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cost of capital

Transcript: Introduction to Cost of Capital Significance of Cost of Capital Investment Decision-Making Capital Budgeting A company's capital budgeting process hinges on understanding its cost of capital, which informs decision-making on long-term investments. It affects cash flow projections and determines which projects are viable within financial constraints. The cost of capital serves as a vital benchmark for evaluating potential investments. Investors expect a return that aligns with this cost, guiding firms in selecting projects that promise adequate returns versus risks. Definition The cost of capital refers to the return investors expect for providing their capital to a business. This metric serves as a crucial benchmark for evaluating investment opportunities and overall business performance. Overview of Long-Term Debt Costs Cost of Debentures Components of Long-Term Debt Cost Definition of Long-Term Debt Irredeemable Debentures Formula for Cost of Irredeemable Debentures Calculation Example of Irredeemable Debentures The cost of long-term debt includes interest payments, issuance costs, and any premiums or discounts on repayment. These expenses can significantly affect a firm's profitability and cash flow management. Long-term debt refers to loans and financial obligations that are not due within a year. It includes bonds, loans, and debentures, providing necessary financing for company growth and operations. Irredeemable debentures do not have a maturity date, meaning interest is paid indefinitely. Their cost is primarily based on the annual interest payments versus market value. The cost of irredeemable debentures is calculated using the formula K_d = I / P, where K_d is the cost of debt, I is the annual interest payment, and P is the market price of the debenture. For a debenture issued at Rs. 100 with an annual interest of Rs. 10, the cost of debt is calculated as K_d = 10 / 100 = 10%. This highlights the expected return for investors. Redeemable Debentures Defined Formula for Cost of Redeemable Debentures Calculation Example of Redeemable Debentures Redeemable debentures are repayable after a specified period, providing investors with defined return timelines. They often feature a higher cost than irredeemable debentures due to redemption risk. The cost of redeemable debentures is expressed as K_d = (I + (RV - NP) / N) / ((RV + NP) / 2), where RV is the redemption value, NP is net proceeds, and N is the number of years to maturity. An example: A company issues debentures at Rs. 90, redeemable at Rs. 100 after 5 years, with an annual interest of Rs. 10. The computed cost is K_d = (10 + (100 - 90) / 5) / ((100 + 90) / 2) = 11.11%. Conclusion Conclusion THANK YOU Evaluating the cost of capital is crucial as it directly affects investment decisions, capital budgeting, and the overall financial strategy of the business. An accurate assessment ensures that firms can attract investors while optimizing their capital structure. Cost of Capital Understanding its Significance in Financial Management

COST OF CAPITAL

Transcript: WACC BETA BETA OF A PROJECT COUNTRY RISK COST OF CAPITAL TARGET CAPITAL STRUCTURE ESTIMATION FORMULA TAX EFFECTS COST OF PREFERRED STOCKS Working Average Capital Cost MCC COST OF DEBT COST OF COMMON EQUITY COST OF CAPITAL WHAT DO CFOs DO? MARGINAL COST OF CAPITAL SCHEDULE

