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Chapter

9

RISK AND THE COST OF CAPITAL
Brealey, Myers, and Allen Principles of Corporate Finance Principles Brealey, Myers,Finance of Corporate and Allen
10th Edition 11th Edition Presented by: Nguyen Xuan Thang
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

9-1 COMPANY AND PROJECT COSTS OF CAPITAL
• Firm Value
• Sum of value of assets

Firm value  PV(AB)  PV(A)  PV(B)

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FIGURE 9.1 COMPANY COST OF CAPITAL
• A company’s cost of capital can be

compared to CAPM required return
Required return SML

5.5
Company cost of capital

0.2

0 0.5
Project beta

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9-1 COMPANY AND PROJECT COSTS OF CAPITAL
• Company Cost of Capital
D E rassets  COC  rdebt  V   requity V 
V  D E D  Market val ue of debt E  Market val ue of equity

rdebt  YTM on bonds requity  rf  β( rm  rf )

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9-1 COMPANY AND PROJECT COSTS OF CAPITAL
• Weighted Average Cost of Capital
• Traditional measure of capital structure, risk

and return
D E WACC  (1  Tc ) rD  V   rE V 

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9-2 MEASURING THE COST OF EQUITY
• Capital Structure (CS)
• Mix of debt and equity within a company • Expand CAPM to include CS
•

r = rf + β(rm − rf)

• requity = rf + β(rm − rf)

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9-2 MEASURING THE COST OF EQUITY
• Estimating Beta
• SML shows relationship between return and risk • CAPM uses beta as proxy for risk • Other methods can also determine slope of

SML and beta
• Regression analysis can be used to find beta

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FIGURE 9.2A CITIGROUP RETURN
Weekly Data 2010-2011 beta = alpha = R-s quared = Correlation = Annualized std dev of market = Annualized std dev of stock = Variance of stock = Std error of beta

1.83 -0.31 0.64 0.80 19.52 44.55 1984.83 0.14

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FIGURE 9.2B CITIGROUP RETURN
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