00 upvote00 downvote

5 visualizações28 páginasMay 02, 2019

© © All Rights Reserved

PDF, TXT ou leia online no Scribd

© All Rights Reserved

5 visualizações

00 upvote00 downvote

© All Rights Reserved

Você está na página 1de 28

• Some

S P li i i

Preliminaries

• Cost of Debt and Preference

• Cost

C off Equity

E i

• Determining the Proportions

• Weighted Average Cost of Capital

• Weighted Marginal Cost of Capital

• Floatation Costs and the WACC

• Divisional and Project Cost of Capital

• Cost of Capital in Practice

• Determining the Optimal Capital Budget

• Factors Affecting the Weighted Average Cost of Capital

COST OF CAPITAL

company) is the rate of return the suppliers of capital would

expect to receive if the capital were invested elsewhere in an

i

investment ( j

(project, b i

business, or company)) off comparable

bl risk

ik

• The

Th cost off capital

i l reflects

fl expectedd return

WEIGHTED AVERAGE

COST OF CAPITAL (WACC)

wE = proportion of equity

rE = cost of equity

q y

wp = proportion of preference

rp = costt off preference

f

wD = proportion of debt

rD = pre-tax cost of debt

tc = corporate tax rate

KEY POINTS

noncallable

ll bl preference;

f andd nonconvertible,

ibl noncallable

ll bl

debt) are considered.

are not included in the calculation of WACC.

COMPANY COST OF CAPITAL AND

PROJECT COST OF CAPITAL

expected by the existing capital providers.

by capital providers for a new project the company

proposes to undertake

• The company

p y cost of capital

p ((WACC)) is the right

g

discount rate for an investment which is a carbon copy

of the existing firm.

COST OF DEBT

n I F

P0 = +

t = 1 (1 + rD)t (1 + rD)n

P0 = current price of the debenture

I = annual interest payment

n = number of years left to maturity

F = maturity value

rD is computed through trial-and-error. A very close

approximation

pp is:

I + (F – P0)/n

rD =

0 6P0 + 0.4F

0.6P 0 4F

ILLUSTRATION

Coupon rate = 12 percent

Period to maturity = 4 years

Current market price = Rs.1040

120 + (1000 – 1040) / 4

rD = = 10.7 percent

0 6 x 1040 + 0.4

0.6 0 4 x 1000

COST OF PREFERENCE

the f i simply

is i l equall to

t its

it yield.

i ld

ILLUSTRATION

Dividend rate : 11 ppercent

Maturity period : 5 years

M k price

Market i :R

Rs.95

95

Approximate yield :

11 + (100 – 95) / 5

= 12.37 percent

0.6 x 95 + 0.4 x 100

COST OF EQUITY

and ((b)) issue of additional equity

q y capital.

p

retaining earnings or issuing additional equity shares,

q y is the same. The onlyy difference is in

the cost of equity

floatation cost.

APPROACHES TO ESTIMATE

COST OF EQUITY

• Security

S i Market

M k Line

Li Approach

A h

SECURITY MARKET LINE

APPROACH

rE = Rf + E [E(RM) – Rf ]

rE = required

i d return on the

h equity

i of the

h company

Rf = risk-free rate

E = beta of the equity of the company

E(RM) = expected return on the market portfolio

Illustration

Rf = 7%, E = 1.2, E(RM) = 15%

rE = 7 + 11.2

2 [15 – 7] = 16

16.6%

6%

INPUTS FOR THE SML

Whil there

While th i disagreement

is di t among finance

fi titi

practitioners, th

the

following would serve.

• The risk-free rate may be estimated as the yield on long-

term bonds that have a maturity of 10 years or more.

• The market risk premium may be estimated as the

difference between the average return on the market

portfolio and the average risk-free rate over the past 10

to 30 years.

• The beta of the stock may be calculated by regressing the

monthly returns on the market index over the past 60

months or so.

BOND YIELD PLUS RISK

PREMIUM APPROACH

Yield on the

Cost of = long-term bonds + Risk

equity of the firm premium

percent 4 percent,

percent or n percent ?

There seems to be no objective way of determining it.

