mba 643 managerial finance lecture 9 weighted average cost of capital l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
MBA 643 Managerial Finance Lecture 9: Weighted Average Cost of Capital PowerPoint Presentation
Download Presentation
MBA 643 Managerial Finance Lecture 9: Weighted Average Cost of Capital

Loading in 2 Seconds...

play fullscreen
1 / 7

MBA 643 Managerial Finance Lecture 9: Weighted Average Cost of Capital - PowerPoint PPT Presentation


  • 126 Views
  • Uploaded on

MBA 643 Managerial Finance Lecture 9: Weighted Average Cost of Capital. Spring 2006 Jim Hsieh. Introduction. From the NPV rule, we accept the project when its NPV>0: But how do we get “r”?

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'MBA 643 Managerial Finance Lecture 9: Weighted Average Cost of Capital' - kasen


Download Now An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
introduction
Introduction
  • From the NPV rule, we accept the project when its NPV>0:
  • But how do we get “r”?
  • Cost of Capital: The return the firm’s investors could expect to earn if they invested in securities with comparable risk.
  • Firms have different types of investors.
components of cost of capital
Components of Cost of Capital
  • Capital Structure: The firm’s mix of long-term debt financing (D) and equity financing (E).
  • Balance Sheet Model (Market Value): A = D + E: It represents the claims for debtholders and stockholders.
  • Various Components of Cost of Capital:
    • Cost of Debt (rD)
    • Cost of Preferred Stock (rpreferred)
    • Cost of Common Stock (rE)
  • Usually we put cost of preferred stock with cost of debt.
weighted average cost of capital
Weighted Average Cost of Capital
  • Question: If a firm has both debt and equity capital, how can we determine its overall cost of capital?
  • Answer: A firm’s overall cost of capital should reflect the required rate of return on the firm’s assets as a whole.
    • It is a mixture of the returns required to compensate its creditors and stockholders.
  • Definition: The weighted average cost of capital (WACC) is the expected rate of return on a portfolio of all firm’s securities.
  • Company overall cost of capital = weighted average of debt and equity returns
estimating wacc from a d e
Estimating WACC -- from A = D + E
  • Case 1: If the firm pays no tax,

rA = WACC = (Total dollar return)/(Initial investments)

= (D*rD + E*rE)/V

= (D/V)*rD + (E/V)*rE = wDrD + wErE

  • Case 2: If the firm pays tax,
    • Interest payments are deducted from income before tax is calculated.
    • After-tax cost of debt = (pre-tax cost of debt)*(1-tax rate)

=rD(1-TC) where TC = corporate marginal tax rate

WACC = (D/V)*rD*(1-TC) + (E/V)*rE = wDrD(1-TC) + wErE

example 1
Example 1
  • FinPro Inc. has issued debt and common stock. The market values of these securities are $5mm and $8mm, respectively. Given that the company pays 7% for debt and 12% for equity, what is the WACC for FinPro? The company has a marginal tax rate equal to 40%.

WACC = wD*rD*(1-TC) + wE*rE

= (5/13)*0.07*(1-0.4)+(8/13)*0.12 = 0.09

estimating r d r e and r preferred recap
Estimating rD, rE, and rpreferred (recap)
  • Cost of debt = rD = YTM*(1-TC)
  • Cost of preferred stock:
    • Since we know P0 = Div1/r for preferred stock, rpreferred = Div1/P0
  • Cost of equity:
    • Approach 1: From SML: rE = rf + (rm – rf)
    • Approach 2: From DDM: P0 = Div1/(rE - g) => rE = Div1/P0 + g