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Arguably, the role of a corporation's management is to increase the value of the firm to its shareholders while observing applicable laws and responsibilities. Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. Corporate finance deals with the strategic financial issues associated with achieving this goal, such as how the corporation should raise and manage its capital, what investments the firm should make, what portion of profits should be returned to shareholders in the form of dividends, and whether it makes sense to merge with or acquire another firm.The primary goal of corporate finance is to maximize shareholder value. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, short term decisions deal with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers). The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms “corporate finance” and “corporate financier” may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses.
(3) If no such opportunities exist.• • • • • • 1 Capital investment decisions o 1.3 Quantifying uncertainty o 1.2 The financing decision o 1. Decisions are based on several inter-related criteria. Capital investment decisions thus comprise an investment decision. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate in consideration of risk.1 The investment decision 1.1.3 The dividend decision o 1.1. maximizing shareholder value dictates that management must return excess cash to shareholders (i. distribution via dividends). (2) These projects must also be financed appropriately.1 Investment banking o 3.2 Financial risk management o 3. and a dividend decision.1.3 Personal and public finance 4 Alternate Approaches 5 See also 6 References 1 Capital investment decisions Capital investment decisions are long-term corporate finance decisions relating to fixed assets and capital structure. .2 Management of working capital 3 Relationship with other areas in finance o 3.e.1 Project valuation 1..4 Corporate finance theory and research 2 Working capital management o 2.1 Decision criteria o 2.2 Valuing flexibility 1. a financing decision.
or capital allocation. Project valuation .1.1. 1.1.1. Making this investment. decision requires estimating the value of each opportunity or project. which is a function of the size. timing and predictability of future cash flows. The investment decision Main article: Capital budgeting Management must allocate limited resources between competing opportunities (projects) in a process known as capital budgeting.
Thus. and this sum net of the initial investment outlay is the NPV. The difference between the two valuations is the "value of flexibility" inherent in the project. and the opportunity with the highest value. and must take into account the project-relevant financing mix. In conjunction with NPV. for example Research & Development projects. but this reality will not be captured in a strict NPV approach. Modified IRR. they may often be used interchangeably: Decision Tree Analysis (DTA) • DTA values flexibility by incorporating possible events (or states) and consequent management decisions. equivalent annuity. and use the weighted average cost of capital (WACC) to reflect the financing mix selected. a project may open (or close) various paths of action to the company. The two most common tools are Decision Tree Analysis (DTA) and Real options analysis (ROA). These are visible from the DCF and include discounted payback period. This requires estimating the size and timing of all of the incremental cash flows resulting from the project. Managers use models such as the CAPM or the APT to estimate a discount rate appropriate for a particular project. Management will therefore employ tools which place an explicit value on these options. the project appropriate discount rate. Alternatives (complements) to NPV include MVA / EVA (Joel Stern. there are several other measures used as (secondary) selection criteria in corporate finance. identifying the proper discount rate – often termed. Valuing flexibility In many cases.2. Stern Stewart & Co) and APV (Stewart Myers).1. The hurdle rate should reflect the riskiness of the investment. Such future cash flows are then discounted to determine their present value (Time value of money). whereas in a DCF valuation the most likely or average or scenario specific cash flows are discounted. the project "hurdle rate" – is critical to making an appropriate decision. See list of valuation topics. The hurdle rate is the minimum acceptable return on an investment—i. (For example. typically measured by volatility of cash flows. here the “flexible and staged nature” of the investment is modelled. capital efficiency. as measured by the resultant net present value (NPV) will be selected.In general. IRR.e. So. and hence "all" potential payoffs are considered. a company would build a factory given that demand . 1. each project's value will be estimated using a discounted cash flow (DCF) valuation. The NPV is greatly affected by the discount rate. These present values are then summed. and ROI.
