财务管理英语

FinancialManagementChapter1

Introductionto

FinancialManagementChapter1IntroductiontoFinancialManagement1.1FinancialManagementandFinancialManager1.2ObjectivesandFunctionsofFinancialManagement1.3FinancialMarketandMarketEfficiency1.4AgencyRelationships1.1

FinancialManagementandFinancialManager1.1.1

FinancialManagementFinancialmanagementisanintegrateddecision-makingprocessconcernedwithacquiring,financing,andmanagingassetstoaccomplishsomeoverallgoalwithinabusinessentity.1.1.2

FinancialManagerFinancialmanager,alsocalledthechieffinancialofficer(CFO),hastheprimaryresponsibilityofacquiringfunds(cash)neededbyafirmandfordirectingthesefundsintoprojectsthatwillmaximizethevalueofthefirmforitsowners.1.2

ObjectivesandFunctionsof

FinancialManagement1.2.1

ObjectivesofFinancialManagementThemostwidelyacceptedobjectiveofthefirmistomaximizethevalueofthefirmforitsowners;thatis,tomaximizeshareholderwealth.Shareholderwealthisrepresentedbythemarketpriceofafirm’scommonstock.1.2

ObjectivesandFunctionsof

FinancialManagement1.2.2

FunctionsofFinancialManagementEstimationofCapitalRequirementsDeterminationofCapitalCompositionChoiceofSourcesofFundsInvestmentofFundsDisposalofSurplusManagementofCashFinancialControls1.3

FinancialMarketandMarketEfficiency1.3.1

FinancialMarketAfinancialmarketisabroadtermdescribinganymarketplacewherebuyersandsellersparticipateinthetradeofassetssuchasequities,bonds,currenciesandderivatives.MoneyMarketsBondMarketsForeignExchangeMarketsShareMarketsDerivativeMarkets1.3.2

MarketEfficiencyTheefficiencyofthecapitalmarketsistheimportant“glue”thatbondsthepresentvalueofafirm’snetcashflow,discountedattheappropriaterisk-adjustedrequiredrateofreturn,toshareholderwealth,asmeasuredbythemarketvalueofacompany’scommonstock.Capitalmarketefficiencyisanimplicitassumptioninmanydecisionmodelsusedwidelyinfinance.1.3

FinancialMarketandMarketEfficiency1.3.3

DegreesofMarketEfficiencyThreelevelsofmarketefficiencyhavebeenidentified,basedontheinformationsetunderconsideration:Weak-formEfficiencySemi-strongFormEfficiencyStrong-formEfficiency1.3

FinancialMarketandMarketEfficiency1.4

AgencyRelationshipsAnagencyrelationshipiscreatedwhendecision-makingauthorityisdelegatedtoanagentwithouttheagentbeingfullyresponsibleforthedecisionthatismade.1.4.1

AgencyProblemsTheseparationoftheownershipandcontrolraisesworriesthatthemanagementteammaypursueobjectivesattractivetothem,butwhicharenotnecessarilybeneficialtotheshareholders.Agencyproblemsexistbetweenstockholdersandmanagersandmayalsoexistbetweencreditorsandcorporations1.4

AgencyRelationships1.4.2

AgencyCostsTheseagencyproblemsgiverisetoanumberofagencycosts,whichareincurredbyshareholderstominimizeagencyproblems.1.4.3

PracticalSolutionstotheAgencyProblemsManagerialCompensationDirectShareholderInterventionThreatofBeingFiredThreatofAcquisition1.4

AgencyRelationshipsChapter2

Introductionto

FinancialStatementsChapter2IntroductiontoFinancialStatements2.1FinancialStatementsandAnnualReports2.2AnalysisofFinancialStatements2.1FinancialStatementsandAnnualReports2.1.1

OverviewofFinancialStatementsFinancialstatements(orfinancialreports)areformalrecordsofthefinancialactivitiesandpositionofabusiness,person,orotherentities.Relevantfinancialinformationispresentedinastructuredmannerandinaformeasywaytounderstand.Ittypicallyincludesbasicfinancialstatements,accompaniedbyamanagementdiscussionandanalysis.2.1FinancialStatementsandAnnualReports2.1.2

