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Chapter 8

ENTREPRENEURIAL FINANCE. Chapter 8. TYPES AND COSTS OF FINANCIAL CAPITAL. Chapter 7: Learning Objectives. Understand some basic characteristics of the financial markets Understand how risk-free securities prices reflect risk-free borrowing rates

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Chapter 8

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  1. ENTREPRENEURIAL FINANCE Chapter 8 TYPES AND COSTS OF FINANCIAL CAPITAL

  2. Chapter 7:Learning Objectives • Understand some basic characteristics of the financial markets • Understand how risk-free securities prices reflect risk-free borrowing rates • Explain how corporate debt prices reflect higher interest rates when a borrower may default • Explain investment risk

  3. Chapter 7:Learning Objectives • Estimate the cost of publicly traded equity capital (e.g., exchange-listed common stocks) • Estimate the cost of private equity capital • Explain how capital costs combine into a weighted average cost of capital (WACC) • Understand venture investors’ target returns and their relation to capital costs

  4. Types & Costs of Financial Capital资金成本及其类别 • Implicit Versus Explicit Financial Capital Costs • 隐含的和显性的资金成本 • Formal historical accounting procedures include explicit records of debt (interest and principal) and dividend capital costs • However, no provision is made to record the less tangible expenses of equity capital (i.e., required capital gains to complement the dividends)

  5. Financial Markets 金融市场 • Public Financial Markets: • 公开交易金融市场 markets for the creation, sale and trade of liquid securities having standardized features • Private Financial Markets: • 非公开交易金融市场 markets for the creation, sale and trade of illiquid securities having less standardized negotiated features

  6. Financial Markets 金融市场 • Venture Debt Capital: 创业企业债务资本 debt raised in early stage from individuals, venture capital firms, and possibly financial institutions • Venture Equity Capital:创业企业权益资本 equity raised in early stage from founding entrepreneurial team, business angels, and venture capitalists

  7. Determining Cost Of Debt Capital确定债务资本成本 • Interest Rate:利率 price paid to borrow funds • Default Risk:违约风险 risk that a borrower will not pay the interest and/or principal on a loan

  8. Determining Cost Of Debt Capital确定债务资本成本 • Nominal Interest Rate (rd):名义利率 observed or stated interest rate • Real Interest Rate (RR):实际利率 interest one would face in the absence of inflation, risk, illiquidity, and any other factors determining the appropriate interest • Risk-free Interest Rate (rf):无风险利率 interest rate on debt that is virtually free of default risk • Inflation: 通货膨胀 rising prices not offset by increasing quality of the goods or services being purchased

  9. Determining Cost Of Debt Capital确定债务资本成本 • Inflation premium (IP):通货膨胀收益 average expected inflation rate over the life of a risk-free loan • Default Risk Premium (DRP):违约风险收益 additional interest rate premium required to compensate the lender for the probability that a borrower will default on a loan • Liquidity Premium (LP):流动性收益 charged when a debt instrument cannot be converted to cash quickly at its existing value • Maturity Premium (MP):到期收益 premium to reflect increased uncertainty associated with long-term debt

  10. Interest Rate Relationships利率的关系 • rf = RR + IP（无风险利率） for debt by effectively default-free borrowers (e.g. U.S. government) • rd = RR + IP + DRP +LP +MP（名义利率） more generally, for more complicated risky debt securities at various maturities and liquidities • Can think of rd = rf + DRP + LP + MP

  11. Determining Cost Of Debt Capital确定债务资本成本 • Prime Rate:基本利率 interest rate charged by banks to their highest quality (lowest default risk) business customers • Bond Rating:债券评级 reflects the default risk of a firm’s bonds as judged by a bond rating agency • Senior Debt:优先债务 debt secured by a venture’s assets • Subordinated Debt:次级债 debt with an inferior claim (relative to senior debt) to venture assets

  12. Determining Cost Of Debt Capital确定债务资本成本 • Term Structure of Interest Rates: • 利率期限结构 relationship between nominal interest rates and time to maturity when default risk is held constant

  13. Determining Cost Of Debt Capital确定债务资本成本 • Yield Curve:收益率曲线 graph of the term structure of interest rates

  14. Determining Market Interest Rates确定市场利率 • rd = RR + IP + DRP +LP +MP （名义利率） • Suppose: • Real interest rate = 3% • Inflation expectation = 3% • Default risk = 5% • Liquidity premium = 3% • Maturity premium = 2% • Then: • rd = 3% + 3% + 5% + 3% + 2% = 16%

  15. What Is Investment Risk?什么是投资风险？ • Investment Risk:投资风险 chance or probability of financial loss from a venture investment • Debt, equity, and founding investors all assume investment risk • A widely accepted measure of risk is the dispersion of possible outcomes around the expected return of an investment – the standard deviation of possible investment returns 标准差度量投资风险

  16. Calculating a Possible Return计算可能的投资回报 • Suppose • Buy stock at $100 • Receive $10 dividend • Ending stock value = $110 • Then:

  17. Calculating an Expected Return计算预期的回报 • Expected Rate of Return: probability-weighted average of all possible rate of return outcomes Economic Probability of Rate of Weighted Climate Occurrence X Return = Return Rapid Growth .30 X 60% = 18.0% Normal .40 X 20% = 8.0% Recession .30 X -20% = -6.0% 1.00 Expected Return = 20.0%

