Cost Of Capital Estmation - Considering Industry Risk
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This document discusses different methods for estimating the cost of equity for Aero Pieces, an aircraft parts company, by incorporating industry risk. It compares using the Capital Asset Pricing Model with an industry risk premium, versus the traditional build-up method which factors industry risk into the company-specific risk premium. Applying each method using equity risk premium data from different sources, the estimated cost of equity for Aero Pieces ranges from 12.40% to 15.80%.
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Risk, Cost of Capital, and ValuationChapter 13Copyrigh.docx
Risk, Cost of Capital, and Valuation
Chapter 13
Copyright © 2013 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
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Key Concepts and SkillsKnow how to determine a firm’s cost of equity capitalUnderstand the impact of beta in determining the firm’s cost of equity capitalKnow how to determine the firm’s overall cost of capitalUnderstand the impact of flotation costs on capital budgeting
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Chapter Outline
13.1 The Cost of Equity Capital
13.2 Estimating the Cost of Equity Capital with the CAPM
13.3 Estimation of Beta
13.4Determinants of Beta
13.5The Dividend Discount Model Approach
13.6Cost of Capital for Divisions and Projects
13.7Cost of Fixed Income Securities
13.8The Weighted Average Cost of Capital
13.9Valuation with RWACC
13.10Estimating Eastman Chemical’s Cost of Capital
13.11Flotation Costs and the Weighted Average Cost of Capital
*
13-*
Where Do We Stand?Earlier chapters on capital budgeting focused on the appropriate size and timing of cash flows.This chapter discusses the appropriate discount rate when cash flows are risky.
*
The terms discount rate, required return, and cost of capital are all synonymous.
13-*
Invest in project
13.1 The Cost of Equity Capital
Firm with
excess cash
Shareholder’s Terminal Value
Pay cash dividend
Shareholder invests in financial asset
Because stockholders can reinvest the dividend in risky financial assets, the expected return on a capital-budgeting project should be at least as great as the expected return on a financial asset of comparable risk.
A firm with excess cash can either pay a dividend or make a capital investment
*
Therefore, the discount rate of a project should be the expected return on a financial asset of comparable risk.
13-*
The Cost of Equity CapitalFrom the firm’s perspective, the expected return is the Cost of Equity Capital:To estimate a firm’s cost of equity capital, we need to know three things:The risk-free rate, RFThe market risk premium,The company beta,
*
13-*
ExampleSuppose the stock of Stansfield Enterprises, a publisher of PowerPoint presentations, has a beta of 1.5. The firm is 100% equity financed. Assume a risk-free rate of 3% and a market risk premium of 7%.What is the appropriate discount rate for an expansion of this firm?
*
You may want to note that this example assumes expansion into projects that are similar to the existing nature of the business. Also, point out that the firm is all equity, thus its discount rate is the cost of equity.
13-*
Example
Suppose Stansfield Enterprises is evaluating the following independent projects. Each costs $100 and lasts one year.
Project
Project b
Project’s Estimated Cash Flows Next Year
IRR
NPV at 13.5%
A
1.5
$125
25%
$10.13
B
1.5
$113.5
13.5%
$0
C
1.5
$105
5%
-$7.49
*
13-*
Using the SML
An all-equity firm should accept projects whose IRRs exceed the cost of equity capital and reject projects whose IRRs fall sh ...
RBSA Research Report- Industry Multiples in India
:: RBSA Research Report- Industry Multiples in India ::
#RBSA #Valuation #InvestmentBanking #AdvisoryServices #Restructuring
Recalculate DIFAL
This document describes a Business Add-In (BAdI) method that allows recalculation of the ICMS ST/FCP base amount and tax amount for interstate transactions of goods in Brazil. The BAdI method can apply state-specific tax laws to override the standard SAP calculation. It has parameters for tax rates, base amounts, and reduction percentages to flexibly determine the ICMS ST/FCP values. An example shows how it could recalculate the tax for an interstate sale with different destination and interstate tax rates.
Beta Estimation and The Cost of Equity
Discuss the methods of estimating beta.
Explain the market model for calculating beta.
Examine the difference between betas of individual firms and the industry beta.
Highlight the beta instability.
Explain the determinants of beta.
Show the use of beta in determining the cost of equity.
elearn.pdf
The document provides an overview of a course on financial modelling for company valuation. The course covers building financial models, developing case studies, modelling concepts like WACC, terminal value calculations, and relative valuation techniques like comparable company analysis. Key topics include forecasting financial statements, linking income statement, balance sheet and cash flow statement, ratio analysis, and valuation approaches like DCF and relative multiples valuation. Practical lessons will include exercises on calculating WACC, terminal values, and conducting a DCF valuation of a company.
