[专业课]【西南财大课件金融经济学】lecture3-costofcapital.pptVIP

Cost of Capitaland Investment decisions 18 September 2005 WACC WACC Under the assumptions of MM, If the company undertakes a new investment project with same risk as the rest of the company, the change in value is: WACC The new investment is financed with debt or equity or both The change in value can also be seen from the liability side: WACC If DBo = 0, and using the fact that DI = DSn +DBn The project adds value for the shareholders if WACC Using (**) in (*): If we assume that there is a target capital structure and therefore that DB/DI = D/(D+E), the term is the WACC Derivation: WACC – lessons Notice that the standard WACC is a by product of MM, and therefore is relies on the same assumptions Notice also there is something intrinsically contradictory in the way it is often applied: You start assuming a constant debt level Then you assume a target debt ratio When the debt ratio is assumed constant, the WACC formula ought to be different Miles-Ezzel WACC: dynamic debt If we assume the debt ratio is constant, the WACC formula is And the formula for relevering betas is Cost of equity: CAPM The discount rate for risky investments (expected return) covers: The time value of money A risk premium E(ri) = rf +bi(E(rm) - rf) This is the most used method to calculate costs of equity Alternative: APT (see book for details if interested) Alternative: Dividend Growth Model Gordon’s growth model: Thus: Applying it: Need dividend yield and growth rate: use analysts’ forecasts use the plowback ratio formula: g = b x ROE, where b is the retention ratio Note: this ‘g’ is the so-called ‘sustainable growth rate’ Pitfalls The d-growth model makes a number of assumptions: constant growth rate constant dividend yield The validity of the model depends on the validity of these assumptions Cost of Debt The rate of return that debt-holders demand to hold the debt Remember: it is the expected return and not the promised one For high-rated bonds, promis