Lecture Notes - Week 8 - 1 slide per page

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1、CostofCapitalEstimation;IntroductiontoFinancialleverageWeek8Readings:chapter17KeyConceptsandSkillsDetermineafirm’scostofequitycapital(r)SDetermineafirm’scostofdebt(r)dDetermineafirm’soverallcostofcapital(r)WACCUnderstandthepitfallsofoverallcostofcapita

2、landhowtomanagethemDeterminethedivisionalcostofcapitalWhatsourcesofcapitaldofirmsuse?CapitalPreferredCommonDebtStockEquityNotesLong-TermRetainedNewCommonPayableDebtEarningsStockCalculatingtheWeightedAverageCostofCapitalWACC=wr(1–T)+wr+wrddppEEThew’srefer

3、tothefirm’scapitalstructureweights.Ther’srefertothecostofeachcomponent.Shouldouranalysisfocusonbefore-taxorafter-taxcapitalcosts?StockholdersfocusonA-TCFs.Therefore,weshouldfocusonA-Tcapitalcosts,i.e.useA-TcostsofcapitalinWACC.Onlyrneedsadjustment,dbecau

4、seinterestistaxdeductible.Shouldouranalysisfocusonhistorical(embedded)costsornew(marginal)costs?Thecostofcapitalisusedprimarilytomakedecisionsthatinvolveraisingnewcapital.So,focusontoday’smarginalcosts(forWACC).Howaretheweightsdetermined?WACC=wr(1–T)+wr+w

5、rddppEE•Useaccountingnumbersormarketvalue(bookvs.marketweights)?•Useactualnumbersortargetcapitalstructure?RequiredReturnWeneedtoknowtherequiredreturnforaninvestmentbeforewecancomputetheNPVandmakeadecisionaboutwhetherornottotaketheinvestmentWeneedtoearnat

6、leasttherequiredreturntocompensateourinvestorsforthefinancingtheyhaveprovided8OverallCostofCapitaloftheFirmCostofCapitalistherequiredrateofreturnonthevarioustypesoffinancingTheoverallcostofcapitalisaweightedaverageoftheindividualrequiredratesofreturn(cos

7、ts)9CostofEquity(r)SThecostofequityisthereturnrequiredbyequityinvestorsgiventheriskofthecashflowsfromthefirmTwomajormethodsfordeterminingthecostofequityDividendgrowthmodelSMLorCAPM10TheDividendGrowthModelApproachD(1g)0P0RgED1RgEP011Example1—Costof

8、Equity:DividendGrowthModelApproachJumboCo.recentlypaidadividendof20centspershare.Thisdividendisexpectedtogrowatarateof5percentperyear,intoperpetuity.ThecurrentmarketpriceofJumbo’ssharesis$7.00pershare.Determi