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Global Cost of Capital

Global Cost of Capital. Chapter 11. Weighted average cost of capital (WACC). k e - cost of equity k d - cost of debt T c - corporate tax rate E - market value of equity D - market value of debt V - total market value of the firm’s securities. WACC effects.

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Global Cost of Capital

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  1. Global Cost of Capital Chapter 11 Chapter 11 - wacc

  2. Weighted average cost of capital (WACC) • ke - cost of equity • kd - cost of debt • Tc - corporate tax rate • E - market value of equity • D - market value of debt • V - total market value of the firm’s securities Chapter 11 - wacc

  3. WACC effects Capital budgeting Pro forma income statements are required for each period The NPV of the NCFs is inversely related to the value of the wacc Chapter 11 - wacc

  4. WACC effects • If you can lower your wacc, more projects become profitable. k kwacc MRR capital budget Chapter 11 - wacc

  5. Leverage effects • leverage effects determine an optimal level of leverage ke kwacc kd leverage Chapter 11 - wacc

  6. Market efficiency • perfect information • standardized accounting practices • standardized reporting practices • no transactions costs • no regulatory costs • governments do not try to restrict capital markets • no monopolistic influences in the market place Chapter 11 - wacc

  7. Cost of equity – FDI (efficient capital markets) • dividend capitalization model • capital asset pricing model Chapter 11 - wacc

  8. Mature capital markets have bond rating agencies AAA, AA, A, BBB, BB, BB, C, D The ratings determine the cost of debt to the firm The type of debt instrument Mortgage bond, coupon bond, discount bond Cost of Debt – FDI (efficient capital markets) Chapter 11 - wacc

  9. Inefficient markets • imperfect information (information barriers) • high transactions costs • exchange rate exposure • regulatory costs • capital restrictions • exchange restrictions • political risk • no competition to exchange Chapter 11 - wacc

  10. Cost of equity – FDI(inefficient capital markets) • If there are no reliable measures of risk in an economy we must make an informed guess by applying a Risk Premium to the domestic return on equity Chapter 11 - wacc

  11. Cost of debt - FDI (inefficient capital markets) • Normal debt markets immature • Governments may offer incentives • Lower interest rates, tax relief, • Supra-national agencies may offer incentives to invest • UN, IMF, etc. Chapter 11 - wacc

  12. Relative market efficiency 0% 100% W. European, Asian Russian S. American, E. European N. American Chapter 11 - wacc

  13. Segment capital markets • Capital markets are internal to the economy • Borrowers and lenders are confined to the geographic confines of the country • European union prior to the euro • Finnish firms could finance only from Finnish sources • Argentine firms could finance only from Argentinian sources Chapter 11 - wacc

  14. Integrated (consolidated) capital markets • Euro zone • With currency unification, capital markets within the euro zone are integrating • Lenders and borrowers have much better opportunities • The market becomes thicker so the prices of borrowing are more efficient • Canada/US is an integrating market Chapter 11 - wacc

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