As with all Decision Making methods. Key Points: Decision trees provide an effective method of Decision Making because they: • • • • Clearly lay out the problem so that all options can be challenged. management chooses the actions corresponding to the highest value path probability weighted. and assuming rational decision making. In a DCF (discounted cash flow) model. An example of the sort of thing you will end up with is shown in Figure 2: . Allow us to analyze fully the possible consequences of a decision. given further demand. decision tree analysis should be used in conjunction with common sense – decision trees are just one important part of your Decision Making tool kit.for its product exceeded a certain level during the pilot-phase. Provide a framework to quantify the values of outcomes and the probabilities of achieving them. Once the tree is constructed: (1) "all" possible events and their resultant paths are visible to management. each management decision in response to an "event" generates a "branch" or "path" which the company could follow. the probabilities of each event are determined or specified by management. and outsource production otherwise. by contrast. Help us to make the best decisions on the basis of existing information and best guesses. there is no "branching" – each scenario must be modelled separately. and maintain it otherwise. (3) This path is then taken as representative of project value. it would similarly expand the factory.) In the decision tree. In turn. (2) given this “knowledge” of the events that could follow.
(2) an appropriate valuation technique is then employed – usually a variant on the Binomial options model or a bespoke simulation model... the decision to be taken is identified as corresponding to either a call option or a put option. e.) 1. assumptions) to the DCF (discounted cash flow) model.. etc. For example. "global" factors (demand for the product. exchange rates.). Quantifying uncertainty Given the uncertainty inherent in project forecasting and valuation.. if sufficiently high. ceteris paribus. several variables may be of interest. commodity prices. Using a related technique. management will develop the ore body. while Black Scholes type formulae are used less often. the viability of a mining project is contingent on the price of gold. (3) The "true" value of the project is then the NPV of the "most likely" scenario plus the option value. a DCF valuation would capture only one of these outcomes. -5%. and their various combinations produce a "value-surface". analysts will wish to assess the sensitivity of project NPV to the various inputs (i. The sensitivity of NPV to a change in that factor is then observed. and is calculated as a "slope": ΔNPV / Δfactor. 0%. (or even a "valuespace".g.) Here: (1) Using financial option theory as a framework.Real options analysis (ROA) • ROA is usually used when the value of a project is contingent on the value of some other asset or underlying variable... if the price is too low.) where NPV is then a function of several variables. in the late 1990s.) as well as for company-specific factors (unit costs. Here. (For example.1.3.e. Again. management will abandon the mining rights.. viewing corporate strategy as a series of options was originally per Timothy Luehrman. etc. and then determine the sensitivity using this formula.). Often. In a typical sensitivity analysis the analyst will vary one key factor while holding all other inputs constant. analysts also run scenario based forecasts of NPV. the analyst will determine NPV at various growth rates in annual revenue as specified (usually at set increments. 5%. a scenario comprises a particular outcome for economy-wide. . -10%. (Real options in corporate finance were first discussed by Stewart Myers in 1977.
10% for "Likely Case" and 25% for "Best Case"). the various combinations of inputs must be internally consistent (see discussion at Financial modeling). or trials. These are often used as estimates of the underlying "spot price" and volatility for the real option valuation as above.g. This histogram provides information not visible from the static DCF: for example. where all key inputs are adjusted so as to be consistent with the growth assumptions. the analyst may specify various revenue growth scenarios (e. and the average NPV of the potential investment – as well as its volatility and other sensitivities – is then observed. Hertz in 1964. with corresponding valuations. For this purpose. such as @Risk or Crystal Ball.g. and calculate the NPV for each. which are then used to generate the NPV histogram. where possible. mathematically reflecting their "random characteristics". Here. Continuing the above example: instead of assigning three discrete values to revenue growth. where management determines a (subjective) probability for each scenario – the NPV for the project is then the probabilityweighted average of the various scenarios. a credit crunch) that drive variations in one or more of the DCF model inputs. "covering all conceivable real world contingencies in proportion to their likelihood". This method was introduced to finance by David B. The resultant statistics (average NPV and standard deviation of NPV) will be a more accurate mirror of the project's "randomness" than the variance observed under the scenario based approach.2.. the cash flow components that are (heavily) impacted by uncertainty are simulated.As an example. An application of this methodology is to determine an "unbiased" NPV. A more robust Monte Carlo model would include the possible occurrence of risk events (e. it allows for an estimate of the probability that a project has a net present value greater than zero (or any other value). and. A further advancement is to construct stochastic or probabilistic financial models – as opposed to the traditional static and deterministic models as above. The output is then a histogram of project NPV. the most common method is to use Monte Carlo simulation to analyze the project’s NPV. These distributions would then be "sampled" repeatedly – incorporating this correlation – so as to generate several thousand random but possible scenarios. whereas for the sensitivity approach these need not be so. typically using a risk-analysis add-in. 5% for "Worst Case". 1. Note that for scenario based analysis. the simulation produces several thousand random but possible outcomes. specify the observed or supposed correlation between the variables. the analyst would assign an appropriate probability distribution to each variable (commonly triangular or beta). although it has only recently become common: today analysts are even able to run simulations in spreadsheet based DCF models. and to the other relevant variables. The financing decision . In contrast to the scenario approach above. see Real options valuation: Valuation inputs.
