Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C

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1. Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C
2. Topics CoveredCompany and Project Costs of CapitalMeasuring
3. Company Cost of CapitalA firm’s value can
4. Company Cost of Capital
5. Company Cost of CapitalA company’s cost of
6. Measuring BetasThe SML shows the relationship between
7. Measuring BetasDell Computer Slope determined from plotting
8. Measuring BetasDell Computer Slope determined from plotting
9. Measuring BetasGeneral Motors Slope determined from plotting
10. Measuring BetasGeneral Motors Slope determined from plotting
11. Measuring BetasExxon Mobil Slope determined from plotting
12. Measuring BetasExxon Mobil Slope determined from plotting
13. Beta Stability
14. Company Cost of Capital simple approachCompany Cost
15. Company Cost of Capital simple approachCompany Cost
16. Capital Structure - the mix of debt
17. Capital Structure & COCCOC = rportfolio =
18. Capital Structure & COCExpected return (%)BdebtBassetsBequityRrdebt=8Rassets=12.2Requity=15Expected Returns and Betas prior to refinancing
19. Union Pacific Corp.Requity = Return on Stock
20. Union Pacific Corp.
21. Union Pacific Corp.Example
22. International RiskSource: The Brattle Group, Inc.s Ratio
23. Asset Betas
24. Asset Betas
25. Risk,DCF and CEQ
26. Risk,DCF and CEQExample Project A is expected to
27. Risk,DCF and CEQExample Project A is expected to
28. Risk,DCF and CEQExample Project A is expected to
29. Risk,DCF and CEQExample Project A is expected to
30. Risk,DCF and CEQExample Project A is expected to
31. Risk,DCF and CEQExample Project A is expected to
32. Risk,DCF and CEQExample Project A is expected to
33. Risk,DCF and CEQExample Project A is expected to
34. Risk,DCF and CEQExample Project A is expected to
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Topics CoveredCompany and Project Costs of CapitalMeasuring the Cost of EquityCapital Structure and COCDiscount Rates for Intl. ProjectsEstimating Discount RatesRisk and DCF

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Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C

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Слайд 1Principles of Corporate Finance

Seventh Edition
Richard A. Brealey
Stewart C. Myers
Slides

by
Matthew Will
Chapter 9
McGraw Hill/Irwin
Copyright © 2003 by The McGraw-Hill Companies,

Capital Budgeting and Risk

Principles of Corporate FinanceSeventh EditionRichard A. Brealey Stewart C. MyersSlides byMatthew WillChapter 9McGraw Hill/IrwinCopyright © 2003 by

Слайд 2Topics Covered
Company and Project Costs of Capital
Measuring the Cost of

Equity
Capital Structure and COC
Discount Rates for Intl. Projects
Estimating Discount Rates
Risk

and DCF

Topics CoveredCompany and Project Costs of CapitalMeasuring the Cost of EquityCapital Structure and COCDiscount Rates for Intl.

Слайд 3Company Cost of Capital
A firm’s value can be stated as

the sum of the value of its various assets

Company Cost of CapitalA firm’s value can be stated as the sum of the value of its

Слайд 4Company Cost of Capital

Слайд 5Company Cost of Capital
A company’s cost of capital can be

compared to the CAPM required return
Required
return
Project Beta
1.26
Company Cost of Capital

13

5.5

0
SML

Company Cost of CapitalA company’s cost of capital can be compared to the CAPM required returnRequiredreturnProject Beta1.26Company

Слайд 6Measuring Betas
The SML shows the relationship between return and risk
CAPM

uses Beta as a proxy for risk
Other methods can be

employed to determine the slope of the SML and thus Beta
Regression analysis can be used to find Beta

Measuring BetasThe SML shows the relationship between return and riskCAPM uses Beta as a proxy for riskOther

Слайд 7Measuring Betas
Dell Computer
Slope determined from plotting the line of

best fit.
Price data – Aug 88- Jan 95
Market return (%)
Dell

return (%)

R2 = .11
B = 1.62

Measuring BetasDell Computer Slope determined from plotting the line of best fit.Price data – Aug 88- Jan

Слайд 8Measuring Betas
Dell Computer
Slope determined from plotting the line of

best fit.
Price data – Feb 95 – Jul 01
Market return

(%)

Dell return (%)

R2 = .27
B = 2.02

Measuring BetasDell Computer Slope determined from plotting the line of best fit.Price data – Feb 95 –

Слайд 9Measuring Betas
General Motors
Slope determined from plotting the line of

best fit.
Price data – Aug 88- Jan 95
Market return (%)
GM

return (%)

