Week 05 - Equity capital, debt capital, CAPM and WACC


In the fifth week of lectures the lecturer explained us about the equity capital, debt capital, cost asset pricing model and weighted average cost of capital. Equity capital is funds paid into a business by investors in exchange for common or preferred stock. This represents the core funding of a business, to which debt funding may be added. Once invested, these funds are at risk at risk, since investors will not be rapid in the event of a corporate liquidation until the claims of all other credits have first been seen settled. Despite this risk, investors are willing to provide equity capital for one or more of the following reasons:

Owing a sufficient number of shares gives an investor some degree of control over the business in which the investment has been made. 
  • The investee may periodically issue dividends to its stockholders
  • The price of the shares may appreciate over time, so that investors can sell their shares for a profit

Debt capital is knows as a part of the total capital invested in the business that is raised through loans. The company has to repay the load in the future date as per the agreement with the banks or investors. Debt capital can be divided into two parts, long term debt and short term debt. 

Capital asset pricing model describes the relationship between systematic risk and expected returns for assets, particularly stocks, CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital. 

The weighted average cost of capital is a calculation of a firms cost of capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation. A firms' WACC increases as the beta and rate of return on equity increase because an increase in WACC denotes a decrease in valuation and an increase in risk. 




Comments

Post a Comment

Popular posts from this blog

Week 02 - Shareholder Value Creation

Image
In the second week of lectures, we were given the topic of International Value Management. Value management is the managing of shareholder value. The key components of Value Management are Organisational capabilities, strategy and finance. traditional methods used to measure performance are Earnings per share and Return on capital employed (ROCE). Earning per share is calculated by dividing profit, net of tax, dividends to shareholders by the amount of ordinary shares outstanding. This shows the amount each shareholder gets if all the net income is distributed among them which usually doesn't happen and instead they are reinvested in the business. ROCE, on the other hand, means the profitability ratio of a company it is measured by comparing the profitability and the capital employed. Moreover, the lecturer briefly explained us about shareholder value creation/destruction, in highly volatile and complicated marketplace, it is important to create shareholder value which can lea...
Read more

Week 04 - Modern portfolio theory

Image
In the fourth week of lectures we were taught on the topic modern portfolio theory. This theory is an investment theory, based on the idea that risk-averse investors can create portfolios to max out the expected return based on a given level of market risk  considering that this risk is part of the reward.  This is one of the most important theories behind finance and investments. Another factor that this theory suggests is that investors given two portfolios would prefer the less risky one over the other. Therefore this suggests that investors will be willing to go for high risk portfolios if the return is fairly high compared to the other. this means that an investor must undergo a higher risk if they are aiming for a higher reward.  The same theory applies for each and every investor. Each investor will evaluate this theory in many different ways. A method which could be used to reduce the portfolio risk would be  by holding co...
Read more