This chapter discusses methods for calculating the cost of capital for foreign investments. It covers calculating the weighted average cost of capital (WACC) using different funding sources as well as the all-equity cost of capital. It also addresses estimating discount rates and betas for foreign projects and establishing an optimal worldwide capital structure.
"
Brian Lord St. Louis is a professional, efficient and friendly as a advisor of Eclectic Holdings LLC. He and his team is very attentive and resourceful."
"
Brian Lord St. Louis is a professional, efficient and friendly as a advisor of Eclectic Holdings LLC. He and his team is very attentive and resourceful."
The concept of Cost of capital for MNC is addressed in this ppt
Subscribe to Vision Academy for Video assistance https://www.youtube.com/channel/UCjzpit_cXjdnzER_165mIiw
Explain the general concept of opportunity cost of capital.
Distinguish between the project cost of capital and the firm’s cost of capital.
Learn about the methods of calculating component cost of capital and the weighted average cost of capital.
Understand the concept and calculation of the marginal cost of capital.
Recognise the need for calculating cost of capital for divisions.
Understand the methodology of determining the divisional beta and divisional cost of capital.
Illustrate the cost of capital calculation for a real company.
The concept of Cost of capital for MNC is addressed in this ppt
Subscribe to Vision Academy for Video assistance https://www.youtube.com/channel/UCjzpit_cXjdnzER_165mIiw
Explain the general concept of opportunity cost of capital.
Distinguish between the project cost of capital and the firm’s cost of capital.
Learn about the methods of calculating component cost of capital and the weighted average cost of capital.
Understand the concept and calculation of the marginal cost of capital.
Recognise the need for calculating cost of capital for divisions.
Understand the methodology of determining the divisional beta and divisional cost of capital.
Illustrate the cost of capital calculation for a real company.
Sheet4Assignment 1 LASA # 2—Capital Budgeting Techniques
Sheet1
Solution
:-A) Computation of WACC:-Cost of equity (Ke) will be calculated using dividend discount model which is as under:-Price of share (P0) = D1/(Ke-g)Ke = (D1/(P0*(1-f))) + gWhere,D1 = D0*(1+g)F = Flotation costKe = ((2.50*(1+6%))/(50*(1-10%))) + 6%Ke = 11.89%i) Equity financing and debt financing are two different sources of financing being used by the organizations to procure funds. Equity and debt are two different sources of financing, equity financing represents internal source of finance whereas debt financing represent external source of finance. Mixture of both is always used by the business organizations to procure funds and is most commonly known as target ratio or capital structure ratio. This ration varies from industry to industry and company and company depending upon various circumstances, equity financing can be raised only through issuing shares in market by the help of initial public offer whereas debt financing can be raise from many sources such as bonds, long term loans, money market instruments etc.Equity Financing has following advantages:1. The total cash flows generated can be used solely for investment purpose, rather than paying back the investors.2. Funds can be raised in shorter time as compared to other sources of funds.However, in equity financing, dilution of ownership easily occurs and more investors can lead to loss of Control.Cost of debt (Kd) will be calculated as follows:-Kd = Market rate of deb*(1-tax rate)Kd = 5%*(1-35%)Kd = 3.25%Debt is a more common source of finance used by most of the organizations, the reason for the same is as follows:-a. Debt is cheaper source of finance as compared to equity the reason being the cost associated with issuing the common stock like. Underwriters commission, legal expenses, various registration charges, issuing of prospectus, printing of various documents etc.b. Debt financing provide leverage to the company which will increase the Earning per Share (EPS) which in turn leads to increase in market value of share, this helps organization to maximize its market capitalization.However, if the expansion venture does not work in favour of the company, then these obligations of repayment of principal and interest may turnout to be a burden to the company. WACC = (Ke*We) + (Kd*Wd)WACC = (11.89%*70%) + (3.25%*30%)WACC = 9.30%B) Computation of NPV of project A:-Depreciation = Cost of the asset – salvage value Life of the asset = 1,500,000/ 3 = 500,000Calculation of cash flows:Revenue – 1,200,000Less Cost – 600,000Less Depreciation – 500,000Profit - 100,000Less taxes (35%) 35,000Profit after taxes .
