...Average Cost of Capital (WACC), she must first find the capital structure of the firm. Cohen incorrectly uses the book value of equity, rather than the market value. Additionally, she uses the book value of debt, however this is acceptable because the market values are not provided in the case. With Nike’s capital structure in hand, Cohen begins calculate the cost of capital for debt and equity. To calculate the cost of debt, Cohen uses historical interest expenses as a proxy, however this is not a forward looking estimation and using the materials provided a better estimation of cost of debt can be made by calculating the yield-to-maturity on Nike’s outstanding bonds. To calculate cost of equity Cohen uses the Capital Asset Pricing Model (CAPM), however incorrectly inputs an average beta instead of the most current beta. The most current beta should be used because it is most representative of the future beta of Nike. The other inputs used in...
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...7:00pm, Cutler Long Term Financing Paper | CISCO Inc. | Team Advantage: | CAPM Model & Discounted Cash Flows Capital Assets pricing and Discounting Cash flow are the widely used valuation methods for investment. ¾ of US companies using CAPM for Capital budgeting. General idea behind a CAPM is that investors need to be compensated for the risk that they are taking. Under the CAPM we are observing how much return Cisco’s investors are expecting. For the Calculation CAPM for CISCO we used numbers based off industry standards from S&P 500 and U.S. Treasury. CISCO Beta was calculated at 1.18 (source: http://finviz.com/quote.ashx?t=csco). For the risk free rate 0.17% was calculated based of the yearly US treasury rate from 2012 (source: http://www.treasury.gov ). 11.62% is the market risk based on the YTD return for the S&P 500 (source: http://money.cnn.com/data/markets/sandp/). 12.97% would be the expected/required return for CISCO. CAPM is calculated as follows: = 0.17% + 1.18 (11.79 -0.17) = 0.17+ 1.18 (11.79 – 0.17) = 1.35 (11.62) = 12.97% Discounted Cash Flow Model relies on future cash flow. It is described as "discounted" cash flow because cash in the future is worth less than cash today. DCF says that a company is worth all of the cash that it could make available to investors in the future. There are 3 approaches to DCF: PV, NPV, DDM. We need 3 input for DCF model: projected CF, discount rate and length of time for ongoing project, also growth...
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...HSA 525-Health Financial Management Assignment # 4 – Medical Associates November 27, 2011 Medical Associates: Equity cost of capital, DCF, CAPM, risk, capital budgeting Medical Associates is a large for-profit group practice. Its dividends are expected to grow at a constant rate of 7% per year into the foreseeable future. The firm's last dividend (D0) was $2, and its current stock price is $23. The firm's beta coefficient is 1.6; the rate of return on 20-year T-bonds currently is 9%; the expected rate of return is 13%. The firm's target capital structure calls for 50% debt financing, the interest rate required on the business's new debt is 10%, and its tax rate is 40%. 1. Calculate Medical Associates' cost of equity estimate using the DCF method. Using the DCF method Cost of Equity = D1/P0 + g D1 = expected dividend= D0 X (1+g) = 2 X 1.07 = 2.14 P0 current price = $23 g = growth rate = 7% Cost of equity = 2.14/23 + 7% = 16.30% 2. Calculate the cost of equity estimate using CAPM. Using CAPM Cost of equity = Rf + (Rm-Rf) beta Rf = risk free rate = 9% Rm = return on market = 13% beta = 1.6 Cost of equity = 9% + (13%-9%) 1.6 = 15.4% 3. On the basis of your answers to #1 & #2, what is your final estimate for the firm's cost of equity? We take the average of the two costs as the final estimate Final estimate is the average of the two = (16.3%+15.4%)/2 = 15.85% 4. Calculate the firm's estimate for corporate cost of capital. Cost...
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...please call us at 617-314-7685. Enjoy! ------------------------------------------------- ------------------------------------------------- ------------------------------------------------- 1. How do you value a company? This question, or variations of it, should be answered by talking about 2 primary valuation methodologies: 1. Intrinsic value (discounted cash flow valuation) 2. Relative valuation (comparables/multiples valuation) * Intrinsic value (DCF) - This approach is the more academically respected approach. The DCF says that the value of a productive asset equals the present value of its cash flows. The answer should run along the line of “project free cash flows for 5-20 years, depending on the availability and reliability of information, and then calculate a terminal value. Discount both the free cash flow projections and terminal value by an appropriate cost of capital (weighted average cost of capital for unlevered DCF and cost of equity for levered DCF). In an unlevered DCF (the more common approach) this will yield the company’s enterprise value (aka firm and transaction value), from which we need to subtract net debt to arrive at equity value. Divide equity value by diluted shares outstanding to arrive at equity value per share. * Relative valuation (Multiples) - The second approach involves determining a comparable peer group – companies that are in the same industry with similar operational,...
