Beruflich Dokumente
Kultur Dokumente
of Capital
Learning Goals
Sources of capital
Cost of each type of funding
Calculation of the weighted average cost of capital
(WACC)
Construction and use of the marginal cost of capital
schedule (MCC)
Market Conditions
Affect risk premiums
Operating Decisions
Affect business risk
Financial Decisions
Affect financial risk
Amount of Financing
Affect flotation costs and market price of security
3
Dividend (Dp)
Market Price (PP) - F
$5.00
$42.00
11.90%
6
kS =
D1
+ g
P0
D1
+ g
P0
Example:
The market price of a share of common stock is
$60. The dividend just paid is $3, and the expected
growth rate is 10%.
10
D1
+ g
P0
Example:
The market price of a share of common stock is $60.
The dividend just paid is $3, and the expected growth
rate is 10%.
kS = 3(1+0.10) + .10
60
=.155 = 15.5%
11
12
13
kS = 5% + 1.2(13% 5%)
= 14.6%
14
kn =
D1
+ g
P0 - F
15
Example:
If additional shares are issued floatation costs
will be 12%. D0 = $3.00 and estimated growth
is 10%, Price is $60 as before.
16
Example:
If additional shares are issued floatation costs will
be 12%. D0 = $3.00 and estimated growth is 10%,
Price is $60 as before.
17
Cost
Bonds
kd = 10%
Preferred Stock
kp = 11.9%
Common Stock
Retained Earnings ks = 15%
New Shares
kn = 16.25%
Gallaghers tax rate is 40%
18
19
20
21
22
23
24
25
27
11.72%
11%
11.09%
10%
Using internal
common equity
9%
0
100,000
Using new
common equity
200,000
Total Financing
300,000
400,000
28
11%
Project 1
MIRR =
12.4%
10%
Project 2
MIRR =
12.1%
Project 3
MIRR =
11.5%
9%
0
100,000
200,000
Total Financing
300,000
400,000
29
11.72%
12%
11.09%
11%
Project 1
IRR =
12.4%
10%
Project 2
IRR =
12.1%
Project 3
IRR =
11.5%
9%
0
100,000
200,000
Total Financing
300,000
400,000
30
12%
11.09%
11%
Project 1
IRR = 12.4% Project 2
IRR = 12.1%
10%
Project 3
IRR = 11.5%
9%
0
100,000
200,000
Total Financing
300,000
400,000
31
= $25,000
= 15,000
= 10,000
32
Your firm is in the 30% tax bracket with a before-tax required rate of return on its
equity of 13% and on its debt of 10%. If the firm uses 60% equity and 40% debt
financing, calculate its after-tax WACC.
Would a firm use WACC or MCC to identify which new capital budgeting projects
should be selected? Why?
A firm's before tax cost of debt on any new issue is 9%; the cost to issue new
preferred stock is 8%. This appears to conflict with the risk/return relationship.
How can this pricing exist?
What determines whether to use the dividend growth model approach or the CAPM
approach to calculate the cost of equity?
33
Capital Budgeting
Decision Methods
Learning Objectives
The capital budgeting process.
Calculation of payback, NPV, IRR, and MIRR for
proposed projects.
Capital rationing.
Measurement of risk in capital budgeting and
how to deal with it.
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
5
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
6
(10,000)
3,500
Cumulative CF -6,500
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
3,500
-3,000
3,500
+500
3,500
7
(10,000)
3,500
Cumulative CF -6,500
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
Payback in
2.9 years
3,500
-3,000
3,500
+500
3,500
8
(10,000)
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
500
500
4,600
10,000
(10,000)
500
Cumulative CF -9,500
A
(10,000.)
3,500
3,500
3,500
3,500
500
-9,000
B
(10,000.)
500
500
4,600
10,000
4,600
-4,400
Payback in
3.4 years
4
10,000
+5,600
10
NPV =
CF1
(1+ k)1
CF2
(1+ k)2
+ .
CFn
n Initial
(1+ k )
Investment
13
(10,000)
P R O J E C T
Time
0
1
2
3
4
500
500
A
(10,000)
3,500
3,500
3,500
3,500
B
(10,000)
500
500
4,600
10,000
4,600
10,000
14
What is the
NPV for
Project B?
Time
0
1
2
3
4
k=10%
0
(10,000)
500
500
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
455
$500
(1.10)1
15
What is the
NPV for
Project B?
