1774 WordsJan 13, 20118 Pages

Chapter 12 – Determinants of Beta and WACC
[pic]
Ct is not known for certain. It is a random variable. It has a probability distribution with a mean and standard deviation.
Ct = E(Ct) = expected cash flow
“r” is the appropriate cost of capital. It should have the same riskiness as Ct
If Ct is a normal extension of the firm’s operations, and the firm is entirely equity financed, we use the stockholders’ required return as found through the CAPM for the appropriate value of ‘r’.
E(Ri) = Rf + (i (Rm – Rf)
Remember: the Beta of security i is the standardized covariance of its returns with the returns on the market portfolio.
(i = Covi,Mkt (2Mkt
Determinants of Beta
1. Cyclicality of revenues – How*…show more content…*

If we want to include the fact that interest payments are tax-deductable to the corporation, we need to modify the Hamada Equation as follows:
(Equity = [pic]
When we add taxes, the computations become a bit more complex, but the principles remain the same.
Example:
Reese’s Pieces Corp. has a capital structure of 80% equity and 20% debt. It is not taxed.
If you do an analysis of its returns vs. the market’s returns for the past five years, you will find that its beta is 0.75. This is the observable (Equity
Suppose the risk-free rate is currently 3% and the market risk-premium is 5.7%.
What is the required return of investors?
According to the CAPM:
E(RRP) = 3% + 0.75 (5.7%) = 7.275%
Now, suppose that Reese’s is considering taking on additional debt that will change its capital structure to 60% equity and 40% debt. How will that change investors’ required rate of return? For simplicity, let’s assume that the Beta of Reese’s debt is zero.
First calculate Reese’s Pieces’ unlevered beta ((Asset ):
(Equity = [pic]
(Asset = ((Equity) / [pic]
= (0.75) / (1 + .2/.8) = (0.6)
Next, ‘relever’ the firm with the new level of debt.
(Equity = [pic]
= 0.6 (1 + .4/.6)
= 0.6 (1.6667) = 1.0
With a new beta of 1.0, the CAPM says investors require a return of:
E(RRP) = 3% + 1 (5.7%) = 8.7%
Weighted-Average Cost of Capital - WACC - The expected return on a

Related

## Relationship Between Wacc & Blackberry’s Value

1088 Words | 5 PagesExecutive Summary: The purpose of this paper is to identify the weighted average cost of capital (WACC) in relation with the firm value. Also, there are some aspects discussed in the paper regarding when a firm should accept a project and when to reject. Systematic risk will be also discussed in the paper concerning their target market and how risky is that. Finally, the approach that BlackBerry took into consideration to overcome their risk. Discussion: All companies’ assets are financed by

## Valuation: Apv vs Wacc

2644 Words | 11 PagesA Note on Valuation Models: CCFs vs. APV vs WACC Fabrice Bienfait Table of Content Introduction..................................................................................................................................... 2 Enterprise Valuation ....................................................................................................................... 2 The Weighted Average Cost of Capital Approach ......................................................................... 2 The

## Diabetes and Beta - Carotene

958 Words | 4 PagesDiabetes Beta- carotene is an organic compound categorized as a terpenoid (Gutiérrez, & Gonzalez, 2010). Naturally, it is a predecessor of vitamin A, and found in several yellow fruits and vegetables. These organic nutrients play a vital role in aiding vision, skin growth, and bone development. In addition to these crucial roles, Beta-carotene may be of significant help in regulating the blood sugar in diabetic persons (Gutiérrez, & Gonzalez, 2010). Human bodies regulate blood sugar levels with

## Hp Wacc Project Essay

1846 Words | 8 Pagestechnology vendors. HP also has strong services and consulting business around its products and partner products. In this analysis, we will use multiple resources to determine HP’s weighted-average cost of capital (WACC). Target Capital Structure The first step in calculating our WACC was to determine the target capital structure. The target structure was determined using market value numbers. Using market value numbers was the most logical method to determine the target capital structure. The

## Nike Wacc

1068 Words | 5 PagesWhat is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not? 1.1 The definition of WACC Weighted average cost of capital(WACC), is a weighted-computational method of analyzing the cost of capital based on the whole capital structure of a firm. The result of WACC is the rate a firm use to monitor the application of the current assets because it represents the return the firm MUST get. For example this rate could

## Calculating Wacc

2481 Words | 10 Pagesweighted average cost of capital (WACC) to be 8.3%. I find error in this calculation as a result of the following points of disagreement: a) Weighting of Capital Structure: Use of book values of capital rather than the market values b) Cost of Debt Calculation: Incorrect method for calculating debt c) Tax Rate: Use of a tax rate derived from the summation of state and statutory taxes instead of the firm's marginal tax rate 2. Revised Calculation of WACC: WACC reflects the weighted average

## Nike Wacc Case Study

2281 Words | 10 PagesFinancial Management Agenda 1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not? 2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and justify your assumptions. 3. 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? 4. What should Kimi Ford recommend regarding

## Wacc for Fiat Group

1125 Words | 5 PagesC10390017, DT366 yr2 Report on the WACC for Fiat motors The WACC is the weighted average cost of capital. It is a calculation of the firms cost of capital taking into account the relevant weight of equity and debt as a proportion of the total. The cost of equity or KE calculated using a risk free rate example German 5yr government bond, the firm’s beta and the return on the market. The firm’s beta is a calculation of the firms exposure to the market, a beta of less than 1 indicates that the firm

## Wacc

1947 Words | 8 PagesCAPITAL BUDGETING Cost of Capital Evaluating Cash Flows Payback, discounted payback NPV IRR, MIRR The Cost of Capital • Cost of Capital Components – Debt – Common Equity • WACC Should we focus on historical (embedded) costs or new (marginal) costs? The cost of capital is used primarily to make decisions which involve raising and investing new capital. So, we should focus on marginal costs. What types of long-term capital do organizations use? nLong-term debt nEquity Weighted

## Beta Management

1114 Words | 5 Pages BETA MANAGEMENT COMPANY Q1. Calculate the variability (standard deviation) of the stock returns of California REIT and Brown Group during the past 2 years. How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest? The stock returns for each month are given in Table 1. Based on the monthly returns, the standard deviation or variability of each stock has been calculated. The standard deviation for California REIT is 9.23% and the standard deviation for

### Relationship Between Wacc & Blackberry’s Value

1088 Words | 5 Pages### Valuation: Apv vs Wacc

2644 Words | 11 Pages### Diabetes and Beta - Carotene

958 Words | 4 Pages### Hp Wacc Project Essay

1846 Words | 8 Pages### Nike Wacc

1068 Words | 5 Pages### Calculating Wacc

2481 Words | 10 Pages### Nike Wacc Case Study

2281 Words | 10 Pages### Wacc for Fiat Group

1125 Words | 5 Pages### Wacc

1947 Words | 8 Pages### Beta Management

1114 Words | 5 Pages