# Weighted Average Cost of Capital For an Apartment Real Estate Investment Trust

Save this PDF as:

Size: px
Start display at page:

Download "Weighted Average Cost of Capital For an Apartment Real Estate Investment Trust"

## Transcription

1 Weighted Average Cost of Capital For an Apartment Real Estate Investment Trust Presented by Lawrence A. Souza Director of Research Professor of Real Estate Finance and Development San Francisco State University American Real Estate Society 16th Annual ARES Meeting Santa Barbara, California Thursday, March 30, 2000

2 Outline Introduction Assumptions Methodology Cost of Debt Financing Cost of Equity Financing Discounted Cash Flow Risk-Primia Method (RP) Capital Asset Pricing Model (Fama-French Three-Factor) (CAPM) Weighted Average Cost of Capital (WACC) Discussion of Results Conclusions

3 Introduction The goal of this analysis is to determine the Weighted Average Cost of Capital for an apartment REIT. The purpose is to give REIT managers a good approach to arriving at the true cost of capital (WACC) for benchmarking against future acquisitions (IRR).

4 Introduction Using a standard corporate finance approach, the Weighted Average Cost of Capital (WACC) is calculated in four steps: Step #1: Step #2: Step #3: Step #4: Estimate Weighted Average Cost of Debt Estimate Cost of Equity Capital Calculate weights for total debt and equity as a percent of total capital structure Add Weighted Cost of Debt to Weighted Cost of Equity to arrive at Weighted Average Cost of Capital (WACC)

5 Assumptions Cost of Capital (COC): Over the long run, must sufficiently compensate debt and equity holders. Composite of capital cost from various funding sources making up capital structure. Minimum rate of return earned on new investment, as not to dilute shareholder interest. Can be used as a discount rate for NPV analysis. Used as benchmark, hurdle rate, when evaluating IRRs. As larger sums of capital raised, cost of debt and equity rise.

6 Assumptions Weighted Average Cost of Capital: Weighted average cost of each new dollar of capital raised at the margin. WACCi = (we x Rei) + (wd x Rdi) where, WACCi = Weighted average cost of capital for company i; we = Weight of equity capital in company i s capital structure, equal to equity capital divided by total capital; REi = Cost of equity for company i; wd = Weight of debt capital in company i s capital structure. Equal to debt capital divided by total capital; RDi = Cost of debt for company i;

7 Assumptions Cost of Retained Earnings: Rate of return stockholders require on the firm s common stock. Opportunity cost if earnings are retained. Should be competitive with alternative investments. If not competitive, paid out as dividends.

8 Assumptions Equity Cost of Capital: Expected mean rate of return for firm s equity, dividends and capital gains or losses. Includes factor costs: Flotation Illiquidity Information Asymmetries

9 Assumptions Debt Cost of Capital: Return firm s creditors demand on new borrowing. Observed directly or indirectly in the market. Risk-free rate plus credit and duration spread premium.

10 Assumptions Discounted Cash Flow Model (Single-Stage): where, Ri = Cost of equity for company i; Di = Summation of prior twelve month s dividend per share for company i; gi = Expected constant earnings growth rate for company i per the ACE database; and, Pi = Most recent price per common share for company i. Notes: 1) Assumes earnings grow at constant rate. 2) Cost of equity is sensitive and positively correlated to estimated growth rate. 3) Does not explicitly consider risk as does risk-premium and CAPM.

11 Assumptions Capital Asset Pricing Model (OLS): where, ki = Expected Future cost of equity; Rf = Rate on risk-free asset; long-term government bond yield for March 31, 1997 (7.2%); bi = Levered beta of company i; and, ERP = Expected equity risk premium. Average of the risk-free rate minus the return on the market. Long-horizon version from Ibbotson Associates' Stocks, Bonds, Bills, and Inflation 1998 Yearbook (7.8%). Notes: 1) Requires estimates of market risk premium and true beta coefficient. 2) Assumes that risk premium is linearly proportionate to the amount of risk taken. 3) Market price of risk is the expected risk premium multiplied by the beta, reflecting market risk.

