Chapter 10 The Cost of Capital

Transcription

1 Chate 10 The Cost of Caital Cost of Caital is the fim s aveage cost of funs, which is the aveage etun equie by the fim s investos Fims use vaious souces of long-tem caital: Long-tem ebt efee stock Common equity Focus on afte-tax athe befoe-tax caital costs. Focus on new (maginal) costs athe than histoical (embee) costs. Weighte Aveage Cost of Caital (WACC) COST OF DEBT AND REFERRED STOCK Cost of ebt M INT n 2( B ) M 3 B A comany has a 15-yea, 12% couon bon that sells fo $1, The bon ays inteest semiannually. What is k? Afte-tax cost of ebt = (1 - T) Flotation costs fo ebt ae small, so ignoe. Cost of efee Stock D Suose a comany's efee stock sells fo $113.10; has a a value of $100; ays a 10% (of a value) ivien; an will exeience a $2 e shae flotation chage if it issues new efee stock. What is the comany's cost of efee?

2 Note: Flotation costs fo efee ae significant, so ae eflecte. Use net ice: ice - floatation costs. efee iviens ae not tax-euctible, so no tax ajustment. Just COST OF EQUITY Comanies can aise equity in two ways 1. Comanies can issue new shaes of common stock. 2. Comanies can etain eanings. Why is thee a cost fo etaine eanings? Eanings can be einveste o ai out as iviens. If ai out, then investos can buy othe secuities, ean a etun. So, thee is an ootunity cost if eanings ae etaine. Ootunity cost: The etun stockholes can ean on altenative investments of equal isk. Common stockholes can buy simila stocks an ean s, o the comany can euchase its own stock an ean s. So, s, is the cost of etaine eanings an it is the cost of common equity. The CAM Aoach s f (m f ) i Assume a isk-fee ate of 7%, a etun on the maket otfolio fo 13%. If this comany has =1.2, what is the cost of equity base on the CAM? Discounte Cash Flow (DCF) Aoach D1 s g 0 The fim just ai a ivien of $4.19, has a ivien gowth ate of 5%, an is cuently selling fo $50, what is the DCF cost of equity?

3 Bon-Yiel-lus-Risk emium Aoach s isk emium If the comany's cost of ebt,, is 10% an it believes that the cost of equity is geneally 4 ecentage oints highe than (in othe wos, isk emium = 4%), what is s using the bon-yiel-lus-isk-emium metho? Note: This isk emium CAM isk emium, (m f ). ouces ballak estimate of s. Useful check. We have thee iffeing estimates of the cost of equity--what s a easonable final estimate of s? Metho Estimate CAM 14.2% DCF 13.8% + R 14.0% Aveage 14.0% Extenal equity (o new common stock) Is the cost of newly issue common stock, e, the same as the cost of etaine eanings? Ou metho fo etemining the cost of extenal equity, e, is base on the cost of etaine eanings. It is ajuste fo flotation costs. e D 1 Net g D1 g (1 0 F) Examle. The fim just ai a ivien of $4.19, has a ivien gowth ate of 5%, an is cuently selling fo $50. Issuance costs fo new common ae $2 e shae fo this comany. What is this comany's cost of extenal equity?

4 Otimal Caital Stuctue Is the ecentage of ebt, efee stock, an common equity that will maximize the ice of the fim s stock Fo ou examle, let s assume this comany s otimal caital stuctue is 30% ebt, 10% efee stock, an 60% common equity Weighte Aveage Cost of Caital (WACC) is the weighte aveage of the comonent costs of ebt, efee stock, an common equity WACC w ( 1T) w w k e s whee w is the ootion of each comonent in the caital stuctue. Note: the w's must sum to 1.0. Assuming ou examle comany uses etaine eanings fo common equity, what s its WACC? Maginal Cost of Caital (MCC) is the cost of obtaining anothe olla of new caital the weighte aveage cost of the last olla of new caital aise. Can the comany aise an unlimite amount of new caital at the 11.1% cost? obably not. As a comany aises lage an lage amounts of funs uing a given time eio, the costs of those funs begin to ise.

5 MCC Scheule. Maginal cost of caital scheule is a gah that elates the fim's weighte aveage cost of each olla of caital to the total amount of new caital aise. It eflects changing costs eening on amounts of caital aise. WACC 10.5% New Caital Raise A "Beak oint" is the olla value of new caital that can be aise befoe an incease in the fim s weighte aveage cost of caital occus Suose that the comany anticiates etaining $60 million ollas in the coming yea--how much can be sent on caital investments befoe extenal equity must be sol? Re taineeanings is60% of thecaitalstuctue Re taineeanings 60% (caitalstuctue) $60million 60% X X Equation fo a etaine eanings beak oint: Beako int aition to etaine equity eanings faction fo the yea MCC Scheule an beak oints een on caital stuctue use. The MCC scheule an Investment Ootunity Scheules can be combine to assist in etemining which investments shoul be unetaken. Wok ST-2 ( 327) as an examle.