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Corporate Finance (Reading 33 (cost of capital) Module 33.1 WACC (LOS 33…

- - - - WACC is given by:
        $WACC = (w_d)[k_d(1-t)]+(w_{ps}(k_{ps})+(w_{ce})(k_{ce}))$
        
        d: % of debt in the capital structure
        
        ps: preferred stock / ce: common equity
    - - List of capital components & components costs:
        $k_d$: rate at which firm can issue new debt = YTM on existing debt = Before-tax component cost of debt
        $k_d(1-t)$: after-tax cost of debt ---- used to calculate the WACC.
        $k_{ps}$: The cost of preferred stock
        $k_{ce}$: The cost of common equity = required rate of return on common stock and is generally difficult to estimate.
      - In most countries, the corporate debt is tax-deductible --- use "after-tax" :(1-t) for the cost of debt
    - - WACC should adjust up for the projects with greater-than-average risk and downward for projects with less-than-average risk.
  - - - In most countries, the corporate debt is tax-deductible --- use "after-tax" :(1-t) for the cost of debt
  - - - Upward sloping Marginal Cost of capital curve & downward sloping "investment opportunity schedule"
    - - X-axis: $ amount need for the new project
        y-axis: WACC
        intersect: optimal capital budget
      - Firm should undertake all the projects with IRRs greater than the cost of funds, and no projects with IRRs below the marginal cost of additional capital required to fund them should be undertaken.
  - - - Capital asset pricing model approach CAPM
        
        1) Estimate the risk-free rate, $R_f$
        
        2) Estimate $\beta$
        
        3) Estimate E($R_{mkt})$
        
        4) CAPM: $k_{ce}=R_f+\beta(E(R_{mkt}))-R_f$
      - The dividend discount model approach: $P_0 = \frac{D_1}{k_{ce}-g}$
        
        Rearrange: $k_{ce}=\frac{D_1}{P_0}+g$
        where g=(retention rate)(return on equity) = (1-payout rate)(ROE)
        
        Difficulty is estimating the firm's future growth rate.
      - The bond yield plus risk premium approach: ad hoc approach to estimate the required rate of return
        
        $k_{ce}=bond\, yield + risk\, premium$
- - - - Cash balances: from selling goods and services, collecting receivables, and generating cash from other sources such as short-term investments.
      - Short-term funding: include Trade credit from vendors, and lines of credit from banks. Effective cash flow management of a collections and payments can also be a source of liquidity for a company.
    - - Using its primary sources of liquidity is unlikely to change the company's normal operations
        :star: But resorting to secondary sources of liquidity such as selling short-term assets/ renegotiate debt agreements --- indicating that its financial position is deteriorating.
    - - Drags on liquidity: delay or reduce cash inflows, or increase borrowing costs---include: uncollected receivables and bad debts, obsolete inventory (takes longer to sell and may ask for sharp price discount), and tight short-term credit due to economic conditions.
      - Pulls on liquidity: Accelerate cash outflows. --- include paying payables sooner than is optimal and changes in credit terms that require repayment of outstanding balances.
  - - - Current Ratio = $\frac{\text{current assets}}{\text{current liabilities}}$
        
        the higher the current ratio --- the more likely it is that the company will be able to pay its short-term bills
        
        Current Ratio <1 ---> negative capital & probably liquidity crisis
      - Quick Ratio/ acid-ratio: more stringent measure of liquidity because it does not include inventories and other assets that might not be very liquid: $\frac{\text{cash+short-term securities+receivables}}{\text{current liabilities}}$
      - The higher the quick ratio, the more likely it is that the company will be able to pay its short-term bills.
      - Receivables turnover = $\frac{\text{credit sales}}{\text{}{average receivables}}$
        
        desirable to have a receivables turnover figure close to the industry norm.
      - Number of days of receivables(average days' sales outstanding), which is the average number of days it takes for the company's customers to pay their bills:
        $\text{number of days of receivables} = \frac{365}{\text{receivables turnover}} = \frac{average receivables}{average day's credit sales}$
        
        A collection period that is too high might mean that customers are too slow in paying their bills, which means too much capital is tied up in assets.
        
        A collection period that is too low might indicate that the firm's credit policy is too rigorous, which might be hampering sales.
      - Inventory turnover =$\frac{\text{cost of goods sold}}{\text{average inventory}}$
      - Average inventory processing period/ number of days of inventory: $\text{number of days of inventory} = \frac{365}{\text{inventory turnover}} =\frac{\text{average inventory}}{\text{average day's COGS}}$
        