12 Assumptions Capital Asset Pricing Model (Three-Factor Fama-French): where, ki = Cost of equity; Rf = Rate on risk-free asset; long-term government bond yield for March 31, 1997 (7.2%); bi = Market coefficient in the Fama-French regression; ERP = Expected equity risk premium. Long-horizon version from Ibbotson Associates' SBBI 1998 Yearbook (7.8%); si = Small-minus-big coefficient in the Fama-French regression; SMBP =Expected small-minus-big risk premium, estimated as the difference between the historical average annual returns on the small-cap and large-cap portfolios, which is 3.70%; hi = high-minus-low coefficient in the Fama-French regression; and, HMLP =Expected high-minus-low risk premium, estimated as the difference between the historical average annual returns on the high market-to-book and low market-to-book portfolios, which is 5.04%.

13 Assumptions Systematic Risk: Unavoidable Derived from external, macroeconomic factors Systematic risk is rewarded with risk premium Size of risk premium proportionate to degree of comovement (beta) with market. Unsystematic Risk: Avoidable through diversification. Not rewarded with risk premium.

14 Assumptions Levered Beta Coefficient: Measures systematic risk for equity shareholders. No adjustment for the debt financing. Incorporates business and financing risks born by equity shareholders. Measures stock s systematic risk, degree returns move with market. Expected or forecast value, not observable, use historical. Moves toward 1.0 as firm size increases. Use monthly return data against S&P 500 index for five years. Use Three Factor Fama-French beta to capture firm size affect.

15 Assumptions Risk-Free Rate: CAPM assumes presence of single risk-less asset. Obligations are default-free. Use 20-year T-bond yield as proxy for risk-free rate. Analysis considers upward shifts in yield curve due to: Economic shocks Restrictive monetary policy Higher expected inflation

16 Assumptions Expected Equity Market Risk Premium: Unobservable in market, estimated from ex post data. Difference between mean market return and mean return on risk-less security. Computed from annual 1926 to 1997, stationary. Discount Rate: Risk-free rate plus company-capital market risk premium.

17 Assumptions Depreciation: First increment of internal funds used to finance investment. Opportunity cost of capital is WACC of existing capital structure. Weighting Methods: Future capital structure (Assets and Capital Markets) Methods: Existing proportions of capital components. Current proportions of market values of outstanding securities. Proportions of target or optimal capital structure.

18 Assumptions Capital Budgeting: No significant budget constraint (capital rationing). Accept projects with positive NPVs. Project cost of capital is same as for existing assets with similar risk/return. Cost of capital is specific to investment, not investor.

19 Methodolgy: : Step #1 Weighted Average Cost of Debt Financing (WACDF): Where, WACDF = LTUDi (WLTUD) + SDi (WSD) + ULCi (WULC) 7.0%~7.4% = 7.5% (44.7%) + 7.7% (41.1%) + 6.4% (14.2%) W = Weight of debt instrument as a percent of total debt financing. LTUDi = Weighted average interest rate on L-T unsecured debt (credit). SDi = Weighted average interest rate on secured debt (mortgages). ULCi = Weighted average interest rate on unsecured lines of credit (bank).

20 Methodolgy: : Step #2 Cost of Equity Financing (CEF): Discounted Cash Flow (FFO) Method (DCF) Where, CECDCF = Sum [PV (DFFOPS(1+g) t+1 -DFFOPS t )]/SP 14.3% = [\$4.21]/\$29.45 (Range: 12.8% %) SP = Target stock price (\$29.45) g = Future FFO growth rate (10%) DFFOP = SP * FFO Yield in Base Year (7.1%) L-T risk-free yield = 6.2% Discount Rate = 8.1% FFO Multiple = 14

21 Methodolgy: : Step #2 Risk-Primia Method (RP): Where, ECCRP L-T = Rf L-T + B [RP L-T ] 14.0% = 6.2% (7.8%) (Range: 14.0% %) L-T 20 year risk-free yield = 6.2% Historical risk premium = 7.8% Beta Coef. = 100%

22 Methodolgy: : Step #2 Capital Asset Pricing Model (CAPM): Where, ECCCAPM L-T = Rf L-T + B n [RP L-T ] 8.1% = 6.2% +.24 (7.8%) (Range: 10.4% %) L-T 20 year risk-free yield = 6.2% Historical risk premium = 7.8% Apartment REIT Industry Market Cap Weighted Beta = 24%

23 Methodolgy: : Step #3 Capital Structure Weights (Existing/Target): Where, 100% = (MC E /TMC D+E ) + (MC D /TMC D+E ) 100% = 67% + 33% MC D = Total market cap debt (\$660 million). MC E = Total market cap equity (\$1.34 billion). TMC = Total market cap debt and equity (\$2 billion).

