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1、Principles of Corporate FinanceSeventh EditionRichard A.Brealey Stewart C.MyersSlides byMatthew WillChapter 9McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Capital Budgeting and Risk9-2McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights r
2、eserved Topics CoveredwCompany and Project Costs of CapitalwMeasuring the Cost of EquitywCapital Structure and COCwDiscount Rates for Intl.ProjectswEstimating Discount RateswRisk and DCF9-3McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Company Cost of CapitalwA
3、firms value can be stated as the sum of the value of its various assets9-4McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Company Cost of Capital9-5McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Company Cost of CapitalwA comp
4、anys cost of capital can be compared to the CAPM required returnRequiredreturnProject Beta1.26Company Cost of Capital135.50SML9-6McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Measuring BetaswThe SML shows the relationship between return and riskwCAPM uses Beta
5、as a proxy for riskwOther methods can be employed to determine the slope of the SML and thus BetawRegression analysis can be used to find Beta9-7McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Measuring BetasDell Computer Slope determined from plotting the line o
6、f best fit.Price data Aug 88-Jan 95Market return(%)Dell return(%)R2=.11B=1.629-8McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Measuring BetasDell Computer Slope determined from plotting the line of best fit.Price data Feb 95 Jul 01Market return(%)Dell return(%)
7、R2=.27B=2.029-9McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Measuring BetasGeneral Motors Slope determined from plotting the line of best fit.Price data Aug 88-Jan 95Market return(%)GM return(%)R2=.13B=0.809-10McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill
8、 Companies,Inc.All rights reserved Measuring BetasGeneral Motors Slope determined from plotting the line of best fit.Price data Feb 95 Jul 01Market return(%)GM return(%)R2=.25B=1.009-11McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Measuring BetasExxon Mobil Slo
9、pe determined from plotting the line of best fit.Price data Aug 88-Jan 95Market return(%)Exxon Mobil return(%)R2=.28B=0.529-12McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Measuring BetasExxon Mobil Slope determined from plotting the line of best fit.Price data
10、 Feb 95 Jul 01Market return(%)Exxon Mobil return(%)R2=.16B=0.429-13McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Beta Stability%IN SAME%WITHIN ONE RISK CLASS 5 CLASS 5 CLASS YEARS LATER YEARS LATER 10(High betas)35 69 9 18 54 8 16 45 7 13 41 6 14 39 5 14 42 4 1
11、3 40 3 16 45 2 21 61 1(Low betas)40 62 Source:Sharpe and Cooper(1972)9-14McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Company Cost of Capitalsimple approachwCompany Cost of Capital(COC)is based on the average beta of the assetswThe average Beta of the assets i
12、s based on the%of funds in each asset9-15McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Company Cost of Capitalsimple approachCompany Cost of Capital(COC)is based on the average beta of the assetsThe average Beta of the assets is based on the%of funds in each as
13、setExample1/3 New Ventures B=2.01/3 Expand existing business B=1.31/3 Plant efficiency B=0.6AVG B of assets=1.39-16McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Capital Structure-the mix of debt&equity within a companyExpand CAPM to include CS R=rf+B(rm-rf)beco
14、mesRequity=rf+B(rm-rf)Capital Structure9-17McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Capital Structure&COCCOC =rportfolio =rassetsrassets=WACC=rdebt(D)+requity(E)(V)(V)Bassets=Bdebt(D)+Bequity(E)(V)(V)requity=rf+Bequity(rm-rf)IMPORTANTE,D,and V are all mark
15、et values9-18McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Capital Structure&COCExpected return(%)BdebtBassetsBequityRrdebt=8Rassets=12.2Requity=15Expected Returns and Betas prior to refinancing9-19McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,In
16、c.All rights reserved Union Pacific Corp.Requity=Return on Stock =15%Rdebt=YTM on bonds =7.5%9-20McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Union Pacific Corp.9-21McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Union Paci
17、fic Corp.Example9-22McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved International RiskSource:The Brattle Group,Inc.s Ratio-Ratio of standard deviations,country index vs.S&P composite index9-23McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All ri
18、ghts reserved Asset Betas9-24McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Asset Betas9-25McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQ9-26McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.A
19、ll rights reserved Risk,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?9-27McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Ris
20、k,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?9-28McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQExamplePr
21、oject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?9-29McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQExampleProject A is expected to
22、 produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?Now assume that the cash flows change,but are RISK FREE.What is the new PV?9-30McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights res
23、erved Risk,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?.Now assume that the cash flows change,but are RISK FREE.What is the new PV?9-31McGraw Hill/IrwinCopyrigh
24、t 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?.Now assume that the cash flows change,but are RISK
25、 FREE.What is the new PV?Since the 94.6 is risk free,we call it a Certainty Equivalent of the 100.9-32McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rat
26、e of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?DEDUCTION FOR RISK9-33McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of
27、 6%,a market premium of 8%,and beta of.75,what is the PV of the project?.Now assume that the cash flows change,but are RISK FREE.What is the new PV?The difference between the 100 and the certainty equivalent(94.6)is 5.4%this%can be considered the annual premium on a risky cash flow9-34McGraw Hill/Ir
28、winCopyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved Risk,DCF and CEQExampleProject A is expected to produce CF=$100 mil for each of three years.Given a risk free rate of 6%,a market premium of 8%,and beta of.75,what is the PV of the project?.Now assume that the cash flows change,but are RISK FREE.What is the new PV?