F|N2101 Business Finance‖
FIN2101 Business Finance II
Module 9 Investment and Financing Decisions
Module 9 Investment and Financing Decisions
Student Activities Reading Study Book, Module 9 Selected Reading 9.1 Tutorial Activities Tutoria/ Workbook. Self Assessment Activity 9.1
Student Activities Reading • Study Book, Module 9 • Selected Reading 9.1 Tutorial Activities • Tutorial Workbook, Self Assessment Activity 9.1
Introduction The cost of capital is used to discount after tax cash flows expected from a firm's investment decision This. in turn determines whether the investment should be accepted or rejected according to the value it Is expected to create Cost of capital is thought of as the rate of return required by the market suppliers of capital in order to attract their funds to the firm
Introduction • The cost of capital is used to discount aftertax cash flows expected from a firm’s investment decision. This, in turn, determines whether the investment should be accepted or rejected according to the value it is expected to create. • Cost of capital is thought of as the rate of return required by the market suppliers of capital in order to attract their funds to the firm
Introduction Does the financing mix affect the firms overall cost of funds, either favourably or unfavourably? MM say No- financing decisions are irrelevant Firms should therefore concentrate on the nvestment decisions
Introduction • Does the financing mix affect the firm’s overall cost of funds, either favourably or unfavourably? • MM say NO - financing decisions are irrelevant. • Firms should therefore concentrate on the investment decisions
Introduction In reality, the cost of capital may decrease with financial leverage, resulting in some negative NPv projects becoming acceptable(positive NPv) This factor therefore needs to be incorporated into our investment decision analysIS
Introduction • In reality, the cost of capital may decrease with financial leverage, resulting in some negative NPV projects becoming acceptable (positive NPV). • This factor therefore needs to be incorporated into our investment decision analysis!
Introduction Under MM assumptions, investment decisions can be separated from the financing decisions In reality, these decisions can't be separated The effects of financing decisions must be included in the analysis
Introduction • Under MM assumptions, investment decisions can be separated from the financing decisions. • In reality, these decisions can’t be separated! • The effects of financing decisions must be included in the analysis
Valuation Methods WACC method-adjusts the discount rate Adjusted present value(APv) method adjusts the nPv for the impact of the financing decision Flow-to-equity (FTE method combination of the other 2 methods
Valuation Methods • WACC method – adjusts the discount rate. • Adjusted present value (APV) method – adjusts the NPV for the impact of the financing decision. • Flow-to-equity (FTE) method – combination of the other 2 methods
WACC kan=k×+ka(1-T)x DV
WACC ( ) V D k 1- T V S k k a = s + d
WACC Reflects, on average the firms cost of long -term financing sources that fund the firm' s long -term assets cind Recognises the mix of different financing Is the average of the rates of return that providers of capital require, with each source's contribution being weighted according to the proportion of capital it provided Is found by weighting the cost of each specific type of capital by its proportion in the firms capital structure
WACC • Reflects, on average, the firm’s cost of long-term financing. • Recognises the mix of different financing sources that fund the firm’s long-term assets. • Is the average of the rates of return that providers of capital require, with each source’s contribution being weighted according to the proportion of capital it provided. • Is found by weighting the cost of each specific type of capital by its proportion in the firm’s capital structure