Learning ObjectivesUpon completion of Chapter 10, you will.docxSHIVA101531
Learning Objectives
Upon completion of Chapter 10, you will be able to:
• Understand the meaning of the weighted average cost of capital (WACC).
• Be able to estimate the weights in the WACC.
• Be able to estimate the cost of debt and how it is affected by taxes.
• Be able to estimate the cost of preferred stock.
• Know three approaches for estimating the cost of equity.
• Understand flotation costs and how they affect the WACC.
• Know when the WACC is the appropriate approach for estimating the required return for a project.
• Know an alternative approach for estimating a project’s required return when the WACC is not
the appropriate measure.
Cost of Capital
10
Nina Mourier/Getty Images
byr80656_10_c10_245-270.indd 245 3/28/13 3:35 PM
CHAPTER 10Section 10.1 Estimating the Discount Rate
Corporate managers use various capital budgeting techniques. Among these tech-niques, net present value (NPV) emerges as the best measure of a project’s con-tribution to shareholder wealth. In NPV analysis, the present value of a project’s
expected future cash flows is compared to the initial investment, and the project is accepted
if the present value exceeds the initial investment. Calculation of NPV requires the analyst
to estimate cash flows and an appropriate discount rate. Techniques for estimating cash
flows were covered in Chapter 6. In this chapter you will learn how to estimate the dis-
count rate. The same estimates of cash flows and discount rate are also used in internal
rate of return analysis. Used in IRR, the discount rate becomes a hurdle rate against which
to compare the project’s IRR.
10.1 Estimating the Discount Rate
To illustrate the calculation and use of the discount rate, we introduce a case study of Pacific Offshore Ltd. (POL). POL is considering the manufacture and sale of har-nesses to be used by sailors who must be tethered to their boats in the high seas.
The harnesses can save the lives of sailors who are washed overboard in rough water and
storms. The NPV of POL’s harness project is $9,110, which was found by discounting the
project’s net cash flows by 12.5%. The project’s internal rate of return of 17.2% is greater
than the 12.5% required rate of return on the harness project. Therefore, whether we use
NPV or IRR, the harness project appears to be acceptable because it meets the respective
decision criteria. Had the required return been 20%, for example, the project would have
been rejected using either criterion.
We have referred to the 12.5% as the harness project’s required rate of return. To be more
specific, 12.5% is the weighted average return demanded by the company’s investors. The
weightings reflect the proportional values of their investments. The cost of the harness
project is $64,384, meaning that the owners must raise that amount from their investors
to fund tools, equipment, and working capital and to pay the cost of reconfiguring the
plant. The owners decided to fund futu ...
Basically computation of Project Appraisal technique with a special reference to financial parameters - Payback, Discounted Cash flow, NPV, IRR etc are explained. The slides are used for educating those who have taken up Project Finance recently
Embracing GenAI - A Strategic ImperativePeter Windle
Artificial Intelligence (AI) technologies such as Generative AI, Image Generators and Large Language Models have had a dramatic impact on teaching, learning and assessment over the past 18 months. The most immediate threat AI posed was to Academic Integrity with Higher Education Institutes (HEIs) focusing their efforts on combating the use of GenAI in assessment. Guidelines were developed for staff and students, policies put in place too. Innovative educators have forged paths in the use of Generative AI for teaching, learning and assessments leading to pockets of transformation springing up across HEIs, often with little or no top-down guidance, support or direction.