 The sources of financing are. Equity financing is less risky with respect to cash flow commitments. since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected. control and earnings. but results in a dilution of share ownership. generically. There are two interrelated decisions here: • Management must identify the "optimal mix" of financing—the capital structure that results in maximum value.Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. The cost of equity is also typically higher than the cost of debt. and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk. thus entailing cash flow implications independent of the project's degree of success. As above. obtained by issuing new debt and equity (and hybrid. Management must attempt to match the long-term financing mix to the assets being financed as closely as possible. capital self-generated by the firm and capital from external funders. • . in terms of both timing and cash flows. Managing any potential asset liability mismatch or duration gap entails matching the assets and liabilities according to maturity pattern ("Cashflow matching") or duration ("immunization"). the financing mix will impact the valuation of the firm (as well as the other longterm financial management decisions). Financing a project through debt results in a liability or obligation that must be serviced.or convertible securities).
or hedging using interest rate. even though an opportunity is currently NPV negative. states that firms look for the cheaper type of financing regardless of their current levels of internal . For example.e. firms may elect to retain earnings or to perform a stock buyback. However economists have developed a set of alternative theories about financing decisions. The dividend decision Whether to issue dividends. If there are no NPV positive opportunities. projects where returns exceed the hurdle rate.3.or credit derivatives. in both cases increasing the value of shares outstanding. Also. such as securitization.managing this relationship in the short-term is a major function of working capital management. and capital investment needs have been met. Other techniques. One of the more recent innovations in this are from a theoretical point of view is the Market timing hypothesis. almost by definition. See Asset liability management. management may consider “investment flexibility” / potential payoffs and decide to retain cash flows. i. some companies will pay "dividends" from stock rather than in cash. 1. is calculated mainly on the basis of the company's unappropriated profit and its earning prospects for the coming year. In other cases. Management must also decide on the form of the dividend distribution. which suggests that firms avoid external financing while they have internal financing available and avoid new equity financing while they can engage in new debt financing at reasonably low interest rates. retain earnings so as to fund growth internally. Today. expect that the company will. see Corporate action. it is generally accepted that dividend policy is value neutral – i. Treasury management. This hypothesis. generally as cash dividends or via a share buyback.e. whether it issued cash dividends or repurchased its stock (see Modigliani-Miller theorem). Interest rate risk. institutional structure. as discussed below. are also common. source of financing (debt or equity) and expenditure framework within a given economy and under given market conditions. Capital structure substitution theory hypothesizes that management manipulates the capital structure such that earnings per share (EPS) are maximized. An emerging area in finance theory is right-financing whereby investment banks and corporations can enhance investment return and company value over time by determining the right investment objectives. Various factors may be taken into consideration: where shareholders must pay tax on dividends. Alternatively. inspired in the behavioral finance literature. cash remaining after all business expenses. then – finance theory suggests – management must return excess cash to shareholders as dividends. One of the main alternative theories of how firms make their financing decisions is the Pecking Order Theory (Stewart Myers). This is the general case. shareholders of a "growth stock". policy framework. The amount is also often calculated based on expected free cash flows i.e.  Corporate finance theory and research Most of the MBA level corporate finance falls under the umbrella of the Trade-Off Theory in which firms are assumed to trade-off the tax benefits of debt with the bankruptcy costs of debt when making their decisions. see above and Real options. Credit risk. and what amount. however there are exceptions. the value of the firm would be the same.
