1、Chapter 12Fundamentals of Corporate FinanceFifth EditionSlides byMatthew WillMcGraw-Hill/IrwinCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved The Weighted-Average Cost of Capital and Company ValuationCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-H

2、ill/Irwin12- 2Topics CoveredGeothermals Cost of CapitalWeighted Average Cost of Capital (WACC)Measuring Capital StructureCalculating Required Rates of ReturnCalculating WACCInterpreting WACCValuing Entire BusinessesCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irw

3、in12- 3Cost of CapitalCost of Capital - The return the firms investors could expect to earn if they invested in securities with comparable degrees of risk.Capital Structure - The firms mix of long term financing and equity financing.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserv

4、ed McGraw-Hill/Irwin12- 4Cost of CapitalExample Geothermal Inc. has the following structure. Given that geothermal pays 8% for debt and 14% for equity, what is the Company Cost of Capital?Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 5Cost of CapitalExamp

5、le - Geothermal Inc. has the following structure. Given that geothermal pays 8% for debt and 14% for equity, what is the Company Cost of Capital?100%$647Assets ValueMarket 70%$453 EquityValueMarket 30%$194 DebtValueMarket Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-H

6、ill/Irwin12- 6Cost of CapitalExample - Geothermal Inc. has the following structure. Given that geothermal pays 8% for debt and 14% for equity, what is the Company Cost of Capital?12.2%=(.7x14%)+(.3x8%)= ReturnPortfolioCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/

7、Irwin12- 7Cost of CapitalExample - Geothermal Inc. has the following structure. Given that geothermal pays 8% for debt and 14% for equity, what is the Company Cost of Capital?12.2%=(.7x14%)+(.3x8%)= ReturnPortfolioInterest is tax deductible. Given a 35% tax rate, debt only costs us 5.2% (i.e. 8 % x

8、.65).11.4%=(.7x14%)+(.3x5.2%)= WACCCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 8WACCWeighted Average Cost of Capital (WACC) - The expected rate of return on a portfolio of all the firms securities.Company cost of capital = Weighted average of debt and e

9、quity returns.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 9WACCV)r x (E+)r x (DassetsequitydebtrequityVEdebtVDassetsrx rx rsinvestment of valueincome totalassets=rCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12-

10、 10WACCTaxes are an important consideration in the company cost of capital because interest payments are deducted from income before tax is calculated. Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 11WACCWeighted -average cost of capital=WACC =x (1 - Tc)r

11、+x rDVdebtEVequityCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 12WACCThree Steps to Calculating Cost of Capital1. Calculate the value of each security as a proportion of the firms market value.2. Determine the required rate of return on each security.3.

12、Calculate a weighted average of these required returns.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 13WACCExample - Executive Fruit has issued debt, preferred stock and common stock. The market value of these securities are $4mil, $2mil, and $6mil, respe

13、ctively. The required returns are 6%, 12%, and 18%, respectively.Q: Determine the WACC for Executive Fruit, Inc. Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 14WACCExample - continuedStep 1 Firm Value = 4 + 2 + 6 = $12 milStep 2Required returns are given

14、Step 3()()WACC =x(1-.35).06 +x.12 +x.18=.123 or 12.3%412212612Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 15WACCIssues in Using WACC Debt has two costs. 1)return on debt and 2)increased cost of equity demanded due to the increase in risk Betas may chang

15、e with capital structure Corporate taxes complicate the analysis and may change our decision B=x B+x BassetsDVdebtEVequityCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 16Measuring Capital StructureIn estimating WACC, do not use the Book Value of securitie

16、s.In estimating WACC, use the Market Value of the securities.Book Values often do not represent the true market value of a firms securities.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 17Measuring Capital StructureMarket Value of Bonds - PV of all coupon

17、s and par value discounted at the current interest rate.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 18Measuring Capital StructureMarket Value of Bonds - PV of all coupons and par value discounted at the current interest rate.Market Value of Equity - Mar

18、ket price per share multiplied by the number of outstanding shares.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 19Measuring Capital StructureCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 20Measuring Capital St

19、ructureIf the long term bonds pay an 8% coupon and mature in 12 years, what is their market value assuming a 9% YTM?70.185$09. 1216.09. 11609. 11609. 1161232PVCopyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 21Measuring Capital StructureBig Oil MARKET Value

20、Balance Sheet (mil)Bank Debt (mil)200.0$ 12.6%LT Bonds185.7$ 11.7%Total Debt385.7$ 24.3%Common Stock1,200.0$ 75.7%Total1,585.7$ 100.0%Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 22Required Rates of ReturnBondsr= YTMdr= CAPM= r+ B(r- r )efmfCommon StockC

21、opyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 23Required Rates of ReturnDividend Discount Model Cost of EquityPerpetuity Growth Model =solve for reP=Divr - g01er=DivP+ ge10Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Ir

22、win12- 24Required Rates of ReturnExpected Return on Preferred StockPrice of Preferred Stock =solve for preferredP=Divr01preferredr=DivPpreferred10Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 25* FCF and PV *Free Cash Flows (FCF) should be the theoretical

23、 basis for all PV calculations.FCF is a more accurate measurement of PV than either Div or EPS.The market price does not always reflect the PV of FCF.When valuing a business for purchase, always use FCF.Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin12- 26Capital BudgetingValuing a Business The value of a business or project is usually computed as the discounted value of FCF out to a