Calculating the Cost of Capital
MGT 4850
Spring 2009
University of Lethbridge
Introduction
• DCF models using accounting statements
to calculate free cash flows
• The Gordon model –cost of equity based
on dividends
• The Capital Asset Pricing Model
• The cost of debt
• WACC
• RADR
Gordon Model with constant
Growth Rate
• Cost of equity
Cost of Equity p.42
Cost of Equity KELLOGG p.43
Kellogg p.44
All Cash Flows to Equity
Gordon Model with all cash flows
Dividend per share p.47
Supernormal growth
• 2 growth rates
• Formula doesn't work
Supernormal growth
• Calculate share price as DCF (dividends
and share price at point 5
Calculating Cost of Equity
• Choosing the growth rate
Capital Asset Pricing Model
•
•
•
•
Calculating beta of stock returns
125 monthly returns for SP500 and stock A
Regression analysis
Beta using variance/covariance matrix
CAPM cost of capital
Setting the regression in Excel (58)
OUTPUT (p. 58)
Regression graph (p. 54)
Intel Returns vs SP500, 2001-2006
25%
15%
5%
-11%
-9%
-7%
-5%
-3%
-1%
-5%
-15%
Intel returns
-13%
1%
3%
5%
7%
SP500 returns
-25%
y = 2.2516x - 0.0029
R2 = 0.5304
-35%
-45%
Cost of Debt (p.67)
Yield Curve (p.69)
BBB Bond Yields, 11Aug06
7%
6%
Yield
5%
4%
3%
y = 0.0001x3 - 0.0023x2 + 0.0152x + 0.0221
R² = 0.8479
2%
1%
0
1
2
3
4
5
Maturity
6
7
8
9
10
11
WACC (p.73)
COMPUTING THE WACC FOR KRAFT
Shares outstanding
Share price, end 2005
Equity value, E
Net debt, D
1,669,880,755
27.75
46,339,190,951
10,884,000,000
WACC based on Gordon per-share dividends and interest from financial statements
Cost of equity, rE
Cost of debt, rD
Tax rate, TC
WACC
16.79% <-- ='Page 71'!B6
5.50% <-- ='Page 67'!B13
29.37% <-- ='Kraft 10K, 2005'!B160
14.33% <-- =$B$4/($B$4+$B$5)*B8+$B$5/($B$4+$B$5)*B9*(1-$B$10)
WACC based on Gordon equity payouts and interest from financial statements
Cost of equity, rE
Cost of debt, rD
Tax rate, TC
WACC
14.46% <-- ='Page 72, top'!B11
5.50% <-- ='Page 67'!B13
29.37% <-- ='Kraft 10K, 2005'!B160
<-- =$B$4/($B$4+$B$5)*B14+$B$5/($B$4+$B$5)*B15*(112.45% $B$10)
WACC based on classic CAPM and interest from financial statements
Cost of equity, rE
Cost of debt, rD
Tax rate, TC
WACC
6.82% <-- ='Page 72, bottom'!B12
5.50% <-- ='Page 67'!B13
29.37% <-- ='Kraft 10K, 2005'!B160
<-- =$B$4/($B$4+$B$5)*B20+$B$5/($B$4+$B$5)*B21*(16.26% $B$10)
WACC based on tax-adjusted CAPM and interest from financial statements
Cost of equity, rE
6.05% <-- ='Page 72, bottom'!B13
Cost of debt, rD
5.50% <-- ='Page 67'!B13
Tax rate, TC
WACC
29.37% <-- ='Kraft 10K, 2005'!B160
<-- =$B$4/($B$4+$B$5)*B26+$B$5/($B$4+$B$5)*B27*(15.64% $B$10)
Using SML to calculate cost of
equity
• Beta as a measure of market risk
• Regression analysis
• Covariance of stock returns with market
returns