Kevin Campbell, University of Stirling, November 2005 11
2008
KOSZT I STRUKTURA KAPITAŁU
Kevin Campbell, University of Stirling, November 2005 22
Cost of Capital Cost of Capital - The return the firm’s
investors could expect to earn if they invested in securities with comparable degrees of risk
Capital Structure - The firm’s mix of long term financing and equity financing
Kevin Campbell, University of Stirling, November 2005 33
Cost of Capital The cost of capital represents the overall cost of
financing to the firm The cost of capital is normally the relevant
discount rate to use in analyzing an investment The overall cost of capital is a weighted average of
the various sources:• WACC = Weighted Average Cost of
Capital• WACC = After-tax cost x weights
Kevin Campbell, University of Stirling, November 2005 44
Cost of Debt The cost of debt to the firm is the effective yield to
maturity (or interest rate) paid to its bondholders Since interest is tax deductible to the firm, the
actual cost of debt is less than the yield to maturity:• After-tax cost of debt = yield x (1 - tax rate)
The cost of debt should also be adjusted for flotation costs (associated with issuing new bonds)
Kevin Campbell, University of Stirling, November 2005 55
with stock with debtEBIT 400,000 400,000- interest expense 0 (50,000)EBT 400,000 350,000- taxes (34%) (136,000) (119,000)EAT 264,000 231,000
Example: Tax effects of Example: Tax effects of financing with debtfinancing with debt
Now, suppose the firm pays $50,000 in dividends to the shareholders
Kevin Campbell, University of Stirling, November 2005 66
with stock with debtEBIT 400,000 400,000- interest expense 0 (50,000)EBT 400,000 350,000- taxes (34%) (136,000) (119,000)EAT 264,000 231,000- dividends (50,000) 0Retained earnings 214,000 231,000
Example: Tax effects of Example: Tax effects of financing with debtfinancing with debt
Kevin Campbell, University of Stirling, November 2005 77
After-tax cost Before-tax cost Tax of Debt of Debt Savings
33,000 = 50,000 - 17,000 OR 33,000 = 50,000 ( 1 - .34)
Or, if we want to look at percentage costs:
-=
Cost of Debt
Kevin Campbell, University of Stirling, November 2005 88
After-tax Before-tax Marginal % cost of % cost of x tax Debt Debt rate
Kd = kd (1 - T)
.066 = .10 (1 - .34)
-= 11
Cost of Debt
Kevin Campbell, University of Stirling, November 2005 99
Prescott Corporation issues a $1,000 par, 20 year bond paying the market rate of 10%. Coupons are annual. The bond will sell for par since it pays the market rate, but flotation costs amount to $50 per bond.
What is the pre-tax and after-tax cost of debt for Prescott Corporation?
EXAMPLE: Cost of Debt
Kevin Campbell, University of Stirling, November 2005 1010
Pre-tax cost of debt:950 = 100(PVIFA 20, Kd) + 1000(PVIF 20, Kd)
using a financial calculator: Kd = 10.61%After-tax cost of debt: Kd = Kd (1 - T) Kd = .1061 (1 - .34) Kd = .07 = 7%
EXAMPLE: Cost of Debt
So a 10% bond costs the firm only 7% (with flotation costs) because interestis tax deductible
Kevin Campbell, University of Stirling, November 2005 1111
Cost of New Preferred Stock
Preferred stock:• has a fixed dividend (similar to debt)• has no maturity date• dividends are not tax deductible and are
expected to be perpetual or infinite Cost of preferred stock = dividend
price - flotation cost
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Cost of Preferred stock: Example
Baker Corporation has preferred stock that sells for $100 per share and pays an annual dividend of $10.50. If the flotation costs are $4 per share, what is the cost of new preferred stock?
