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RV1: Cost of Capital: How you define it?

What are the factors affecting cost of


capital?
 Define Cost of Capital:
- The structure of the capital: Cost of capital is the cost for a business but return for
an investor. (debt to equity ratio)
- The opportunity cost: Cost of capital refers to the opportunity cost of making a
specific investment. It is the rate of return that could have been earned by putting the
same money in different investment having similar risk and other characteristic.
 The factors affecting Cost of Capital:
- 3 types of factors :
+ Cost of Equity capital = Risk Free Rate + Beta * (Market Risk Premium – Risk
Free Rate )
+ Cost of Debt capital = Interest Rate * ( 1-Tax Rate)
+ WACC = Weight of Equity * Cost of Equity + Weight of debt * Cost of Debt
- FUNDAMENTAL FACTORS AFFECTING COST OF CAPITAL: MARKET
OPPORTUNITY; CAPITAL PROVIDER’S PREFERENCES; RISK; INFLATION
- ECONOMIC AND OTHER FACTORS AFFECTING COST OF CAPITAL:
FEDERAL RESERVE POLICY; FEDERAL BUDGET DEFICIT OR SURPLUS;
TRADE ACTIVITY; FOREIGN TRADE SURPLUSES OR DEFICITS; COUNTRY
RISK; EXCHANGE RATE RISK
- INDIVIDUAL COMPANY FACTORS AFFECTING COST OF CAPITAL: CAPITAL
STRUCTURE POLICY; DIVIDEND POLICY; INVESTMENT POLICY;
 Sample
RV2: What is the Capital Structure? How capital structure affects the cost of ca
pital?
 definition of capital structure
o Capital Structure refers to the amount of debt and/or equity employed
by a firm to fund its operations and finance its assets. Debt comes in the
form of bond issues or long-term notes payable, while equity is classified
as common stock, preferred stock or retained earnings. Short-term debt
such as working capital requirements is also considered to be part of the
capital structure.
 How capital structure affects the cost of capital:
- Debt is a cheaper source of financing as compared to equity. However,
the cost of issuing additional debt will exceed the cost of issuing new equity. For a co
mpany with a lot of debt, adding new debt will increase its risk of default.
A higher default risk will increase the cost of debt, and a high default risk may also dr
ive the cost of equity up because shareholders will likely also expect a premium for t
aking on additional risk.
 equity financing is attractive because it does not create a default risk to
the company. Also, equity financing may offer an easier way to raise a large amo
unt of capital. However, for some companies equity financing may not be
a good option, as it will reduce the control of current shareholders over the busine
ss.

RV3: What are factors affecting your project evaluation? ( thay chua)
 Cashflow: The higher the cashflow, the higher the return. The frequency of CF
(monthly, quartly, annually); Inflows (sales revenue: volume of sale, price)
Salvage value (recover a part of investment cost)
 outflows ( equipments, working capital ( labor, material. Production,…. ):
Depreciation: Higher depre -> Lower taxable income EBIT -> lower tax
payment; Intial investment for lands, equip, facilities,v.v;)
 Economic scenarios: Normal ( normal inflation, normal growing demands)
Pessimistic Normal Optimistic best
Worst base case
Volume Demand down Little Grow; Stable Steep growing demand
Price down Little Grown; Stable Growing price
Effect Total inflow decrease Total inflows increase

 Risk involve: Different project -> Different risk level ->


Use different RRR as discount rate to determine NPV. The higher the risk -> the
higher the RRR -> the lower the present value of CF.
 Interest rate: Firms borrowed money from the bank for project.
High fluctuation -> Uncertainty of present value. If the interest rate grow up ->
PVs of CFs go down -> margin of project go down.
 Inflation:
Pessimistic Normal Oppotimistic best
Worst base case
Probability 20% 60% 20%
Volume 100 200  300
Price 20 30  40
Effect 2000 6000  12000
EXPECTED= 20% * 2000 + 60%*6000+20%*12000=

- Term: The longer the project: risk higher, RRR higher -> PV of FV go down -> (higher
provision -> reduce margin) + lower NPV

RV4: How you monitor and control the financial risks of project?
- The Monitoring and Controlling process oversees all the tasks and metrics
necessary to ensure that the approved and authorized project is within scope, on
time, and on budget so that the project proceeds with minimal risk. This process
involves comparing actual performance with planned performance and taking
corrective action to yield the desired outcome when significant differences exist.
Monitoring and Controlling process is continuously performed throughout the life of
the project. Key Tasks:
+ Scope Verification and Change Control
+ Schedule Control
+ Cost Control
+ Quality Control
+ Performance Reporting
+ Risk Control
+ Contract Administration
+ Complete Monitoring and Controlling Phase Review
- Continuous monitoring and controlling of project risks ensure that the risk response
strategy and the risk treatment action plan are implemented and progressed
effectively. Usually risk reviews are included in the regular agenda of project
management meetings and used at most project phases and milestones. Risk
reviews facilitate better change management and continuous improvement.
- The process of controlling and monitoring risks includes the following tools and
techniques: risk reassessment, risk audits, technical performance measurement,
reserve analysis, status meetings. The main input to the risk controlling and
monitoring process is the watch list of the prioritized risks that have been identified
for risk responding and treatment actions. The risk watch list is used as criteria to
review work performance data, including deliverables status, costs incurred, and
project schedule progress.
RV5: Principle of Bond valuation, Stock Valuation. Factors affecting valuation?
Factors affecting investment performance?
 What is Bond Valuation
Bond valuation is a technique for determining the theoretical fair value of a partic
ular bond. Bond valuation includes calculating the present value of the bond's fut
ure interest payments, also known as its cash flow, and the bond's value upon m
aturity, also known as its face value or par value. Because a bond's par value an
d interest payments are fixed,
an investor uses bond valuation to determine what rate of return is required for a
bond investment to be worthwhile.
 Factor affect bond valuation : coupon rate,maturity date,current price, discoun
t rate
 Factors affecting bond prices:Interest rates, Inflation, Credit ratings.
-

 Stock Valuation
- stock valuation is the method of calculating theoretical values of companies
and their stocks. The main use of these methods is to predict future market
prices, or more generally, potential market prices, and thus to profit from price
movement – stocks that are judged undervalued (with respect to their theoretical
value) are bought, while stocks that are judged overvalued are sold, in the
expectation that undervalued stocks will overall rise in value, while overvalued
stocks will generally decrease in value.
 Factor affecting stock valuation:
- Stock prices can be affected by: company news and performance, industry
performance, investor sentiment, economic factors.

 Factors effecting investment performance:


- Interest rates (the cost of borrowing)
- Economic growth (changes in demand)
- Confidence/expectations
- Technological developments (productivity of capital)
- Availability of finance from banks.
- Others (depreciation, wage costs, inflation, government policy)
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