COST OF CAPITAL

Transcript: FORMULA RETAINED EARNING Cost of Debt Cost of Equity Shares Cost of Preference Shares Cost of Retained Earning Cost of debt capital is associated with the amount of interest that is paid on currently outstanding debts. it is denoted by Kd. COST OF CAPITAL (MEANING) The cost of funds used for financing a business. Cost of capital depends on the mode of financing used – it refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt. Many companies use a combination of debt and equity to finance their businesses, and for such companies, their overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WACC). EXAMPLE Cost of preference share capital is that part of cost of capital in which we calculate the amount which is payable to preference shareholders in the form of dividend with fixed rate. It is denoted by Kp. Cost of Equity Share is the annual rate of return that an investor expects to earn when investing in the shares of the company. It is denoted by Ke FORMULA GROWTH APPROACH Ke = D/P + g where, Ke - cost of equity share D - Dividend P - Current market price of Equity Share g - Growth Rate Of Dividend DIVIDEND CAPITALISATION APPROACH Ke = D/P ratio approach EARNING CAPITALISATION APPROACH Ke = E/P ratio approach where, D- Dividend E- Earning Per Share P- Net Proceed or Market price of an equity share IRREDEEMABLE PREFERENCE SHARE Kp = D/P where, D - Dividend (including dividend tax if any) P- Proceed from issue Now issue of irredeemable preference share is not permissable as per Companies Act 1956 THANKYOU COST OF EQUITY SHARE when an investor purchases stock in a company, he/she expects to see a return on that investment. Since the individual expects to get back more than his/her initial investment, the cost of capital is equal to this return that the investor receives, or the money that the company misses out on by selling its stock. According to Solomom Ezra " The cost of capital is the minimum required rate of earning or the cut-off rate of capital expenditure." IRREDEMABLE DEBT Kd = I/NP (Before Tax) Kd = I(1-t)/ NP (After Tax) Where, Kd - Cost of debt t - Tax Rate I - Interest NP - Net Price COST OF CAPITAL PRESENTED BY:- HARSHITA PARIHAR AYUSHI VIJAYVARGIYA POORWA TIWARI APARNA PATHAK A firm's overall cost of capital is the weighted average of the cost of various sources of finance used by it. The weighted assigned to various sources of fund may be book value or market value. Formula: Ko= TotalWeighted Cost/ Total Capital x 100 FORMULA REDEEMABLE PREFERENCE SHARE Cost of Retained Earning is normally used equal to te cost of equity share capital. But sometimes it remains less than cost of equity because it does not require any floatation cost. DEFINITION COST OF PREFERENCE SHARE REDEEMABLE DEBT when tax benefit on issue cost is not considered Kd = [I(1-t)+(R-P)/n]/ (R+P)/2 when tax benefit on issue cost is also considered Kd = [I(1-t)+(R-P)(1-t)/n]/(R+P)/2 where, I- Interest t- Tax rate R- Redemption price P- Net proceed from debt Redeemable preference shares (Tax benefit on cost of issue considered) Kp = [D+(R-P)/n x (1-t)]/(R+P)/2 where, D- Dividend (including dividend tax ,if any) R- Redemption price P- Proceeds from issue t- Tax rate n- Number of years COMPONENTS/TYPES OF COST OF CAPITAL COST OF DEBT OVERALL COST OF CAPITAL