10.94% .1094 4 - $100
$10.50 KP
Kevin Campbell, University of Stirling, November 2005 1313
Cost of Equity: Retained Earnings Why is there a cost for retained earnings? Earnings can be reinvested or paid out as
dividends Investors could buy other securities, and
earn a return. Thus, there is an opportunity cost if
earnings are retained
Kevin Campbell, University of Stirling, November 2005 1414
Cost of Equity: Retained Earnings Common stock equity is available through
retained earnings (R/E) or by issuing new common stock:• Common equity = R/E + New common stock
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Cost of Equity: New Common Stock
The cost of new common stock is higher than the cost of retained earnings because of flotation costs• selling and distribution costs (such as
sales commissions) for the new securities
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Cost of Equity There are a number of methods used to
determine the cost of equity We will focus on two
Dividend growth Model CAPM
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The Dividend Growth Model Approach
Estimating the cost of equity: the dividend growth model approachAccording to the constant growth (Gordon) model, D1 P0 = RE - g
Rearranging D1
RE = + g P0
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Example: Estimating the Dividend Growth Rate
PercentageYear Dividend Dollar Change Change
1990 $4.00 --
1991 4.40 $0.40 10.00%
1992 4.75 0.35 7.95
1993 5.25 0.50 10.53
1994 5.65 0.40 7.62
Average Growth Rate(10.00 + 7.95 + 10.53 + 7.62)/4 = 9.025%
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Dividend Growth Model
This model has drawbacks:
Some firms concentrate on growth and do not pay dividends at all, or only irregularly
Growth rates may also be hard to estimate Also this model doesn’t adjust for market risk
Therefore many financial managers prefer the capital asset pricing model (CAPM) - or security market line (SML) - approach for estimating the cost of equity
Kevin Campbell, University of Stirling, November 2005 2020
Capital Asset Pricing Model (CAPM)
)( fmf RRβRkj
Cost ofcapital Risk-free
return
Average rate of returnon common stocks
(WIG)
Co-varianceof returns against
the portfolio(departure from the average)
B < 1, security is safer than WIG averageB > 1, security is riskier than WIG average
Kevin Campbell, University of Stirling, November 2005 2121
The Security Market Line (SML)
Required rate of return Percent
0.5 1.0 1.5 2.0
SML = Rf + (Km – Rf)
Beta (risk)
Market risk premium
20.0
18.0
16.0
14.0
12.0
10.0
8.0
5.5Rf
Kevin Campbell, University of Stirling, November 2005 2222
Finding the Required Return on Common Stock using the Capital Asset Pricing ModelThe Capital Asset Pricing Model (CAPM) can be used to estimate the required return on individual stocks. The formula:
RK R K fmjfj where jK = Required return on stock j fR = Risk-free rate of return (usually current rate on Treasury Bill). j = Beta coefficient for stock j represents risk of the stock mK = Return in market as measured by some proxy portfolio (index) Suppose that Baker has the following values:
fR = 5.5% j = 1.0 mK = 12%
.
Kevin Campbell, University of Stirling, November 2005 2323
Finding the Required Return on Common Stock using the Capital Asset Pricing Model
Then, using the CAPM we would get a required return of
12% 5.5-12 1.0 5.5 K j
.
Kevin Campbell, University of Stirling, November 2005 2424
CAPM/SML approach Advantage: Evaluates risk, applicable
to firms that don’t pay dividends
Disadvantage: Need to estimate• Beta• the risk premium (usually based on past data,
not future projections)• use an appropriate risk free rate of interest
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Estimation of Beta: Measuring Market Risk Market Portfolio - Portfolio of all assets in
the economy In practice a broad stock market index,
such as the WIG, is used to represent the market
Beta - sensitivity of a stock’s return to the return on the market portfolio
Kevin Campbell, University of Stirling, November 2005 2626
Estimation of Beta Theoretically, the calculation of beta is
straightforward: Problems
1.Betas may vary over time.2.The sample size may be inadequate.3.Betas are influenced by changing financial leverage and business risk.
Solutions• Problems 1 and 2 (above) can be moderated by more sophisticated statistical
techniques.• Problem 3 can be lessened by adjusting for changes in business and financial
risk.• Look at average beta estimates of comparable firms in the industry.