Time
0
1
2
3
4
k=10%
0
(10,000)
455
413
500
500
$500
(1.10) 2
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
16
What is the
NPV for
Project B?
k=10%
0
(10,000)
455
413
3,456
500
500
$500
(1.10) 2
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
$4,600
(1.10) 3
17
What is the
NPV for
Project B?
k=10%
0
(10,000)
455
413
3,456
6,830
500
500
$500
(1.10) 2
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
$4,600
(1.10) 3
$10,000
(1.10) 4
18
What is the
NPV for
Project B?
k=10%
0
(10,000)
500
500
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
455
413
3,456
6,830
$11,154
19
P R O J E C T
What is the
NPV for
Project B?
k=10%
0
(10,000)
Time
0
1
2
3
4
500
500
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
455
413
3,456
6,830
$11,154
P R O J E C T
What is the
NPV for
Project B?
k=10%
0
(10,000)
Time
0
1
2
3
4
500
500
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
4,600
10,000
455
413
3,456
6,830
NPV > $0
$1,154 > $0
21
Financial Calculator:
Additional Keys used to enter
Cash Flows and compute the
Net Present Value (NPV)
22
Financial Calculator:
Additional Keys used to
enter Cash Flows and
compute the Net
Present Value (NPV)
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
Financial Calculator:
Additional Keys used to
enter Cash Flows and
compute the Net Present
Value (NPV)
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
Financial Calculator:
Additional Keys used
to enter Cash Flows
and compute the Net
Present Value (NPV)
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
25
P R O J E C T
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
Time
0
1
2
3
4
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
26
CF0 =
-10,000
+/- ENTER
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
27
C01 =
500
500
ENTER
CF
NPV
IRR
I/Y
PV
PMT
CF 10000
+/- ENTER
FV
28
F01 =
2
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
+/- ENTER
500
ENTER
ENTER
4600
P/YR
CF
NPV
IRR
I/Y
PV
PMT
CF 10000
+/- ENTER
500
ENTER
ENTER
4600
ENTER
FV
30
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
CF 10000
+/- ENTER
500
ENTER
ENTER
4600
1
ENTER
ENTER
31
10000
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
CF 10000
+/- ENTER
500
ENTER
ENTER
4600
ENTER
ENTER
10000
ENTER
32
1
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
CF 10000
+/- ENTER
500
ENTER
ENTER
4600
ENTER
ENTER
10000
ENTER
33
ENTER
I =
10
NPV
10
ENTER
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
k = 10%
34
NPV =
1,153.95
10
ENTER
P/YR
CF
NPV
IRR
I/Y
PV
PMT
CPT
FV
>0
Accept
>0
Accept
NPV
=
$1,154
B
If projects are independent, accept both projects.
If projects are mutually exclusive, accept the project
with the higher NPV.
36
37
P R O J E C T
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
Time
0
1
2
3
4
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
39
P R O J E C T
IRR =
13.5%
P/YR
CF
NPV
IRR
I/Y
PV
PMT
Time
0
1
2
3
4
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
FV
CPT
40
Example:
k = 10%
IRRA = 14.96%
IRRB = 13.50%
> 10%
> 10%
Accept
Accept
41
TV
inflows
PVoutflow =
n
(1 + MIRR)
Assumes cash inflows are reinvested at k, the safe reinvestment rate.
MIRR avoids the problem of multiple IRRs.
We accept if MIRR > the required rate of return.
42
P R O J E C T
What is the
MIRR for
Project B?
Time
0
1
2
3
4
A
(10,000.)
3,500
3,500
3,500
3,500
B
(10,000.)
500
500
4,600
10,000
Safe =2%
0
(10,000)
500
500
4,600
(10,000)/(1.02)0
500(1.02)3
500(1.02)2
4,600(1.02)1
10,000
10,000(1.02)0
10,000
4,692
520
531
(10,000)
10,000 =
15,743
(1 + MIRR)4
15,743 43
MIRR = .12 = 12%
CF
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
+/- ENTER
500
ENTER
ENTER
4600
ENTER
ENTER
10000
ENTER
ENTER
44
14,544
NPV
IRR
I/Y
PV
PMT
ENTER
CPT
P/YR
CF
NPV
FV
Calculator Enter:
N
= 4
I/YR = 2
PV = -14544
PMT = 0
CPT FV = ?
FV =
15,743
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
46
Calculator Enter:
N
= 4
PV = -10000
PMT = 0
FV = 15,743
CPT I/YR = ??