24 Methodolgy: : Step #4 Weighted Average Cost of Capital: Discounted Cash Flow (FFO) Method (DCF) Where, WACC DCF = [(we) x (Rei)] + [(wd) x (Rdi)] 12.0%~11.9% = [(.67) x (.143)] + [(.33) x (.07)] (Range: %)

25 Methodolgy: : Step #4 Risk-Primia Method (RP) Where, WACC RP = [(we) x (Rei)] + [(wd) x (Rdi)] 12.0%~11.7% = [(.67) x (.14)] + [(.33) x (.07)] (Range: 11.6% %)

26 Methodolgy: : Step #4 Capital Asset Pricing Model (CAPM) Where, WACC CAPM = [(we) x (Rei)] + [(wd) x (Rdi)] 8.0%~7.7% = [(.67) x (.081)] + [(.33) x (.07)] (Range: 6.2% - 9.1%)

27 Discussion of Results Weighted average cost of capital calculations based on historical data: Risk premiums Betas Current risk-free rates WACCs could be higher after taking into consideration: Rising interest rates Wider credit spreads Higher returns on alternative capital market investments Lower target stock price Higher systematic risk

28 Metro Area Apartment Cycles and their Trends CONCLUSIONS Institutionalization, securitization and internationalization of real estate is placing new demands on management to learn the concept of cost of capita. Cost of capital is the most decisive factor in REIT performance and competition as opportunities for external growth diminish and individual deals make a smaller impact on total portfolio return. Institutional investors are demanding long run accretion, requiring IRRs in excess of WACC (Franchise Value). Better rated companies will utilize more debt in the future to further drive down the weighted average cost of capital. Cost of capital is only a criterion that should be examined with other data with respect to business decisions and not the sole criterion.

### NIKE Case Study Solutions

NIKE Case Study Solutions Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the

### A Basic Introduction to the Methodology Used to Determine a Discount Rate

A Basic Introduction to the Methodology Used to Determine a Discount Rate By Dubravka Tosic, Ph.D. The term discount rate is one of the most fundamental, widely used terms in finance and economics. Whether

### Models of Risk and Return

Models of Risk and Return Aswath Damodaran Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for

### Current Ratio: Current Assets / Current Liabilities. Measure of whether company has enough cash to cover immediate expenses

1 Beta: a measure of a stock s volatility relative to the overall market (typically the S&P500 index is used as a proxy for the overall market ). The higher the beta, the more volatile the stock price.

### Risk (beta), Return & Capital Budgeting Chpt. 12: problems 2,6,9,13,15. I. Applications of CAPM. 1) risk premium

Risk (beta), Return & Capital Budgeting Chpt. 12: problems 2,6,9,13,15 I. Applications of CAPM 1) risk premium estimate from historical data (Ibbotson) 2) risk free rate Tbill vs. Tbond, consistent with

### OMEGA HEALTHCARE INVESTORS, INC. FUNDS FROM OPERATIONS Unaudited (In thousands, except per share amounts) Pro Forma Analysis

OMEGA HEALTHCARE INVESTORS, INC. FUNDS FROM OPERATIONS (In thousands, except per share amounts) Net income available to common stockholders. \$ 25,592 Deduct gain from real estate dispositions.. (11,806)

### Chapter 9 The Cost of Capital ANSWERS TO SELEECTED END-OF-CHAPTER QUESTIONS

Chapter 9 The Cost of Capital ANSWERS TO SELEECTED END-OF-CHAPTER QUESTIONS 9-1 a. The weighted average cost of capital, WACC, is the weighted average of the after-tax component costs of capital -debt,

### Corporate Finance. Slide 1 咨询热线 : 学习平台 : lms.finance365.com

Corporate Finance Capital Budgeting Cost of Capital Measures of Leverage Dividends and Share Repurchases Working capital management Corporate Governance of Listed Companies Slide 1 Capital Budgeting Slide

### The cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction

The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal

### Some common mistakes to avoid in estimating and applying discount rates

Discount rates Some common mistakes to avoid in estimating and applying discount rates One of the most critical issues for an investor to consider in a strategic acquisition is to estimate how much the