Cost of Capital

Transcript: Significance of Cost of Capital Overview of Preference Share Capital Definition of Cost of Capital Characteristics of Preference Shares The cost of capital is a critical measure for evaluating investment opportunities and guiding corporate finance decisions. A company with a lower cost of capital can undertake more projects, increasing its profitability and market value over time. Preference shares represent a hybrid equity instrument that combines features of both equity and debt. They typically pay dividends at a fixed rate and may have redeemable or irredeemable characteristics, influencing their risk and return profiles. Preference share capital represents a hybrid form of financing that provides a fixed dividend to shareholders before common shareholders receive any dividends. This type of capital can be categorized into irredeemable and redeemable preference shares, each with distinct characteristics and implications. Cost of capital refers to the minimum return that a company must earn on its investments to satisfy its investors. It includes the cost of equity, debt, and preference shares, providing a comprehensive overview of what the company needs to generate to maintain its value. Priority of Preference Shareholders Cost of Irredeemable Preference Shares Treatment of Dividends Formula for Irredeemable Preference Shares Preference shareholders have a superior claim on assets and dividends over ordinary equity shareholders. In the event of liquidation, they are paid before common shareholders, making them less risky but potential returns lower compared to ordinary shares. Dividends paid to preference shareholders are considered an appropriation of after-tax profits, not an expense. This treatment means these payments do not reduce the company’s tax liability, impacting overall financial strategy. The cost of irredeemable preference shares is akin to calculating perpetuity. It represents dividends paid to shareholders without a redemption feature, making it a key financial metric for investors seeking stable income. The formula for calculating the cost of irredeemable preference shares (Kp) is Kp = PD / Po, where PD stands for annual preference dividend and Po represents the net proceeds from the issue. Example Calculation - Irredeemable Example Calculation - Redeemable Formula for Redeemable Preference Shares Cost of Redeemable Preference Shares For redeemable preference shares with an annual dividend (PD) of $6, a redemption value (RV) of $100, net proceeds (NP) of $90, and remaining life (n) of 5 years, the cost is Kp = 6 + (100 - 90) / 5 / ((100 + 90) / 2) = 7.23%. If a company pays an annual preference dividend (PD) of $5 and the net proceeds from issuing the shares (Po) is $50, the cost of irredeemable preference shares would be Kp = 5 / 50 = 0.10 or 10%. Redeemable preference shares offer an expected return through dividends and a redemption value at maturity. Their cost is essential for assessing the overall expense of capital financing for companies. The cost of redeemable preference shares (Kp) is calculated with Kp = PD + (RV - NP) / n / ((RV + NP) / 2), where RV is redemption value, NP is net proceeds, and n is the remaining life of shares. Importance in Financial Decision Making Future Trends in Preference Capital Financing Summary of Key Points Preference shares are crucial in corporate financing, providing fixed dividends and priority over equity dividends. The cost of irredeemable and redeemable preference shares influences a company’s overall cost of capital and strategic financial planning. Understanding the cost of capital, particularly preference shares, enables firms to evaluate investment projects accurately. It impacts decision-making regarding financing strategies, capital structure, and overall financial health. The trend towards hybrid financing structures includes increasing reliance on preference shares. Advances in finance technology may streamline the issuance and management of these securities, responding to market demands for flexibility and lower costs. Understanding Cost of Capital A Comprehensive Analysis of Preference Shares

cost of capital

Transcript: Background Common stock (Brigham and Houston, 2009) Debt Common stock 1. Market Interest Rate 2. What is the cost of debt? Interest expense is tax deductible = (1 – 0.4)*10% = 6.00% (after tax costs) Cost of Capital Formula for WACC Introduction Firms cannot control Interest rates in the economy The general level of stock prices Tax rates Firm can control Capital structure Dividend payout ratio Capital budgeting decision rules “Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.” You are an assistant to the VP of Finance at Coleman Technologies. In order to assess the company’s expansion strategy your task is to estimate Coleman’s cost of capital: Alfred Fraser, Douglas Ebanks where: D =preferred dividend P =dividend by the current price of the preferred stock Overall WACC Flotation s What goes into WACC calculations? P/S 9% > 6% Debt If the tax rate = 40% Then, Where: T = the firm’s marginal tax rate rd = interest rate on the firm’s new debt ( = before-tax component cost of debt ) rp = component cost of preferred stock rs = component cost of common equity raised by retaining earnings wd, wp, wc = target weights of three types of capital Debt Preferred stock Retained earnings Common stock Thank you Preferred issue is a perpetual Preferred dividends are not tax deductible, so no adjustment is needed Use nominal rates to be consistent Consistent approach for all calculations (NPV, DCF) p 4. Implied cost of equity capital Cash flows and rate of return calculations should be done on a after-tax basis. Cost of debt (interest expense) is tax deductible, therefore multiplied with (1 – tax rate). Only current, marginal costs are used for WACC calculations, not historical costs. 10% x (1-40%) = 6.00% Outline Preferred stock Definition of Flotation costs Investment bankers’ fees Not an issue, BUT substantial Approaches Factors that affect the WACC If the following conditions are met: The project can match the average risk/return profile The previous projects are sufficiently large 2 r = Bond yield + Risk premium = 10.0% + 4.0%=14.0% However, the coincidence is extremely small. Preferred stock s 2. Bond-Yield-plus-Risk-Premium approach Background Components of the WACC WACC = APPROPRIATE DISCOUNT RATE Background 3. Overall WACC Group 11 After tax adjustment Common stock Retained earnings Can WACC be used as a hurdle rate? Adjust the cost of capital Components Our 10% pre-tax estimate is the nominal cost of debt, EAR = 1.05 – 1.0 = 0.1025 = 10.25% Debt Capital Asset Pricing Model (CAPM) Bond-Yield-plus-Risk-Premium approach Discounted cash flow (DCF) approach Implied cost of equity capital Background Flotation Costs (Source: investopedia.com) Conclusion WACC could be used as a hurdle rate Reference For a closely held company(CAPM not applicable); this method is somewhat subjective “get us in the right ballpark” https://www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-the-cost-of-capital-10/valuing-different-costs-88/the-cost-of-new-common-stock-379-3902/ http://www.information-management.com/issues/2007_58/master_data_management_mdm_quality-10015358-1.html http://2012books.lardbucket.org/books/finance-for-managers/s12-04-cost-of-common-stock.html http://en.wikipedia.org/wiki/Weighted_average_cost_of_capital http://www.stockresearching.com/2013/11/23/google-inc-fundamental-analysis-wacc-cost-of-debt-and-cost-of-equity-goog/ http://www.valuebasedmanagement.net/methods_wacc.html Wang, P. (2013): Estimating Firm-Specific Implied Risk Premium Brigham, E. and Houston, J.(2010) Fundamentals of Financial Management (Custom Edition). South Western Cengage Learning. ISBN 9781408039137. Please note that this book is only available in the University bookshop. Approaches N = 30 (15x2, because we have semiannual payments) PMT = 60 (12% Coupon x 1000.00 FV, divided by 2 = 60) PV = - 1153.72 FV = 1000.00 YTM = 5.00002% x 2 (because of semiannual values) ≈ 10% p.a. p Overall WACC Common stock Common stock Debt The risk premium (r - long term bond yield) is typically between 3% and 5% Component cost of common equity 1. CAPM approach Any question? Definition of WACC Overall WACC Add flotation costs to a project’s cost P/S 9.00% < 10% Debt Flotation Flotation