MIRR
12.01
P/YR
CF
NPV
IRR
I/Y
PV
PMT
FV
47
55
56
= .05971, or 5.971%
57
CV with Y
30.48%
Change in CV
-2.85
60
Non-simple Projects
Non-simple projects have one or
more negative future cash flows
after the initial investment.
62
Non-simple projects
How would a negative cash flow in year 4
affect Project Zs NPV?
k=10%
0
(10,000)
5,000
5,000
5,000
-6,000
4,545
4,132
3,757
-4,098
8,336 - $10,000 = -$1,664 NPV
63
68
70
4,424
4,424
4,424
4,424
3,324
2,497
1,876
12,121
71
72
73
ECP Homework
1. The following net cash flows are projected for two separate projects. Your required rate
of return is 12%.
Year
0
1
2
3
4
5
6
a.
b.
c.
d.
Project A
($150,000)
$30,000
$30,000
$30,000
$30,000
$30,000
$30,000
Project B
($400,000)
$100,000
$100,000
$100,000
$100,000
$100,000
$100,000
ECP Homework
2. What is meant by risk adjusted discount rates?
3. Explain why the NPV method of capital budgeting is preferable over the payback method.
4. A firm has a net present value of zero. Should the project be rejected? Explain.
5. You have estimated the MIRR for a new project with the following probabilities:
Possible MIRR Value
4%
7%
10%
11%
14%
Probability
5%
15%
15%
50%
15%
Business
Valuation
98
Learning Objectives
Understand the importance of business valuation.
Understand the importance of stock and bond
valuation.
Learn to compute the value and yield to maturity of
bonds.
Learn to compute the value and expected yield on
preferred stock and common stock.
Learn to compute the value of a complete business.
99
101
102
Bonds
Cur
Yld
Vol
Close
Net
Chg
AMR 624
ATT 8.35s25
IBM 633/8 05
IBM 6 /8 09
cv
6
8.3 110
6.6 228
6.6 228
91 -1
102 +
9655/8 -1/18
96 /8 - /8
Kroger 9s99
8.8
1017/8 -
74
104
Cur
Yld
Vol
Close
Net
Chg
AMR 624
ATT 8.35s25
IBM 633/8 05
IBM 6 /8 09
cv
6
8.3 110
6.6 228
6.6 228
91 -1
102 +
9655/8 -1/18
96 /8 - /8
Kroger 9s99
8.8
1017/8 -
74
Bonds
AMR 624
ATT 8.35s25
IBM 633/8 05
IBM 6 /8 09
Vol
cv
6
8.3 110
6.6 228
6.6 228
Close
Net
Chg
91 -1
102 +
9655/8 -1/18
96 /8 - /8
Kroger 9s99
8.8
74 1017/8 -
Suppose IBM makes annual coupon payments. The person
who buys the bond at the beginning of 2005 for $966.25 will
receive 5 annual coupon payments of $63.75 each and a
$1,000 principal payment in 5 years (at the end of 2009).
2005
0
2006
1
63.75
2007
2
63.75
2008
3
63.75
2009
4
63.75
63.75
1000.00
106
2006
1
63.75
2007
2
63.75
2008
3
63.75
2009
4
63.75
63.75
1000.00
Compute the Value for the IBM Bond given that you require an
8% return on your investment.
107
2006
1
63.75
2007
2
63.75
2008
3
63.75
2009
4
63.75
63.75
1000.00
108
2006
1
63.75
2007
2
63.75
2008
3
63.75
2009
4
63.75
63.75
1000.00
2006
1
2007
2
63.75
63.75
2008
3
63.75
2009
4
63.75
63.75
1000.00
I/YR
PV
PMT
FV
.01 rounding
difference
? 63.75 1,000
110
2005
0
2006
1
45
45
2007
2
45
45
2008
3
45
45
2009
4
45
45
45
45
1000
111
45
2005
2006
2007
45
45
45
45
45
2008
2009
45
45
45
45
1000
10%
2
112
45
2005
2006
2007
45
45
45
45
45
2008
2009
45
45
45
45
1000
Calculator Solution:
0
45
2005
2006
2007
45
45
45
45
45
45
2008
2009
45
45
45
1000
961.38
10
I/YR
PV
PMT
FV
45 1,000
114
Yield to Maturity
If an investor purchases a 6.375% annual coupon
bond today for $966.25 and holds it until maturity
(5 years), what is the expected annual rate of
return ?
0
-966.25
??
+ ??
