FIN 351-lecture 8.pptVIP

* 16 * * 23 * 23 * * * * 3 * 4 * 5 * * * * * * * * * 12 * * * * * * * FIN 351-lecture 8 Corporate Financing and Market Efficiency Where to get money for good projects Today’s plan Review WACC Investment Decision vs. Financing Decision Does the stock price follow a random walk? Three forms of Market Efficiency Weak form efficiency Semi-strong form efficiency Strong form efficiency Several types of securities What have we learned in the last lecture ? Motivation for WACC How do we know that a project is worth taking? How do we find the cost of capital for a project ? What is the formula of WACC without tax? What is the formula of WACC with tax? Should we use the market value or book value of equity and debt in calculating WACC? What have we learned in the last lecture (1)? WACC without tax WACC with tax What have we learned in the last lecture (2)? The cost of bond It is the YTM, the expected return required by the investors. That is The expected return on a bond can also be calculated by using CAPM What have we learned in the last lecture (2)? The cost of equity is calculated by using CAPM Dividend growth model What have we learned in the last lecture (2)? Three steps in calculating WACC First step: Calculate the market value of each security and calculate its portfolio weight Second step: Determine the cost of capital on each security. Third step: Calculate a weighted average cost of capital on these securities. A summary example John Cox, a recent MBA student of SFSU, was asked by his boss in Geothermal to decide whether the firm should take an expansion project: the cost of the project is $30 million, and the project is expected to generate a perpetual incremental cash flow of $4.5 million. Currently, Geothermal has 20 million shares of common stocks outstanding, with a market price of $22.65 per share. The Beta of the firm’s equity is 1.1. The risk free rate is 4% and the market risk premium is 5.6%. The firm also has long-term debt