How does the cost of equity capital affect a firms NPV?
101508
The Stock Market and Investment: Another look at the micro-foundations of q Theory\nAbstract\nThis paper introduces a novel distinction between real q and financial q. The paper examines\nthree versions of financial q developed by Brainard and Tobin, Minsky, and Hayashi. These\ntheories differ regarding the nature of stock market price determination and their use of marginal\nproductivity theory. It is shown that non-profit maximizing behavior by managers does not\ninvalidate q theory. It is also shown that if managers and shareholders have different profit\nexpectations, this leads to an equilibrium value of q that differs from unity. Lastly, the implicit\nclaims in q theory regarding the efficient role of stock markets as regulators of capital\naccumulation are shown to depend on assumptions about stockholder behavior.\nJEL ref.: E2\nKeywords: q theory, stock markets, investment, arbitrage, cost of equity capital, profit\nmaximization.\nRevised August 1999\nForthcoming Cambridge Journal of Economics.\nThomas I. Palley\nAssistant Director of Public Policy, AFL-CIO\n815 Sixteenth Street, NW\nWashington DC 20006\n1\nI The implications of stock market q for policy\nThe monetary transmission mechanism remains an enduring area of interest in monetary\nmacroeconomics. Macroeconomic models have traditionally emphasized the interest rate channel\nwhich affects investment spending by establishing a hurdle rate of return for the marginal\nefficiency of investment. However, this traditional channel has been replaced increasingly by\nBrainard and Tobin's (1968, 1977) q theory of investment. Their approach emphasizes equity\nprices, and shifts attention away from the bond and money markets toward equity markets. In\nplace of interest rates, equity prices become the main channel whereby monetary policy affects\ninvestment spending (Blanchard, 1981).1\nThe q approach to the transmission mechanism increases the macroeconomic significance of\nstock markets which now take on an important role in managing the process of capital\naccumulation. This argument has taken on heightened policy significance owing to the debate\nover privatization of state funded old age pension schemes. Privatization would likely increase\nsaving in the form of equities, thereby increasing equity prices and q. If q theory holds, this\nwould raise investment spending and capital accumulation, thereby helping address the problem\nof supporting an aged population.\nA second reason why q theory has taken on increased policy significance is the shift within\nthe U.S. to budget surplus. Fiscal conservatives argue that a reduced national debt will increase\ninvestment because reduced supplies of debt will lower interest rates and have a portfolio knock-\n1. Both q and the conventional Keynesian interest rate mechanism share a reliance on asset\nmarket "price" signals as the means for affecting real economic activity. This contrasts with\ntheories emphasizing "quantity" effects, such as the credit rationing approach (Stiglitz and\nWeiss, 1981). In addition to affecting investment spending through q, equity prices also affect\nconsumption spending through their impact on household wealth. This wealth effect is separable\nand distinct.\n2\non effect that raises equity prices and q. Finally, a third policy development concerns the\nfostering of equity markets in developing countries. If q matters for investment, then developing\ncountries should be encouraged to promote local stock markets, and this provides a justification\nfor privatization in order to create widespread equity ownership.\nFor all of the above reasons, q theory of investment has taken on greater policy significance.\nThis paper analyzes the theoretical foundations of q’s claimed link between equity markets and\ninvestment spending. It clarifies the differences between alternative constructions of q, and\nshows that these rest on (i) different interpretations of the efficiency of stock m
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You need to rethink your question...Are you talking about Private Equity investing?  Starting your own business? Consulting in private sector?  Without this information, your answers will be limited in scope and might not apply.
156829
It depends on the equity later on down the road. Does the \n\nproperty hold value? Is this the only place you have \n\nlooked? It is your investment which you would need to think \n\nabout- it not just a yes or no answer.
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An easier way to look at it is to change the "c" to an "l". In other words, "opportunity lost".\n\nOpportunity cost is the price for committing your resources to a project. While they are committed, you can't spend them on other projects. So, you lost your control over your money and, if another project comes up, you lost the ability to invest in it.
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C.\n\nThe risk will determine how much is too much risk.  If the firm is cyclic, then the amount of debt should be lower so that the firm can still make interest payment during the down times.\n\nThe tax structure determines the amount of tax shield and also factors into the optimal capital structure.  More tax means more debt.\n\nEdit: By the way, Mark, I've gone through your papers a few years back and they were rather interesting.  I would have sent an email, but you don't have your up here on Answers and I didn't really want to invade your privacy by going through other channels.
