N there is an element of circularity that is

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n There is an element of circularity that is introduced into every valuation by doing this, since the values that we attach to the firm and equity at the end of the analysis are different from the values we gave them at the beginning. n As a general rule, the debt that you should subtract from firm value to arrive at the value of equity should be the same debt that you used to compute the cost of capital.

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Aswath Damodaran 19 Estimating Cost of Capital: Titan Cements n Equity Cost of Equity = 5.10% + 0.96 (4%+1.59%) = 10.47% Market Value of Equity = 739,217 million GDr (78.7%) n Debt Cost of debt = 5.10% + 0.75% +0.95%= 6.80% Market Value of Debt = 199,766 million GDr (21.3 %) n Cost of Capital Cost of Capital = 10.47 % (.787) + 6.80% (1- .2449) (0.213)) = 9.33 % Mature market premium Greek country premium Company default spread Country default spread
Aswath Damodaran 20 Titan Cement: Book Value Weights n Titan Cement has a book value of equity of 135,857 million GDR and a book value of debt of 200,000 million GDR. Estimate the cost of capital using book value weights instead of market value weights.

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Aswath Damodaran 21 Estimating A U.S. Dollar Cost of Capital: Siderar - An Argentine Steel Company n Equity Cost of Equity = 6.00% + 0.71 (4% +10.53%) = 16.32% Market Value of Equity = 3.20* 310.89 = 995 million (94.37%) n Debt Cost of debt = 6.00% + 5.25% (Country default) +1.25% (Company default) = 12.5% Market Value of Debt = 59 Mil (5.63%) n Cost of Capital Cost of Capital = 16.32 % (.9437) + 12.50% (1-.3345) (.0563)) = 16.32 % (.9437) + 8.32% (.0563)) = 15.87 % Mature Market Premium Country Risk Premium for Argentina
Aswath Damodaran 22 Converting a Dollar Cost of Capital into a Peso cost of capital n Approach 1: Use a peso riskfree rate in all of the calculations above. For instance, if the peso riskfree rate was 10%, the cost of capital would be computed as follows: Cost of Equity = 10.00% + 0.71 (4% +10.53%) = 20.32% Cost of Debt = = 10.00% + 5.25% (Country default) +1.25% (Company default) = 16.5% (This assumes the peso riskfree rate has no country risk premium embedded in it.) n Approach 2: Use the differential inflation rate to estimate the cost of capital. For instance, if the inflation rate in pesos is 7% and the inflation rate in the U.S. is 3% Cost of capital= = 1.1587 (1.07/1.03) = 1.2037--> 20.37% (1 + Cost of Capital \$ ) 1 + Inflation Peso 1 + Inflation \$

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Aswath Damodaran 23 Dealing with Hybrids and Preferred Stock n When dealing with hybrids (convertible bonds, for instance), break the security down into debt and equity and allocate the amounts accordingly. Thus, if a firm has \$ 125 million in convertible debt outstanding, break the \$125 million into straight debt and conversion option components. The conversion option is equity. n When dealing with preferred stock, it is better to keep it as a separate component. The cost of preferred stock is the preferred dividend yield.
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