Corporate_Finance_Global_Edition_Chapter.pptx
This chapter discusses methods for estimating the cost of equity and debt capital for firms and calculating a weighted average cost of capital. It introduces the capital asset pricing model (CAPM) as a method to estimate the cost of equity based on the risk-free rate, market risk premium, and a stock's beta. Determinants of beta like operating and financial leverage are also covered. The chapter then discusses using the WACC to evaluate projects and value firms by discounting cash flows. It concludes by addressing flotation costs associated with raising new capital.
MECH 3330 Project 2 Due 12116 Design a tube bank that .docx
MECH 3330 Project 2 Due: 12/1/16
Design a tube bank that will increase the temperature of a 1200 CFM flow of air from 35⁰F to
100⁰F. Assume a constant pressure of 1atm. Each tube will have a diameter of 0.5in and a
length of 24in. The tube configuration must fit in an area of 18in by 18in. Assume reasonable
uniform surface temperature for the outside of the tubes.
Finding will be presented in a report with a memo cover sheet. A narrative including an
Introduction, Analysis Methods, Results, and Conclusions needs to be provided.
Introduction: Describe the problem
Analysis Methods: Describe the methods used to analyze the problem. Include equations used
and any other tools used.
Results: Provide a dimensioned drawing of the design along with any results obtained from
calculations or other analysis methods. The drawing should include the tube configuration,
number of tubes, and tub spacing.
Conclusions: Provide a summary of the problem, analysis, and results. Also discuss what
measurements and controls should be added to insure 100⁰F air at the exit.
Notes:
The report must be created in a word processing program.
All drawings must be created with a computer aided drafting program.
Internally Reference all research sources and also include a reference page
FINAL EXAM MGT 5002
MULTIPLE CHOICE CHAPTER 9
(9-5) Required return
1). If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks
a. the stock is experiencing supernormal growth.
b. the stock should be sold.
c. the stock is a good buy.
d. management is probably not trying to maximize the price per share.
e. dividends are not likely to be declared.
(9-1) Preemptive right
2). The preemptive right is important to shareholders because it
a. allows managers to buy additional shares below the current market price.
b. will result in higher dividends per share.
c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their ownership interests.
e. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
(9-2) Classified stock
3). Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?
a. All common stocks fall into one of three classes: A, B, and C.
b. All common stocks, regardless of class, must have the same voting rights.
c. All firms have several classes of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. Some class or classes of common stock are entitled to more votes per share than other classes.
(9-5) Constant growth model
4). If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.
a. The expected return on the stock is 5% a year.
b. The stock’s ...
1. Which one of the following is NOT an attractive way to reduce p.docx
1. Which one of the following is NOT an attractive way to reduce production and/or marketing costs and strive to achieve a competitive advantage over rivals based on lower overall costs per entry-level camera sold?
Keeping a watchful eye on warranty costs for entry-level cameras and endeavoring to keep them below the industry-average benchmark (as reported on p. 5 of the GLO-BUS Statistical Review)
Making sure that total compensation per full-time PAT member remains at or very close to the industry-low benchmark (as reported on p. 6 of the GLO-BUS Statistical Review)
Striving to keeping marketing costs per entry-level camera in all 4 geographic regions sold to levels that are substantially below the industry-average benchmark (as reported on p. 6 of the GLO-BUS Statistical Review)
Trying several different "what-if" entries for core components to be used in entry-level cameras in order to discover the lowest cost combination for achieving the target P/Q rating
Paying full-time PAT members a sufficiently high total compensation package that boosts the productivity of the labor force enough to keep labor costs per entry-level camera below the industry-average benchmark (as reported on p. 5 of the GLO-BUS Statistical Review)
2. If a management team wishes to boost the company's stock price, then it should consider actions toissue additional shares of common stock and use the proceeds to pay off the borrowings against the company's line of credit.boost the prices it charges for entry-level and multi-featured cameras by a minimum of $10 in all four geographic regions.boost the amount of earnings retained in the business and increase the hoard of cash held in the company's retrained earnings account.spend additional money on corporate social responsibility and corporate citizenship.boost the company's net income and EPS and, also, to repurchase shares of common stock.
3. Which one of the following is NOT a way to improve the P/Q rating of a company's brand of multi-featured cameras?
Increasing the size of the LCD display screen for multi-featured cameras
Spending additional money to improve the imaging devices used in making the company's multi-featured cameras
Improving the optical zoom capability of the company's multi-featured cameras
Spending additional money to improve the ergonomics of the company's multi-featured camera models
Increasing the warranty period for multi-featured cameras from 1 year to 2 years
4. If a company earns net income of $25 million in Year 8, has 10 million shares of stock, pays a dividend of $1.00 per share, and has annual interest costs of $10 million, thenthe company's retained earnings for the year would be $5 million; the $5 million in retained earnings would be shown on the company's balance sheet as a reduction in equity investment by stockholders in Year 9.the company's EPS for Year 8 would be $2.50 and its retained earnings for Year 8 would be $15 million (net income of $25 million less divi ...