2005
2006
2007
63.75
63.75
63.75
2008
2009
63.75
63.75
1000.00
966.25
115
Yield to Maturity
If an investor purchases a 6.375% annual coupon
bond today for $966.25 and holds it until maturity
(5 years), what is the expected annual rate of
return ?
0
-966.25
??
+ ??
966.25
2005
2006
2007
63.75
63.75
63.75
2008
2009
63.75
63.75
1000.00
Yield to Maturity
2005
0
-966.25
2006
63.75
2007
2008
2009
63.75
63.75
Calculator Solution:
63.75
63.75
1000.00
7.203%
N
I/YR
PV
PMT
FV
Yield to Maturity
2005
0
-966.25
63.75
2006
2
63.75
2007
2008
2009
63.75
63.75
63.75
1000.00
118
VB
119
VB
VB
120
PE
Vol
100s
5067
6263
35 34 34 -
29 285/8 287/8 -
2377//8820 RJR
9.7 9.7
...
20 Nab
RJRpfB
Nab pfB 2.312.31
23 ...
966
...
24
966 23
245/8 23
235/8 ...
Sym Div
s 42 29 QuakerOats
s 36 25 RJR Nabisco
P0=23.75
D1=2.31
.60
Yld
%
9.4
...
D2=2.31
2248
Hi
Net
Close Chg
Lo
6 6
D3=2.31
63/8 -
D=2.31
PE
Vol
100s
5067
6263
35 34 34 -
29 285/8 287/8 -
2377//8820 RJR
9.7 9.7
...
20 Nab
RJRpfB
Nab pfB 2.312.31
23 ...
966
...
24
966 23
245/8 23
235/8 ...
Sym Div
s 42 29 QuakerOats
s 36 25 RJR Nabisco
.60
P0=23.75
P0 =
9.4
...
2248
D1=2.31
2.31
(1+ kp)
Yld
%
D2=2.31
2.31
(1+ kp)2
Hi
Net
Close Chg
Lo
6 6
63/8
D3=2.31
2.31
(1+ kp)3
D=2.31
122
PE
Vol
100s
5067
6263
35 34 34 -
29 285/8 287/8 -
2377//8820 RJR
9.7 9.7
...
20 Nab
RJRpfB
Nab pfB 2.312.31
23 ...
966
...
24
966 23
245/8 23
235/8 ...
Sym Div
s 42 29 QuakerOats
s 36 25 RJR Nabisco
.60
P0=23.75
P0 =
9.4
...
2248
D1=2.31
+
Dp
kp
2.31
(1+ kp )2
Hi
Net
Close Chg
Lo
6 6
63/8
D2=2.31
2.31
(1+ kp)
P0 =
Yld
%
D3=2.31
2.31
(1+ kp )3
+
2.31
.10
D=2.31
$23.10
123
P0
P0 =
D1
D2
D3
D1
(1+ ks )
D2
(1+ ks )2
D3
(1+ ks )3
124
P0
P0 =
D1
D2
D3
D1
(1+ ks )
D2
(1+ ks )2
D3
(1+ ks )3
125
D0
126
D0
P0 =
+
D0 (1+ g)2
(1+ ks )2
D0 (1+ g)3
(1+ ks )3
Reduces to:
P0 =
D0(1+g)
ks g
D1
ks g
Requires ks
>g
127
P0 =
P0 =
D0(1+g)
ks g
1.14(1+.07)
.11 .07
D1
ks g
=
= $30.50
128
130
ECP Homework
1. Indicate which of the following bonds seems to be reported incorrectly with respect to discount, premium,
or par and explain why.
Bond
A
B
C
D
Price
105
100
101
102
Coupon Rate
9%
6%
5%
0%
Yield to Maturity
8%
6%
4.5%
5%
2. What is the price of a ten-year $1,000 par-value bond with a 9% annual coupon rate and a 10% annual
yield to maturity assuming semi-annual coupon payments?
3. You have an issue of preferred stock that is paying a $3 annual dividend. A fair rate of return on this
investment is calculated to be 13.5%. What is the value of this preferred stock issue?
4. Total assets of a firm are $1,000,000 and the total liabilities are $400,000. 500,000 shares of common
stock have been issued and 250,000 shares are outstanding. The market price of the stock is $15 and net
income for the past year was $150,000.
a.. Calculate the book value of the firm.
b. Calculate the book value per share.
c. Calculate the P/E ratio.
5. A firms common stock is currently selling for $12.50 per share. The required rate of return is 9% and the
company will pay an annual dividend of $.50 per share one year from now which will grow at a constant rate
for the next several years. What is the growth rate?
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