### The Cost of Capital. Chapter 10. Cost of Debt (r d ) The Cost of Capital. Calculating the cost of obtaining funds for a project

The Cost of Capital Chapter 10 (def) - Cost of obtaining money to fund asset purchase - use as estimate of r (discount rate) If we can earn more than the cost of capital (r) from a project than company

### SampleFinal Finance 320 Finance Department

SampleFinal Finance 320 Finance Department Name Chapters: 1, 2, 3, 4, 5, 6, 7, 8, 9, 11, 12, and 13 1) A C corporation earns \$4.50 per share before taxes. The corporate tax rate is 35%, the personal tax

### Homework Solutions - Lecture 2

Homework Solutions - Lecture 2 1. The value of the S&P 500 index is 1286.12 and the treasury rate is 3.43%. In a typical year, stock repurchases increase the average payout ratio on S&P 500 stocks to over

### Topics CHAPTER 9. What types of long-term capital do firms use? Capital Components. Before-tax vs. After-tax Capital Costs

Topics CHAPTER 9 The Cost of Capital Cost of Capital Components Debt Preferred Common Equity WACC 1 2 What types of long-term capital do firms use? Long-term debt Preferred stock Common equity Capital

### Chapter 11 Calculating the Cost of Capital

Chapter 11 Calculating the Cost of Capital (def) - Cost of obtaining money to fund asset purchase - use as estimate of r (discount rate) If we can earn more than the cost of capital (r) from a project

### CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.

### INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK

INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK Bank of Tokyo-Mitsubishi Professor of Economics and Finance Sloan School of Management Massachusetts Institute

### 1. CFI Holdings is a conglomerate listed on the Zimbabwe Stock Exchange (ZSE) and has three operating divisions as follows:

NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY FACULTY OF COMMERCE DEPARTMENT OF FINANCE BACHELOR OF COMMERCE HONOURS DEGREE IN FINANCE PART II 2 ND SEMESTER FINAL EXAMINATION MAY 2005 CORPORATE FINANCE

### INTERVIEWS - FINANCIAL MODELING

420 W. 118th Street, Room 420 New York, NY 10027 P: 212-854-4613 F: 212-854-6190 www.sipa.columbia.edu/ocs INTERVIEWS - FINANCIAL MODELING Basic valuation concepts are among the most popular technical

### MBA 8230 Corporation Finance (Part II) Practice Final Exam #2

MBA 8230 Corporation Finance (Part II) Practice Final Exam #2 1. Which of the following input factors, if increased, would result in a decrease in the value of a call option? a. the volatility of the company's

### Estimating Cost of Capital. 2. The cost of capital is an opportunity cost it depends on where the money goes, not where it comes from

Estimating Cost of Capal 1. Vocabulary the following all mean the same thing: a. Required return b. Appropriate discount rate c. Cost of capal (or cost of money) 2. The cost of capal is an opportuny cost

### ( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100

Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded

### OMEGA HEALTHCARE INVESTORS, INC. FUNDS FROM OPERATIONS Unaudited (In thousands, except per share amounts)

OMEGA HEALTHCARE INVESTORS, INC. FUNDS FROM OPERATIONS (In thousands, except per share amounts) Three Months Ended Net income... \$ 113,154 Deduct gain from real estate dispositions... (13,221) Sub-total...

### Equity Risk Premiums: Looking backwards and forwards

Equity Risk Premiums: Looking backwards and forwards Aswath Damodaran Aswath Damodaran 1 What is the Equity Risk Premium? Intuitively, the equity risk premium measures what investors demand over and above

### Chapter 13, ROIC and WACC

Chapter 13, ROIC and WACC Lakehead University Winter 2005 Role of the CFO The Chief Financial Officer (CFO) is involved in the following decisions: Management Decisions Financing Decisions Investment Decisions

### Equity Risk Premium Article Michael Annin, CFA and Dominic Falaschetti, CFA

Equity Risk Premium Article Michael Annin, CFA and Dominic Falaschetti, CFA This article appears in the January/February 1998 issue of Valuation Strategies. Executive Summary This article explores one

### Chapter 11 The Cost of Capital ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 11 The Cost of Capital ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 11-1 a. The weighted average cost of capital, WACC, is the weighted average of the after-tax component costs of capital -debt,

