why do financial managers make inv decisions?
to maximize shareholder wealth
what is the cost of capital?
average cost of debt and equity capital
what is the acceptance rule?
returns > WACC
uses for WACC?
- evaluation of capital projects (when to accept)
- firm valuation (discounts future cash flows)
- determines of company’s economic value added
- determines FV of assets
what is target capital structure?
best mix of d&e that minimizes WACC and maximizes firm value (first choice = what the firm should be aiming for)
why are market value weights preferred?
- the MV of d&e is the real value at risk for the finance providers
- book values are historical and don’t represent real value at risk
if interest is paid semi-annually on a bond
use EAR not apr
if there are multiple types of debt
calculate individual costs, add up and find a weighted average
the risk free rate
rate for long term gov bonds (reflects l-t inflation better and ordinary shares r long term)
beta
measures the volatility of systemic risk of a share compared to the market
market risk premium
(Rm - Rf)
average risk premium investors earned in the past
methods 4 finding cost of ordinary shares
capm
dividend growth model
bond yield + risk premium
cost of retained earnings
cost of current ordinary shares no flotation costs
what does WACC represent?
- the average rate of return required by capital providers
- the minimum rate of return on the firm’s assets, to create wealth
- the opportunity cost of capital for the firms investors
what do we incl in the cost of debt?
- all long term debt
why do we ignore the historical cost of debt?
because it does not reflect current cost. int rates change over time.
what does economic value added do?
measures firm performance better than accounting data can
what does future WACC look at?
next year’s RE
new issue of OS, PS and bonds
