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Describe the Harvards Business Review Of 2012 on Cost Of Capital.

Describe the Harvards Business Review Of 2012 on Cost Of Capital.

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- 1. Do You Know Your COST OF CAPITAL?? Harvard Business Review July-August 2012
- 2. Cost Of Capital • Cost of Capital - The return the firm’s investors could expect to earn if they invested in securities or Project with comparable degrees of risk. • Capital Structure - The firm’s mix of long term financing and equity financing. Prepared By - Vinay Golchha 12/23/2013 2
- 3. • The cost of capital represents the overall cost of financing to the firm • The cost of capital is normally the relevant discount rate to use in analyzing an investment • The overall cost of capital is a weighted average of the various sources: • WACC = Weighted Average Cost of Capital • WACC = After-tax cost x weights Prepared By - Vinay Golchha 12/23/2013 3
- 4. Harvard Business Review • Choose to Invest massive Amount. • Corporates strategy & Companies Competitiveness for future. • Develop Employment & Economy growth. • Opportunities vary across industries & Companies. • Fair Evaluation Of financial return. • Conducted a Survey by Association for Financial Profession. • Comprising about More then 300 Top Financial Officers assumptions they use in financial model to Quantify investment. • 80% Use Discounted cash Flow analysis to estimates the values. • 90% Use CAPM Model to estimate Cost Of equity. Prepared By - Vinay Golchha 12/23/2013 4
- 5. CAPM MODEL kj Cost of capital Rf Risk-free return β ( Rm Co-variance of returns against the portfolio (departure from the average) Rf ) Average rate of return on common stocks (WIG) B < 1, security is safer than WIG average B > 1, security is riskier than WIG average Prepared By - Vinay Golchha 12/23/2013 5
- 6. CAPM APPROACH Advantage: Evaluates risk, applicable to firms that don’t pay dividends Disadvantage: Need to estimate • Beta • the risk premium (usually based on past data, not future projections) • use an appropriate risk free rate of interest Prepared By - Vinay Golchha 12/23/2013 6
- 7. Core Six Questions • Q 1. What’s Your Forecasting Time Horizon? • Q 2. What’s Your Cost Of Debt? • Q 3. What’s Your Risk Free Rate? • Q 4. What’s the Equity – Market Risk Premium? • Q 5. What’s Your Beta Period? • Q 6. What’s Your Debt-to-Equity Ratio? Prepared By - Vinay Golchha 12/23/2013 7
- 8. Investment Time Horizon 10 Yrs. [PERCENTAGE] 5 Yrs. [PERCENTAGE] 15 Yrs. [PERCENTAGE] Other [PERCENTAGE] Prepared By - Vinay Golchha 12/23/2013 8
- 9. Cost Of Debt Cost Of Debt – The effective rate that a company pays on its debt. Forecasted Rate On New Issuance* [PERCENTAGE] Current Rate On Outstanding Debt [PERCENTAGE] Average Historical Rate [PERCENTAGE] Prepared By - Vinay Golchha 12/23/2013 9
- 10. Risk Free Rate 4% 11% Risk Free Rate – The risk-free rate represents the interest an investor would expect from an absolutely riskfree investment over a specified period of time. 6% 90 DAYS 52 WEEKS 5 YEARS 46% 10 YEARS 16% 20 YEARS 30 YEARS OTHERS 5% 12% Prepared By - Vinay Golchha 12/23/2013 10
- 11. Equity Market Premium Equity Market Premium The excess return that an individual stock or the overall stock market provides over a riskfree rate. 17% < 3% 3%-4% 11% 49% 5%-6% 23% Prepared By - Vinay Golchha 7% or >7% 12/23/2013 11
- 12. Beta Period Or Risk Of Company Stock 2% [PERCENTAGE] Beta Sensitivity of a stock’s return to the return on the market portfolio 1 41% 2 3 5 others 13% 15% Prepared By - Vinay Golchha 12/23/2013 12
- 13. Debt-To-Equity Ratio Debt-toequity RatioIt indicates what proportion of equity and debt the company is using to finance its assets. Targeted Book Debt to Equity [PERCENTAGE] Current Book Debt To Equity [PERCENTAGE] Current Market Debt To Equity [PERCENTAGE] Current Book Debt To Current Market Equity [PERCENTAGE] Prepared By - Vinay Golchha 12/23/2013 13
- 14. Prepared By - Vinay Golchha 12/23/2013 14

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