(Another measure is gross operating cycle which is the same as net operating cycle except that it does not take into account the creditors deferral period.resources. That is. A good starting point for the theoretical corporate finance literature is the book by Jean Tirole. and working capital management applies different criteria in decision making: the main considerations are (1) cash flow / liquidity and (2) profitability / return on capital (of which cash flow is probably the most important).) In this context. In so doing. the most useful measure of profitability is Return on capital (ROC). firm value is enhanced through appropriately selecting and funding NPV positive investments. or cash conversion cycle. This represents the time difference between cash payment for raw materials and cash collection for sales. exceeds the cost of . short term. As a result. i. As above. The goal of Working Capital (i. working capital decisions differ from capital investment decisions in terms of discounting and profitability considerations. firm value is enhanced when. These involve managing the relationship between a firm's short-term assets and its short-term liabilities. the return on capital. firm value is enhanced when. • • The most widely used measure of cash flow is the net operating cycle. In general this is as follows: As above. and cash requirements (Current Liabilities). in turn. have implications in terms of cash flow and cost of capital. Return on equity (ROE) shows this result for the firm's shareholders. although some constraints – such as those imposed by loan covenants – may be more relevant here). and that it has sufficient cash flow to service long term debt. The result is shown as a percentage. short term) management is therefore to ensure that the firm is able to operate.e. Because this number effectively corresponds to the time that the firm's cash is tied up in operations and unavailable for other activities. determined by dividing relevant income for the 12 months by capital employed. they are also "reversible" to some extent.e. Working capital management decisions are therefore not taken on the same basis as long term decisions. debt and equity. the decisions relating to working capital are always current. In the context of long term. decisions. the return on capital exceeds the cost of capital. and if. The cash conversion cycle indicates the firm's ability to convert its resources into cash. In addition to time horizon. working capital is the difference between resources in cash or readily convertible into cash (Current Assets).  Working capital management Main article: Working capital Decisions relating to working capital and short term financing are referred to as working capital management. and to satisfy both maturing shortterm debt and upcoming operational expenses. and if. management generally aims at a low net count. capital investment decisions.  Decision criteria Working capital is the amount of capital which is readily available to an organization. the goal of Corporate Finance is the maximization of firm value. See Economic value added (EVA). (Considerations as to Risk appetite and return targets remain identical. These investments.
Identify the cash balance which allows for the business to meet day to day expenses. demergers.e. demergers and takeovers of public companies. Debtors management. see Discounts and allowances. • • • • Cash management.capital. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials – and minimizes reordering costs – and hence increases cash flow. such that cash flows and returns are acceptable. Just In Time (JIT). see Supply chain management. development or expansion capital Mergers. Implement appropriate Credit scoring policies and techniques such that the risk of default on any new business is acceptable given these criteria. including the flotation of companies on a recognised stock exchange in order to raise capital for development and/or to restructure ownership Raising capital via the issue of other forms of equity. to describe activities. In the United Kingdom and Commonwealth countries. inventories and debtors) and the short term financing. start-up. as above. In the United States it is used. divisions or subsidiaries – typically backed by private equity Equity issues by companies. Short term financing.  Management of working capital Guided by the above criteria. but reduces cash holding costs. Economic production quantity (EPQ). the terms “corporate finance” and “corporate financier” tend to be associated with investment banking – i. given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier. credit terms which will attract customers. acquisitions or the sale of private companies Mergers. it may be necessary to utilize a bank loan (or overdraft).  Relationship with other areas in finance  Investment banking Use of the term “corporate finance” varies considerably across the world. Identify the appropriate source of financing. such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa). decisions and techniques that deal with many aspects of a company’s finances and capital. including public-to-private deals Management buy-out. however.e. Inventory management. i. These may include • • • • • • Raising seed. debt and related securities for the refinancing and restructuring of businesses . or to "convert debtors to cash" through "factoring". buy-in or similar of companies. These policies aim at managing the current assets (generally cash and cash equivalents. in that they link shortterm policy with long-term decision making. Economic order quantity (EOQ). management will use a combination of policies and techniques for the management of working capital. with transactions in which capital is raised for the corporation. ROC measures are therefore useful as a management tool. There are two inter-related roles here: Identify the appropriate credit policy.