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...Henry, Robinson, Stowe; 2010). Correct valuation of real assets can present challenges to financial analysts. Different models can be used to arrive at the closest estimate of value and yet certain issues will always arise. This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes Model for Real Options. Questions to be addressed in the study are: 1. Evaluate Amoco’s and Apache’s corporate objectives and strategies. Is it reasonable to expect that the MW properties are more valuable to Apache than to Amoco? What sources of value most plausibly account for the difference between buyer and seller? 2. Structure and execute a DCF valuation of all the MW reserves. How much are the reserves worth? Is your estimate more likely to be biased high or low? What are the sources of bias? 3. How would you structure an analysis of MW as a portfolio of assets in place and options? Specifically, which parts of the business should be regarded as assets in place and which as options? What kinds of options are present? Should this approach yield a higher or lower value that the DCF approach? 4. Execute the analysis you structured in Question 3, beginning with assets in place. How risky are the assets that underlie the options; i.e. how would you estimate SD for each? How much is the whole portfolio worth? 5. Assuming a sale goes through, how does Apache exercise each of the various options...
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...Chapter 11 The Cost of Capital Sources of Capital Component Costs WACC Adjusting for Flotation Costs Adjusting for Risk 11-1 What sources of long-term capital do firms use? Long-Term Capital Long-Term Debt Preferred Stock Common Stock Retained Earnings New Common Stock 11-2 Calculating the Weighted Average Cost of Capital WACC = wdrd(1 – T) + wprp + wcrs The w’s refer to the firm’s capital structure weights. The r’s refer to the cost of each component. 11-3 Should our analysis focus on before-tax or after-tax capital costs? Stockholders focus on A-T CFs. Therefore, we should focus on A-T capital costs, i.e. use A-T costs of capital in WACC. Only rd needs adjustment, because interest is tax deductible. 11-4 Should our analysis focus on historical (embedded) costs or new (marginal) costs? The cost of capital is used primarily to make decisions that involve raising new capital. So, focus on today’s marginal costs (for WACC). 11-5 How are the weights determined? WACC = wdrd(1 – T) + wprp + wcrs Use accounting numbers or market value (book vs. market weights)? Use actual numbers or target capital structure? 11-6 Component Cost of Debt WACC = wdrd(1 – T) + wprp + wcrs rd is the marginal cost of debt capital. The yield to maturity on outstanding L-T debt is often used as a measure of rd. Why tax-adjust; i.e., why rd(1 – T)? 11-7 A 15-year, 12% semiannual coupon bond sells for $1,153.72. What is the cost of debt (rd)? Remember...
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...Finance Theories Taxonomy 1 Finance Theories Taxonomy 2 Finance Theories Taxonomy This document presents a taxonomy of selected finance theories developed in past 5 decades by academics, practitioners and scholars in the United States, Europe, Asia and Latin America. A total of 14 theories and models are synthesized in this work, organized in five tables with the same structure: Theories of capital structure; capital budgeting and cost of equity; asset valuation, financial behavior and international finances. Each table contains theories organized alphabetically with an indication of its germinal or current character. The description of the theory is accompanied by current examples of empirical research that updates or contradicts the theory and additional information about limitations, scope and opportunities of research. Finance Theories Taxonomy 3 Table 1 Finance Theories Taxonomy: Theories of capital structure Theory General description Current examples of the theory Other attributes Modigliani and Miller Germinal theory of corporate finance A review of the theory by Criticism against flaws of M& M theory Theory of investment proposed by Miller and Modigliani Miller himself, offers a new (Ball, 2001) (1958) argues that “the value of a firm view about the so called ‘junk 1. Market perfection. M&M assumed is independent of its capital structure” bonds’ which were considered information was...