  18. Measuring Risk as a Dispersion Around an Average标准差度量风险 Weighted Outcome Minus Difference Probability Squared Expected Return Squared x of Outcome = Deviations 60% - 20% = 40% 1,600 x .3 = 480.0 20% - 20% = 0 0 x .4 = 0.0 -20% - 20% = -40% 1,600 x .3 = 480.0 Variance = 960.0 Standard Deviation = 31.0%

  19. Measuring Risk as a Dispersion Around an Average标准差衡量风险 Calculating Standard Deviation:计算标准差 • Calculate the expected rate of return on an investment based on estimates of possible returns and probabilities associated with those returns • Subtract the expected value from each outcome to determine deviations from the expected value • Square each difference or deviation • Multiply each squared deviation by the probability of the outcome and sum the weighted squared deviation to get the variance • Calculate the square root of the variance to get standard deviation

  20. Graphical View Of Dispersion: Continuous Probability Distributions of Rates of Return

  21. Measuring Risk as a Dispersion Around an Average标准差度量风险 • Coefficient of Variation:方差系数 • Standard Deviation / Expected Return • Coefficient of Variation: shows the dispersion risk per unit of expected rate of return – a ratio of risk to reward • 单位预期收益率的风险程度

  22. Estimating the Cost of Equity Capital估算股权资本成本 • Private Equity Investors 私人股权投资者 owners of proprietorships, partners in partnerships, and owners in closely held corporations • Closely Held Corporations • 非公开交易股份公司 corporations whose stock is not publicly traded • Publicly Traded Stock Investors • 公开发行股票的投资者 equity investors of firms whose stocks trade in public markets such as the over-the-counter market or an organized securities exchange

  23. Estimating the Cost of Equity Capital估算股权资本成本 • Organized Securities Exchange: • 有组织的证券交易 a formally organized exchange typically having a physical location with a trading floor where trades take place under rules set by the exchange • Over-the-Counter (OTC) Market: • 柜台交易（OTC）市场 network of brokers and dealers that interact electronically without having a formal location • Market Capitalization (market cap):资本市场 determined by multiplying a firm’s current stock price by the number of shares that are outstanding

  24. Cost of Equity Capital for Public Corporations上市公司股权资本成本 re = rf + IRP = RR + IP + IRP where: re = cost of common equity普通股资本成本 rf = risk-free interest rate无风险利率 RR = real rate of interest实际利率 IP = inflation premium通货膨胀收益 IRP = equity investment risk premium 股权投资风险收益 • IRP: additional return expected by investors in a risky publicly traded common stock投资者在购买公开上市普通股股票时，对风险的额外预期报酬率。

  25. Cost of Equity Capital for Public Corporations上市公司股权资本成本 • Expected Return on Venture’s Equity (re) using the Security Market Line (SML): re = rf + [rm – rf] b where rf = risk-free interest rate rm = expected annual rate of return on stock market b(beta) = systematic risk of firm to the overall stock market

  26. Cost of Equity Capital for Public Corporations上市公司股权资本成本 • Expected Return on Venture’s Equity (re) using the Security Market Line (SML): re = rf + [MRP] b • MRP:市场风险收益 market risk premium = excess average annual return of common stocks over long-term government bonds 股票投资收益超过无风险投资的收益

  27. Cost of Equity Capital for Private Ventures私营企业股权资本成本 • Venture Hubris: 创业风险 optimism expressed in business plan projections that ignore the possibility of failure or underperformance • What do we do with such projections? Use rv = re + AP + LP + HPP where: rv = rate of return for venture investors 创业企业投资的报酬率 re = cost of common equity 股权资本成本 AP = advisory premium 咨询服务收益 LP = liquidity risk 流动性风险 HPP = hubris projections premium创业企业投资的风险收益

  28. Weighted Average Cost of Capital (WACC)加权平均资本成本 • WACC:加权平均资本成本 weighted average cost of the individual components of interest-bearing debt and common equity capital • After-tax WACC:税后加权平均资本成本 = (1 – tax rate) x (debt rate) x (debt%) + equity rate x (1 – debt%)

  29. Weighted Average Cost of Capital (WACC)加权平均资本成本例题 • WACC Example for $1 Venture with: • $.50 of debt • $.50 of equity • debt interest rate = 10% • tax rate = 30% • required return to equity holders = 20% • After-tax WACC = (1 – tax rate) x (debt rate) x (debt%) + equity rate x (1 – debt%) = (.70 x .10 x .5) + (.20 x .5) = .135 or 13.5%

  30. Graphically,

  31. Using WACC to Complete Calibration of EVA使用加权平均资本成本度量企业的成长 • EVA:经济增加值 Net Operating Profit After Taxes (NOPAT) – After-tax Dollar Cost of Financial Capital Used • NOPAT = EBIT(1- Effective Tax Rate) • After-Tax Dollar Cost of Financial Capital Used = amount of financial capital x WACC

  32. Using WACC to Complete Calibration of EVA使用加权平均资本成本度量企业的成长例题 • For example: Beta Omega Corp has the following information: • EBIT = $500,000 • Amount of Financial Capital = $1,600,000 • WACC = 19.0% • Tax = 30% • NOPAT = [$500,000 x (1-.30)] = $350,000 • After-Tax Cost of Financial Capital Used = $1,600,000 x .19 = $304,000 • EVA = $350,000 - $304,000 = $46,000

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