Modern PowerPoint Presentation Templates

Transcript: Introduction to Modern PowerPoint Presentation Templates Modern PowerPoint presentation templates are essential tools for creating effective and visually appealing presentations. They streamline the design process, ensuring that content is presented in a clear and engaging manner, ultimately enhancing the overall impact on the audience. Customizable Designs Modern PowerPoint templates allow users to tailor designs to fit their specific needs, ensuring that presentations reflect personal or brand identity. This adaptability makes it easier to create unique and relevant content. User-Friendly Interfaces User-friendly interfaces simplify the process of creating presentations, making it accessible for individuals with varying levels of expertise, from beginners to advanced users. Key Features of Modern Templates High-Quality Graphics High-quality graphics included in modern templates help to enhance the overall visual appeal of presentations, making them more engaging and professional. This feature is crucial for capturing audience attention. Compatibility with Various Software Modern templates are designed to be compatible with various software platforms, ensuring that users can seamlessly integrate them into their preferred tools without technical issues. Modern PowerPoint Presentation Templates Time-efficient design process Benefits of Using Modern Templates Professional look and feel Increased audience retention Streamlined collaboration Explore a Collection of Innovative and Stylish Templates for Effective Presentations Popular Types of Modern Templates Understanding the distribution of modern PowerPoint templates across various categories. 40% 30% 20% 10% Creative templates Business templates Educational templates Infographic templates

