WEIGHTED AVERAGE COST OF CAPITAL

σ p (%)
VALUATION CAPM
TERMINAL VALUE APPROACHES 35 Firm-Specific Risk
WACC = discount rate for DCF re = rf + ß(r m – rf)
PV of FCFF + PV of TV EBITDA MULTIPLE PERPETUITY GROWTH MRP Total Risk (σ p)

relative valuation Gordon Growth Model systematic risk vs. 20

company’s ability to BETA unsystematic risk Market Risk
generate free cash flow trading comps analysis
CF0 (1 + g) diversification
PV = market sensitivity 0
EBIT r–g 10 20 30 40 2,000+
– Cash Taxes
Business risk = ß # Stocks in Portfolio
Tax-effected EBIT (“NOPAT”) FUNDAMENTAL ANALYSIS Financial risk = ßL-ßU
+ Depreciation & Amortization & INVESTMENT BANKING ßL = ßU [1 + (1–T) (D/E)]
– Capital Expenditures
+/– ∆ Working Capital core projection and valuation model SML
securities research Return
Free Cash Flow to Firm
excess return Under-valued stock
SML
industry top down analysis
MICRO ECON the quest for alpha
bottoms up build-up rm (market)
risk / return profile rm = 15%
securities issuance market porfolio
costs and supply of goods
maximizing profits rf = 5% rf (t-bills) Over-valued stock

profit & loss curves

variable & fixed costs
WACC 0 1 2 Risk (β)

CAPITAL BUDGETING COMMERCIAL BANKING Weighted Average Cost of Capital

project / investment decisions lending / borrowing
SAVE vs SPEND
bank debt / loans
WACC = wdkd + weke + wpkp
capital allocation EFFICIENT FRONTIER TECHNICAL ANALYSIS
corporate bonds
NPV è discount rate investment grade / high yield portfolio mgmt & optimization trading rules, trend analysis
IRR vs. WACC (hurdle rate) credit analysis / spread investor policy statement inefficient markets (EMH)
firm vs. company specific WACC PREFERRED STOCK
Return % Portfolio Including
hybrid security, equity kicker Alternatives Resistance Level
100% Stocks
MERGERS & ACQUISITIONS CAPITAL STRUCTURE
warrants & convertibles
build vs. buy decisions private equity
Total Enterprise Value Conventional Stock /
corporate finance advisory venture capital Bond Portfolio
– Net Debt
strategic alternatives Equity Value weights Support Level
restructuring / distressed ÷ Shares Outstanding 100% Bonds
for WACC
Price per Share
Risk (Standard Deviation)
WACC SENSITIVITY => IMPLICATIONS ON BETA, CAPITAL STRUCTURE & VALUE
D/E ßL re = ke we wd WACC VALUE PRICE GLOBAL ECON MACRO ECON ARBITRAGE PRICING THEORY
0.0% 1.00 12.5% 100.0% 0.0% 12.5% $ 2,100 $ 42.00
25.0% 1.15 13.6% 80.0% 20.0% 11.9% 2,296 36.52 foreign exchange & BOP supply & demand multi-factor model & econometrics
50.0% 1.30 14.8% 66.7% 33.3% 11.4% 2,448 32.31 FX currency markets G = C + I + G + (X-M) GDP growth
75.0% 1.45 15.9% 57.1% 42.9% 11.1% 2,570 28.97 purchasing power parity supply side economics interest rates
interest rate parity business cycle inflation
100.0% 1.60 17.0% 50.0% 50.0% 10.9% 2,669 26.25
Fisher effect unemployment
rf = 5.0%, kd = 8.0%, rm - rf = 7.5%, ßU = 1.00, T = 40.0%, g = 5.0%, FCFF = $150, DPS = $3.00 y = ß1x1 + ß2x2 +. . . + ßnxn + b
money supply
ßL = ßU [1 + (1-T) (D/E)] Value = FCFF * (1+g) / (WACC-g) Price = DPS * (1+g) / (ke-g) => useless

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