DIVIDEND GROWTH MODEL APPROACH

D1

P0 =

rE – g

D1

So, rE = +g

P0

Thus, the expected return of equity shareholders, which in

equilibrium is also the required return, is equal to the dividend

yield plus the expected growth rate

GETTING A HANDLE OVER g

years.

q y)

EARNINGS-PRICE RATIO APPROACH

Cost of equity = E1 / PO

where E1 = the expected EPS for the next year

PO = the current market price

This approach provides an accurate measure in the

following two cases:

• When the EPS is constant and the dividend payout

ratio is 100 percent.

p

• When retained earnings earn a rate of return equal to

th costt off equity.

the it

DETERMINING THE

PROPORTIONS OR WEIGHTS

weights stated in market value terms.

is that the current capital structure may not reflect the

capital

p structure expected

p in future.

order

d tot justify

j tif its

it valuation

l ti theth firm

fi mustt earn

competitive returns for shareholders and debtholders on

the current (market) value of their investments.

investments

WACC

Source

S off Capital

C i l Proportion

P i Cost

C Weighted

W i h d Cost

C

(1) (2) [(1) x (2)]

Debt 0.60 16.0% 9.60%

Preference 0.05 14.0% 0.70%

Equity 0.35 8.4% 2.94%

WACC = 13.24%

13 24%

WEIGHTED MARGINAL COST OF CAPITAL

SCHEDULE

The procedure for determining the weighted marginal cost of

capital involves the following steps:

of its use through an analysis of current market conditions and

an assessment of the expectations of investors and lenders.

the new components would change, given the capital structure

policy of the firm. These levels, called breaking points, can be

established using the following relationship.

WEIGHTED MARGINAL COST OF CAPITAL

SCHEDULE

TFj

BPj =

wj

where BPj is the breaking point on account of financing source

j TFj is

j, i the

h totall new financing

fi i from

f source j at the

h breaking

b ki

point, and wj is the proportion of financing source j in the

capital structure.

b

between the

h breaking

b ki points.

i

p

4. Prepare the weighted

g marginal

g cost of capital

p schedule which

reflects the WACC for each level of total new financing.

DETERMINING THE OPTIMAL

Return,

CAPITAL BUDGET

Cost (%)

A

18 Investment Opportunity Curve

B

17

16 C

15 14.6%

14 14.0%

13.2% D

13

E

12 Marginal Cost of Capital Curve

11

10 Optimal Capital Budget

Amount (in million rupees)

DIVISIONAL AND PROJECT COST

OF CAPITAL

• Using WACC for evaluating investments whose risks are

different from those of the overall firm leads to poor

decisions. In such cases, the expected return must be

compared with the risk-adjusted required return, as

calculated

l l t d byb the

th security

it market

k t line.

li

by differing risks may calculate separate divisional costs

of capital. Two approaches are commonly employed for

this purpose:

• The pure play approach

• The subjective approach

FLOATATION COSTS

Fl t ti or issue

• Floatation i t consist

costs i t off items

it lik

like

underwriting costs, brokerage expenses, fees of

merchant bankers,

bankers underpricing cost,

cost and so on.on

the WACC to reflect the floatation costs:

WACC

Revised WACC =

1 – Floatation costs

to consider floatation costs as part of the project cost.

SOME MISCONCEPTIONS

S

Severall misconceptions

i ti h t i

characterise th calculation

the l l ti andd

application of cost of capital in practice.

p

impractical.

on equity.

equity

significantly less that the external equity.

SOME MISCONCEPTIONS

accounting-based measure.

l the

th same costt off capital

it l to

t all

ll

projects.

SUMMING UP

• A company’s

p y cost of capital

p is the weighted

g average

g cost of the

various sources of finance used by it, viz., equity, preference and

debt.

• Since debt and preference entail more or less fixed

fi ed payments,

pa ments

estimating their cost is relatively easy.

• Three

ee app

approaches

oac es aaree commonly

co o y used to estimate

est ate the

t e cost of

o

equity : security market line approach, bond yield plus risk

premium approach, and dividend growth model approach.

• Th

The appropriate

i t weights

i ht in

i the

th WACC calculation

l l ti are the

th target

t t

capital structure weights stated in market value terms

• In multidivisional firms, it is advisable to calculate divisional costs

of capital.

• Floatation costs may be considered as part of project cost.

• Several misconceptions characterise cost of capital in practice.

## Muito mais do que documentos

Descubra tudo o que o Scribd tem a oferecer, incluindo livros e audiolivros de grandes editoras.

Cancele quando quiser.