2)(),(
M
iM
M
Mi
σσ
RVarRRCovβ
Kevin Campbell, University of Stirling, November 2005 2727
Stability of Beta Most analysts argue that betas are generally
stable for firms remaining in the same industry That’s not to say that a firm’s beta can’t
change• Changes in product line• Changes in technology• Deregulation• Changes in financial leverage
Kevin Campbell, University of Stirling, November 2005 2828
What is the appropriate risk-free rate? Use the yield on a long-term bond if you are
analyzing cash flows from a long-term investment
For short-term investments, it is entirely appropriate to use the yield on short-term government securities
Use the nominal risk-free rate if you discount nominal cash flows and real risk-free rate if you discount real cash flows
Kevin Campbell, University of Stirling, November 2005 2929
Survey evidence: What do you use for the risk-free rate?
Corporations Financial Advisors90-day T-bill (4%) 90-day T-bill (10%)
3-7 year Treasuries (7%) 5-10 year Treasuries (10%)10-year Treasuries (33%) 10-30 year Treasuries (30%)20-year Treasuries (4%) 30-year Treasuries (40%)
10-30 year Treasuries (33%) N/A (10%)10-years or 90-day; depends
(4%)N/A (15%) Source: Bruner et. al. (1998)
Kevin Campbell, University of Stirling, November 2005 3030
Weighted Average Cost of Capital (WACC) WACC weights the cost of equity and the cost
of debt by the percentage of each used in a firm’s capital structure
WACC=(E/ V) x RE + (D/ V) x RD x (1-TC)• (E/V)= Equity % of total value• (D/V)=Debt % of total value• (1-Tc)=After-tax % or reciprocal of corp tax rate Tc.
The after-tax rate must be considered because interest on corporate debt is deductible
Kevin Campbell, University of Stirling, November 2005 3131
WACC IllustrationABC Corp has 1.4 million shares common valued at $20 per share =$28 million. Debt has face value of $5 million and trades at 93% of face ($4.65 million) in the market. Total market value of both equity + debt thus =$32.65 million. Equity % = .8576 and Debt % = .1424
Risk free rate is 4%, risk premium=7% and ABC’s β=.74
Return on equity per SML : RE = 4% + (7% x .74)=9.18%
Tax rate is 40%
Current yield on market debt is 11%
Kevin Campbell, University of Stirling, November 2005 3232
WACC IllustrationWACC = (E/V) x RE + (D/V) x RD x (1-Tc)
= .8576 x .0918 + (.1424 x .11 x .60)
= .088126 or 8.81%
Kevin Campbell, University of Stirling, November 2005 3333
Final notes on WACC WACC should be based on market rates and
valuation, not on book values of debt or equity Book values may not reflect the current
marketplace WACC will reflect what a firm needs to earn on
a new investment. But the new investment should also reflect a risk level similar to the firm’s Beta used to calculate the firm’s RE. • In the case of ABC Co., the relatively low WACC of
8.81% reflects ABC’s β=.74. A riskier investment should reflect a higher interest rate.
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Final notes on WACC The WACC is not constant It changes in accordance with the risk of
the company and with the floatation costs of new capital
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Marginal cost of capital and investment projects16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Percent
10 15 19 5039Amount of capital ($ millions)
11.23%
70 85 95
Marginal cost of capital
Kmc
A
BC
D EF
GH
10.77%
10.41%
---------
Kevin Campbell, University of Stirling, November 2005 3636
The End …. KAPITAŁ - bogactwo zebrane uprzednio w celu podjęcia dalszej produkcji (F. Quesnay, XVIII) wszelki wynik procesu produkcyjnego, który przeznaczony jest do późniejszego
wykorzystania w procesie produkcyjnym (MCKenzzie, Nardelli,1991) całokształt zaangażowanych w przedsiębiorstwie wewnętrznych i
zewnętrznych, własnych i obcych, terminowych i nieterminowych zasobów (bilans)
STRUKTURA KAPITAŁU proporcja udziału kapitału własnego i obcego w finansowaniu działalności
przedsiębiorstwa relacja wartości zadłużenia długoterminowego do kapitałów własnych
przedsiębiorstwa struktura finansowania – struktura kapitału = zobowiązania bieżące ramy statycznego kompromisu, w którym przedsiębiorstwo ustala docelową
wielkość wskaźnika zadłużenia i stopniowo zbliża się do jego osiągnięcia.