Aes Cost of Capital

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International Capital Structure and the Cost of Capital

Agenda
1 2 3 4 5

International Capital Structure and the Cost of Capital Analyzing Cost of Capital among Countries

Cross Border Listing of Stocks International Asset Pricing Model (IAPM) The Financial Structure of Subsidiaries Case Analysis - AES Corporation

6

International Capital Structure and the Cost of Capital

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International Capital Structure and the Cost of Capital
• Firms are becoming multinational in both scope AND in capital structure • Fully integrated financial markets = the same cost of capital both domestically and abroad o

If not, opportunity may exists to decrease cost of capital

Cost of Capital
• The minimum rate of return an investment must generate to cover its financing cost • Firms will undertake projects if the return is expected to exceed the cost of capital • Return = Cost of Capital : value unchanged • Return > Cost of Capital : firm’s value increases • Return < Cost of Capital : bad investment

Weighted Average Cost of Capital (K)
• When a firm has both debt and equity financing, weighted average cost of capital:

K = (1-λ)K+ λ(1- t)i

K = (1-λ)KL + λi(1- t)
• (1- λ) = weight of cost of capital that is from equity • KL = cost of equity capital

• λ = debt-to-total-market-value ratio (weight of total cost of capital that is from debt) • i = before-tax cost of debt capital (borrowing) • t = marginal corporate income tax rate o

Interest payments are tax deductible

K = (1-λ)KL + λi(1- t)
• (1- λ) = weight of cost of capital that is from equity

• KL = cost of equity capital
• λ = debt-to-total-market-value ratio (weight of total cost of capital that is from debt) • i = before-tax cost of debt capital (borrowing)

• t = marginal corporate income tax rate
o

Interest payments are tax deductible

K = (1-λ)KL + λi(1- t)
• (1- λ) = weight of cost of capital that is from equity • KL = cost of equity capital • λ = debt-to-total-market-value ratio (weight of total cost of capital that is from debt)

• i = before-tax cost of debt capital (borrowing)
• t = marginal corporate income tax rate
o

Interest payments are tax deductible

K = (1-λ)KL + λi(1- t)
• (1- λ) = weight of cost of capital that is from equity • KL = cost of equity capital

• λ = debt-to-total-market-value ratio (weight of total cost of capital that is from debt) • i = before-tax cost of debt capital (borrowing) • t = marginal corporate income tax rate o

Interest payments are tax deductible

K = (1-λ)KL + λi(1- t)
• (1- λ) = weight of cost of capital that is from equity • KL = cost of equity capital

• λ = debt-to-total-market-value ratio (weight of total cost of capital that is from debt) • i = before-tax cost of debt capital (borrowing) • t = marginal corporate income tax rate o

Interest payments are tax deductible

Example
• K = (1-λ)KL + λ(1- t)i
o Company

is financing 30% of capital by debt (λ)

 So they’re financing 70% (1-0.30) by equity (1-λ)

• Cost of equity capital is 10% • Before-tax cost of borrowing is 6% • Marginal corporate tax rate is 15% K = (0.70)0.10 + 0.30(1-0.15)0.06

Example
• K = (1-λ)KL + λ(1- t)i
o Company

is financing 30% of capital by debt (λ)

 So they’re financing 70% (1-0.30) by equity (1-λ)

• Cost of equity capital is 10%

• Before-tax cost of borrowing is 6%
• Marginal corporate tax rate is 15%
K = (0.70)0.10 + 0.30(1-0.15)0.06

Example
• K = (1-λ)KL + λ(1- t)i
o Company

is financing 30% of capital by debt (λ)

 So they’re financing 70% (1-0.30) by equity (1-λ)

• Cost of equity capital is 10% • Before-tax cost of borrowing is 6% • Marginal corporate tax rate is 15% K = (0.70)0.10 + 0.30(1-0.15)0.06

Example
• K = (1-λ)KL + λ(1- t)i
o Company

is financing 30% of capital by debt (λ)

 So they’re financing 70% (1-0.30) by equity (1-λ)

• Cost of equity capital is 10%

• Before-tax cost of borrowing is 6%
•...
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