chapter 9 the cost of capital - kocwcontents.kocw.net/.../2014/hanyang/chunghyunchul/10.pdf ·...
TRANSCRIPT
11-1 2014_5_15
The Cost of Capital
Sources of capital
Component costs
WACC
Adjusting for flotation costs
11-2 2014_5_15
What sources of long-term capital do firms use?
Long-Term Capital
Long-Term Debt Common Stock
Retained Earnings (Internal Equity)
New Common Stock (External Equity)
11-3 2014_5_15
Calculating the weighted average cost of capital
WACC = wdkd(1-t) + wsks
The ‘w’s refer to the firm’s capital structure weights.
The ‘k’s refer to the cost of each component.
11-4 2014_5_15
Should our analysis focus on before-tax or after-tax capital costs?
Stockholders focus on A-T CFs. Therefore, we should focus on A-T capital costs, i.e. use A-T costs of capital in WACC. Only kd needs adjustment, because interest is tax deductible.
11-5 2014_5_15
How are the weights determined?
WACC = wdkd(1-t) + wsks
Use accounting numbers or market value (book vs. market weights)?
Use actual numbers or target capital structure?
11-6 2014_5_15
Component cost of debt
WACC = wdkd(1-t) + wsks
kd is the interest rate on new debt, not that on already outstanding debt; YTM
Why tax-adjust, i.e. why kd(1-t)?
Interest is tax deductible.
11-7 2014_5_15
Component cost of equity
WACC = wdkd(1-t) + wsks
ks is the cost of common equity raised by retaining earnings.
ke is the cost of common equity raised by issuing new common stock.
Increased for floatation costs
11-8 2014_5_15
Why is there a cost for retained earnings?
Earnings can be reinvested or paid out as
dividends.
If earnings are retained, there is an
opportunity cost (the return that
stockholders could earn on alternative
investments of equal risk).
11-9 2014_5_15
Three ways to determine the cost of common equity, ks
CAPM: ks = kRF + (kM – kRF) β
DCF: ks = D1 / P0 + g
Bond-Yield-Plus-Risk Premium:
ks = kd + RP
11-10 2014_5_15
If the kRF = 7%, RPM = 6%, and the firm’s beta is 1.2, what’s the cost of common equity based upon the CAPM?
ks = kRF + (kM – kRF) β
= 7.0% + (6.0%)1.2 = 14.2%
11-11 2014_5_15
If D0 = $4.19, P0 = $50, and g = 5%, what’s the cost of common equity based upon the DCF approach?
D1 = D0 (1+g)
D1 = $4.19 (1 + .05)
D1 = $4.3995
ks = D1 / P0 + g
= $4.3995 / $50 + 0.05
= 13.8%
11-12 2014_5_15
If kd = 10% and RP = 4%, what is ks using the bond-yield-plus-risk-premium method?
This RP is not the same as the CAPM RPM.
This method produces a ballpark estimate of ks, and can serve as a useful check.
ks = kd + RP
ks = 10.0% + 4.0% = 14.0%
11-13 2014_5_15
What is a reasonable final estimate of ks?
Method Estimate
CAPM 14.2%
DCF 13.8%
kd + RP 14.0%
Average 14.0%
11-14 2014_5_15
Why is the cost of retained earnings cheaper than the cost of issuing new common stock?
When a company issues new common stock they also have to pay flotation costs to the underwriter.
Flotation costs depend on the size and risk of the firm and on the type of capital being raised.
11-15 2014_5_15
If issuing new common stock incurs a flotation cost of 15% of the proceeds, what is ke?
15.4%
5.0% $42.50
$4.3995
5.0% 0.15)$50(1-
)$4.19(1.05
g f)(1-P
g)(1D k
0
0e
11-16 2014_5_15
Ignoring flotation costs, what is the firm’s WACC?
WACC = wdkd(1-t) + wsks
= 0.4(10%)(0.6) + 0.6(14%)
= 2.4% + 8.4%
= 10.8%
11-17 2014_5_15
What factors influence a company’s composite WACC?
Uncontrollable Factors (Market conditions)
Interest rates
Tax rates
Controllable Factors
The firm’s capital structure
Firm’s dividend policy
Firm’s investment policy: Firms with riskier projects generally have a higher WACC.
WACC = wdkd(1-t) + wsks
11-18 2014_5_15
Calculating a cost of capital
(예) 보통주: D0 300원 (6%로 지속성장 기대), 시장가 4,000원,
발행경비 시장가의 10%; 만기수익률(YTM): 5%; 법인세율: 40%
구분 자본구조(천원) 구성비율(%) 원천별비용(%) 가중비율
채권 30,000 30 3 0.9
보통주(신주) 40,000 40 14.83 5.93
유보이익 30,000 30 13.95 4.19
합계 100,000 100 WACC= 11.02
WACC = wdkd(1-t) + wsks + weke