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Chapter 8

TYPES AND COSTS OF FINANCIAL CAPITAL

ENTREPRENEURIAL FINANCE

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Chapter 7:Learning Objectives

Understand some basic characteristics of the financial markets

Understand how risk-free securities prices reflect risk-free borrowing rates

Explain how corporate debt prices reflect higher interest rates when a borrower may default

Explain investment risk

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Chapter 7:Learning Objectives

Estimate the cost of publicly traded equity capital (e.g., exchange-listed common stocks)

Estimate the cost of private equity capital Explain how capital costs combine into a

weighted average cost of capital (WACC) Understand venture investors’ target returns

and their relation to capital costs

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Types & Costs of Financial Capital资金成本及其类别

Implicit Versus Explicit Financial Capital Costs 隐含的和显性的资金成本

• Formal historical accounting procedures include explicit records of debt (interest and principal) and dividend capital costs

• However, no provision is made to record the less tangible expenses of equity capital (i.e., required capital gains to complement the dividends)

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Financial Markets 金融市场

Public Financial Markets: 公开交易金融市场

markets for the creation, sale and trade of liquid securities having standardized features

Private Financial Markets: 非公开交易金融市场

markets for the creation, sale and trade of illiquid securities having less standardized negotiated features

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Financial Markets 金融市场

Venture Debt Capital: 创业企业债务资本debt raised in early stage from individuals, venture capital firms, and possibly financial institutions

Venture Equity Capital: 创业企业权益资本equity raised in early stage from founding entrepreneurial team, business angels, and venture capitalists

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Determining Cost Of Debt Capital 确定债务资本成本

Interest Rate: 利率price paid to borrow funds

Default Risk: 违约风险risk that a borrower will not pay the interest and/or principal on a loan

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Determining Cost Of Debt Capital 确定债务资本成本 Nominal Interest Rate (rd): 名义利率

observed or stated interest rate

Real Interest Rate (RR): 实际利率interest one would face in the absence of inflation, risk, illiquidity, and any other factors determining the appropriate interest

Risk-free Interest Rate (rf): 无风险利率interest rate on debt that is virtually free of default risk

Inflation: 通货膨胀rising prices not offset by increasing quality of the goods or services being purchased

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Determining Cost Of Debt Capital确定债务资本成本

Inflation premium (IP): 通货膨胀收益average expected inflation rate over the life of a risk-free loan

Default Risk Premium (DRP): 违约风险收益additional interest rate premium required to compensate the lender for the probability that a borrower will default on a loan

Liquidity Premium (LP): 流动性收益charged when a debt instrument cannot be converted to cash quickly at its existing value

Maturity Premium (MP): 到期收益premium to reflect increased uncertainty associated with long-term debt

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Interest Rate Relationships利率的关系 rf = RR + IP （无风险利率）

for debt by effectively default-free borrowers (e.g. U.S. government)

rd = RR + IP + DRP +LP +MP （名义利率）more generally, for more complicated risky debt securities at various maturities and liquidities

Can think of rd = rf + DRP + LP + MP

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Determining Cost Of Debt Capital 确定债务资本成本 Prime Rate: 基本利率

interest rate charged by banks to their highest quality (lowest default risk) business customers

Bond Rating: 债券评级reflects the default risk of a firm’s bonds as judged by a bond rating agency

Senior Debt: 优先债务debt secured by a venture’s assets

Subordinated Debt: 次级债debt with an inferior claim (relative to senior debt) to venture assets

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Determining Cost Of Debt Capital 确定债务资本成本 Term Structure of Interest Rates: 利率期限结构

relationship between nominal interest rates and time to maturity when default risk is held constant

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Determining Cost Of Debt Capital 确定债务资本成本 Yield Curve: 收益率曲线

graph of the term structure of interest rates

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Determining Market Interest Rates 确定市场利率

rd = RR + IP + DRP +LP +MP （名义利率） Suppose:

• Real interest rate = 3%

• Inflation expectation = 3%

• Default risk = 5%

• Liquidity premium = 3%

• Maturity premium = 2% Then:

• rd = 3% + 3% + 5% + 3% + 2% = 16%

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What Is Investment Risk?什么是投资风险？

Investment Risk: 投资风险chance or probability of financial loss from a venture investment

• Debt, equity, and founding investors all assume investment risk

• A widely accepted measure of risk is the dispersion of possible outcomes around the expected return of an investment – the standard deviation of possible investment returns 标准差度量投资风险

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Calculating a Possible Return计算可能的投资回报

Suppose• Buy stock at $100

• Receive $10 dividend

• Ending stock value = $110 Then:

100x Value Beginning

Value) Beginning- Value (Ending FlowCash Return of Rate %

20.0% 100x $100

$100) - ($110 $10Return of Rate %

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Calculating an Expected Return计算预期的回报

Expected Rate of Return:probability-weighted average of all possible rate of return outcomes

Economic Probability of Rate of Weighted

Climate Occurrence X Return = Return

Rapid Growth .30 X 60% = 18.0%

Normal .40 X 20% = 8.0%

Recession .30 X -20% = -6.0%

1.00 Expected Return = 20.0%

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Measuring Risk as a Dispersion Around an Average 标准差度量风险

