Valuation and levered Betas. Some interesting questions to consider in applications. Today’s plan. Review what we have learned in the last lecture An example of a cash-flow calculation Examine the impact of financing on the cost of equity (levered Betas) Two approaches to calculate NPV
Some interesting questions to consider in applications
FIN 819: lecture 5
Cost of Capital
(a) What is the expected return on this bond or what is the cost of debt for this bond?
(b) Suppose that the YTM is 9%, what is the market value of this bond?
Company A has a very old packaging machine which can be used for another two years. It has no book and market values. The maintenance cost for this old machine is $20,000 every year. Now a new packaging machine is available at the price of $ 300,000, which is depreciated in three years. If the new packaging machine is used, the maintenance cost is $10,000 every year. If there is no inflation, the cost capital is 10%, and the tax rate is 40% for company A.
a. What is the valuation horizon used in this problem?
b. Should company A invest in the new packaging machine now or
waiting two years later?
Liabilities and Equity
Debt Tax shield (TX)
Unlevered asset (UA)
is not affected by firms’ capital structure, but decided by firms’ business risk.
Suppose that the tax-shield is as risky as debt.