CorporateAnnualReportsTypicalannualreportswillinclude:GeneralcorporateinformationOperatingandfinancialreviewDirector’sreportCorporategovernanceinformationChairman’sstatementAuditor’sreportContents:non-auditedinformationFinancialstatementsNotestothefinancialstatementsAccountingpoliciesOtherfeatures2.2

AnalysisofFinancialStatementsThereareseveralwaysinwhichfinancialstatementsmightbeanalyzed.Inpractice,oneofthemostimportantmethodsisthetechniqueknownasratioanalysis,whichinvolvesthecalculationofanumberofaccountingratios.2.2.1

TheNeedforRatiosWithoutratios,financialstatementswouldbelargelyuninformativetoallbuttheveryskilled.Withratios,financialstatementscanbeinterpretedandusefullyappliedtosatisfytheneedsofthereader.2.2

AnalysisofFinancialStatements2.2.2

TypesofAccountingRatiosProfitabilityratios.Theprofitabilityratiosmeasuretheprofitoroperatingsuccessofanentityforagivenperiodoftime.Liquidityratios.Theliquidityratiosmeasuretheshort-termabilityofanentitytopayitsmaturingobligationsandtomeetunexpectedneedforcash.Solvencyratios.Solvencyratiosmeasuretheabilityofanentitytosurviveoveralongperiodoftime.2.2.3

UsersofRatios2.2

AnalysisofFinancialStatementsRatiocategoryExamplesofinterestedgroupsProfitabilityShareholders,management,employees,creditors,competitors,potentialinvestorsLiquidityShareholders,suppliers,creditors,competitorsSolvencyShareholders,potentialinvestors,creditors

2.2

AnalysisofFinancialStatements2.2

AnalysisofFinancialStatements

2.2

AnalysisofFinancialStatements

2.2

AnalysisofFinancialStatements

2.2

AnalysisofFinancialStatements

2.2

AnalysisofFinancialStatementsChapter3

TimeValueofMoneyChapter3TimeValueofMoney3.1ValueCreationandCorporateInvestment3.2SimpleandCompoundInterest3.3FutureValueandPresentValue3.1

ValueCreationandCorporateInvestmentIfweacceptthattheobjectiveofinvestmentwithinafirmistocreatevalueforitsowners,thenthepurposeofallocatingmoneytoaparticulardivisionorprojectistogeneratecashinflowsinthefuturesignificantlygreaterthantheamountinvested,thenputmostsimply,theprojectappraisaldecisionisoneinvolvingthecomparisonoftheamountofcashputintoaninvestmentwiththeamountofcashreturned.Thekeyphraseandthetrickyissueis“significantlygreaterthan”。3.2

SimpleandCompoundInterest3.2.1

SimpleInterestSimpleinterestistheinterestthatispaidonlyontheoriginalprincipal.Nointerestispaidontheaccumulatedinterestpayments.3.2

SimpleandCompoundInterest3.2.1

SimpleInterestExample3-1Supposethatasumof$10isdepositedinabankaccountthatpays12percentannum.Attheendofyear1,theinvestorwouldhave$11.20intheaccount.Thatis:F=P(1+i)$11.20=10×(1+0.12)WhereF=Futurevalue,P=Presentvalue,i=Interestrate.Theinitialsum,calledtheprincipal,ismultipliedbytheinterestratetogivetheannualreturn.Attheendoffiveyears:F=P(1+i·n)Wheren=numberofyears.Thus,$16=10×(1+0.12×5)3.2

SimpleandCompoundInterest3.2.2

CompoundInterestThemoreusualsituationintherealworldisforinteresttobepaidonthesumthataccumulates—whetherornotthatsumcomesfromtheprincipalorfromtheinterestreceivedinpreviousperiods.3.2

SimpleandCompoundInterest3.2.2

CompoundInterestExample3-2Aninvestmentof$10ismadeataninterestrateof12percentwiththeinterestbeingcompounded.Inoneyearthecapitalwouldgrowby12percentto$11.20.Inthesecondyearthecapitalwouldgrowby12percent,butthistimethegrowthwouldbeontheaccumulatedvalueof$11.20andthuswouldamounttoanextra$