### Fundamentals Level Skills Module, Paper F9

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2008 Answers 1 (a) Calculation of weighted average cost of capital (WACC) Cost of equity Cost of equity using capital asset

### Use the table for the questions 18 and 19 below.

Use the table for the questions 18 and 19 below. The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price

### Fundamentals Level Skills Module, Paper F9

Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2008 Answers 1 (a) Rights issue price = 2 5 x 0 8 = \$2 00 per share Theoretical ex rights price = ((2 50 x 4) + (1 x 2 00)/5=\$2

### Economic Feasibility Studies

Economic Feasibility Studies ١ Introduction Every long term decision the firm makes is a capital budgeting decision whenever it changes the company s cash flows. The difficulty with making these decisions

### CORPORATE FINANCE REVIEW FOR THIRD QUIZ. Aswath Damodaran

CORPORATE FINANCE REVIEW FOR THIRD QUIZ Aswath Damodaran Basic Skills Needed What is the trade off involved in the capital structure choice? Can you estimate the optimal debt ratio for a firm using the

### a) The Dividend Growth Model Approach: Recall the constant dividend growth model for the price of a rm s stock:

Cost of Capital Chapter 14 A) The Cost of Capital: Some Preliminaries: The Security market line (SML) and capital asset pricing model (CAPM) describe the relationship between systematic risk and expected

### 1. What are the three types of business organizations? Define them

Written Exam Ticket 1 1. What is Finance? What do financial managers try to maximize, and what is their second objective? 2. How do you compare cash flows at different points in time? 3. Write the formulas

### Cash flow before tax 1,587 1,915 1,442 2,027 Tax at 28% (444) (536) (404) (568)

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2014 Answers 1 (a) Calculation of NPV Year 1 2 3 4 5 \$000 \$000 \$000 \$000 \$000 Sales income 5,670 6,808 5,788 6,928 Variable

### ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure

ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for \$40/share. Your analysis of the company

### CAPITALIZATION/DISCOUNT

Fundamentals, Techniques & Theory CAPITALIZATION/DISCOUNT RATES CHAPTER FIVE CAPITALIZATION/DISCOUNT RATES I. OVERVIEW Money doesn t always bring happiness People with ten million dollars are no happier

### Things to Absorb, Read, and Do

Things to Absorb, Read, and Do Things to absorb - Everything, plus remember some material from previous chapters. This chapter applies Chapter s 6, 7, and 12, Risk and Return concepts to the market value

### Cost of Capital Basics

Cost of Capital Basics The corporate cost of capital is a blend (weighted average) of the costs of the financing components. It is used as a benchmark rate of return in new new project evaluations. Key

### FINANCIAL PLANNING ASSOCIATION OF MALAYSIA

FINANCIAL PLANNING ASSOCIATION OF MALAYSIA MODULE 4 INVESTMENT PLANNING Course Objectives To understand the concepts of risk and return, the financial markets and the various financial instruments available,

### Discussion of Discounting in Oil and Gas Property Appraisal

Discussion of Discounting in Oil and Gas Property Appraisal Because investors prefer immediate cash returns over future cash returns, investors pay less for future cashflows; i.e., they "discount" them.

1.0 FINANCING PRINCIPLES Module 1: Corporate Finance and the Role of Venture Capital Financing Financing Principles 1.01 Introduction to Financing Principles 1.02 Capitalization of a Business 1.03 Capital

### Cost of Capital Presentation for ERRA Tariff Committee Dr. Konstantin Petrov / Waisum Cheng / Dr. Daniel Grote April 2009 Experience you can trust.

Cost of Capital Presentation for ERRA Tariff Committee Dr. Konstantin Petrov / Waisum Cheng / Dr. Daniel Grote April 2009 Experience you can trust. Agenda 1.Definition of Cost of Capital a) Concept and

### 1 (a) Net present value of investment in new machinery Year 1 2 3 4 5 \$000 \$000 \$000 \$000 \$000 Sales income 6,084 6,327 6,580 6,844

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2013 Answers 1 (a) Net present value of investment in new machinery Year 1 2 3 4 5 \$000 \$000 \$000 \$000 \$000 Sales income 6,084

### Source of Finance and their Relative Costs F. COST OF CAPITAL

F. COST OF CAPITAL 1. Source of Finance and their Relative Costs 2. Estimating the Cost of Equity 3. Estimating the Cost of Debt and Other Capital Instruments 4. Estimating the Overall Cost of Capital

### Answers to Concepts in Review

Answers to Concepts in Review 1. A portfolio is simply a collection of investments assembled to meet a common investment goal. An efficient portfolio is a portfolio offering the highest expected return

### NIKE Case Study. Professor Corwin. An overview of the individual questions and their relation to the lecture topics is provided below.

