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Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
Cost of capital
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Cost of capital

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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.

Published in: Economy & Finance, Business
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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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