Ch 6 Cost of Capital(公司理财(哈工大深圳研究生院,王苏生).ppt

HIT SGS Corporation Finance Chapter 6 COST OF CAPITAL OBJECTIVES Define and compute the cost of capital (WACC-weighted average cost of capital) Review Risk-Return: CAPM Learn how to incorporate risk in DCF valuations DEFINITION OF COST OF CAPITAL The opportunity cost of capital is expected return that the owners of the firm could have earned if they invested in other projects with similar risk ? It recognizes the foregone opportunities when investing in the project as opposed to other projects with similar risk ? Example: The opportunity cost of capital for a risk free project is the yield on treasury notes ? Cost of equity depends on the risk of the project (both business risk and financial risk) COST OF CAPITAL The cost of capital is the minimum rate of return the firm should expect to earn on its invested funds so that all providers of funds just earn their required rate of return Cost of capital is also called discount rate, hurdle rate, or required rate of return THE IMPORTANCE OF THECOST OF CAPITAL The cost of capital is used to evaluate projects. It accounts for both time value of money and risk The effect of an error in estimating the cost of capital Under estimation of hurdle rates leads to acceptance of negative NPV projects Over estimation of hurdle rates results in rejection of positive NPV projects Cost of Capital: WACC WACC (Weighted Average Cost of Capital) Formula Common Errors Equity is cheaper than debt We can borrow all of the $100M required for this project at an interest rate of 7%. Thus our cost of capital is 7% Whose cost of capital should be used when valuing an acquisition target? The bu