This Gasta posits a strategic approach to integrating AI into HEIs to prepare staff, students and the curriculum for an evolving world and workplace. We will highlight the advantages of working with these technologies beyond the realm of teaching, learning and assessment by considering prompt engineering skills, industry impact, curriculum changes, and the need for staff upskilling. In contrast, not engaging strategically with Generative AI poses risks, including falling behind peers, missed opportunities and failing to ensure our graduates remain employable. The rapid evolution of AI technologies necessitates a proactive and strategic approach if we are to remain relevant.
A Strategic Approach: GenAI in EducationPeter Windle
Artificial Intelligence (AI) technologies such as Generative AI, Image Generators and Large Language Models have had a dramatic impact on teaching, learning and assessment over the past 18 months. The most immediate threat AI posed was to Academic Integrity with Higher Education Institutes (HEIs) focusing their efforts on combating the use of GenAI in assessment. Guidelines were developed for staff and students, policies put in place too. Innovative educators have forged paths in the use of Generative AI for teaching, learning and assessments leading to pockets of transformation springing up across HEIs, often with little or no top-down guidance, support or direction.
This Gasta posits a strategic approach to integrating AI into HEIs to prepare staff, students and the curriculum for an evolving world and workplace. We will highlight the advantages of working with these technologies beyond the realm of teaching, learning and assessment by considering prompt engineering skills, industry impact, curriculum changes, and the need for staff upskilling. In contrast, not engaging strategically with Generative AI poses risks, including falling behind peers, missed opportunities and failing to ensure our graduates remain employable. The rapid evolution of AI technologies necessitates a proactive and strategic approach if we are to remain relevant.
Macroeconomics- Movie Location
This will be used as part of your Personal Professional Portfolio once graded.
Objective:
Prepare a presentation or a paper using research, basic comparative analysis, data organization and application of economic information. You will make an informed assessment of an economic climate outside of the United States to accomplish an entertainment industry objective.
Unit 8 - Information and Communication Technology (Paper I).pdfThiyagu K
This slides describes the basic concepts of ICT, basics of Email, Emerging Technology and Digital Initiatives in Education. This presentations aligns with the UGC Paper I syllabus.
Acetabularia Information For Class 9 .docxvaibhavrinwa19
Acetabularia acetabulum is a single-celled green alga that in its vegetative state is morphologically differentiated into a basal rhizoid and an axially elongated stalk, which bears whorls of branching hairs. The single diploid nucleus resides in the rhizoid.
Group Presentation 2 Economics.Ariana Buscigliopptx
Ch14
1. CHAPTER 14CHAPTER 14
THE COST OFTHE COST OF
CAPITAL FORCAPITAL FOR
FOREIGNFOREIGN
INVESTMENTSINVESTMENTS
2. CHAPTER OVERVIEW:CHAPTER OVERVIEW:
I.I. THE COST OF EQUITY CAPITALTHE COST OF EQUITY CAPITAL
II.II. THE WEIGHTED AVERAGE COSTTHE WEIGHTED AVERAGE COST
OF CAPITAL FOR FOREIGNOF CAPITAL FOR FOREIGN
PROJECTSPROJECTS
III.III. THE ALL-EQUITY COST OFTHE ALL-EQUITY COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
IV.IV. DISCOUNT RATESDISCOUNT RATES
V.V. ESTABLISHING A WORLDWIDEESTABLISHING A WORLDWIDE
CAPITAL STRUCTURECAPITAL STRUCTURE
3. I. THE COST OF EQUITYI. THE COST OF EQUITY
CAPITALCAPITAL
A.A. DefinitionDefinition
1. the minimum (required) rate of1. the minimum (required) rate of
returnreturn
necessary to induce investors to buynecessary to induce investors to buy
or hold the firm’s stock.or hold the firm’s stock.