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...terms of capital structure. Also, our team has been assigned to determine the significance these weights hold, in terms of the WACC. The first task to be completed was to determine which components made up the capital structure of Ace and how the company weighted their system. Within this information we were able to compile the debt, preferred stock, and common equity that created the company’s capital structure. After computing these statistics it is apparent that there has to be a decision made in order to choose the cost and weight that should be assigned to retained earnings. The problem is that there are three ways in determining these numbers: * Capital Asset Pricing Model-Priced at 14.40% * Discounted Cash Flow (DCF)-Priced at 17.78% * Bond-Yield-Plus-Risk-Premium-Priced at 12.00% Through the analysis of Ace Repair, our group feels as if that ACE Repair should follow through with WACC valuation according to the value estimated method. As they are a publicly traded company, using book value can lead to bad valuations as new capital is raised at the market value, not book value. Also, the market values are often higher than book values, and can lead to poor valuations, and have negative effects during a recession. Analysis The weighted average cost of capital (WACC) includes the weights used for debt, preferred equity, and common equity. WACC also includes, the company’s marginal tax rate and the...
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...[$3 / $27] + 0.05 Cost of equity from new stock (R) = 0.1611 (or) 16.11% Cost of equity from new stock (R) = 16.11% In this case, the cost of internal equity (or retained earnings) will be equal to the required rate of return on the stock (Rs) Here Rs = D1/P +g so, (3/30) + .05 = .10 + .05 = .15 (or 15%) Now, you have to factor in flotation costs to find the cost of external equity... Re (for external) =[ D1/(P*(1-F))] + g Here Re = [3/(30*(1-.10) ]+ .05 Re = 3/(30*.90) + .05 = 3/27 + .05 = .1111 + .05 so, Re = .1611 10.6 Dividend growth rate (g) = 7% per year Common Stock value (P0) = $23 per share Dividend just paid (or) Last dividend (D0) = $2 Current year dividend to pay (D1) = $2.14 (a) Using the DCF approach, what is its cost of common equity? Cost of Common Equity (R) = [D1 / P0] +g Cost of Common Equity (R) = [$2.14 / $23] + 0.07 Cost of Common Equity (R) = 0.1630 (or) 16.30% Cost of Common Equity (R) = 16.30% (b) If the firm’s beta is 1.6, the risk-free rate is 9%, and the average return on the...
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...will not bear this risk hence it is eliminated. Risk premium of a systematic risk can be captured through beta coefficient. Beta measures the volatility of the stock. However, it determines the sensitivity of the stock return to the systematic risk and not the total risk. If beta is 1 then the risk premium of the stock equals that of market. With a greater beta the investors expect a greater risk premium to compensate them for the additional risk taken and vice versa. Answer to Essay Question #2: Define the following terms and explain how they affect one another. More specifically, for what purposes are they used and how do they relate to one another: efficient portfolio, individual investor, short selling, Sharpe ratio, beta and CAPM. Efficient portfolio: It is an optimal portfolio that provides...
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...Semester 2013 Place, Date Dortmund, 28th February 2014 Corporate Evaluation of Philip Morris International I Executive Summary The task of this assignment was to evaluate a company (if possible, listed) by two different evaluation methods: DCF method and multiplier method. The DCF analysis is divided into two separate evaluations: DCF entity method (WACC) and DCF equity method. In addition to calculating a corresponding theoretical foundation as well as a critical analysis of assessment methods / results was expected. Philip Morris International, as one of the biggest cigarette sellers of the world, is evaluated in this assignment to date of 31st December 2012. During evaluation by multiplier method the multipliers “price-earnings-ratio” and “market capitalization / EBITDA” were chosen and as peer companies British American Tobacco p.l.c., Imperial Tobacco Group p.l.c. and Japan Tobacco Inc. were used. The result of Philip Morris International evaluation by multiplier method is a value between $111 billion and $160 billion. The theoretical analysis of the different evaluation methodologies indicated that an evaluation by multiplier method can only give a rough guidance of the real corporate value. The evaluation by DCF method result a company value of Philip Morris International between $120 billion (Equity approach) and $152 billion (Entity approach). In this assignment it is clear that each of the evaluation methodologies may exert advantages and disadvantages. It...
