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1、Chapter13COSTOFCAPITALAlexTajirianCostofCapital13-21OBJECTIVE#Managingtheright-hand-sideoftheB/S#Bynow,forvaluationanalysis,weknow:!criteria:NPV,IRR,payback!whattherelevantCFsare!howtocomputenetCFs!howtointroduceforecasterrorinCFs(WHATIF,...)#Sourcesoffinancing:
2、Debt,equity,retainedearnings,preferredstock,warrants,venturecapital,andbankloans,strategicalliances.!Bankloans,venturecapital,andwarrantsnotdiscussed!Tosimplify,weconcentrateonlyondebt,equity,andretainedearnings.#Costoffinancing=costofcapital=?!Definition:Therat
3、ethatmustbeearnedtosatisfytherequiredrateofreturnofthefirm'sinvestors.!Whatisthecostofeachsourceoffinancing?!Whatisaproject'scostofcapital?#WhymightcostofcapitalinJapanbelowerthaninU.S.?©morevalue.com,1997AlexTajirianCostofCapital13-32MOTIVATION2.1WHYISCOSTOFCAP
4、ITALIMPORTANT?IffinancingcostisreducedYNPVincreasesYmoreprojectsendupwithNPV>0Ymorewealthcreatedtoshareholders.2.2SOMEPRELIMINARIES!Minimumrequiredreturn/costofcapital=thatparticulardiscountratekthatmakesNPV=0.!Thereturngeneratedbyasecurityisthecostofthatsecurit
5、ytothecompanythatissuedit.]costofcapitaltothefirm=rewardtoinvestors.!Thecostofcapitaldependsprimarilyontheuseoffunds,i.e.,theriskoftheCFs,notonthesource.QriskofCFs(systematicrisk)Qcompanycapitalstructure©morevalue.com,1997AlexTajirianCostofCapital13-42.3COSTCOMP
6、ONENTSCase1Assumefirmhasnodebt&hasretainedearnings.RememberfromthechapteronPerformanceMeasures:NetIncome=totaldividend+retainedearningsIfacompanycannotfindprofitableprojects,i.e.,projectswithreturnatleastequaltoks,thenthefirmshoulddistributeretainedearningstosha
7、reholdersasdividends.Thus,ifthecompanyisretainingyourmoney,thentheminimumacceptablerewardtoyou(anaverageinvestor)istherequiredreturnonequityYrequiredreturnonretainedearnings=ks/requiredreturnonequity.Butrewardtoinvestor=costofcapitaltothefirm.ˆrequiredreturnoneq
8、uity=costofretainedearnings.Case2Nowsupposefirmneedstoissuenewequityforanexpansionproject.Obviouslyke>ks](costofnewequity)>(costofretainedearnings)](requiredreturnonn