        It is considered desirable to have an inventory processing period close to the industry norm.
      - Payables turnover = $\frac{\text{purchases}}{\text{average trade payables}}$
      - Payables payment period /number of days of payables --- average time it takes the company to pay its bills:
        $\text{number of days of payables} = \frac{365}{\text{payables turnover ratio}} = \frac{\text{Average payables}}{\text{Average day's purchases}}$
  - - - High cash conversion cycles are considered undesirable. A conversion cycle that is too high implies that the company has an excessive amount of investment in working capital.
  - - - Percentage discount from face value is : %discount = $(\frac{\text{face value-price}}{\text{face value}})$
      - Discount-basis yield (bank discount yield or BDY) is: discount-basis yield = $(\frac{\text{face value-price}}{\text{face value}})(\frac{360}{\text{days}}) = \%\text{discount}*(\frac{360}{days})$
      - The money market yield is: $\text{MMY}=(\frac{\text{face value-price}}{\text{price}})(\frac{360}{\text{days}}) $ = $\text{holding period yield}*(\frac{360}{\text{days}})$
      - BEY = $(\frac{F-P}{P})(\frac{365}{days to maturity})$ = HPY *365 /days
    - - begins with a statement of the purpose and objectives +strategies on types of investments.
      - Include specific information on who is allowed to purchased securities / who is responsible / steps taken if the investment guidelines are not followed.
      - types of securities permitted for investment of short-term funds / limitations on the credit ratings
      - Should be evaluated on how well the policy can be expected to satisfy the goals and purpose of short-term investments, generating yield without taking on excessive credit or liquidity risk.
  - - - Using Aging Schedule to compare the average days of receivables to the firm's historical performance or to the average ratios for a group of comparable companies.
      - Use the weighted average collection period to the historical trend can provide a clearer picture of what is driving the changes in the receivables.
        
        The company must always evaluate the trade-off between stricter credit terms (and borrower creditworthiness) and the ability to make sales
        
        Terms that are too strict will lead to less-than-optimal sales
        
        Terms that are lenient will increase sales at the cost of longer average days of receivables, which must be funded at some cost, and will increase bad accounts, directly affecting profitability.
    - - Comparing Avg. days of inventory and inventory turnover ratios between industries, or even between two firms that have different business strategies, can be misleading.
    - - A.P represents a source of working capital to the firm.
        
        If the firm pays its payables prior to their due dates --- cash is used unnecessarily and interest on it is sacrificed.
        
        If the firm pays its payables late, it can damage relationships with suppliers and lead to more restrictive credit terms or even requirements that purchases be made for cash.
      - Typical terms on payables contain a discount available to those who pay quickly as well as a due date E.g. Terms of "2/10 net 60" mean that if the invoice is paid within 10 days, the company does not take advantage of the discount, the net amount is due 60 days from the date of the invoice.
        
        $\text{cost of trade credit} = (1+\frac{\%discount}{1-\%discount})^\frac{365}{\text{days past discount}}-1 $
        
        Trade credit: can be a source of liquidity for a company
        
        However, when the cost of trade credit is greater than the company's cost of short-term liquidity from other sources, the company is better off paying the invoice within (ideally at the end of the discount period. )
        
        Number of days of payables = accounts payable / average day's purchases
        
        A company with a short payable period = high payables turnover ---> should take advantage of the discounts for paying early because it has good low-cost funds available to finance its working capital needs.
  - - - Lines of Credit: Used primarily by large, financially sound companies.
        
        Uncommitted line of credit: A bank extends an offer of credit credit for a certain amount but may refuse to lend if circumstances change.
        
        Committed (Regular) line of credit. A bank extends an offer of credit that it commits for some period of time.
        
        A more reliable source of short-term finding than an uncommitted line of credit
        
        Interest charges are stated in terms of a short-term reference rate + a premium
        
        Outside the United States, similar arrangements are referred to as overdraft lines of credit
        
        Revolving line of credit:
        -- More reliable source of short-term financing than a committed line of credit. --- Revolving lines of credit are typically for longer terms, sometimes as long as years. --- can be listed on a firm's financial statements in the footnotes as a source of liquidity.
        
        Blanket Lien: gives the bank right to claim to all current and future firm assets as collateral in case the primary collateral is insufficient and the borrowing firm defaults.
      - 2. Banker's acceptance: Used by firms that export goods. A banker's acceptance is a guarantee from the bank of the firm that has ordered the goods stating that a payment will be made upon receipt of the goods. --- The exporting company can then sell this acceptance at a discount in order to generate immediate funds.
      - Factoring: the actual sale of receivables at a discount from their face values.
        -- the factor (the buyer of the receivables) takes on the responsibility for collecting receivables and the credit risk of the receivables)
    - - Large, creditworthy companies can issue short-term debt securities called commercial paper. Whether the firm sells the paper directly to investors (direct placement) or sells it through dealers (dealer-placed paper), the interest costs are typically slightly less than the rate they could.
- - - - -- One-tier Board Structure: Both company executives and non-executive board members serve on a single board of directors.
      - -- Two-tier structure: Non-executives serve on a Supervisory Board that oversees a management board, made up of company executives.
  - - - Directors who are also managers favor managers at EXPENSE of the shareholders or when directors FAVOR one group of shareholders at the expense of another.
      - Firm managers and directors may choose a lower level of business risk than shareholders [because shareholders have a diversified portfolio and are not dependent on the firm for employment]
      - Information asymmetry: between shareholders and managers --- managers have more and better information about the functioning of the firm and its strategic direction than shareholders do. --- This decreases the ability of shareholders or non-executive directors to monitor and evaluate whether managers are acting in the best interests of shareholders.
    - - In the event of an acquisition of the company, controlling shareholders may be in a position to get BETTER TERMS for themselves relative to the terms forced on minority shareholders.
        
