Global Cost of Capital
Chapter 11
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Chapter 11 - wacc
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Weighted average cost of
capital (WACC)
k wacc  xe  re  xd  rd  1  Tc  
Dd
E
 ke 
 k d  1  Tc 
V
V






ke
kd
Tc
E
D
V
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- cost of equity
- cost of debt
- corporate tax rate
- market value of equity
- market value of debt
- total market value of the firm’s securities
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WACC effects
 Capital budgeting
 Pro forma income statements are
required for each period
 The NPV of the NCFs is inversely related
to the value of the wacc
T
NPV  
t 1
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NCFt
(1  wacc)t
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WACC effects
 If you can lower your wacc, more
projects become profitable.
k
kwacc
MRR
capital budget
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Leverage effects
 leverage effects determine an optimal
level of leverage
k
e
kwacc
kd
leverage
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Market efficiency
 perfect information
 standardized accounting practices
 standardized reporting practices
 no transactions costs
 no regulatory costs
 governments do not try to restrict capital
markets
 no monopolistic influences in the
market place
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Cost of equity – FDI
(efficient capital markets)
 dividend capitalization model
ke




D0 1  g  

g
P0
 capital asset pricing model
ke  k rf   e  k m  k rf 
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Chapter 11 - wacc
e 
Cove,m
Varm
7
Cost of Debt – FDI
(efficient capital markets)
 Mature capital markets have bond
rating agencies
 AAA, AA, A, BBB, BB, BB, C, D
 The ratings determine the cost of debt to
the firm
 The type of debt instrument
 Mortgage bond, coupon bond, discount
bond
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Inefficient markets
 imperfect information (information
barriers)
 high transactions costs
 exchange rate exposure
 regulatory costs
 capital restrictions
 exchange restrictions
 political risk
 no competition to exchange
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Cost of equity – FDI
(inefficient capital markets)
 If there are no reliable measures of
risk in an economy we must make an
informed guess by applying a Risk
Premium to the domestic return on
equity
ke  k rf   e  k m  k rf   RP
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Cost of debt - FDI
(inefficient capital markets)
 Normal debt markets immature
 Governments may offer incentives
 Lower interest rates, tax relief,
 Supra-national agencies may offer
incentives to invest
 UN, IMF, etc.
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Relative market efficiency
0%
100%
W. European,
Asian
Russian
S. American,
E. European
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N. American
12
Segment capital markets
 Capital markets are internal to the
economy
 Borrowers and lenders are confined to
the geographic confines of the country
 European union prior to the euro
 Finnish firms could finance only from
Finnish sources
 Argentine firms could finance only from
Argentinian sources
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Integrated (consolidated)
capital markets
 Euro zone
 With currency unification, capital
markets within the euro zone are
integrating
 Lenders and borrowers have much better
opportunities
 The market becomes thicker so the prices
of borrowing are more efficient
 Canada/US is an integrating market
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