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  • ME Report (Lester)

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    Mazy Jennifer Gonzales
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    This document discusses capital and the cost of capital. It defines capital as financial wealth used to start or maintain a business. Capital can come from borrowing from banks (debt) or an owner's money (equity). The cost of debt is the interest rate paid on borrowings, while the cost of equity is the required rate of return for shareholders. The cost of capital depends on the source of funds - it is the interest rate for debt or dividend rate for equity. The weighted average cost of capital (WACC) weights the cost of each category of capital (debt and equity) based on its proportion of the total capital structure to determine a company's overall cost of capital.

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    CAPM

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    This document discusses capital and the cost of capital. It defines capital as financial wealth used to start or maintain a business. Capital can come from borrowing from banks (debt) or an owner's money (equity). The cost of debt is the interest rate paid on borrowings, while the cost of equity is the required rate of return for shareholders. The cost of capital depends on the source of funds - it is the interest rate for debt or dividend rate for equity. The weighted average cost of capital (WACC) weights the cost of each category of capital (debt and equity) based on its proportion of the total capital structure to determine a company's overall cost of capital.

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    © All Rights Reserved
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    7 views11 pages

    ME Report (Lester)

    Uploaded by

    Mazy Jennifer Gonzales
    This document discusses capital and the cost of capital. It defines capital as financial wealth used to start or maintain a business. Capital can come from borrowing from banks (debt) or an owner's money (equity). The cost of debt is the interest rate paid on borrowings, while the cost of equity is the required rate of return for shareholders. The cost of capital depends on the source of funds - it is the interest rate for debt or dividend rate for equity. The weighted average cost of capital (WACC) weights the cost of each category of capital (debt and equity) based on its proportion of the total capital structure to determine a company's overall cost of capital.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 11

    What is Capital?

    Refers to a financial wealth, that is used to start or maintain a business.


    Where does Capital come from?
    1.
    2.

    Borrow from the bank ( Debt )


    Owners Money ( Equity )

    What is the cost of Debt?


    Is the interest rate a company pays on its borrowings. Ex. Bank Interest Rate
    What is the cost of Equity?
    The required rate of return on investment of the common shareholders of the company.
    Can be calculated using CAPM
    What is the Cost of Capital?
    It depends on where did you get the money to start a company.
    -If you got the money from the Bank at 5% interest rate , then your cost of capital is 5%
    -If you got the money from investor at 10% dividend rate , then your cost of capital is 10%

    WACC
    Weighted Average Cost of
    capital
    WACC- is a calculation of a firms cost of capital in which
    each category of capital is proportionately weighted.
    All sources of capital, includingcommon,preferred
    stock,bondsand any other long-term debt.
    Debt and Equity.

    Capital
    40%

    60%

    EQUITY

    DEBT

    Cost of equity
    10%

    Cost of debt
    5%
    30% Tax rate

    E = value of equity
    D = value of debt
    V=D+E
    Re = cost of equity
    Rd = Cost of Debt
    Tc = Corporate Tax Rate

    WACC= 6.1 %

    he Rationale for Weighted Average Cost of Capital:


    Ex. Proposal of a new project.
    An acceptance criterion.

    ACCE
    PT

    3.9%

    DECLINE

    6.1
    %
    WACC

    LOSS
    1.1%

    5%

    PROFIT

    6.1
    %

    RATE
    WACC
    OF
    RETU
    RN if a Company has both
    emember: Only use WACC

    10%

    RATE
    OF
    RETU
    RN and Debt
    Equity

    Cost of
    Equity
    ital Asset Pricing Model (CAPM)- A model that describes the relationship between
    and expected (required) return.

    Cost of Equity

    Ex. Average RR in PSE

    5%
    Ex. Banks/ T-Bill

    Risk
    free

    3%
    Risk
    Free
    Rate

    Medium
    Risk

    Risk
    premium

    Higher
    Risk

    3%
    total= 8%

    BETA = 1.4

    What is Beta (

    )?

    An index of systematic risk. It measures the sensitivity of a stocks returns


    to changes in returns on the market portfolio. Ex. Volatility in the Stock Mar
    A stock with average risk has a
    beta of 1.0

    Low Risk Stocks have betas less than 1.0

    SMPH BETA 1.08

    Highrisk stocks have betas greater


    than 1.0

    MCP BETA 1.89

    JFC BETA 0.6

    Cost of Equity

    Ex. Average RR in PSE

    5%
    Ex. Banks/ T-Bill

    Risk
    free

    3%
    Risk
    Free
    Rate

    Medium
    Risk

    Risk
    premium

    Higher
    Risk

    ?
    10%

    3%
    total= 8%

    BETA = 1.4

    other method for determining the cost of equity is to use a


    nstant Growth Model.

    CAPM

    CONSTANT GROWTH MODEL

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