Weighted

Outcome Minus Difference Probability Squared

Expected Return Squared x of Outcome = Deviations

60% - 20% = 40% 1,600 x .3 = 480.0

20% - 20% = 0 0 x .4 = 0.0

-20% - 20% = -40% 1,600 x .3 = 480.0 Variance =

960.0

Standard Deviation =

31.0%

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Measuring Risk as a Dispersion Around an Average 标准差衡量风险

Calculating Standard Deviation: 计算标准差• Calculate the expected rate of return on an investment

based on estimates of possible returns and probabilities associated with those returns

• Subtract the expected value from each outcome to determine deviations from the expected value

• Square each difference or deviation

• Multiply each squared deviation by the probability of the outcome and sum the weighted squared deviation to get the variance

• Calculate the square root of the variance to get standard deviation

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Graphical View Of Dispersion: Continuous Probability Distributions of Rates of Return

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Measuring Risk as a Dispersion Around an Average 标准差度量风险

Coefficient of Variation: 方差系数• Standard Deviation / Expected Return

• Coefficient of Variation: shows the dispersion risk per unit of expected rate of return – a ratio of risk to reward

• 单位预期收益率的风险程度

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Estimating the Cost of Equity Capital估算股权资本成本

Private Equity Investors 私人股权投资者owners of proprietorships, partners in partnerships, and owners in closely held corporations

Closely Held Corporations 非公开交易股份公司

corporations whose stock is not publicly traded

Publicly Traded Stock Investors 公开发行股票的投资者

equity investors of firms whose stocks trade in public markets such as the over-the-counter market or an organized securities exchange

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Estimating the Cost of Equity Capital估算股权资本成本

Organized Securities Exchange: 有组织的证券交易

a formally organized exchange typically having a physical location with a trading floor where trades take place under rules set by the exchange

Over-the-Counter (OTC) Market: 柜台交易（ OTC ）市场

network of brokers and dealers that interact electronically without having a formal location

Market Capitalization (market cap): 资本市场determined by multiplying a firm’s current stock price by the number of shares that are outstanding

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Cost of Equity Capital for Public Corporations 上市公司股权资本成本

re = rf + IRP = RR + IP + IRPwhere:

re = cost of common equity 普通股资本成本rf = risk-free interest rate 无风险利率RR = real rate of interest 实际利率IP = inflation premium 通货膨胀收益IRP = equity investment risk premium

股权投资风险收益 IRP: additional return expected by investors in a risky publicly

traded common stock 投资者在购买公开上市普通股股票时，对风险的额外预期报酬率。

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Cost of Equity Capital for Public Corporations 上市公司股权资本成本 Expected Return on Venture’s Equity (re) using

the Security Market Line (SML):

re = rf + [rm – rf]

where rf = risk-free interest rate

rm = expected annual rate of return on stock market

(beta) = systematic risk of firm to the overall stock

market

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Cost of Equity Capital for Public Corporations 上市公司股权资本成本 Expected Return on Venture’s Equity (re) using

the Security Market Line (SML):

re = rf + [MRP]

MRP: 市场风险收益market risk premium = excess average annual return of common stocks over long-term government bonds

股票投资收益超过无风险投资的收益

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Cost of Equity Capital for Private Ventures

私营企业股权资本成本Venture Hubris: 创业风险

optimism expressed in business plan projections that ignore the possibility of failure or underperformance

What do we do with such projections? Userv = re + AP + LP + HPP

where:rv = rate of return for venture investors 创业企业投资的报酬率re = cost of common equity 股权资本成本AP = advisory premium 咨询服务收益LP = liquidity risk 流动性风险HPP = hubris projections premium 创业企业投资的风险收益

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Weighted Average Cost of Capital (WACC) 加权平均资本成本

WACC: 加权平均资本成本weighted average cost of the individual components of interest-bearing debt and common equity capital

After-tax WACC: 税后加权平均资本成本= (1 – tax rate) x (debt rate) x (debt%) +

equity rate x (1 – debt%)

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Weighted Average Cost of Capital (WACC) 加权平均资本成本例题 WACC Example for $1 Venture with:

• $.50 of debt

• $.50 of equity

• debt interest rate = 10%

• tax rate = 30%

• required return to equity holders = 20%

After-tax WACC = (1 – tax rate) x (debt rate) x (debt%) +

equity rate x (1 – debt%)

= (.70 x .10 x .5) + (.20 x .5)

= .135 or 13.5%

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Graphically,

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Using WACC to Complete Calibration of EVA使用加权平均资本成本度量企业的成长

EVA: 经济增加值Net Operating Profit After Taxes (NOPAT) – After-tax Dollar Cost of Financial Capital Used

• NOPAT = EBIT(1- Effective Tax Rate)

• After-Tax Dollar Cost of Financial Capital Used = amount of financial capital x WACC

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Using WACC to Complete Calibration of EVA

使用加权平均资本成本度量企业的成长例题 For example: Beta Omega Corp has the

following information:• EBIT = $500,000

• Amount of Financial Capital = $1,600,000

• WACC = 19.0%

• Tax = 30% NOPAT = [$500,000 x (1-.30)] = $350,000 After-Tax Cost of Financial Capital Used =

$1,600,000 x .19 = $304,000 EVA = $350,000 - $304,000 = $46,000