whether by means of private placing or further issues on a stock market. especially when linked to the types of transactions listed above  Financial risk management Main article: Financial risk management See also: Financial engineering.• • • Financing joint ventures. Settlement risk. typically. There is a fundamental debate relating to "Risk Management" and shareholder value: in question is the shareholder's desire to optimize risk versus taking exposure to pure risk (a risk event that only has a negative side. sole proprietorships. especially where linked to one of the transactions listed above. Because corporations deal in quantities of money much greater than . Secondly. governments. It is common for large corporations to have risk management teams. forward contracts. the "second generation" exotic derivatives usually trade OTC. often these overlap with the internal audit function. foreign exchange rates and stock prices (market risk). such as loss of life or limb). for example. many still apply risk management informally. Firstly. IAS 39. "over the counter" (OTC) contracts tend to be costly to create and monitor. is focused on the impact on corporate value due to adverse changes in commodity prices. interest rates. Some of the tools developed by and for corporations have broad application to entities other than corporations. The debate links the value of risk management in a market to the cost of bankruptcy in that market. See Fisher separation theorem. Liquidity risk. Value at Risk. both disciplines share the goal of enhancing. Mark-to-market accounting. to partnerships. derivatives that trade on well-established financial markets or exchanges are often preferred. FASB 133. Volatility risk. see Cash flow hedge. mutual funds. Risk management  is the process of measuring risk and then developing and implementing strategies to manage ("hedge") that risk. futures contracts. It will also play an important role in short term cashand treasury management. Interest rate risk. Financial risk management. Because company specific. infrastructure finance. and swaps. Raising debt and restructuring debt. firm exposure to business and market risk is a direct result of previous Investment and Financing decisions. and personal wealth management. But in other cases their application is very limited outside of the corporate finance arena. Financial risk. firm value. Operational risk. The discipline typically focuses on risks that can be hedged using traded financial instruments. Foreign exchange hedge. These standard derivative instruments include options.  Personal and public finance Corporate finance utilizes tools from almost all areas of finance. Note that hedging-related transactions will attract their own accounting treatment: see Hedge accounting. not-for-profit organizations. While it is impractical for many small firms to have formal risk management teams. Derivatives are often employed here. Default (finance). or preserving. Credit risk. project finance. public-private partnerships and privatisations Secondary equity issues. This area is related to corporate finance in two ways.
Chance 1. Campbell R. particularly related to stock buybacks made purportedly to "return value to shareholders. however. Prof. New York University's Stern School of Business 2. Aswath Damodaran. It can be differentiated from personal finance and public finance.g.individuals. the analysis has developed into a discipline of its own. Don M. Recently.  Alternate Approaches A standard assumption in Corporate finance is that shareholders are the residual claimants and that the primary goal of executives should be to maximize shareholder value. ." which is predicated on a legally erroneous assumption. This criticism in turn brings into question the advice of corporate finance. Harvey. Prof.  See also Book: Finance Wikipedia books are collections of articles that can be downloaded or ordered in print. Lynn Stout ) have questioned this assumption. ^ See: Investment Decisions and Capital Budgeting. implying that the assumed goal of maximizing shareholder value is inappropriate for a public corporation. ^ The framework for this section is based on Notes by Aswath Damodaran at New York University's Stern School of Business 3. legal scholars (e. Wikiversity has learning materials about Corporate finance • • • • • • • Financial modeling Business organizations Financial planning Investment bank Venture capital Right-financing Factoring (finance) Lists: • • List of accounting topics List of finance topics o List of corporate finance topics o List of valuation topics  References ^ See Corporate Finance: First Principles. The Investment Decision of the Corporation.
