Chapter 15 Required Returns and the cost of Capital 15-1
15-1 Chapter 15 Required Returns and the Cost of Capital
Required Returns and the Cost of Capital Creation of value n Overall Cost of Capital of the Firm a Project-Specific Required Rates n Group-Specific Required Rates n Total Risk Evaluation 15-2
15-2 Required Returns and the Cost of Capital Creation of Value Overall Cost of Capital of the Firm Project-Specific Required Rates Group-Specific Required Rates Total Risk Evaluation
Key Sources of Value creation Industry Attractiveness Growth Barriers to Other phase of competitive e.g. patents, product entry temporary cycle monopoly oligopoly pricing Marketing Perceived Superior Cost and price quality ganizational capability Competitive Advantage 15-3
15-3 Key Sources of Value Creation Growth phase of product cycle Barriers to competitive entry Other -- e.g. patents, temporary monopoly power, oligopoly pricing Cost Marketing and price Perceived quality Superior organizational capability Industry Attractiveness Competitive Advantage
Overall Cost of Capital of the Firm Cost of Capital is the required rate of return on the various types of financing. The overall cost of capital is a weighted average of the individual required rates of return(costs) 15-4
15-4 Overall Cost of Capital of the Firm Cost of Capital is the required rate of return on the various types of financing. The overall cost of capital is a weighted average of the individual required rates of return (costs)
Market value of Long-Term Type of Financing Mkt Val Weight Long-Term Debt $35M35% Preferred stock $15M15% Common Stock Equity $50M 50% $100M100% 15-5
15-5 Type of Financing Mkt Val Weight Long-Term Debt $35M 35% Preferred Stock $15M 15% Common Stock Equity $50M 50% $100M 100% Market Value of Long-Term Financing
Cost of Debt Cost of Debt is the required rate of return on investment of the lenders of a company. Pn=∑ j=1 (1+k。y k1=ka(1-T) 15-6
15-6 Cost of Debt is the required rate of return on investment of the lenders of a company. ki = kd ( 1 - T ) Cost of Debt P0 = I j + Pj (1 + kd ) j n j =1
Determination of the Cost of debt Assume that Basket Wonders BWhas $1, 000 par value zero-coupon bonds outstanding. BWbonds are currently trading at $385.54 with 10 years to maturity. BW tax bracket is 40% $0+$1,000 $38554= (1+kd)10 15-7
15-7 Assume that Basket Wonders (BW) has $1,000 par value zero-coupon bonds outstanding. BW bonds are currently trading at $385.54 with 10 years to maturity. BW tax bracket is 40%. Determination of the Cost of Debt $385.54 = $0 + $1,000 (1 + kd ) 10
Determination of the Cost of debt (1+k)10=$1,000/$38554 =2.5938 (1+k)=(25938)110) =1.1 d =.1or10% k1=10%(1-40) k:=6% 15-8
15-8 (1 + kd ) 10 = $1,000 / $385.54 = 2.5938 (1 + kd ) = (2.5938) (1/10) = 1.1 kd = .1 or 10% ki = 10% ( 1 - .40 ) ki = 6% Determination of the Cost of Debt
Cost of Preferred stock Cost of Preferred stock is the required rate of return on investment of the preferred shareholders of the company. k。=D,/P P 15-9
15-9 Cost of Preferred Stock is the required rate of return on investment of the preferred shareholders of the company. kP = DP / P0 Cost of Preferred Stock
Determination of the Cost of Preferred Steel Assume that Basket Wonders Bw has preferred stock outstanding with par value of $100, dividend per share of $6.30, and a current market value of $70 per share kp=$630/$70 P=9 15-10
15-10 Assume that Basket Wonders (BW) has preferred stock outstanding with par value of $100, dividend per share of $6.30, and a current market value of $70 per share. kP = $6.30 / $70 kP = 9% Determination of the Cost of Preferred Stock