R2 = .13
B = 0.80

Measuring BetasGeneral Motors Slope determined from plotting the line of best fit.Price data – Aug 88- Jan

Слайд 10Measuring Betas
General Motors
Slope determined from plotting the line of

best fit.
Price data – Feb 95 – Jul 01
Market return

(%)

GM return (%)

R2 = .25
B = 1.00

Measuring BetasGeneral Motors Slope determined from plotting the line of best fit.Price data – Feb 95 –

Слайд 11Measuring Betas
Exxon Mobil
Slope determined from plotting the line of

best fit.
Price data – Aug 88- Jan 95
Market return (%)
Exxon

Mobil return (%)

R2 = .28
B = 0.52

Measuring BetasExxon Mobil Slope determined from plotting the line of best fit.Price data – Aug 88- Jan

Слайд 12Measuring Betas
Exxon Mobil
Slope determined from plotting the line of

best fit.
Price data – Feb 95 – Jul 01
Market return

(%)

Exxon Mobil return (%)

R2 = .16
B = 0.42

Measuring BetasExxon Mobil Slope determined from plotting the line of best fit.Price data – Feb 95 –

Слайд 13Beta Stability

% IN SAME

% WITHIN ONE
RISK CLASS 5 CLASS 5
CLASS YEARS LATER YEARS LATER

10 (High betas) 35 69

9 18 54

8 16 45

7 13 41

6 14 39

5 14 42

4 13 40

3 16 45

2 21 61

1 (Low betas) 40 62

Source: Sharpe and Cooper (1972)

Слайд 14Company Cost of Capital simple approach
Company Cost of Capital (COC) is

based on the average beta of the assets

The average Beta

of the assets is based on the % of funds in each asset

Company Cost of Capital simple approachCompany Cost of Capital (COC) is based on the average beta of

Слайд 15Company Cost of Capital simple approach
Company Cost of Capital (COC) is

based on the average beta of the assets

The average Beta

of the assets is based on the % of funds in each asset

Example
1/3 New Ventures B=2.0
1/3 Expand existing business B=1.3
1/3 Plant efficiency B=0.6

AVG B of assets = 1.3

Слайд 16Capital Structure - the mix of debt & equity within

a company

Expand CAPM to include CS

R

= rf + B ( rm - rf )
becomes
Requity = rf + B ( rm - rf )

Capital Structure

Слайд 17Capital Structure & COC
COC = rportfolio = rassets

rassets = WACC

= rdebt (D) + requity (E)

(V) (V)

Bassets = Bdebt (D) + Bequity (E)
(V) (V)

requity = rf + Bequity ( rm - rf )

IMPORTANT
E, D, and V are all market values

Capital Structure & COCCOC = rportfolio = rassetsrassets = WACC = rdebt (D) + requity (E)

Слайд 18Capital Structure & COC
Expected return (%)
Bdebt
Bassets
Bequity
Rrdebt=8
Rassets=12.2
Requity=15
Expected Returns and Betas prior

to refinancing

Слайд 19Union Pacific Corp.
Requity = Return on Stock

= 15%

Rdebt = YTM on bonds

= 7.5 %

Слайд 20Union Pacific Corp.

Слайд 21Union Pacific Corp.
Example

Слайд 22International Risk
Source: The Brattle Group, Inc.
s Ratio - Ratio of

standard deviations, country index vs. S&P composite index

International RiskSource: The Brattle Group, Inc.s Ratio - Ratio of standard deviations, country index vs. S&P composite

Слайд 23Asset Betas

Слайд 24Asset Betas

Слайд 25Risk,DCF and CEQ

Слайд 26Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?

Risk,DCF and CEQExample Project A is expected to produce CF = $100 mil for each of three years.

Слайд 27Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?

Слайд 28Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?

Слайд 29Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?

Now assume that the cash flows change, but are RISK FREE. What is the new PV?

Слайд 30Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?.. Now assume that the cash flows change, but are RISK FREE. What is the new PV?

Слайд 31Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?.. Now assume that the cash flows change, but are RISK FREE. What is the new PV?

Since the 94.6 is risk free, we call it a Certainty Equivalent of the 100.

Слайд 32Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project? DEDUCTION FOR RISK

Слайд 33Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?.. Now assume that the cash flows change, but are RISK FREE. What is the new PV?

The difference between the 100 and the certainty equivalent (94.6) is 5.4%…this % can be considered the annual premium on a risky cash flow

Слайд 34Risk,DCF and CEQ
Example
Project A is expected to produce CF =

$100 mil for each of three years. Given a risk

free rate of 6%, a market premium of 8%, and beta of .75, what is the PV of the project?.. Now assume that the cash flows change, but are RISK FREE. What is the new PV?