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MOD 6 Cost of Capital and Valuation

MOD 6 Cost of Capital and Valuation. Yiwen Lin. Agenda. Relations among risk elements 60 months r eturns Beta Estimation and Regression Analysis Cost of Equity Capital using CAPM Cost of Debt capital and issues WACC Revisit DCF Model. Relations among risk elements.

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MOD 6 Cost of Capital and Valuation

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  1. MOD 6 Cost of Capital and Valuation Yiwen Lin

  2. Agenda • Relations among risk elements • 60 months returns • Beta Estimation and Regression Analysis • Cost of Equity Capital using CAPM • Cost of Debt capital and issues • WACC • Revisit DCF Model

  3. Relations among risk elements • Time value of money • Compensation for taking the risk of investing in the enterprise operations • Assumption1: current interest rates are a good approximation of expected interest rates • Assumption 2: current risk of the enterprise operations is a good approximation of the expected enterprise risk • Sources of risk: Inherent risk in the enterprise and debt • Enterprise risk: estimated by debt and equity

  4. Marketand firmreturns • DatafactsusedtoestimateBeta • Formula:Rn=(Pn-Pn-1)/Pn-1 • Use S&P 500 as the market anchor • 60 months (5 years) data ending 12/31/2013 • Data Source: Yahoo Finance

  5. S&P500marketreturn ExcerptData

  6. Panera return ExcerptData

  7. Beta Estimation andRegression Analysis • UsetheS&P500and Panera monthlyreturnsforcalculation • Beta=Covariance(rPNRA,rMkt) Variance(rMkt) • Reference:Bloomberg AdjustedBeta=0.874

  8. Beta Estimation ExcerptData

  9. Beta Comparison • Betarangesfrom0.761to1.180 • Outlier:YAHOOFINANCEbeta • Possiblecause:usedifferentdatatocalculatebeta • Conclusion:Use0.85 • Rationalization: • SimilartoBloomberg’sbeta0.874 • Sensitivityanalysisrepresentsasmallstandarddeviation • Lowconfidenceinthedatabecauseweusethepasttopredictthefuture

  10. Cost of Equity Capital using CAPM • rEq=rrf+[β × (rMkt–rrf)] • Marketriskpremiumestimation • Bloomberg:9.366% • GoldmanSachs:8.635% • S&P500:9.006% • Conclusion:use9.100% • Rationalization: • Lowconfidenceindatasourceduetopotentialvolatilityinthemarket • Averagereflectstheoveralloutlook

  11. Cost of Debt Capital • Issue1:Paneradoesnothavedebtoutstanding Thecompanyhasanetfinancialasset(NFA) • Possiblesolution:SimilartoDell,usethecashinvestmentreturntoapproximatecostofdebtcapital

  12. Cost of Debt Capital(Cont.) • Issue2:thecompanycloseditsStrategicCashportfolioin2007,andnocashinvestmentoutstandingasofQ32013. • Solution: What about other investments?

  13. Cost of Debt Capital(Cont.) • Issue3:Duetoliquidityneeds,Panerasoldoutitsheld-to-maturitymunicipalindustrialrevenuebondspriortomaturityasofQ32013. • Conclusion:Costofdebtcapital:0% • Cross-referencefromBloomberg:0%

  14. WACC

  15. WACC (Cont.) CrossreferencetoBloomberg:9.4%

  16. DCF Model from Mod 5

  17. Revisit DCF Model

  18. Final Conclusion • Conclusion:Nodramaticimpactonenterprisevaluewithupdatedrequiredrateofreturn. • 10%VS.9.383% • Lowconfidenceinthecalculationprocess • Weusecostofdebtandcostofequitytoestimatecostofenterprisecapital,however,theriskrelatedtoequityinvestmentarisesfromenterpriseoperationsandborrowing.

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