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...make in her analysis? Which method is best for calculating the cost of equity? • Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method? • What should Kimi Ford recommend regarding an investment in Nike? 2 1 13/3/2013 Background • Kimi Ford needs to decide on investing in Nike, Inc. • To do so, Kimi Ford needs to derive fair value of Nike stock to compare with current market share price • Kimi Ford tasked Cohen to compute Nike’s Cost of Capital 3 Scope 1. Review of Cohen’s Analysis 2. Nike’s Cost of Equity 3. Valuation Methods and Selection a. Market Approach b. Income Approach 4. Choice of Valuation Method 5. Risk Assessment a. Sensitivity Analysis b. Scenario Analysis 6. Investment Recommendation 4 2 13/3/2013 Cohen’s Analysis Issues Opinion Single or Multiple Cost of Capital Appropriate to use Single Cost of Capital as business segments in Nike subject to same risk factors Methodology for Appropriate to use WACC calculating Cost of Capital Capital Structure Inappropriate to derive capital structure from book values After-Tax Cost of Debt Inappropriate to use 4.3% as cost of debt; use YTM Appropriate to use tax rate of 38%; Cost of Equity Appropriate to use CAPM Appropriate to use 20-year Treasury rates as Risk-Free Rate;...
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...not complex, but many of the issues merit a great deal of discussion and require a sound understanding of cost of capital principles. Model Description The model takes much of the busywork out of the case, so it enables students to spend more time on interpretation and evaluation. Like most case models, the student and instructor versions differ only in regards to the input data. The instructor’s version contains the complete base case inputs, while these inputs are zeroed out in the student version of the model. The model uses market data relevant to both the business’s debt and equity as inputs to estimate the costs of debt and equity. Both YTM and YTC costs of debt are estimated, while the cost of equity is estimated using the CAPM, DCF, and Debt cost + Risk premium methods. Note that students must use judgment regarding which component cost estimates should be used in the corporate cost of...
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...Adjusted Present Value The adjusted present value ("APV") analysis is similar to the DCF analysis, except that the APV does not attempt to capture taxes and other financing effects in a WACC or adjusted discount rate. Recall from our discussion of DCF that the WACC used in the DCF analysis is calculated as a blend of the cost of debt and the cost of equity, thereby capturing the effects of taxes and financing. APV, on the other hand, seeks to value these effects separately. APV = base-case NPV + sum of PVs of financing side effects The APV method is not used as frequently in practice as is the DCF analysis, but more in academic circles. However, the APV is often considered to yield a more accurate valuation. Interest Tax Shields The most important financing side effect is the interest tax shield ("ITS"). When a company has debt, the interest it pays on that debt that is tax-deductible, creating interest tax shields that have value. In the DCF analysis, the ITS are baked in by including the tax-effected cost of debt in the WACC used to discount free cash flows ("FCF"). For APV purposes, the ITS in a given year is calculated as: ITS = Interest Expense × Tax Rate If the projected taxes to be paid exceed the ITS generated in a given year, the entire ITS is consumed in that year and no ITS carryforward is accumulated. However, if the company has more ITS in a given year than taxes paid: * The excess ITS can be carried back up to 3 years to offset taxable income in those...
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...sCAPITAL MANAGEMENT LEGG MASON March 16, 2006 Michael J. Mauboussin Common Errors in DCF Models Do You Use Economically Sound and Transparent Models? Discounted cash flow analysis is the most accurate and flexible method for valuing projects, divisions, and companies. Any analysis, however, is only as accurate as the forecasts it relies on. Errors in estimating the key ingredients of corporate value . . . can lead to mistakes in valuation. Tim Koller, Marc Goedhart, and David Wessels Valuation: Measuring and Managing the Value of Companies 1 A Return to First Principles mmauboussin@lmfunds.com Say you had to come up with a fair offer to buy your local dry cleaner and the seller limited the extent of your financial information to the answers to five questions. Which questions would you ask? Chances are you wouldn’t ask how the quarter is progressing or about last year’s earnings, but you would focus on the prospects for cash coming in versus cash going out over time. Sole proprietors understand intimately that the value of their business hinges on the cash flow the business generates. No distributable cash, no value. Cash puts food on the table and pays the mortgage; earnings do not. Equity investors are business buyers. While most shareholders own only a small fraction of a company, they are owners nonetheless. The source of shareholder value, and value changes, is no different than the sole proprietor’s: it’s all about the cash. Most investors don’t think...
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