Chap013 risk, cost of capital and capital budgeting.pptVIP

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Chap013 risk, cost of capital and capital budgeting.ppt

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Chap013 risk, cost of capital and capital budgeting

* * The terms discount rate, required return, and cost of capital are all synonymous. * Therefore, the discount rate of a project should be the expected return on a financial asset of comparable risk. * * You may want to note that this example assumes expansion into projects that are similar to the existing nature of the business. * * This, again, assumes independent projects. This is a good point at which to review the relation between IRR and NPV. * This approach follows Ibbotson. * * 3 * * * * * * * * * * * Note that even if a firm pays no dividend, there is still a cost to equity, as investors expect to receive future payouts (i.e., the growth). Further, investors also face opportunity costs for investing in one firm versus another, implying that dividend yield is only a piece of the whole issue. * To estimate the cost of capital for a division, a “pure play” approach could be used, although finding exactly similar firms may be difficult, particularly considering underlying financial and operational structure. * 17 * * * There is no tax adjustment because dividends are not tax deductible. 13-* Risk, Cost of Capital, and Capital Budgeting Chapter 13 Copyright ? 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Key Concepts and Skills Know how to determine a firm’s cost of equity capital Understand the impact of beta in determining the firm’s cost of equity capital Know how to determine the firm’s overall cost of capital Understand the impact of flotation costs on capital budgeting Chapter Outline 13.1 The Cost of Equity Capital 13.2 Estimating the Cost of Equity Capital with the CAPM 13.3 Estimation of Beta 13.4 Beta, Covariance and Correlation 13.5 Determinants of Beta 13.6 Dividend Discount Model 13.7 Cost of Capital for Divisions and Projects 13.8 Cost of Fixed Income Securities 13.9 The Weighted Average Cost of Capital 13.10 Estimating Eastman Chemical’s Cost of Capital 13.11 Flotation Costs and the Weighted Average Cost of