SimpleandCompoundInterest3.2.2

CompoundInterestExample3-2Attheendoftwoyears:F=P(1+i)(1+i)F=11.20(1+0.12)=$12.54Alternatively,F=P(1+i)2Overfiveyearstheresultwouldbe:F=P(1+i)5;

$17.62=10×(1+0.12)5Theinterestontheaccumulatedinterestwasthereforethedifferencebetweenthetotalarisingfromsimpleinterestandthatfromthecompoundinterest:17.62-16.00=$1.62Almostallinvestmentspaycompoundinterest,sowewillbeusingcompoundingthroughoutthebook.3.3

FutureValueandPresentValue3.3.1

FutureValueFuturevaluemeasuresthenominalfuturesumofmoneythatagivensumofmoneyis“worth”ataspecifiedtimeinthefutureassumingacertaininterestrate,ormoregenerally,rateofreturn;itisthepresentvaluemultipliedbytheaccumulationfunction.FVn=PV(1+i)n=PV(F/P,i,n)3.3

FutureValueandPresentValue3.3.2

PresentValuePresentvalue(PV)isthecurrentvalueofafuturesumofmoneyorstreamofcashflowsgivenaspecifiedrateofreturn.PV=FVn/(1+i)n=FV(P/F,i,n)3.3

FutureValueandPresentValue

3.3

FutureValueandPresentValue3.3.4

AnnuityAnannuityisaseriesofpaymentsorreceiptsofequalamounts.Annuitiesareusuallyclassifiedintofourcategories:Ordinaryannuity:isanannuitywhosepaymentsaremadeattheendofeachperiod.Annuitydue:

isanannuitywhosepaymentsaremadeatthebeginningofeachperiod.Deferredannuity:isanannuitywhichthefirstcashflowintheseriesoccursbeyondoneperiodfromtoday.Perpetuity:isanannuityforwhichthepaymentscontinueforever.3.3

FutureValueandPresentValue

AlsowecanuseSpreadsheet

methodtosolvetheFVforOrdinaryannuity

Interestrate(perannum)Year1%5%10%12%15%11.00001.00001.00001.00001.000022.01002.05002.10002.12002.150033.03013.15253.31003.37443.472544.06044.31014.64104.77934.993455.10105.52566.10516.35286.74243.3

FutureValueandPresentValue

3.3

FutureValueandPresentValueAlsowecanuseSpreadsheet

methodtosolvethePVforOrdinaryannuity

InterestratePeriod1%5%10%12%15%10.99010.95240.90910.89290.869621.97041.85941.73551.69011.625732.94102.72322.48692.40182.283243.90203.54603.16993.03732.855054.85344.32953.79083.60483.3522

3.3

FutureValueandPresentValueOrdinaryAnnuityPMTPMTPMT0123i%PMTPMT0123i%PMTAnnuityDue3.3

FutureValueandPresentValue

3.3

FutureValueandPresentValue

3.3

FutureValueandPresentValue

3.3

FutureValueandPresentValue

3.3

FutureValueandPresentValueChapter4

RiskandReturnChapter4RiskandReturn4.1UnderstandingReturn4.2UnderstandingRisk4.3PortfolioTheory4.4CapitalAssetPricingModel(CAPM)4.1

UnderstandingReturn4.1.1

ReturnAreturnexpressthefinancialperformanceofafinancialasset(orinvestment),whichmightbeaboveorbelowitsvalueatthetimeofpurchase/investment.Areturncanbeexpressedineithermonetary($)orpercentage(%)terms.Returnstofinancialassetorinvestmentcanbecalculatedoverwhatevertimeperiodannually,quarterlyorevendaily.4.1

UnderstandingReturn

4.1

UnderstandingReturn

4.2

UnderstandingRisk4.2.1

Risk1.DefiningRiskThedictionarydefinitionofrisk,the“possibilityoflossorinjury,”focusesontheperilsofputtingoneselfinasituationinwhichtheoutcomeisunknown.Hereisthedefinitionwewilluse:Riskisameasureofuncertaintyaboutthefuturepayofftoaninvestment,measuredoversometimehorizonandrelativetoabenchmark.4.2