Working Capital Management. Prof. April 2005 (revised January 2011) 22. Prof. Alfred Rappaport Columbia University & Michael Mauboussin 10. mining companies sometimes employ the “Hill of Value” methodology in their planning. LL. Don M. Aswath Damodaran 11.com. Prof. Market Volatility & Proposed Changes. Aswath Damodaran. ^ a b See Probabilistic Approaches: Scenario Analysis. Harvey ^ See for example Campbell R. Stanford University. Prof. ^ See: Valuation. "How Mining Companies Improve Share Price by Destroying Shareholder Value" 12.com 6. ^ See: The Financing Decision of the Corporation. ^ a b See: "Capital Budgeting Under Risk". How Do You Assess The Value of A Company's "Real Options"?. Cohen. ^ See The 20 Principles of Financial Management. John C. "Defining corporate finance in the UK". 25. Decision Tree Primer. Capital Structure. Hall. Ch. Kirkwood Arizona State University 8. Aswath Damodaran. Harvey's Hypertextual Finance Glossary or investopedia. ^ See: Global Association of Risk Professionals (GARP). Aswath Damodaran 15. 14. Don M. ^ For example. Campbell R.com. ^ See:Optimal Balance of Financial Instruments: Long-Term Management. Prof. Aswath Damodaran 18. 9. Harvey.9 in Schaum's outline of theory and problems of financial management. Prof. Los Angeles School of Law Research Paper No. Groth. Citigroup 16. Jae K. Prof. Louisiana State University 21. ^ See Working Capital Management. 13. Prof. Prof. Applications of option pricing theory to equity valuation. treasury. Stout (2007). Bad and Not-So-Bad Arguments for Shareholder Primacy. Siegel. ^ The Flaw of Averages. mindtools. Equity Valuation. B. REGULATION Spring 2007. Corporate Finance Faculty. Prof.4. Campbell R. ^ Beaney. Professional Risk Managers' International Association (PRMIA) 23. 5. ICAEW.. Studyfinance. Stout (2002). Lynn A.govt.g. ^ Capital Structure: Implications. University of California. e. Prof. [hide] • v . ^ See: Quantifying Corporate Financial Risk. ^ See:Identifying real options. Sam Savage. Prof. Decision Trees and Simulations. Tom Arnold & Richard Shockley 7. Shim and Joel G. George Washington University Law School 17. ^ See The theory of Corporate Finance. A Generalised Procedure for Locating the Optimal Capital Structure. ^ Lynn A. 2011 (Business & finance). Chance. Craig W.nz 20. Shaun.M. Texas A&M University. The Mythical Benefits of Shareholder Control. Nishant Choudhary. see. ^ See: Real Options Analysis and the Assumptions of the NPV Rule. E. David Shimko. ^ See: Decision Tree Analysis. Princeton University Press 19. Prof. Ruben D. Chance. ^ See Dividend Policy.
• • t e Corporate finance and investment banking Senior secured debt · Senior debt · Second lien debt · Subordinated debt · Mezzanine debt · Convertible debt · Exchangeable debt · Preferred equity · Warrant · Shareholder loan · Common equity · Pari passu Initial public offering (IPO) · Secondary market offering (SEO) · Follow-on offering · Rights issue · Equity offerings Private placement · Spin out · Equity carveout · Greenshoe (Reverse) · Book building · Bookrunner · Underwriter Mergers and Takeover · acquisitions Reverse takeover · Tender offer · Proxy fight · Capital structure Transactions (terms / conditions) .
Poison pill · Staggered board · Squeeze out · Tag-along right · Dragalong right · Pre-emption right · Control premium · Due diligence · Divestment · Sell side · Buy side · Demerger · Supermajority · Pitch book Leveraged buyout · Leveraged recap · Financial sponsor · Private equity · Bond offering · High-yield debt · DIP financing · Project finance · Debt restructuring Leverage .
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Companies raise money from a number of sources: common equity. Companies can use WACC to see if the investment projects available to them are worthwhile to undertake.1 Contents [hide] • • • • 1 Calculation 2 See also 3 References 4 External links 1.htm The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. or they will invest elsewhere. and so on. a non-profit organization.wikipedia. Different securities. and other providers of capital.edu/~adamodar/New_Home_Page/cflect.stern.2  Calculation In general. warrants.. which represent different sources of finance. is the required rate of return for security .• Wikipedia® is a registered trademark of the Wikimedia Foundation.org/wiki/Corporate_finance http://pages. straight debt. the WACC can be calculated with the following formula: where is the number of sources of capital (securities. convertible debt. governmental subsidies. the more laborious it is to calculate the WACC. The WACC is calculated taking into account the relative weights of each component of the capital structure. exchangeable debt. The more complex the company's capital structure. in a country with corporate tax rate is calculated as: . executive stock options. are expected to generate different returns. 1. the WACC for a company financed by one type of shares with the total market value of and cost of equity and one type of bonds with the total market value of and cost of debt . For example. Contact us http://en. preferred equity. The WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors. pension liabilities. Tax effects can be incorporated into this formula. types of liabilities). options. Inc. owners.nyu. is the market value of all outstanding securities .