It is the price the firm has to pay to the suppliers of long term capital for using their money

in the business. Interpretation: The minimum rate of return the firm must generate on every Taka it takes from the suppliers of long term capital to minimally satisfy them Separation of investment decision from financing decision.

The Standard WACC Equation kw = WACC = wd(kd)(1-t) + wpr(kpr) + we(ks) Ignore Preferred Stock Now kw = WACC = wd(kd)(1-t) + we(ks)

With 40 % Debt Ratio, kd = 10%, ks = 25%, and a tax rate of 30%, the kw is 17.8%

Investment Taka 10,00,000 Minimum return required After tax 1,78,000 Debt Holders Share (10% of Taka 4,00,000) Taka 40,000 Return required by shareholders:.25*6,00,000 = 1,50,000 Before Tax Required Return 2,54,286 Interest on Debt 40,000 Return after Interest 2,14,286 Tax 64,286 Return After Tax 1,50,000 Shareholders Required return on their share of Investment 1,50,000 Minimally satisfied Get a better return, everything now belongs to shareholders.

Kd = Yield to Maturity Use and Forms of Long-term Debt in Bangladesh No Bonds or Debentures in The Market
ACI Zero Coupon Bonds IBBL Perpetual Bonds

Spread Between Deposit Rate and Lending Rate

Cost of Long-term Debt from Financial Institution

A bond paying an annual coupon of 12 percent, maturing in 15 years, callable after 8 years at a call price of Taka 1050. What is the yield to call if current price is Taka 950? PV = -950, PMT = 120, N = 8, FV = 1050 CPT [I/Y] = 13.44%. This should be used as before tax cost of debt. Under what circumstances will the company call the callable bond?

A 12 percent annual coupon convertible bond maturing in 2020 is convertible after 2016 into 50 common shares per Bond. Current price of the bond is Taka 1020. Current share price of the company is taka 16.5. Share price growth historically has been 10 percent. What is the before tax cost of the bonds as a source of LT. Debt Capital?

Conversion Price = Taka 20 Conversion Ratio = 50 shares per Bond Straight or Pure Bond Value (Assuming a required return of 13%): Taka 952.01. Known as Floor Value Market Value of the Bond with the assumptions/information. Assume you will convert it in 2016 (4 years from now).

Expected stock price in 4 years: 16.5*(1+.10)4 = 24.16 Investors will convert to 50 shares per Bond, in 2016 Value of the stocks in 2016: 50*24.16 = 1,208 Implied Return indicated to Bond Investors: Current Price 1020, 4 payments of Taka 120 and Taka 1,208 at the end of 2016: 15.43 percent. Cost of Convertible Bond Capital is greater than coupon rate.

Inflation Expectation and Real Rate of Return

Inflation : 30 year average: 7.54% Real Interest Rate: 7-8.6%, at present (Lending Rate) T-Bond Rates Availability and Liquidity Spread between Deposit Rate and Lending Rate: 56% Nominal Lending Rate: 7.5 +7-8.6% = 14.5-16.1% (Lending) Nominal Lending rate: 7.5(IP) + 3.5(Real Deposit Rate) + 5.5% (Spread between deposit and lending) = 16.5% kd for average risk L.T. Debt now = 16.5%

Company with Constant Earnings. No retained earnings, since there is no growth. Company pays out all earnings as dividend. Value= Po = D/k = Earnings/k Required Return = k = D/Po = E/Po Cost of Equity = k = 1/PE Ratio

Company with Growing Earnings. Company retains part of earnings to support growth. Value = Po = D1/(k-g) + g

= Do(1+g)/(k-g)+g k = D1/P0 + g = Div Yield + Cap Appreciation

How do you determine g?

Retention Growth
G = ROE*(1-DPO)

Sustainable Growth Rate

G* = M(b)(1+D/E)/[(A/S)-M(b)(1+D/E)]
M= Margin on sales, b = target retention rate, (A/S) = ratio of total assets to sales.

1. 2. 3. 4. 5. 6.

Historical Growth Rate, Roughly Regression Slope (Time Is Predictor) GDP Growth (The Business Should Grow with The Whole Economy) Inflation Rate Historical ROE Growth Asset Growth

If it pays dividend,
Must recognize total dividend expectation,

includes

Cash Dividend Bonus Shares Right Shares

For Right Shares, We Need Ratio of Issue Issue Price Market Price
On issue date

Bond Yield +
ke = Bond Yield + Premium (Required Return Reflecting Risk)

Capital Asset Pricing Model

ke = krf + (km-krf) Betai (Required Return

Reflecting Risk)

In Bangladesh, Beta estimates are not reliable

We do not have dependable data on market returns Stock price fluctuations had been too severe to produce reliable estimate of beta. Beta values fluctuate too much year to year

Proxy for Stock Market

DSE All-Share Index DSE General Index (DGEN) DSE 30 DSEX Lack of Long History Representativeness Complexity in deriving dividend yield for DSE 20

Capital Gains Dividend Yield

Cash Dividend Bonus Shares

Cost of New Equity

Adjust for Floatation cost
ke = [D1/P0(1-f)] + g (No adjustment for tax rebate)

No Adjustment Necessary for New DebtCapital Cost of Preferred Stock Capital

kpr = Dpr/Net Price per Pr. Share

Book Value Weights Market Value Weights Target Structure Weights

For a firm with no debt, paying constant dividend less than 20%: WACC = ks = D/P0 or 1/PE Ratio For a firm with no debt, paying dividend less than 20% growing at g: WACC: Ks = D1/Po + g. Or required return on stock as indicated by CAPM WACC = Ks = krf + (km-krf)Beta For a firm with no debt, paying dividend: WACC = Adjusted cost of retained earnings Ks = D1(1+tr)/Po + g. Or required return on stock as indicated by CAPM Ks = krf + (km-krf)Beta For a firm with debt, paying no dividend: WACC = Wd(kd-t)+We(Ks) For a firm with debt, paying dividends: WACC = Wd*kd((1--t)+We(Adjusted Ks)

Tax rate, t = 42.5 percent for banks and financial institutions,

45

percent of mobile phone operators

30 percent for public companies other than banks and financial institutions. 37.5 Percent for private companies other than banks and financial institutions.

Return

**

RiskAdjusted Discount Rate

*
*
WACC

* *

* *

Risk

Risk Adjusted Discount Rate

RADR

Risk Use judgment to add 3 to 4 % to previous level of required return