2. used to value future equity cash2. used to value future equity cash
flowsflows
3. determines common stock price3. determines common stock price
4. THE COST OF EQUITYTHE COST OF EQUITY
CAPITALCAPITAL
B.B. Capital Asset Pricing ModelCapital Asset Pricing Model
rrii = r= rff ++ ΒΒii ( r( rmm - r- rff ))
where rwhere rii = the equity required rate= the equity required rate
rrff = the risk free return rate= the risk free return rate
ΒΒii= Cov(r= Cov(rmm, r, rii)/)/ σσ22
rrmm wherewhere
5. THE COST OF EQUITYTHE COST OF EQUITY
CAPITALCAPITAL
Cov(rCov(rmm, r, rii) is the covariance between asset) is the covariance between asset
and market returns andand market returns and σσ22
rrmm , the variance, the variance
of market returns.of market returns.
6. II.II. THE WEIGHTED AVERAGE COSTTHE WEIGHTED AVERAGE COST
OF CAPITAL FOR FOREIGN PROJECTSOF CAPITAL FOR FOREIGN PROJECTS
II.II.THE WEIGHTED AVERAGE COST OFTHE WEIGHTED AVERAGE COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
A.A. Weighted Average Cost of CapitalWeighted Average Cost of Capital
(WACC = k(WACC = k00))
kk00 = (1-L) k= (1-L) kee + L i+ L idd (1 - t)(1 - t)
where L = the parent’s debt ratiowhere L = the parent’s debt ratio
iidd (1 - t) = the after-tax debt cost(1 - t) = the after-tax debt cost
kkee = the equity cost of capital= the equity cost of capital
7. THE WEIGHTED AVERAGE COST OFTHE WEIGHTED AVERAGE COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
kk00 is used as the discount rate in theis used as the discount rate in the
calculation of Net Present Value.calculation of Net Present Value.
2.2. Two CaveatsTwo Caveats
a. Weights must be a proportion usinga. Weights must be a proportion using
market, not book value.market, not book value.
b. Calculating WACC, weights must beb. Calculating WACC, weights must be
marginal reflecting future debtmarginal reflecting future debt
structure.structure.
8. THE WEIGHTED AVERAGE COST OFTHE WEIGHTED AVERAGE COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
B.B. Costing Various Sources of FundsCosting Various Sources of Funds
1.1. Components of a New Investment (I)Components of a New Investment (I)
I = P + EI = P + E ff + D+ D ff
wherewhere I = require subsidiaryI = require subsidiary
financingfinancing
P = dollars by parentP = dollars by parent
EE ff = subsidiary’s retained= subsidiary’s retained
earningsearnings
DD = dollars from debt= dollars from debt
9. THE WEIGHTED AVERAGE COST OFTHE WEIGHTED AVERAGE COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
2. First compute each component2. First compute each component
a.a. Parent’s company funds (kParent’s company funds (k00))
required rate equal to the marginalrequired rate equal to the marginal
cost of capitalcost of capital
b.b. Retained Earnings (kRetained Earnings (kss))
a function of dividends,a function of dividends,
withholding taxes, tax deferral,withholding taxes, tax deferral,
and transfer costs.and transfer costs.
kk = k= k (1-T)(1-T)
10. THE WEIGHTED AVERAGE COST OFTHE WEIGHTED AVERAGE COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
c. Local Currency Debt (rc. Local Currency Debt (rff))
after-tax dollar cost of borrowingafter-tax dollar cost of borrowing
locallylocally
11. THE WEIGHTED AVERAGE COST OFTHE WEIGHTED AVERAGE COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
C. Computing WACC(kC. Computing WACC(k11))
kk11 = k= k00 - a(k- a(kee --kkss) - b[ i) - b[ idd(1-t) - i(1-t) - iff ]]
12. III.III. THE ALL-EQUITY COST OFTHE ALL-EQUITY COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
III.III. THE ALL-EQUITY COST OFTHE ALL-EQUITY COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
A.A. WACC sometimes awkwardWACC sometimes awkward
1. To go from the parent to the project1. To go from the parent to the project
2. Solution: Use all equity discount2. Solution: Use all equity discount
raterate
3. To calculate:3. To calculate:
kk**
= r= rff ++ ΒΒ**
( r( rmm - r- rff ))
13. THE ALL-EQUITY COST OFTHE ALL-EQUITY COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
4.4. ΒΒ**
is the all-equity beta associated withis the all-equity beta associated with
the unleveraged cash flows.the unleveraged cash flows.
