Weighted Average Cost of Capital (WACC) SEPPA Lec

Transcript:Weighted Average Cost of Capital (WACC) SEPPA Lec:
Weighted Average Cost of Capital (WACC) SEPPA Lec 8 By Prof. Amrit Nakarmi 07 Aug 2016 Raising capital for energy Co. Investment Debt Preferred share Common share Bond Loan Owners of Co. have common shares Discount rate It is the interest rate expected by the investor in an energy project It is also the opportunity cost of capital and it return on investment foregone by the investor elsewhere by committing capital in the energy project. Present value if projected in future will be compounded at this rate. Future values will be discounted at this rate top bring them to present value. Raising Capital for Energy Co. Debt can be raised from Bank Loan & bond (debenture) Fixed interest payment or coupons. The rate is called interest rate or coupon rate. Coupons are paid twice a year. 8/7/2016 5 Cost of Debt A firm with a 40% tax rate issues $1,000 bonds at a face value with coupon rate of 16%. Ignoring underwriting and issuing expenses, Market yield (market rate of return) = rd =160/1000 = 16% Cost of debt (to the company)=Rd=160*(1-0.4)/1000 =9.6% 8/7/2016 6 Cost of Preferred Share A corporation issues new $100 preferred shares that provide $12 in annual dividends. The firm has identical preferred shares outstanding that also trade at $100/share. The firm’s tax rate is 40%. 8/7/2016 7 Cost of Preferred Share Net Proceeds of preferred share (to the Co.) =NPp=100 Dp=12/100 =12% 8/7/2016 8 Cost of Equity A corporation issues new $100 common shares that provide $16 in annual dividends. The firm has identical common shares outstanding that also trade at $100/share. The firm’s tax rate is 40%. 8/7/2016 9 Cost of Equity Net Proceeds of common share (to the Co.) =NPe=100 re=16/100 =16% 8/7/2016 10 Weighted Average Cost of Capital (WACC) If ‘I’ is the total investment, then I =B+P+E, where B is borrowing (loans and bonds), P is preferred shares, and E is equity. Then, WACC =Rb(1-Tax)*B/I +kp*P/I + ke*E/I 8/7/2016 11 Example on WACC A firm plans on financing major new expansion programs by drawing on funds in the following proportions that roughly corresponds to its current capital structure: Long –term debt $30 mil Preferred shares $10 mil New common shares $40 mil Issuing and underwriting expenses can be ignored. Debt can be issued at a coupon rate of 12%, and the dividend yield on preferred shares would be 9%. Common Shares