NIKE Case Study Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the most important

### The Tangent or Efficient Portfolio

The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of reward-to-volatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r

### Valuating the levered firm

Valuating the levered firm Valuation and Capital Budgeting for the Levered Firm 18-0 Introduction In a strict MM world, firms can analyze real investments as if they are all-equity-financed. Under MM assumptions,

### Discounted Cash Flow Valuation: Basics

Discounted Cash Flow Valuation: Basics Aswath Damodaran Aswath Damodaran 1 Discounted Cashflow Valuation: Basis for Approach Value = t=n CF t t =1(1+r) t where CF t is the cash flow in period t, r is the

### The Equity Risk Premium and its Relevance for Financial Market Practitioners

Financial Market Practitioners Professor Jeremy Batstone-Carr, Director of Private Client Research University of the West of England, Friday 27 June 2014 MADE FOR YOU What is Equity Risk Premium? The difference

### The Weighted Average Cost of Capital

The Weighted Average Cost of Capital What Does "Cost of Capital" Mean? "Cost of capital" is defined as "the opportunity cost of all capital invested in an enterprise." Let's dissect this definition: Opportunity

### Stock Valuation: Gordon Growth Model. Week 2

Stock Valuation: Gordon Growth Model Week 2 Approaches to Valuation 1. Discounted Cash Flow Valuation The value of an asset is the sum of the discounted cash flows. 2. Contingent Claim Valuation A contingent

### Finance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4)

Finance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4) Julian Vu 2-3: Given: Security A Security B r = 7% r = 12% σ (standard deviation) = 35% σ (standard deviation)

### Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document)

Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document) 1. Portfolio risk & return. Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

### STUDENT CAN HAVE ONE LETTER SIZE FORMULA SHEET PREPARED BY STUDENT HIM/HERSELF. FINANCIAL CALCULATOR/TI-83 OR THEIR EQUIVALENCES ARE ALLOWED.

Test III-FINN3120-090 Fall 2009 (2.5 PTS PER QUESTION. MAX 100 PTS) Type A Name ID PRINT YOUR NAME AND ID ON THE TEST, ANSWER SHEET AND FORMULA SHEET. TURN IN THE TEST, OPSCAN ANSWER SHEET AND FORMULA

### Practice Bulletin No. 2

Practice Bulletin No. 2 INTERNATIONAL GLOSSARY OF BUSINESS VALUATION TERMS To enhance and sustain the quality of business valuations for the benefit of the profession and its clientele, the below identified

### Contribution 787 1,368 1,813 983. Taxable cash flow 682 1,253 1,688 858 Tax liabilities (205) (376) (506) (257)

Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2012 Answers 1 (a) Calculation of net present value (NPV) As nominal after-tax cash flows are to be discounted, the nominal

### Discounted Cash Flow. Alessandro Macrì. Legal Counsel, GMAC Financial Services

Discounted Cash Flow Alessandro Macrì Legal Counsel, GMAC Financial Services History The idea that the value of an asset is the present value of the cash flows that you expect to generate by holding it

### t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

### Chapter 7. . 1. component of the convertible can be estimated as 1100-796.15 = 303.85.

Chapter 7 7-1 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders

### Cost of Capital and Project Valuation

Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different

### International Glossary of Business Valuation Terms*

40 Statement on Standards for Valuation Services No. 1 APPENDIX B International Glossary of Business Valuation Terms* To enhance and sustain the quality of business valuations for the benefit of the profession

### According to Modigliani-Miller Proposition II with corporate taxes, the value of levered equity is:

Homework 2 1. A project has a NPV, assuming all equity financing, of \$1.5 million. To finance the project, debt is issued with associated flotation costs of \$60,000. The flotation costs can be amortized