14. THE ALL-EQUITY COST OFTHE ALL-EQUITY COST OF
CAPITAL FOR FOREIGN PROJECTSCAPITAL FOR FOREIGN PROJECTS
5. Unlevering beta obtained by5. Unlevering beta obtained by
where Bwhere B**
= the firm’s stock price beta= the firm’s stock price beta
D/E = the debt to equity ratioD/E = the debt to equity ratio
t = the firm’s marginal taxt = the firm’s marginal tax
EDt
e
/)1(1
*
−+
=
β
β
15. IV.IV. DISCOUNT RATES FORDISCOUNT RATES FOR
FOREIGN PROJECTSFOREIGN PROJECTS
IV.IV. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
A.A. Systematic RiskSystematic Risk
1. Not diversifiable1. Not diversifiable
2. Foreign projects in non-2. Foreign projects in non-
synchronous economies should besynchronous economies should be
less correlated with domesticless correlated with domestic
markets.markets.
16. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
3. Paradox: LDCs have greater political3. Paradox: LDCs have greater political
risk but offer higher probability ofrisk but offer higher probability of
diversification benefits.diversification benefits.
17. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
B.B. Key Issues in Estimating ForeignKey Issues in Estimating Foreign
Project BetasProject Betas
-find firms publicly traded that share-find firms publicly traded that share
similar risk characteristicssimilar risk characteristics
-use the average beta as a proxy-use the average beta as a proxy
18. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
1.1. Three Issues:Three Issues:
a.a. Should proxies be U.S. or localShould proxies be U.S. or local
companies?companies?
b.b. Which is the relevant baseWhich is the relevant base
portfolio to use?portfolio to use?
c.c. Should the market risk premium beShould the market risk premium be
based on U.S. or local market?based on U.S. or local market?
19. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
2.2. Proxy CompaniesProxy Companies
a. Most desirable to use locala. Most desirable to use local
firmsfirms
b. Alternative:b. Alternative:
find a proxy industry in thefind a proxy industry in the
local marketlocal market
20. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
3.3. Relevant Base (Market) PortfolioRelevant Base (Market) Portfolio
a. If capital markets are globallya. If capital markets are globally
integrated, choose world mkt.integrated, choose world mkt.
b. If not, domestic portfolio is bestb. If not, domestic portfolio is best
21. DISCOUNT RATES FOR FOREIGNDISCOUNT RATES FOR FOREIGN
PROJECTSPROJECTS
4.4. Relevant Market Risk PremiumRelevant Market Risk Premium
a. Use the U.S. portfolioa. Use the U.S. portfolio
b. Foreign project: should haveb. Foreign project: should have
no higher than domestic riskno higher than domestic risk
and cost of capital.and cost of capital.
22. V.V. ESTABLISHING AWORLDESTABLISHING AWORLD
WIDE CAPITAL STRUCTUREWIDE CAPITAL STRUCTURE
V.V. ESTABLISHING A WORLDWIDEESTABLISHING A WORLDWIDE
CAPITAL STRUCTURECAPITAL STRUCTURE
A.A. MNC Advantage:MNC Advantage:
uses more debt due touses more debt due to
diversificationdiversification
23. ESTABLISHING AWORLD WIDEESTABLISHING AWORLD WIDE
CAPITAL STRUCTURECAPITAL STRUCTURE
B.B. What is proper capital structure?What is proper capital structure?
1.1. Borrowing in local currency helpsBorrowing in local currency helps
to reduce exchange rate riskto reduce exchange rate risk
2.2. Allow subsidiary to exceed parentAllow subsidiary to exceed parent
capitalization norm if local mkt.capitalization norm if local mkt.
has lower costs.has lower costs.