Tài liệu Estimating risk parameters and costs of financing

ESTIMATING RISK PARAMETERS AND COSTS OF FINANCING


In the last chapter, we laid the groundwork for estimating the costs of equity and


capital for firms by looking at how best to estimate a riskless rate that operates as a base


for all costs, an equity risk premium for estimating the cost of equity and default spreads


for estimating the cost of debt. We did not, however, consider how to estimate the risk


parameters for individual firms. In this chapter, we will examine the process of estimating


risk parameters for individual firms, both for estimating cost of equity and the cost of


debt.


For the cost of equity, we will look at the standard process of estimating the beta


for a firm and consider alternative approaches. For the cost of debt, we will examine bond


ratings as measures of default risk and the determinants of these ratings.


We will close the chapter by bringing together the risk parameter estimates for


individual firms and the economy-wide estimates of the riskfree rate and risk premia to


estimate a cost of capital for the firm. To do this, we will argue that the sources of capital


have to be weighted by their relative market values.


The Cost of Equity and Capital


Firms raise money from both equity investors and lenders to fund investments.


Both groups of investors make their investments expecting to make a return. In chapter 4,


we argued that the expected return for equity investors would include a premium for the


equity risk in the investment. We label this expected return the cost of equity. Similarly,


the expected return that lenders hope to make on their investments includes a premium


for default risk and we call that expected return the cost of debt. If we consider all of the


financing that the firm takes on, the composite cost of financing will be a weighted average


of the costs of equity and debt and this weighted cost is the cost of capital.


We will begin by estimating the equity risk in a firm and using the equity risk to


estimate the cost of equity and we follow up by measuring the default risk to estimate a