UnderstandingRisk4.2.1

Risk2.ClassifyingRisksWecanclassifyallrisksintooneoftwogroups:

（1）thoseaffectingasmallnumberofpeoplebutononeelseand

（2）thoseaffectingeveryone.Wewillcallthefirstoftheseunsystematicordiversifiablerisksandthesecondsystematicormarketrisks.4.2.1

Risk3.RiskPreferenceRisk-aversion:

Investorswhodislikeriskandrequirehigherratesofreturntoencouragethemtoholdriskiersecurities.Risk-neutral:Investorswhoselectstheinvestmentwiththehighestexpectedreturnanddonottakeintoaccounttheriskofaninvestmentinhisdecisionmaking.Risk-seeking:Investorswhoprefertoinvestinaportfoliowhichhasuncertainoutcome.Risk-seekinginvestorslovetotakerisks.4.2

UnderstandingRisk

4.2

UnderstandingRisk4.3

PortfolioTheory4.3.1

BasicAssumptionsInvestorslikemorereturnandlessrisk.Thediversificationofaninvestmentportfoliocanreducerisk.Anintuitiveexplanationofthisinvestmentdiversificationisbasedontheproverb:donotputallyoureggsintoonebasket.Modernportfoliotheory(MPT),ormean-varianceanalysis,isamathematicalframeworkforassemblingaportfolioofassetsthattheexpectedreturnismaximizedforagivenlevelofrisk,definedasvariance.Itskeyinsightisthatanasset’sriskandreturnshouldnotbeassessedbyitself,butbyhowitcontributestoaportfolio’soverallriskandreturn.4.3.2

PortfolioReturnandRisk1.PortfolioReturnThereturnsfromtheportfoliowillsimplybetheweightedaverageofthereturnsfromthetwoassets,asshownbelow:Rp=W1R1+W2R24.3

PortfolioTheory4.3

PortfolioTheory

4.3

PortfolioTheory

4.3

PortfolioTheory4.3

PortfolioTheory4.3.2

PortfolioReturnandRisk3.CovarianceandCorrelationofReturnsforTwoAssetsCovariancemeasurestheextenttowhichtwovariablemovetogetherovertime.Apositivecovariancemeansthatthevariabletendtomovetogether.Negativecovariancemeansthatthetwovariabletendtomoveinoppositedirections.Acovarianceofzeromeansthereisnolinerrelationshipbetweenthetwovariables.4.3

PortfolioTheory

4.3

PortfolioTheory

4.3

PortfolioTheory4.3.2

PortfolioReturnandRisk4.TheEffectonaPortfolio’sRiskofInvestinginAssetsofDifferentCorrelationCoefficientWeshowtheserelationsgraphicallyinFigure4-1byplottingtheportfolioriskandreturnforallportfoliooftworiskyassets,forassumedvaluesoftheassets’returnscorrelation.4.3

PortfolioTheory4.3.3

Minimum-VarianceandEfficientFrontiersTheportfolioontheefficientfrontierthathastheleastriskistheglobalminimum-varianceportfolio.4.3

PortfolioTheory4.3.4

TheSelectionofanOptimalPortfolioAninvestor’sutilityfunctionrepresentstheinvestor’spreferencesintermsofriskandreturn(i.e.,hisdegreeofriskaversion).Anindifferencecurveisatoolfromeconomicsthat,inthisapplication,plotscombinationsofrisk(standarddeviation)andexpectedreturnamongwhichaninvestorisindifferent.InFigure4-3,weshowthreeindifferencecurvesforaninvestor.Theinvestor’sexpectedutilityisthesameforallpointsalongasingleindifferencecurve.IndifferencecurveI1representsthemostpreferredportfolioinFigure4-3;ourinvestorwillpreferanyportfolioalongI1toanyportfoliooneitherI2orI3.4.3

