Discount Rates, Cost of Capital, and Property Acquisition Evaluations (September 1988)

1988 ◽  
Author(s):  
R.J. Miller ◽  
R. Vasquez
Keyword(s):  
Cost Of Capital ◽  
Discount Rates ◽  
Property Acquisition

Cost of capital and discount rates in cash flow valuations for resources projects

2018 ◽  
Vol 59 ◽  
pp. 525-531 ◽  
Author(s):  
Eric Lilford ◽  
Bryan Maybee ◽  
Dan Packey
Keyword(s):  
Cash Flow ◽  
Cost Of Capital ◽  
Discount Rates

A New Approach to Capital Budgeting in Closely-Held Firms and Small Firms

1981 ◽  
Vol 5 (4) ◽  
pp. 30-35 ◽  
Author(s):  
Thomas H. McInish ◽  
Ronald J. Kudla
Keyword(s):  
Small Firms ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Separation Principle ◽  
Discount Rates ◽  
Present Value ◽  
Investor Returns

The traditional application of the net present value method in capital budgeting involves the use of market derived discount rates such as the cost of capital. Justification of these discount rates stems from the separation principle that states that investment decisions can be made independent of shareholders' tastes and preferences. The purpose of this paper is to show that the separation principle does not hold for closely-held firms and small firms, and, accordingly, market-derived discount rates are inappropriate. Two capital budgeting techniques which are appropriate for these firms are presented. Accept/reject decisions for capital budgeting projects are often made using a technique known as “net present value” (NPV).1 Using the NPV method, acceptable projects are those for which the project's cost is less than the present value of the project's cash flows discounted at the firm's cost of capital; in other words, acceptable projects have a positive NPV. The firm's cost of capital is usually taken to be the weighted average of the firm's cost of equity and debt as measured by investor returns in the capital markets. Justification for use of a discount rate, determined by reference to market-wide investor returns, is based on “the separation principle” which asserts that corporations can make capital budgeting decisions independently of their shareholders' views.2 But because a critical assumption of the separation principle is that shares are readily marketable, it is likely that the separation principle and, hence, market-determined discount rates are inappropriate for closely-held firms and small firms.3 In this paper, we discuss two capital budgeting approaches which are applicable to firms whose shares are not readily marketable. This paper is divided into five sections. First, we discuss the traditional net present value approach to capital budgeting and, then, we indicate in detail, why it may not be suitable for use by closely-held firms and small firms. In the third and fourth sections, we explain two capital budgeting techniques which may be appropriate for use by these firms. Finally, we summarize our conclusions.

scholarly journals Generalization of the Modigliani–Miller Theory for the Case of Variable Profit

Mathematics ◽  
2021 ◽  
Vol 9 (11) ◽  
pp. 1286
Author(s):  
Peter Brusov ◽  
Tatiana Filatova ◽  
Natali Orekhova ◽  
Veniamin Kulik ◽  
She-I Chang ◽  
...  
Keyword(s):  
Corporate Finance ◽  
Tilt Angle ◽  
Dividend Policy ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Discount Rates ◽  
Business Valuation ◽  
The World ◽  
Equity Cost ◽  
First Time

For the first time we have generalized the world-famous theory by Nobel Prize winners Modigliani and Miller for the case of variable profit, which significantly extends the application of the theory in practice, specifically in business valuation, ratings, corporate finance, etc. We demonstrate that all the theorems, statements and formulae of Modigliani and Miller are changed significantly. We combine theoretical and numerical (by MS Excel) considerations. The following results are obtained: (1) Discount rate for leverage company changes from the weighted average cost of capital, WACC, to WACC–g (where g is growing rate), for a financially independent company from k0 to k0–g. This means that WACC and k0 are no longer the discount rates as it takes place in case of classical Modigliani–Miller theory with constant profit. WACC grows with g, while real discount rates WACC–g and k0–g decrease with g. This leads to an increase of company capitalization with g. (2) The tilt angle of the equity cost ke(L) grows with g. This should change the dividend policy of the company, because the economically justified value of dividends is equal to equity cost. (3) A qualitatively new effect in corporate finance has been discovered: at rate g < g* the slope of the curve ke(L) turns out to be negative, which could significantly alter the principles of the company’s dividend policy.

Component Technologies, Inc.: Adding FlexConnex Capacity

2000 ◽  
Vol 15 (2) ◽  
pp. 257-282
Author(s):  
Julie H. Hertenstein
Keyword(s):  
Cost Of Capital ◽  
Electronic Devices ◽  
Capital Investments ◽  
Discount Rates ◽  
Manufacturing Planning ◽  
Time Horizons ◽  
Hurdle Rate ◽  
Planning Staff ◽  
Percent Rate ◽  
Financial Analyses

Component Technologies, Inc. (CTI) manufactures components used in electronic devices. CTI is considering adding manufacturing capacity for FlexConnex to meet increased future demand. CTI's manufacturing planning staff identifies three options to meet this demand. The staff performs preliminary financial analyses to evaluate whether to conduct detailed planning for and evaluation of each of the three options. During their analysis, they consider which discount rate is more appropriate: the 20 percent rate, which the corporate finance manual states is the hurdle rate for capital investments, or 10 percent, which the staff believes is closer to the corporate cost of capital. They experiment with both discount rates, and two time horizons. This case requires you to calculate net present values (NPVs) and to analyze the effect of different discount rates and time horizons. It also asks you to consider the effect of other financial and nonfinancial issues on your analysis.

scholarly journals New Models for Analyzing Changes in Company Value Based on Stochastic Discount Rates

2019 ◽  
Vol 23 (3) ◽  
pp. 35-48 ◽  
Author(s):  
P. E. Zhukov
Keyword(s):  
Cash Flow ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Cash Flows ◽  
Free Cash Flow ◽  
Discount Rates ◽  
The Third ◽  
Company Value ◽  
New Models ◽  
Zero Growth

We propose new models for analyzing changes in the value of the company using stochastic discount rates. It is shown that for the majority of the companies under study, local changes in the rate of the company value growth (percentage changes to the previous level) are not explained by the corresponding changes neither in the weighted average cost of capital (WACC), nor in the cash flows. This fact, as well as the research results by J. Cochrane, who proved that discount rates volatility is the main contributor to price volatility, became initial prerequisites for building models based on stochastic discount rates. The work presents three models built on stochastic discount rates, where cash flows are assumed to be growing with a certain trend, and the factors affecting the price of the company are described by stochastic discount factors. These models are alternative in relation to the commonly used traditional cash flow discounting (DCF) models where the free cash flow is discounted through the WACC, or the free flow to capital at the opportunity cost of equity. The first model is used to analyze the dependence of the company value on investments. It uses free cash flow subject to zero growth. The second model uses net cash flow from operating activities plus interest, minus the minimum investment subject to zero growth. The third model uses net cash flow from operating activities plus interest adjusted to taxes. This model requires to estimate the rates of the company downsizing subject to zero investment. The third model is applicable for companies with volatile investments, where it is difficult to reliably estimate free cash flow in case of zero growth. The models are designed for analysis of the factors influencing the value of the company for value-based management. Another application of the models is the evaluation of investment value of the company and the answer to the question of its possible overestimated or underestimated value. The third way to apply this model is the empirical evaluation of the weighted average cost of capital applicable to the company’s investment projects, alternative to WACC, assessed by standard methods.

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