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I would try to find a local investor. I've started 3 companies and you do not want capital venture firms giving you money. Find a local businessman or company to invest. 200-500k is a very small investment. Just make sure you have an attorney look over the documents before signing anything if you find an investor. If I didn't have a law degree, I wouldn't have noticed many of the stipulations. You can get screwed pretty easily and end up only owning 30-40% of the company you worked so hard to start.
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If each cash flow is subject to a binomial distribution (i.e. 60000 w/ a prob of 90%, and $0 otherwise) the the expected cash flow vector is the dot product of the $$$ & the probability vector.\n\nAssuming the investor is risk averse, the certainty equivalent NPV is simply the NPV of the expected cash flow vector discounted at the RFR.  The answer is b (w/ some rounding- I got $18701).\n\nIf you can't assume the binomial distribution or risk aversion, then the answer is d.
977094
Businesses that are financed by loan capital need to increase their margins higher than the interest rate in order to turn a profit. They may cut down costs for example by retrenching staff  or increase sale price.\n\nSuppliers to the business may also increase their prices in order to service the higher interest. This will lead to higher input costs thus higher prices.\n\nConsumers who borrow money to purchase from business will shy away from higher interest loans leading to reduced sales volume by business a thus a real  possibility of closure.\n\nShare holders expect their returns to be higher than if their money was in the bank. So they will be pressure on businesses to turn out higher profits ... in all the turbulent waters mentioned above.\n\nBusiness can be punished by shareholders/ Financial investors by removing their investment not only from that business and that industry, but from the entire UK region and invest in other friendly parts in the Globe if they feel an impediment on their profits or unpleasant surprises on their capital.\n\nHigher interest left unchecked could return UK back to the dark days of iron and steel making in several villages of South Wales in the 1700s
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Financing is bringing money (usually cash) to the firm.  With a larger cash reserve, the company will have more liquid assets.\n\nThe firm could also take out a large revolver at a bank and this type of financing would help to ease the uneven cash flows for a cyclic industry and help increase liquidity.
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I presume you're talking about "Use of Proceeds"?  Usually when a company raises capital from a group of investors (from selling stock or bonds) they will include a chart listing how much is expected to be received and what it will be used for.  Here's an example:\n\nSource of Funds:\nSale of stock - $75 million\n\nUse of Proceeds:\nRepay bank loan - $45 million\nInvestment in new plant - $20 million\nFees and expenses - $5 million\nGeneral corporate purposes - $5 million\n\nTypically the "source of funds" is on the left side and the "use of proceeds" is on the right side.  Obviously, both sides must total the same amount.
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use the CAPM (capital asset pricing) model to determine the cost of equity...\n\ncost of equity = risk free rate + beta of stock*(expected mkt return - risk free rate)\n\nremember that the "(expected mkt return - risk free rate)" part of the equation is the "market risk premium".\n\nand to calculate market risk premium is one of the biggest debates in finance!  The valuation book put out by McKinsey says to use the historical market risk premium of 5%\n\ngood luck!
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In short, assume probability distribution of rates at a given point of time in future is normally distributed. From the graph, you can read off the rates you are looking for. 25% points on either sides of the mid point would be the best and worst case scenarios while the mid point would be the typical scenario. Use the rates you get to compute NPV. Sigma would be the vols at which caps/floors/swaptions are priced for the tenor of the cash flows.
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How would the following items affect the AFN? \n\n    * Higher dividend payout ratio?\n          o Increase AFN: Less retained earnings.\n    * Higher profit margin?\n          o Decrease AFN: Higher profits, more retained earnings.\n    * Higher capital intensity ratio?\n          o Increase AFN: Need more assets for given sales.\n    * Pay suppliers in 60 days, rather than 30 days?\n          o Decrease AFN: Trade creditors supply more capital (i.e., L*/S0 increases).
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The net asset value (NAV) of a mutual fund is simply its assets minus its liabilities. In other words, NAV equals the fund's worth. If a fund has assets of $50 million and liabilities of $10 million, it would have a NAV of $40 million. \n\nThis number is important to investors, because it is from NAV that the price per unit of a fund is calculated. By dividing the NAV of a fund by the number of outstanding units, you are left with the price per unit. In our example, if the fund had 4,000,000 shares outstanding, the price-per-share value would be $40 million divided by 4,000,000, which equals $10. \n\nThe NAVs of funds are constantly changing and, as such, so are their price per shares. Funds usually wait until the end of each trading day to recalculate their NAV and individual share prices. \n\nWe should note that simply analyzing the NAV is not a good measure of the fund's growth. Funds are constantly paying out distributions of both capital gains and dividends, which reduce the NAV of the fund and do not reflect any appreciation in the price per unit. Say a fund's price per unit increased from $10 to $15, but the fund also distributed $5 per share to all unit holders. The fund hasn't simply appreciated by 50% ($10*1.5 = $15), as the per-unit cost would suggest; it has actually appreciated 100% ($10*2 = $20). So do not mistake a fund's per-share price based on NAV for the actual earnings of the fund.