### ] (3.3) ] (1 + r)t (3.4)

Present value = future value after t periods (3.1) (1 + r) t PV of perpetuity = C = cash payment (3.2) r interest rate Present value of t-year annuity = C [ 1 1 ] (3.3) r r(1 + r) t Future value of annuity

### CHAPTER 14 COST OF CAPITAL

CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,

### Cost of Capital, Valuation and Strategic Financial Decision Making

Cost of Capital, Valuation and Strategic Financial Decision Making By Dr. Valerio Poti, - Examiner in Professional 2 Stage Strategic Corporate Finance The financial crisis that hit financial markets in

### SAMPLE FACT EXAM (You must score 70% to successfully clear FACT)

SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) 1. What is the present value (PV) of \$100,000 received five years from now, assuming the interest rate is 8% per year? a. \$600,000.00 b.

### DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2.

DUK UNIRSITY Fuqua School of Business FINANC 351 - CORPORAT FINANC Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%. Consider a firm that earns \$1,000

### The CAPM (Capital Asset Pricing Model) NPV Dependent on Discount Rate Schedule

The CAPM (Capital Asset Pricing Model) Massachusetts Institute of Technology CAPM Slide 1 of NPV Dependent on Discount Rate Schedule Discussed NPV and time value of money Choice of discount rate influences

### Basics of Discounted Cash Flow Valuation. Aswath Damodaran

Basics of Discounted Cash Flow Valuation Aswath Damodaran 1 Discounted Cashflow Valuation: Basis for Approach t = n CF Value = t t =1(1+ r) t where, n = Life of the asset CF t = Cashflow in period t r

### Industrial and investment analysis as a tool for regulation

Industrial and investment analysis as a tool for regulation Marina Di Giacomo, Università di Torino Turin School of Local Regulation International Summer School on Regulation of Local Public Services 1

### Paper 2. Derivatives Investment Consultant Examination. Thailand Securities Institute November 2014

Derivatives Investment Consultant Examination Paper 2 Thailand Securities Institute November 2014 Copyright 2014, All right reserve Thailand Securities Institute (TSI) The Stock Exchange of Thailand Page

### COST OF CAPITAL Compute the cost of debt. Compute the cost of preferred stock.

OBJECTIVE 1 Compute the cost of debt. The method of computing the yield to maturity for bonds will be used how to compute the cost of debt. Because interest payments are tax deductible, only after-tax

### I. Estimating Discount Rates

I. Estimating Discount Rates DCF Valuation Aswath Damodaran 1 Estimating Inputs: Discount Rates Critical ingredient in discounted cashflow valuation. Errors in estimating the discount rate or mismatching

### MGT201 Solved MCQs(500) By

MGT201 Solved MCQs(500) By http://www.vustudents.net Why companies invest in projects with negative NPV? Because there is hidden value in each project Because there may be chance of rapid growth Because

### Question 1. Marking scheme. F9 ACCA June 2013 Exam: BPP Answers

Question 1 Text references. NPV is covered in Chapter 8 and real or nominal terms in Chapter 9. Financial objectives are covered in Chapter 1. Top tips. Part (b) requires you to explain the different approaches.

### Net revenue 785 25 1,721 05 5,038 54 3,340 65 Tax payable (235 58) (516 32) (1,511 56) (1,002 20)

Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2013 Answers 1 (a) Calculating the net present value of the investment project using a nominal terms approach requires the

### Discounted Cash Flow: Application and Misapplication. Hal Heaton, PhD

Discounted Cash Flow: Application and Misapplication Hal Heaton, PhD The Income Approach to Valuation In the income approach (specifically the discounted cash flow approach) value is determined by discounting

### Capital budgeting & risk

Capital budgeting & risk A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Measurement of project risk 3. Incorporating risk in the capital budgeting decision 4. Assessment of

### If you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = \$14,000/2,500 = \$5.60

Problems Relating to Capital Structure and Leverage 1. EBIT and Leverage Money Inc., has no debt outstanding and a total market value of \$150,000. Earnings before interest and taxes [EBIT] are projected

### Equity Market Risk Premium Research Summary. 12 April 2016

Equity Market Risk Premium Research Summary 12 April 2016 Introduction welcome If you are reading this, it is likely that you are in regular contact with KPMG on the topic of valuations. The goal of this

### KEY EQUATIONS APPENDIX CHAPTER 2 CHAPTER 3

KEY EQUATIONS B CHAPTER 2 1. The balance sheet identity or equation: Assets Liabilities Shareholders equity [2.1] 2. The income statement equation: Revenues Expenses Income [2.2] 3.The cash flow identity:

### CHAPTER 26 VALUING REAL ESTATE

1 CHAPTER 26 VALUING REAL ESTATE The valuation models developed for financial assets are applicable for real assets as well. Real estate investments comprise the most significant component of real asset

### CAPITAL PROJECTS. To calculate the WACC, it is first necessary to determine the cost of each of the three sources of financing.

