International Corporate Finance Chp 12:The global cost and availability of capital Xin Chen Visiting Associate Professor Aarhus School of Business
1 International Corporate Finance Chp 12: The global cost and availability of capital Xin Chen Visiting Associate Professor Aarhus School of Business
Global Cost and Availability of Capital Global integration of capital markets has given many firms access to new and cheaper sources of funds beyond those available in their home markets. If a firm is located in a country with illiquid, small,and/or segmented capital markets,it can achieve this lower global cost and greater availability of capital by a properly designed and implemented strategy
Global Cost and Availability of Capital Global integration of capital markets has given many firms access to new and cheaper sources of funds beyond those available in their home markets. If a firm is located in a country with illiquid, small, and/or segmented capital markets, it can achieve this lower global cost and greater availability of capital by a properly designed and implemented strategy
Exhibit 12.1.Dimensions of the Cost and Availability of Capital Strategy Local Market Access Global Market Access Firm-Specific Characteristics Firm's securities appeal Firm's securities appeal to only to domestic investors international portfolio investors Market Liquidity for Firm's Securities Illiquid domestic securities market Highly liquid domestic market and and limited international liquidity broad international participation Effect of Market Segmentation on Firm's Securities and Cost of Capital Segmented domestic securities Access to global securities market market that prices shares that prices shares according to according to domestic standards international standards
Exhibit 12.1 Dimensions of the Cost and Availability of Capital Strategy
Global Cost and Availability of Capital A firm that must source its long-term debt and equity in a highly illiquid domestic securities market will probably have a relatively high cost of capital and will face limited availability of such capital which will,in turn,damage the overall competitiveness of the firm. Firms resident in industrial countries with small capital markets may enjoy an improved availability of funds at a lower cost,but would also benefit from access to highly liquid global markets
Global Cost and Availability of Capital A firm that must source its long-term debt and equity in a highly illiquid domestic securities market will probably have a relatively high cost of capital and will face limited availability of such capital which will, in turn, damage the overall competitiveness of the firm. Firms resident in industrial countries with small capital markets may enjoy an improved availability of funds at a lower cost, but would also benefit from access to highly liquid global markets
Global Cost and Availability of Capital Firms resident in countries with segmented capital markets must devise a strategy to escape dependence on that market for their long-term debt and equity needs. A national capital market is segmented if the required rate of return on securities in that market differs from the required rate of return on securities of comparable expected return and risk traded on other securities markets
Global Cost and Availability of Capital Firms resident in countries with segmented capital markets must devise a strategy to escape dependence on that market for their long-term debt and equity needs. A national capital market is segmented if the required rate of return on securities in that market differs from the required rate of return on securities of comparable expected return and risk traded on other securities markets
Weighted Average Cost of Capital A firm normally finds its weighted average cost of capital (WACC)by combining the cost of equity with the cost of debt in proportion to the relative weight of each in the firm's optimal long-term financial structure: kwxcc=k.+ka(1-)
Weighted Average Cost of Capital A firm normally finds its weighted average cost of capital (WACC) by combining the cost of equity with the cost of debt in proportion to the relative weight of each in the firm’s optimal long-term financial structure: kWACC = keE + kd (1-t)D V V
Weighted Average Cost of Capital kwAcc weighted average after-tax cost of capital ke risk-adjusted cost of equity k=before-tax cost of debt t marginal tax rate E market value of the firm's equity D market value of the firm's debt V total market value of the firm's securities =(D+E)
Weighted Average Cost of Capital kWACC = weighted average after-tax cost of capital ke = risk-adjusted cost of equity kd = before-tax cost of debt t = marginal tax rate E = market value of the firm’s equity D = market value of the firm’s debt V = total market value of the firm’s securities =(D+E)
Weighted Average Cost of Capital The capital asset pricing model (CAPM)approach is to define the cost of equity for a firm by the following formula: ke=kt+βkm-k) ke expected (required)rate of return on equity Krf=rate of interest on risk-free bonds (Treasury bonds,for example) B=coefficient of systematic risk for the firm km expected (required)rate of return on the market portfolio of stocks
Weighted Average Cost of Capital The capital asset pricing model (CAPM) approach is to define the cost of equity for a firm by the following formula: ke = krf + βj(km – krf) ke = expected (required) rate of return on equity krf = rate of interest on risk-free bonds (Treasury bonds, for example) βj = coefficient of systematic risk for the firm km = expected (required) rate of return on the market portfolio of stocks
Beta B can be interpreted as measure of how risky this asset is compared to the general risk level in the market β<1："low"risk asset B 1 "high"risk asset Systematic vs.firm specific risk --Systematic risk:risk of holding the market portfolio --Firm specific risk:risk that is unique for the asset According to CAPM,the market compensates investors for taking systematic risk but not for taking specific risk since the specific risk can be diversified away!
Beta β can be interpreted as measure of how risky this asset is compared to the general risk level in the market β 1 : "high" risk asset Systematic vs. firm specific risk --Systematic risk: risk of holding the market portfolio --Firm specific risk: risk that is unique for the asset According to CAPM, the market compensates investors for taking systematic risk but not for taking specific risk since the specific risk can be diversified away!
Weighted Average Cost of Capital --Calculating cost of equity in practice I 传 How to estimate B 1 Choice of proxy for the market portfolio 2 Time period:6 months,1 year,5 years or .. 3 Returns:daily,weekly or monthly observations? 4 Use the market model (regression) ke=kr+β(km-k) 5 Reality check does this seem reasonable? -1 usually0<β<2 --2 Market portfolio B 1
Weighted Average Cost of Capital --Calculating cost of equity in practice I How to estimate β 1 Choice of proxy for the market portfolio 2 Time period: 6 months, 1 year, 5 years or ... ? 3 Returns: daily, weekly or monthly observations? 4 Use the market model (regression) ke = krf + βj(km – krf) 5 Reality check - does this seem reasonable? --1 usually 0<β<2 --2 Market portfolio β = 1