval, determine price o Sell securities to the public Some points to note: o IPO’s rise in value on first day of issue o Private placement is the sale of securities to a limited number of investors without public offering
York SOS: Students Offering Support 11 Sample Problems 1. Page 270 #35 – Chapter 8 Note : 1. The 1 year feasibility study is a sunk cost and should not be considered. 2. Price/volume increase factor = (1+ inflation)*(1+ unit sales increase) = (1.015)*(1.04)= 1.0556 For example to find sale revenue in year 2, we multiply year 1 revenue by the price/volume factor. T 1 T 2 T 3 T 4 T 5 T 6 Sales Revenue 255,000 269,178 284,144 299,942 316,619 334,223 Less: Variable cost 16,000 16,889.6 17,828.7 18,819.9 19,866.3 20,970.9 Fixed cost 40,000 40,000 40,000 40,000 40,000 40,000 EBIT 199,000 212,288.4 226,315.3 241,122.1 256,758.7 273,252.1 Less: Taxes35 % 69,650 74,300.9 79,210.4 84,392.7 89,865.5 95,638.2 Net Income 129,350 137,987.5 147,104.9 156,729.4 166,893.2 177,613.9 T 0 T 1 T 2 T 3 T 4 T 5 T 6 Net Working Capital 40,000 44,000 48,400 53,240 58,564 64,420 70,862 Change in NWC 4,000 4,400 4,840 5,324 5,856 6,442 T 0 T 1 T 2 T 3 T 4 T 5 T 6 Investment: Land 150,000 Building 350,000 Equipment 250,000 Net working Capital 40,000 (790,000) NWC (4,000) (4,400) (4,840) (5,324) (5,856) (6,442) Net Income ( Excluding CCA tax shield ) 129,350 137,987.5 147,104.9 156,729.4 166,893.2 177,613.9 Salvage Value: Building 300,000 Equipment 125,000 T 0 T 1 T 2 T 3 T 4 T 5 T 6 Total Cash flow ( excluding CCA tax shield) (790,000) 125,350 133,587.5 142,264.9 151,405.4 161,037.2 596,171.9 Discount Factor (12%) 1.000 .8929 .7972 .7118 .6355 .5674 .5066 PV excluding CCA tax shield (790,000) 111,925 106,495.9 101,264.1 96,218.13 91,372.5 302,020.7