Lecture 10 BF ( capital )

It is important not use an average discount rate instead of project specific

discount rates that will : not invest in positive NPV or over investing in a
negative NPV project.
The firm needs to provide returns that are higher than the market
expectations.
It is also know as the cost of capital because the firms need to
provide returns at the capital rate
However if an investor invested in all of the companys assets the
average of the cost of capital is the correct return
What is the relationship between risk and earnings?
the expected return premium on any asset is proportional to its
systematic risk.
What is cost of capital?
The required return to entice investors and compensate them for the risk.
this is the discount rate companys should use when valuing projects.
How do you determine the level of risk on a portfolio?
It is the weighted average of the securities on a portfolio. These weights
must be based on market values ( values used by investors).
What is the weighted average cost of capital?
The weighted average of a projects cost for each security used in
financing, the wweights are fractional amounts of each securitys total
market value.

Unlevered firm: firms without debt

Levered firm: firms with debt outstanding. the weighted average cost of
capital is the cost of equity.
How does WACC value assets?
By discounting cash flows at the weighted average cost of capital which
gives the NPV as well as the value of the firms securitie when applied to
total firm cash flow.
What are the limitations of CAPM?
Many debt securities and preference shares do not trade frequentlyyhus
the estimated CAPM may be outdated, ordinary shares which are traded
frequently can be valued using CAPM.
What is the cost of debt?
This is the tax benefits of debt. The return on debt if the YTM. Thus the
cost of debt is given by:

how do you calculate the cost fo preference share?

how do you calculate the cost of a preference share?

this is the expected return demanded by investors.
What is the capital asset pricing model?

what is the risk free rate?

The investment horizon for investors and for the project. Most firms will
use the yields on government bonds as the risk free rate.
What is the beta?
It reflects the systematic risk of a project. However a firms systematic
beta maybe inappropriate due to estimation error the average risk of a
fimr not being reflective of project risk nor the future risk or other factors.
Most of the time betas is basedon the average of asingle industry firmsin
the industry project

Floatation cost?
A cost incurred by a company when issuing securities. Common expenses
include underwriting, legal and registration fees.
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