Cost of Capital

1
Cost of Capital
2
Identify Industry and Comparable Companies

• Are there other public companies in the industry?
• Are there public companies with similar
  characteristics?
• Determine average equity beta for comparable
  companies.
• Determine of equity for comparable companies.

3
Boston Celtics Comparable Companies

• There are no other publicly owned professional
  basketball franchises. Sports franchises.
• What are key economic drivers?

4
Boston Celtics Comparable Companies

• There are no other publicly owned professional
  basketball franchises. Sports franchises.
• What are key economic drivers?
• Team performance.

5
Boston Celtics Comparable Companies

• There are no other publicly owned professional
  basketball franchises. Sports franchises.
• What are key economic drivers?
• Team performance.
• Popularity of Basketball as a sport.

6
Boston Celtics Comparable Companies

• There are no other publicly owned professional
  basketball franchises. Sports franchises.
• What are key economic drivers?
• Team performance.
• Popularity of Basketball as a sport.
• Disposable income of fans.
• Similar to other entertainment companies

7
Identify Industry and Comparable Companies

• Are there other public companies in the industry?
• Are there public companies with similar
  characteristics?
• Determine average equity beta for comparable
  companies.
• Determine of equity for comparable companies.

8
Comparable Companies
Company Eq. Beta
LTD to BV Assets Capital Cities
Comm. .93
43.2 Chris-Craft
.68 42.3 Taft Broadcasting
.82
64.3 United Cable
.95 82.7 Viacom Intl
.69
46.9 Average .814 55.9
9
Impact of Financial Leverage
Published betas for publicly traded stock reflect
the actual capital structure of each respective
company. As such they can be referred to as
levered betas. An unlevered beta is the beta
the company would have if the companys assets
were 100 financed with equity (e.g., it had no
debt).
10
Levered Beta toUnlevered Beta
BL Bu 1 (1 - t) Wd / We
Bu Unlevered Beta BL Levered Beta
(published) t tax rate for the company Wd
Percent debt in the capital structure We
Percent equity in the capital structure
11
Unlevered Beta to Levered Beta
BL Bu (1 (1 - t) Wd / We)
BL Levered Beta (calculated) Bu Unlevered
Beta t tax rate for the company Wd Percent
debt in the capital structure We Percent equity
in the capital structure
12
Comparable Companies
Company Eq. Beta
LTD to BV Assets Unlevered
Beta Capital Cities Comm. .93
43.2 .619 Chris-Craft
.68
42.3 .458 Taft Broadcasting
.82 64.3
.375 United Cable
.95 82.7
.229 Viacom Intl
.69 46.9
.436 Average .814 55.9 .443
13
Cost of Capital
rE rF beta ( E(rM) -
rF)
14
Cost of Equity Capital
rE rF beta ( E(rM) -
rF)
Cost of Equity Risk Free Rate
(Beta x Risk Premium) 1986 Cost of Equity
7.65 ( .443
x 7.60 )
15
Cost of Capital
Cost of Capital Risk Free Rate
(BetaUnlevered x Risk Premium) 1986 C of C
7.65 ( .443
x 7.6 ) 11.02 T. Bond (30
Year)
Previous Calc. Empirical Average 1926 -
1993
16
Determine Present Value of Cash Flows
Present Value of a stream of cash flows (using MS
Excel) NPV (Discount rate, cash flow yr. 1,
cash flow yr. 2, .) Present Value of Cash
Flow for Terminal Year
Cash Flow for Terminal Year
Discount Rate


( 1 Discount Rate) Number of years out
17
Boston Celtics Firm Value
Value of Equity Discounted Cash Flows
18
Present Value of First Five Years Cash Flows
Look up how to determine a series of cash flows
in MS Excel. Use the same discount rate for
each year of the series.
19
Present Value of Terminal Year
Cash Flow in Terminal Year Discount Rate (1
Discount Rate) n

n number of years out for the terminal year
20
Terminal Year Alternatives

• Do you forecast growth in sales in the terminal
  year?