Valncaps2
This document discusses several valuation methods including comparable multiples, discounted cash flow analysis, and heuristic methods. It provides an overview of comparable multiples like P/E, price to book, and enterprise value to EBITDA. It then describes using a discounted cash flow approach including estimating free cash flows, determining an appropriate time horizon, and calculating the cost of debt and equity. The document emphasizes that discounted cash flow analysis accounts for synergies and specific company characteristics better than heuristic multiples which have limitations.
Valuation methodology
This document provides an overview of various valuation methodologies including multiples-based methods like P/E, price to book, and enterprise value to EBITDA multiples as well as discounted cash flow methods. It discusses steps for using multiples including determining average transaction multiples for comparable firms and industries. It also outlines how to build a discounted cash flow model including templates for income statements, cash flow statements, and considerations for estimating time horizons and costs of debt and equity.
Total Economic Impact™ IBM System Storage SAN, Volume Controller
In June 2011, IBM commissioned Forrester Consulting to examine the total economic impact and potential return on investment (ROI) enterprises may realize by deploying System Storage SAN Volume Controller (SVC). The purpose of this study is to provide readers with a framework to evaluate the potential financial impact of System Storage SAN Volume Controller on enterprise organizations. SVC is designed to simplify and centralize storage infrastructure and offer benefits of storage virtualization for large enterprises.
Valuation class
A session on Valuation my Acton Master Teacher Jeff Serra.
More about him here http://www.actonmba.org/2011/09/person-11/
SAP Treasury
1. The SAP Easy Access menu was changed under Multi Currency Accounting, with new entries for periodic processing and subledger processing, and deleted entries.
2. Enhancements were made to Central Finance configuration consistency checks, including additional checks for G/L accounts, profitability analysis, and currency and valuation profiles. A new balances comparison report was also added.
3. New functions were added for Central Finance, including the ability to undo CO initial load preparation, implement custom mapping logic, replicate custom project fields, use new AVL functions to replicate purchase orders, and ensure payment and clearing of historical open items takes place in the central finance system.
AmeritradeCF
The consultant was hired to estimate Ameritrade's cost of capital for upcoming $100 million in technology investments and $155 million in advertising. To do so, the consultant analyzed comparable discount brokerage firms to determine Ameritrade's beta since it only recently went public. The analysis found Ameritrade's weighted average cost of capital to be 23.34%. Partially financing with long-term debt could lower the cost of capital and make the investments more attractive. The consultant recommends the investments only if expected returns exceed 23.34%, otherwise debt financing should be considered.
Individual reflection report on a Client's Investment portfolio
The document provides a detailed summary of the author's contributions to creating an investment portfolio for Mr. Brown. Key contributions included:
1) Analyzing stock price and dividend data to identify 502 companies, which was narrowed down to 30 companies based on criteria like average dividend yield, correlation with the S&P 500 index, and beta.
2) Using the Sharp's manual and online calculators to determine optimal allocations across 13 companies, which was further reduced to 12 companies by eliminating overlapping industry exposure.
3) Designing a hedging strategy using S&P 500 index futures, inputting the portfolio into the Eikon analytics platform, and allocating $700,000 across the 12 stocks based
THE CAPM.pptx
The Capital Asset Pricing Model (CAPM) is a model used to determine the expected return of an asset based on its beta and the expected market return. Beta measures the volatility of a security compared to the overall market. The CAPM formula states that the expected return is equal to the risk-free rate plus the product of beta and the market risk premium. CAPM helps price assets by linking their expected return to the amount of non-diversifiable risk relative to the market.
AgendaComprehending risk when modeling investment (project) de.docx
Agenda
Comprehending risk when modeling investment (project) decisions
Standalone Risk
Market Risk
1
1
Project Risk
Standalone Risk: Risk based on uncertainty of a projects cash flows
Sensitivity
Scenarios
Breakeven
Simulations
Market Risk: Risk of the project as seen by a well diversified investor
Beta
2
Sensitivity, Scenario, and Break-Even
Each allows us to look behind the NPV number to see how stable our estimates are.
Breakeven: sales required to breakeven
Accounting break-even: sales volume at which net income = 0
Cash break-even: sales volume at which operating cash flow = 0
Financial break-even: sales volume at which net present value = 0
Sensitivity: how sensitive a particular NPV calculation is to changes in an input variable holding all other assumptions are held constant
Scenario: examine impact on NPV given a confluence of factors
When working with spreadsheets, try to build your model so that you can adjust variables in a single cell and have the NPV calculations update accordingly.