1105732
Wow... this really is one of those "it depends" answers.  \n\nBefore I even go into what "depends", I'll throw out a simple, but likely incomplete answer:  \n - Assuming the "management" in question is actually getting paid by the business as part of running the business, AND there is an interest by the investor to actually split profit (more on this later), reasonable splits could be anwhere from 80 / 20 at a HIGH end to as small as 97 / 3 at a lower end with the investor getting the big number.\n\nBut let's step back.  \n\nFirst, there's some information missing.  \n  - What' the "exit plan" for the business? Is there any intent to sell the business to some other entity down the road to unlock much more value than normal profit?  If not, why not?  It may be the business is not sell-able easily etc and that the goal is simply to "milk" the profit to provide value to the participants.  \n\n  -  How MUCH capital has been provided to the venture relative to the sales of the company and profit and the amount paid to management as part of their compensation.  Both the investor and the management person / team have an opportunity cost to be a part of the venture.  The investor is giving up capital that could be used elsewhere for other investments that could return more.  The management is giving up their choice of employment and could choose a different employer to make more $$$.  So, another factor is to look at the "Sunk Cost" provided by the management relative to the size and revenue of the business and the management compensation as a % of the business and as is comporable in the market.  The goal is to look for an equitable balance in terms of "participation".  For instance, If management receives $50,000 for their "effort" via compensation and the venture in the business is $200,000 which, earning 10% in the stock market would normally earn $20,000 the it's important to look at:\n-  Would management recieve more somewhere else?  Let's say no that the $50,000 is comparable.\n-  Is 10% for the investor a reasonable expectation in the "market".  I know that large corporate venture folks use around 15% as a typical hurdle rate rather than 10%.  For a small business, though, I find 10% - 12% is reasonable.  So, let's say 10% works and therefore the investor can assume a $20,000 return every year.  \n-  If the Profit is $35,000, it would be reasonable to assume the capital holder would get $20,000 of the $35,000 "off the top" (what we often call a "preference") leaving $15,000 to be the actual amount split. Often, if there is no stock participation (a little more on that in a sec) and the company didn't need the $15,000, the rightful "owner" of the $15k is the Capital provider since they are the one who "owns" the company (I'm assuming there has to be some agreement in place that provides a lien on company assets or something as part of the capital contribution).  \n  -  So, it really is up to the capital owner to decide to forgo some of the $15k to the management team as an "incentive" or "reward" based on their performance.  But AGAIN, this assumes you don't need the $35k profit to run the business to begin with.  If you take the $$ out of the business and the business becomes cash poor, the capital provider shouldn't take anything because it puts the actual original investment at risk.\n\nThis begs the question... what's the ownership structure of the business?  There should be some "split" of ownership between management and the investor.  Even in a simple "S" Corporation you have shareholders and percentages.  Same in an LLC.  If you have set up stock or "participation shares" or similiar then any profit going out of the business is simply shared baseed on those percentages based on the board or manag
823264
This sounds unfavorable, simply because it is too good to be true. \n\n\nFirst. Your math is a bit suspect.  IRR is the discount rate so that the NPV equals the future cash flows.  16% return over 7 years equalling 3.6m and 5.4m at 9%, but you're getting it for 4.6m which indicats an IRR somewhere in the teens. \n\nSecondly, the IRR seems to high for a power plant.  Typically, Independent Power Producers tend to have take-or-pay cost-plus contracts with low yields (roughly 3-5%). Since cost-plus takes out most of the operating risk, it is low return (but can be enhanced through leverage).  Your IRR is basically "too good to be true", which makes me think that the contract is not cost-plus (e.g. pre-schedule pricing with a mismatch in revenues/costs where you bear price risk on fuel) or is in a situation where there are other mitigating factors (e.g. unstable government, lack of reliable legal system). \n\nIf it is not cost-plus, you will need to hedge away price risk on your fuel.  Since futures contracts don't go out 7 years, let alone 21, you would need to secure in deliverable forwards - or preferrably in actually buying a fuel (e.g. coal commitment, natural gas line) due to default risk. \n\nAlso, how do you plan on exiting this investment unless you structure a put in the equity injection?
68626
If there is increase in net income it will increase assets in balance sheet becouse the profit will transform in assets and if decrease in profit it may go from capital side.