PortfolioTheory4.3.4

TheSelectionofanOptimalPortfolio4.3

PortfolioTheory4.3.4

TheSelectionofanOptimalPortfolioCombiningariskyportfoliowitharisk-freeassetistheprocessthatsupportsthetwofund

separationtheorem,whichstatesthatallinvestorsoptimumportfolioswillbemadeupofsomecombinationofanoptimalportfolioofriskyassetandtherisk-freeasset.Thelinerepresentingthesepossiblecombinationsofrisk-freeassetandtheoptimalriskyassetportfolioisreferredtoasthecapitalallocationline.4.3

PortfolioTheory4.3.4

TheSelectionofanOptimalPortfolio4.3

PortfolioTheory4.3.5

SystematicRiskandUnsystematicRiskTotalriskcanbebrokendownintoitscomponentparts:unsystematicriskandsystematicrisk.Mathematically:Totalrisk=Unsystematicrisk+SystematicriskFigure4-7providesageneralrepresentationofthisconcept.Note,inthefigure,thatonceyougetto30ormoresecuritiesinaportfolio,thestandarddeviationremainsconstant.Theremainingriskissystematic,ornon-diversifiablerisk.4.3

PortfolioTheory4.3.5

SystematicRiskandUnsystematicRisk4.4

CapitalAssetPricingModel(CAPM)Thecapitalassetpricingmodel(CAPM)isanimportanttoolusedtoanalyzetherelationshipbetweenriskandratesofreturn.TheprimaryconclusionoftheCAPMisthis:therelevantriskofanindividualstockisitscontributiontotheriskofawell-diversifiedportfolio.Infinance,thecapitalassetpricingmodel(CAPM)isamodelusedtodetermineatheoreticallyappropriaterequiredrateofreturnofanasset,tomakedecisionsaboutaddingassetstoawell-diversifiedportfolio.4.4

CapitalAssetPricingModel(CAPM)

Chapter5

CategoriesofCapitalBudgetingProjectsChapter5CategoriesofCapitalBudgetingProjects5.1CapitalBudgeting5.2ProjectAppraisal5.3ProjectAppraisalRules5.4TheInvestmentProcess5.1

CapitalBudgetingThecapitalbudgetingprocessistheprocessofidentifyingandevaluatingcapitalprojects,thatis,projectswherethecashflowtothefirmwillbereceivedoveraperiodlongerthanayear.Forexample,whethertobuyanewmachine,expandbusinessinanothergeographicarea,movethecorporateheadquarterstoCleveland,orreplaceadeliverytruck,tonameafew,canbeexaminedusingacapitalbudgetinganalysis.5.2

ProjectAppraisal5.2.1

CategoriesofCapitalBudgetingProjects

Replacementproject:Acapitalinvestmentdesignedtoimproveefficiencyortomaintainorincreaserevenuesbyreplacingdeterioratedorobsoletefixedassets.Anexpansionproject:Acapitalinvestmentdesignedprimarilytoenhancerevenuesbyincreasingoperatingcapacityinexistingproductsormarketsorbyfocusingoperationstoexpandintocompletelynewproductsormarkets.5.2

ProjectAppraisal5.2.1

CategoriesofCapitalBudgetingProjects

Independentproject:Projectsthatareunrelatedtoeachotherandallowforeachprojecttobeevaluatedbasedonitsownprofitability.Mutuallyexclusive:Itmeansthatonlyoneprojectinasetofpossibleprojectscanbeacceptedandthattheprojectscompetewitheachother.5.2

ProjectAppraisal5.2.2

AreProfitCalculationsUsefulforEstimatingProjectViability?Profitisaconceptdevelopedbyaccountantsinordertoassistthemwithauditingandreporting.Profitfiguresarederivedbytakingwhatisacontinuousprocess,achangeinacompany’sworthovertime,andallocatingthesechangestodiscreteperiodsoftime.Shareholdersmakecurrentconsumptionsacrifices,ortheygiveupthereturnavailableelsewherewhentheychoosetoinvesttheirmoneyinafirm.Whatisofinteresttothemarethefuturecashflowsandtheprecisetimingofthesecashflows.Theaccountantdoesadifficultandimportantjobbuttheprofitfiguresproducedarenotsuitableforprojectappraisal.Profitisapoorapproachfortwomainreasons:depreciationandworkingcapital.5.2