3
3
Monte Carlo Simulation
A more sophisticated variation of the scenario analysis is Monte Carlo simulation.
In a Monte Carlo simulation, analysts specify a range or a distribution of potential outcomes for each of the model’s assumptions.
Pick a probability distribution for each input variable (units, price, variable costs, etc).
The computer program will pick a random value from each input variable, calculate the NPV and store the result. This is a trial.
Repeat the process many times, saving the input variables and the output (NPV).
End result: Probability distribution of NPV based on sample of simulated values.
4
Example
5
6
When a firm with both debt and equity invests in an asset similar to its existing assets (business), the WACC is the appropriate discount rate to use in NPV calculations.
In conglomerates, the WACC reflects the return that the firm must earn on average across all its assets to satisfy investors, but using the WACC to discount cash flows of a particular investment leads to mistakes.
Any project’s cost of capital depends on the use to which the capital is being put—not the source.
Therefore, it depends on the risk of the project and not the risk of the company.
When a firm invests in an asset that is different from its existing assets, it should look for pure-play firms to find the right discount rate.
6
Finding the Right Discount Rate
6
You are a financial analyst at General Electric and are preparing a cost of equity estimate for a project analysis using NPV:
CAPM = Risk Free Rate + Beta * Market Risk Premium
9.5% = 3.0% + 1.1 * 5.9%
Lines of Business
Financial Services
Power Generation
Aviation
Transportation
Health Care
Consumer Goods
When evaluating a new power generation investment for GE, which cost of capital should be used?
Capital Budgeting & Project Risk
7
Beta
1.8
0.6
1.2
1.3
0.8
1.1
7
17
Capital Budgeti.
Lecture007.pdf
This document discusses the cost of capital, discount rate, and required return for capital budgeting. It covers:
1) How the required return on a project should be at least as great as the expected return on comparable financial assets of the same risk.
2) How the cost of capital depends on the risk of the investment, and how this cost is used as the discount rate.
3) How to estimate the cost of equity using the dividend growth model and CAPM approaches, as well as the costs of debt and preferred stock.
4) How the weighted average cost of capital incorporates the individual costs based on the firm's capital structure.
Ch. 6ed Cost of Capital.ppt.ppt
The document provides an overview of cost of capital concepts including the components of cost of capital (debt, preferred stock, common equity), weighted average cost of capital (WACC), and factors that affect the WACC. It then discusses various methods for calculating the cost of different capital components, including the cost of debt, cost of preferred stock, and cost of common equity using the capital asset pricing model (CAPM), dividend capitalization model, and own-bond-yield-plus-risk-premium method. Examples are provided to illustrate how to apply these methods to determine the weighted average cost of capital for a company.
01 fs analysis
This document provides an overview of financial statement analysis techniques including horizontal analysis, vertical analysis, and calculating various financial ratios. It defines key terms, outlines objectives and limitations of financial statement analysis, and provides formulas and explanations for various liquidity, activity, solvency, profitability, and market-test ratios. Examples and exercises are also included to demonstrate applying these techniques.
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- 1. Cost of Capital Estimation: Considering Industry Risk Brown Bag Presentation September 15, 2008 Paul Daddio
Editor's Notes
- Underlying theoretical issues: e.g., we won’t discuss how to adjust CSRP for when you’re using beta-adjusted size premium vs. non-beta adjusted
- SBBI says to use beta-adjusted size premia, but use non-beta-adjusted size premium when accounting for industry risk in CSRP instead of using an IRP Discuss differences b/w beta-adjusted and non-beta-adjusted
- Estimate beta: Performed by selecting publicly traded companies comparable to the subject, then regressing their stock returns against a market return such as S&P 500. From these betas, the beta of the subject company is estimated. Estimate size premium: use beta-adjusted size premium for all MCAPM methods. This avoids double-counting because beta-adjusted size premia exclude the portion of returns on small stocks that can be explained by their higher betas. Estimate CSRP: Be sure to take into account that SBBI size premium data is not at all precise (unlike Duff & Phelps). So, if, for example, the subject is significantly smaller than the median sized company in the selected SBBI size category the CSRP would be larger than if using D&P to account for the additional risk due to the subject’s size that is not picked up through the size premium.
- Estimate company-specific risk premium: D&P is precise about size, so CSRP will tend to be narrower (i.e., closer to 0) than when using SBBI because size risk is fully captured in D&P.
- Estimate size premium: Select the non-beta-adjusted size premium for all build-up methods. This implicitly makes the assumption that the systematic risk of the subject company is the same as the risk of the small company portfolio.