5: The Cost of Capital

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5 The Cost of Capital
C.E.E.B.S.
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LEARNING OUTCOMES

• An understanding of the underlying principles in
  establishing the opportunity cost of capital for
  a firm.
• Estimate the cost of equity capital for (a) all
  firms across the market and (b) individual
  companies that are quoted.
• Make reasonable adjustments to the methods of
  estimating the equity cost of capital for firms
  that are not traded.
• Estimate raw betas from price data, making any
  necessary judgements and corrections to eliminate
  beta bias.
• Estimate the firms cost of debt capital
  irrespective of whether the firm has traded debt
  or is financed through loans.
• Draw the estimates together to calculate the
  weighted average cost of capital making the
  necessary adjustments for the impact of tax.

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Flow chart for estimatingopportunity cost of a
resource
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Cobham plc Dividends per ordinary share
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Worldwide equity risk premium (historical)
relative to bills (1900 2003)
source Dimson, E., Marsh, P., and Staunton
(2004)
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Two components in estimating the future growth of
the economy.
(charts taken from the Bank of England Inflation
Report, February 2004. )
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Regression outputs for Cobham plc
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(No Transcript)
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Estimating the standard error of beta for a group
of securities
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Beta and expected returns for Cobham plc using
the Capital Asset Pricing Model (rf 4.75 per
cent, ERP 3.5 per cent)
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The three risk factors in Fama and Frenchs 3
factor model
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Comparative US and UK data for the Fama and
French 3 factors (as at April 2005)
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Bond data for a company whose debt is traded
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Analysis of the average coupon rate for Cobhams
outstanding debt using the weighted average
method.
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The US Treasury yield curve (www.bondonline.com
April 2005)
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Reuters Corporate Spreads (shown as basis points)
for Industrials (www.bondsonline.com)
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Estimating the market value equivalent for
Cobhams outstanding debt
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WACC in premium form
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• Many Thanks for your Attention