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Module 6 – Cost of Capital Junichi Hara

Module 6 – Cost of Capital Junichi Hara. Agenda. Cost of Equity Cost of Debt WACC. 1. Cost of Equity. CAPM. Find r Eq using Capital Asset Pricing Model. 3 inputs needed: Risk free return Market return Beta. Input 1 – Risk Free Rate.

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Module 6 – Cost of Capital Junichi Hara

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  1. Module 6– Cost of CapitalJunichi Hara

  2. Agenda • Cost of Equity • Cost of Debt • WACC

  3. 1. Cost of Equity

  4. CAPM • Find rEq using Capital Asset Pricing Model 3 inputs needed: Risk free return Market return Beta

  5. Input 1 – Risk Free Rate • Monthly price of 30 Years Treasury Yield Bond • 60 months collected from Yahoo! Finance • Annualized return: 2.78%

  6. Input 2 – Market Return • Monthly price of S&P 500 Index • 60 months collected from Yahoo! Finance • Annualized return: 17.98%

  7. Input 3 - Beta • Three options: • Calculate myself • Bloomberg • Other sites

  8. Beta – Calculate Myself • Run a regression in Excel • Dependent variable: WMT • Independent variable: S&P 500

  9. Beta – Calculate Myself

  10. Beta – Calculate Myself Beta: 0.310 Represents how “sensitive” Walmart’s stock value is to entire market. Walmart seems pretty insensitive. Makes sense. Sells non-luxury goods and essentials

  11. Beta – Calculate Myself Intercept: 0.006 Represents return on equity if beta were zero. Value is independent of market. Could be seen as risk free rate (e.g. treasury bond).

  12. Beta – Calculate Myself Standard error Represents part of return unexplained by just Beta. Could reduce this by using more complex multi-variable model.

  13. Input 3 - Beta • Three options: • Calculate myself - 0.310 • Bloomberg • Other sites

  14. Beta - Bloomberg

  15. Beta - Bloomberg • Beta: 0.490

  16. Input 3 - Beta • Three options: • Calculate myself - 0.310 • Bloomberg - 0.490 • Other sites

  17. Other Sites

  18. Input 3 - Beta • Three options: • Calculate myself - 0.310 • Bloomberg - 0.490 • Other sites - 0.408 • Which beta do I use?

  19. Input 3 - Beta • Three options: • Calculate myself - 0.310 • Bloomberg - 0.490 • Other sites - 0.408 • Use average:0.403

  20. CAPM • rf= 2.78% • rMkt= 17.98% • β = 0.403 • re = 7.10%

  21. 2. Cost of Debt

  22. Two Methods • RNFL Method • Borrowing Rate Method

  23. 1. RNFL Method • RNFL ≈ rd • Utilize reformulated financial statements

  24. 1. RNFL Method • Average RNFL - 2.63%

  25. Two Methods • RNFL Method - 2.63% • Borrowing Rate Method

  26. 2. Borrowing Rate Method • rD = Pretax borrowing rate X (1 – Tax rate) • Where to find borrowing rate?

  27. Footnote • \ • “Thereafter” best indicator of long term?

  28. 2. Borrowing Rate Method • rD= 5.3% X (1 - 37%) = 3.34%

  29. Two Methods • RNFL Method - 2.63% • Borrowing Rate Method 3.34%

  30. Final Cost of Debt • RNFL Method - 2.63% • Borrowing Rate Method 3.34% Average (rd to use for WACC): 2.99%

  31. 3. WACC

  32. WACC Calculation • VD – Book value of NFL • VEq= Market cap of WMT • VEnt= Sum of net debt and equity

  33. WACC Calculation • VD– $60,050 • VEq= $242,040 • VEnt= $302,090

  34. WACC Calculation • Plug in everything • WACC = 6.28%

  35. Bloomberg • My WACC: 6.28% • Bloomberg: 6.50%

  36. Questions?

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