Big Picture - E-Commerce - Lecture Slides, Slides of Fundamentals of E-Commerce

Download Big Picture - E-Commerce - Lecture Slides and more Slides Fundamentals of E-Commerce in PDF only on Docsity!

CAPITAL STRUCTURE:

FINDING THE RIGHT FINANCING

MIX

You can have too much debt… or too liEle..

32

33

The Big Picture..

33

35

I. The Cost of Capital Approach

35

¨ Value of a Firm = Present Value of Cash Flows to the

Firm, discounted back at the cost of capital.

¨ If the cash flows to the firm are held constant, and

the cost of capital is minimized, the value of the firm

will be maximized.

36

Measuring Cost of Capital

36

¨ Recapping our discussion of cost of capital: ¨ The cost of debt is the market interest rate that the firm has to pay on its long term borrowing today, net of tax benefits. It will be a funcNon of: (a) The long-­‐term riskfree rate (b) The default spread for the company, reflecNng its credit risk (c) The firm’s marginal tax rate ¨ The cost of equity reflects the expected return demanded by marginal equity investors. If they are diversified, only the porNon of the equity risk that cannot be diversified away (beta or betas) will be priced into the cost of equity. ¨ The cost of capital is the cost of each component weighted by its relaNve market value. ¨ Cost of capital = Cost of equity (E/(D+E)) + A_er-­‐tax cost of debt (D/(D+E))

38

Applying Cost of Capital Approach: The

Textbook Example 38

Assume the firm has $200 million in cash flows, expected to grow 3% a year forever.

39

The U-­‐shaped Cost of Capital Graph…

39

41

Mechanics of Cost of Capital EsNmaNon

41

¨ 1. EsNmate the Cost of Equity at different levels of debt:

¤ Equity will become riskier -­‐> Beta will increase -­‐> Cost of Equity will increase. ¤ EsNmaNon will use levered beta calculaNon

¨ 2. EsNmate the Cost of Debt at different levels of debt:

¤ Default risk will go up and bond raNngs will go down as debt goes up -­‐> Cost of Debt will increase. ¤ To esNmaNng bond raNngs, we will use the interest coverage raNo (EBIT/Interest expense)

¨ 3. EsNmate the Cost of Capital at different levels of debt

¨ 4. Calculate the effect on Firm Value and Stock Price.