ProjectAppraisal5.2.3

GuidelinesforEstimatingProjectCashFlowsDecisionsareBasedonCashFlows,notAccountingIncomeCashFlowsareBasedonOpportunityCostsTheTimingofCashFlowsisImportantCashFlowsareAnalyzedonanAfter-taxBasisFinancingCostsareReflectedintheProject’sRequiredRateofReturn5.3

ProjectAppraisalRules

5.3

ProjectAppraisalRules5.3.1

NetPresentValue(NPV)

ApositiveNPVprojectisexpectedtoincreaseshareholderwealth,anegativeNPVprojectisexpectedtodecreaseshareholderwealth,andazeroNPVprojecthasnoexpectedeffectonshareholderwealth.Forindependentprojects,theNPVdecisionruleissimplytoacceptanyprojectwithapositiveNPVandtorejectanyprojectwithanegativeNPV.5.3

ProjectAppraisalRules

5.3

ProjectAppraisalRules5.3.2InternalRateofReturn(IRR)IRRdecisionrule:IfIRR>therequiredrateofreturn,accepttheproject.IfIRR<therequiredrateofreturn,rejecttheproject.5.3

ProjectAppraisalRules5.3.2InternalRateofReturn(IRR)1.TheRelativeAdvantagesandDisadvantagesoftheNPVandIRRMethodsAkeyadvantageofNPVisthatitisadirectmeasureoftheexpectedincreaseinthevalueofafirm.NPVistheoreticallythebestmethod.Itsmainweaknessisthatitdoesnotincludeanyconsiderationofthesizeoftheproject.AkeyadvantageofIRRisthatitmeasuresprofitabilityasapercentage,showingthereturnoneachdollarinvested.TheIRRprovidesinformationonthemarginofsafetythattheNPVdoesnot.ThedisadvantagesoftheIRRmethodare(1)thepossibilityofproducingrankingsofmutuallyexclusiveprojectsthatdifferfromthosefromNPVanalysisand(2)thepossibilitythanaprojecthasmultipleIRRsornoIRR.5.3

ProjectAppraisalRules5.3.2InternalRateofReturn(IRR)2.ConflictingProjectRankingsConsidertwoprojectswithaninitialinvestmentof$1,000andarequiredrateofreturnof10%(Table5-2).5.3

ProjectAppraisalRules5.3.2InternalRateofReturn(IRR)3.The“MultipleIRR”and“NoIRR”ProblemsWhenthecashflowschangesignmorethanonce,thereismorethanoneIRRWhenyousolveforIRRyouaresolvingfortherootofanequation,andwhenyoucrossthex-axismorethanonce,therewillbemorethanonereturnthatsolvestheequationIfyouhavemorethanoneIRR,whichonedoyouusetomakeyourdecision?5.3

ProjectAppraisalRules5.3.2InternalRateofReturn(IRR)3.The“MultipleIRR”and“NoIRR”ProblemsSupposeaninvestmentwillcost$90,000initiallyandwillgeneratethefollowingcashflows:Year1:132,000;Year2:100,000;Year3:-150,000Therequiredreturnis15%.Shouldweacceptorrejecttheproject?5.3

ProjectAppraisalRules

5.3

ProjectAppraisalRules5.3.3

PaybackPeriodandDiscountedPaybackPeriod2.DiscountedPaybackperiodThediscountedpaybackmethoddiscountstheestimatedcashflowsbytheproject'scostofcapital.Itisthenumberofyearsittakesforaprojecttoreturnitsinitialinvestmentincurrent(presentvalue)dollars.Thedrawbackofpaybackanddiscountedpaybackisthatitdoesnotconsideranycashflowsbeyondthepaybackperiod.Boththepaybackanddiscountedpaybackgiveusanindicationofaproject'sriskandliquidity(i.e.,theshorterthepayback,thegreatertheliquidity).Paybackisameasureofprojectrisk,sinedistantcashflowsareriskierthannearcashflows.5.3

ProjectAppraisalRules

5.3

ProjectAppraisalRules5.3.4

AccountingRateofReturn1)ComparisonofdifferentalternativesIfseveralinvestmentsareproposedandthemanagementhavetochoosethebestduetolimitedfunds,theproposalwiththehighestaccountingrateofreturnispreferred.