Cost of Capital

Transcript: Capital structure and Cost of Capital Out-of-pocket Costs The cost of capital is the cost of a company's funds (both debt and equity), or from an investor point of view It is the minimum return that investors expect for providing capital to the company Capital Structure Explicit cost The term ‘capital’ refers to any financial resources or assets owned by a business that are useful in further development and generating income. Implicit cost Implicit cost Interest on owner's capital, Salary to owner, rent of owner's building, etc The costs in which there is no cash outlay, is known as Implicit Cost Estimation of Cost Implied Objective Equity share Preference share Retained earning Borrowed capital Components of COC Capital structure consist of to words Capital and structure Mix-up of various sources of funds in desired proportion Company can raise their capital through owned or borrowed capital or both Cost of equity refers to a shareholder's required rate of return on an equity investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Cost of Debt The costs which involve outflow of cash due to the use of factors of production is known as Explicit Cost. Components of capital structure Cost of Pref. Share capital (Kp) = amount of preference dividend/ Preference share capital Kp = D/P Cost of debt generally refers to the effective paid by a company on its debts. Cost of preference share capital is that part of cost of capital in which we calculate the amount which is payable to preference shareholders in the form of dividend with fixed rate. It will affect on capability to receive funds from this source. External Factors Market condition Cost of capital Government regulation Taxation Competition Types of COC An explicit cost is a direct payment made to others in the course of running a business, such as wage, rent and materials Kd = i(1-t)/P0 Kd = cost of debt (required rate of return) i = annual interest paid P0 = ex interest market value of debt t = corporation tax rate Cost Risk Control Flexibility Timing INTRODUCTION Subjective Aarti Ganesh Rashmi NIhal Aishwarya Nikita Priyanka Usama Arunkumar Factors influencing capital structure Meaning BASIS FOR COMPARISON Imputed Costs Principles of capital structure Example Types of COC Member Actual Occurrence Cost Of Preference Share Cost of Equity Cost of equity = Risk free rate of return + Beta × (market rate of return – risk free rate of return) Internal Factors Requirement of capital Size and nature of business Growth of business firms Trading on equity Future plan Weighted Average Cost of Capital (WACC) An implicit cost is any cost that has already occurred but is not necessarily shown or reported as a separate expense. It represents an opportunity cost Cost of Equity Cost of Debt Cost Preference share capital Cost of Retained earning Alternatively Salaries, rent, advertisement, wages, etc Explicit cost Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted Cost of Capital

Cost of capital

Transcript: factors affecting cost of capital factors affecting cost of capital (0.14 x 8.44%) + (0.86 x 9.33%) = 1.1816 + 8.0238 = 9.2054% Cost of Capital - definition 2. Dividend Policy Given that the firm has control over its payout ratio, the breakpoint of the MCC schedule can be changed. For example, as the payout ratio of the company increases the breakpoint between lower-cost internally generated equity and newly issued equity is lowered. The cost of funds used for financing a business. Cost of capital depends on the mode of financing used – it refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt. Many companies use a combination of debt and equity to finance their businesses, and for such companies, their overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WACC). Since the cost of capital represents a hurdle rate that a company must overcome before it can generate value, it is extensively used in the capital budgeting process to determine whether the company should proceed with a project. Weighted average cost of capital debt = £9/£80 x (1-25%) = 8.44% Cost of capital 5. Tax Rates Tax rates affect the after-tax cost of debt. As tax rates increase, the cost of debt decreases, decreasing the cost of capital. Factors affecting cost of capital 4. Level of Interest Rates The level of interest rates will affect the cost of debt and, potentially, the cost of equity. For example, when interest rates increase the cost of debt increases, which increases the cost of capital. factors affecting cost of capital 1. Capital Structure Policy As we have been discussing above, a firm has control over its capital structure, targeting an optimal capital structure. As more debt is issued, the cost of debt increases, and as more equity is issued, the cost of equity increases. 3. Investment Policy It is assumed that, when making investment decisions, the company is making investments with similar degrees of risk. If a company changes its investment policy relative to its risk, both the cost of debt and cost of equity change. Debt = £9.6m/£68.6m x 100 = 14% equity = £39m + £20m = £59m/68.6m = 0.86 x 100 = 86% % of debt and equity factors affecting cost of capital 20(1.04/390)+0.04 = 20.8/390 + 0.04 = 9.33% equity = next years dividend per share/current value of stock + dividend growth rate x 100 Celtor plc - cost of debt and equity

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