CAPITAL PROJECTS INTRODUCTION This reference document covers two topics related to capital projects. The first topic is the cost of capital to use as the discount rate when calculating the net present

### CFS. Syllabus. Certified Finance Specialist. International benchmark in Finance profession

CFS Certified Finance Specialist Syllabus International benchmark in Finance profession Certified Finance Specialist Summary: This award will provide candidates the opportunity to gain advanced level knowledge

### Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 36)

Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required

### Problem 1 Problem 2 Problem 3

Problem 1 (1) Book Value Debt/Equity Ratio = 2500/2500 = 100% Market Value of Equity = 50 million * \$ 80 = \$4,000 Market Value of Debt =.80 * 2500 = \$2,000 Debt/Equity Ratio in market value terms = 2000/4000

### Chapter 14 Capital Structure in a Perfect Market

Chapter 14 Capital Structure in a Perfect Market 14-1. Consider a project with free cash flows in one year of \$130,000 or \$180,000, with each outcome being equally likely. The initial investment required

### Jeffrey F. Jaffe Spring Semester 2016 Corporate Finance FNCE 100 Syllabus, page 1. Spring 2016 Corporate Finance FNCE 100 Wharton School of Business

Corporate Finance FNCE 100 Syllabus, page 1 Spring 2016 Corporate Finance FNCE 100 Wharton School of Business Syllabus Course Description: This course provides an introduction to the theory, the methods,

### NASAA Investment Adviser Competency Exam (Series 65) Exam Specifications and Outline (Effective 1/1/2010)

NASAA Investment Adviser Competency Exam (Series 65) Exam Specifications and Outline (Effective 1/1/2010) CONTENT AREA # of Items 1. Economic Factors and Business Information 19 (14%) A. Basic economic

### Level 6 Advanced Diploma in Finance (531) 126 Credits

Level 6 Advanced Diploma in Finance (531) 126 Credits Unit: Finance Theory Guided Learning Hours: 210 Exam Paper No.: 4 Prerequisites: Knowledge of Finance. Number of Credits: 21 Corequisites: A pass or

### 12 April 2007. Hedging for regulated AER

12 April 2007 Hedging for regulated businesses AER Project Team Tom Hird (Ph.D.) NERA Economic Consulting Level 16 33 Exhibition Street Melbourne 3000 Tel: +61 3 9245 5537 Fax: +61 3 8640 0800 www.nera.com

### MBA (3rd Sem) 2013-14 MBA/29/FM-302/T/ODD/13-14

Full Marks : 70 MBA/29/FM-302/T/ODD/13-14 2013-14 MBA (3rd Sem) Paper Name : Corporate Finance Paper Code : FM-302 Time : 3 Hours The figures in the right-hand margin indicate marks. Candidates are required

### Paper F9. Financial Management. Friday 6 June 2014. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants.

Fundamentals Level Skills Module Financial Management Friday 6 June 2014 Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FOUR questions are compulsory and MUST be attempted. Formulae

### Chapter 11, Risk and Return

Chapter 11, Risk and Return 1. A portfolio is. A) a group of assets, such as stocks and bonds, held as a collective unit by an investor B) the expected return on a risky asset C) the expected return on

### CHAPTER 9: THE CAPITAL ASSET PRICING MODEL

CHAPTER 9: THE CAPITAL ASSET PRICING MODEL PROBLEM SETS 1. E(r P ) = r f + β P [E(r M ) r f ] 18 = 6 + β P(14 6) β P = 12/8 = 1.5 2. If the security s correlation coefficient with the market portfolio

### Choice of Discount Rate

Choice of Discount Rate Discussion Plan Basic Theory and Practice A common practical approach: WACC = Weighted Average Cost of Capital Look ahead: CAPM = Capital Asset Pricing Model Massachusetts Institute