2)AdvantagesanddisadvantagesofARR

(1)AdvantagesAccountingrateofreturnissimpleandstraightforwardtocompute.Itfocusesonaccountingnetoperatingincome.Creditorsandinvestorsuseaccountingnetoperatingincometoevaluatetheperformanceofmanagement.5.3

ProjectAppraisalRules5.3.4

AccountingRateofReturn2)AdvantagesanddisadvantagesofARR(2)DisadvantagesAccountingrateofreturnmethoddoesnottakeintoaccountthetimevalueofmoney.Underthismethodadollarinhandandadollartobereceivedinfutureareconsideredofequalvalue.Cashisveryimportantforeverybusiness.Ifaninvestmentquicklygeneratescashinflow,thecompanycaninvestinotherprofitableprojects.Butaccountingrateofreturnmethodfocusonaccountingnetoperatingincomeratherthancashflow.Theaccountingrateofreturndoesnotremainconstantoverusefullifeformanyprojects.Aprojectmay,therefore,lookdesirableinoneperiodbutundesirableinanotherperiod.5.4

TheInvestmentProcessChapter6

CostofCapitalChapter6CostofCapital6.1IntroductiontotheCostofCapital6.2CostofDebt6.3CostofEquity6.4WeightedAverageCostofCapital6.1

IntroductiontotheCostofCapital6.1.1

SourceofFinanceMostcompaniesraisemoneyusingacombinationofdebtandequity.Debtiscomposedoftwoforms,whichareshort-termdebtandlong-termdebt.Andtheequityisalong-termconcept,whichincludespreferredstock,commonstockandretainedearning.Thischapterwillfocusonthelong-termcapital,whichisshowninFigure6-1.6.1

IntroductiontotheCostofCapital6.1.1

SourceofFinance6.1

IntroductiontotheCostofCapital6.1.2

WhatistheCostofCapital?Costofcapitalisthepricethatacompanyshouldpayforachievingcapitalfrominvestors,includingshareholdersandcreditors.Itistheminimumrateofreturnthatcapitalproviderstoearninthebestalternativeinvestmentwiththesameorsimilarriskandduration.6.1

IntroductiontotheCostofCapital

6.2

CostofDebtDebtisoneofmainfinancingtypesforcorporate.Debtresultsintaxsavingsbecauseinterestpaymentsaredeductedfromthecompany’sincomebeforecorporationtaxislevied.Therefore,debtswillreducetheamountoftaxableincomeofafirm.Thecostofdebtfinancingisrelatedto:TheinterestpayabletotheborrowedmoneyNetamountofdebtwhichisinvolvedtherelateddirectcostAfirm’staxrate6.2

CostofDebt

6.3

CostofEquity

6.3

CostofEquity

6.3

CostofEquity

6.3

CostofEquity

6.4

WeightedAverageCostofCapital

6.4

WeightedAverageCostofCapital6.4.2

FactorsAffectingtheWeightedAverageCostofCapitalManyfactorswillhaveinfluencesontheweightedaveragecostofcapital.Someelementscanbecontrolledbycompanieswhiletheothersareoutoftheircontrol.1.FactorsControlledbyCompanyThecapitalstructure;dividendpolicy;investmentpolicy2.FactorsUncontrolledbyCompanyInterestrates;TaxratesChapter7

CapitalStructureChapter7CapitalStructure7.1LeverageAnalysis7.2CapitalStructureandCostofCapital7.3CapitalStructureTheory7.4FactorsthatInfluenceaFirm’sCapitalStructureDecision7.5FeaturesofanOptimalCapitalStructure7.6ValueofaFirmandCostofCapital7.1

LeverageAnalysisLeverageanalysisisatoolthatisusuallyusedbyfinancialmanagersforfinancialanalysis.Inordertofacilitatetheanalysis,wemakethefollowingassumptions:Thecompanyonlysellsonekindofproductandthesellingpriceisconstant;Theunitvariablecostandtotal