Professional Documents
Culture Documents
Topics
Debt
Preferred
Common Equity
WACC
Composite
Risk Adjustments
WACC with Flotation Costs
2
rd
rs
rps
rce
re
3
10-3
WACC
Weighted Average Cost of Capital
Weights
Component
costs
Capital Components
Cost of Debt
Calculator Solution
A 22-year, 9%
44
semiannual coupon
835.42
bond sells for
45
1000
$835.42
= 5.50%
Bond pays a
semiannual coupon:
rd = 5.5% x 2 = 11%
rd AT
= rd BT(1 - T)
rd AT
t
N
[
1
r
(
1
T
)]
[
1
r
(
1
T
)]
t 1
d
d
N
(10 - 2)
Where:
M = Bonds par value (face value)
F = Flotation cost as a %
N = Number of coupon payments
T = Corporate tax rate
INT = Dollars of interest per period
rd(1-T) = after tax cost of debt adjusted for inflation
10
Flotation cost = 1%
N = 60
PV = -1000(1-.01) = -990
Calculator Solution
60
990
33
1000
= 3.34%
Preferred Stock
No tax adjustment
Use rps
r ps
$10
Dividend
D
ps
Pps ( 1 F )
F=
(10 - 3)
Where:
Dps = Preferred dividend
PPS = Preferred stock price
F = Flotation cost %
r ps
$10
10.3%
$100 ( 1 .025 )
13
Indirectly
15
16
rs
2. DCF:
rs
= D1/P0 + g
3. Own-Bond-Yield-Plus-Risk Premium:
rs
= rd + Bond RP
18
rs = D1/P0 + g
3. Own-Bond-Yield-Plus-Risk Premium:
rs = rd + Bond RP
19
3.
4.
Estimating rRF
Estimating RPM or RM
Ex Ante = Forward-Looking
Expected Return
rM
If market
Value Line
or Reuters
D1
22
RPM Estimate #1
RPM = 11.73%
rM Estimate
Forward-looking RPM:
Problems:
Past = future?
Growth rates sensitive to period
measured
23
RPM Estimate #2
RPM = 17.79%
rM Estimate
Forward-looking RPM:
(Spring 2008)
Reuters S&P500 dividend yield = 2.61%
Yahoo Earnings growth rate = 19.1%
rM=[0.0261(1+.191)]+0.191=22.21%
22.21% - 4.42% = 17.79%
rM
D0 ( 1 g )
g
P0
Problems:
24
RM
RPM=RM- rRF
Brigham-Daves RPM = [3.5, 6.5]
25
Estimating Beta -
Historical Beta
Multinational issues
26
RPM = 6%
= 1.1
rs = D1/P0 + g
3. Own-Bond-Yield-Plus-Risk Premium:
rs = rd + Bond RP
28
D1
rs g
(10 - 5)
D1
rs r s
expected g
Po
1.
2.
3.
30
Earnings Retention
Model
NCC Data:
ROE = 14.5%
Dividend payout ratio = 52%
Retention rate = 100% - 52% = 48%
31
Earnings Retention
Assumptions
1.
2.
3.
4.
g = 6.9%
33
D1
P0
P0 = $32
+g=
$2.40
D0(1+g)
P0
g = 7%
+g
+ 0.07
$32
= 0.075 + 0.07
= 14.5%
34
rs = D1/P0 + g
3. Own-Bond-Yield-Plus-Risk Premium:
rs = rd + Bond RP
35
rs = rd + RP
Useful check
36
Final Estimate of rs
Method
CAPM
Estimat Used by
e
14.6%
74% - 85%
DCF
14.5%
16%
rd + RP
14.7%
Non-public
Average
14.6%
37
NCC: D1 = $2.40
P0 = $32
(10 - 9)
F = 12.5%
$2.40
re re
.07 15.6%
$32 ( 1 .125 )
38
Topics
Debt
Preferred
Common Equity
WACC
Composite
Risk Adjusted
WACC with Flotation Costs
39
WACC
Weighted Average Cost of Capital
Weights
Component
costs
40
WACC Weights
41
NCCs WACC
Weighted Average Cost of
Capital
Component
Debt (before
tax)
Preferred Stock
Common equity
w
r
0.30 11.0%
0.10 10.3%
0.60 14.6%
42
43
Estimating Weights
Given:
The stock price is $50
There are 3 million shares of
stock
$25 million of preferred stock
$75 million of debt
45
Estimating Weights
Vd = $75 million
Estimating Weights
47
WACC
48
Market conditions
Interest rates
The market risk premium
Tax rates
49
Topics
Debt
Preferred
Common Equity
WACC
Composite
Risk Adjusted
WACC with Flotation Costs
50
Risk-Adjusted WACC
Acceptance Region
WACC
WACC H
Acceptance Region
Rejection Region
WACC F
Rejection Region
WACC L
Risk L
Risk H
Risk
52
53
The Risk-Adjusted
Divisional Cost of Capital
55
56
Subjective Approach
57
Discount Rate
WACC 8%
7%
Low Risk
WACC 3%
WACC
High Risk
Very High Risk
WACC + 5%
WACC + 10%
12%
15%
20%
25%
58
Topics
Debt
Preferred
Common Equity
WACC
Composite
Risk Adjusted
WACC with Flotation Costs
59
Flotation Costs
NCCs WACC
With New Debt
Component
w
New Debt (afterd 0.30
tax)
Preferred Stock
ps 0.10
New Common
c
0.60
WACC = wdrATd + wpsrps + wcre
equity
r
6.68%
10.3%
14.6%
61
NCCs WACC
With New Debt & New Equity
Component
w
New Debt (afterd 0.30
tax)
Preferred Stock
ps 0.10
New Common
c
0.60
WACC = wdrATd + wpsrps + wcre
equity
r
6.68%
10.3%
15.6%
62
NCCs WACC
WACC Description
No New Issues
With New Debt
With New Debt & New
Equity
WACC
11.770
%
11.794
%
12.394
%
63
64
WACC2 = 12.394%
13
12
WACC1 = 11.77%
External debt
& equity
10
9
No external funds
500
66
CHAPTER 10
The Cost of Capital
67