        -- Majority shareholders may cause the company to enter into related party transactions, agreements or specific transactions that benefit entities in which they have a financial interest, to the detriment of minority shareholders.
    - - Share holders may prefer more business risk than creditors do --- creditors have a limited upside compared to shareholders.
      - Equity owners may act against the interest of creditors by issuing new debt that increases existing creditors' default risk / or by paying bigger dividends to the shareholders, increases creditor's default risk.
    - - The company may decide to raise prices or reduce product quality in order to increase profits to the detriment of customers.
      - The company may employ strategies that significantly reduce the taxes they pay to the government.
  - - - Contractual infrastructure
        
        Contracts between the company and its stakeholders that spell out the rights and responsibilities of the company and the stakeholders.
      - Organizational infrastructure
        
        A company's corporate governance procedures, including its internal systems and practices, that address how it manages its stakeholder relationships.
      - Governmental infrastructure
        
        comprises the regulations to which companies are subject.
    - - The Legal infrastructure
        
        identifies the laws relevant to and the legal recourse of stakeholders when their rights are violated.
    - - Annual general meeting
        --- audited financial statement / addresses the company's performance / significant actions over the period / answer shareholder questions.
        
        Anyone owning shares is permitted to attend the meeting.
        
        Shareholders who does not attend the annual general meeting can vote by proxy, meaning she assigns her right to vote to another who will attend the meeting.
      - Ordinary resolution (approval of auditor and the election of directors), require a simple majority of the votes cast
      - Resolutions require amendment of corporate bylaws / merger&takeover --- termed special resolutions --- required a supermajority vote for passage -- typically two-thirds or three-fourths of the votes cast
        
        special resolutions can also be addressed at extraordinary general meetings --- can be called at anytime when there is a resolution about a matter that requires a vote of the shareholders.
      - Voting method when Multiple elections at one meeting
        
        Majority voting
        -The candidate with the most votes for each single board position is elected.
        
        Cumulative voting
        -Shareholders can cast all their votes for a single board candidate or divide them among board candidates ---cumulative voting can result in greater minority shareholder representation on the board compared to majority voting
      - Minority shareholders may have special rights by law when the company is acquired by another company.
  - - - One-tier Board: one single board of directors that includes both internal and external directors
        
        Internal directors --- executive directors --- senior managers employed by the firm
        
        External board members (non-executive directors) --- those who are not company management
        
        Independent directors: non-executive directors who have no other relationship with the company
        
        Lead independent director: has the ability to call meetings of the independent directors, separate from meetings of the full board.
      - Two-tier Board: There is a supervisory board that typically excludes executive directions.
        
        The supervisory board and the management board (made up of executive directors) operate independently.
        
        Management board is typically led by the company's CEO
      - The general practice now is for all board member elections to be held at the same meeting and each election to be multiple years
        
        Staggered Board: elections for some board positions are held each year. --- The structure limits the ability of shareholders to replace board members in any one year and is used less now than it has been historically.
    - - Board directors are:
        
        *Elected by shareholders to act in their interest
        
        *they are mandated by corporate law to be fully informed and to use due diligence and their expertise in fulfilling their obligation to act in the interest of the company and its shareholders.
      - Board directors' responsibilities:
        
        Selecting senior management ,setting their compensation and bonus structure, evaluating their performance, and replacing them as needed.
        
        Setting the strategic direction for the company and making sure that management implements the strategy approved by the board.
        
        Approving capital performance, significant acquisitions, and large investment expenditures.
        
        Reviewing company performance and implementing any necessary corrective steps.
        
        Planning for continuity of management and the succession of the CEO and other senior managers.
        
        Establishing, monitoring, and overseeing the firm's internal controls and risk management system.
        
        Ensuring the quality of the firm's financial reporting and internal audit, as well as oversight of the external auditors.
    - - Audit committee:
        
        Oversight of financial reporting function and implementation of accounting policies
        
        Effectiveness of the company's internal controls and the internal audit function.
        
        Recommending an external auditor and its compensation.
        
        Proposing remedies based on their review of internal and external audits.
      - Governance committee
        
        Oversight of the company's corporate governance code
        
        Implementing the company's code of ethics and policies regarding conflicts of interest.
        
        Monitoring changes in relevant laws and regulations
        
        Ensuring that the company is in compliance with all applicable laws and regulations, as well as with the company's governance policies.
      - Nominations committee: Proposes qualified candidates for election to the board; Manages the search process; Align the board's composition with the company's corporate governance policies.
      - Compensation committee / Remuneration committee: Recommends the AMOUNT of COMPENSATION to be paid to directors and senior managers. / Oversight of employee benefits / Evaluation of senior managers.
      - Risk Committee:
        
        Inform the board about appropriate risk policy and risk tolerance of the organization
        
        *Oversees the enterprise-wide risk management processes of the organization.
      - Investment Committee
        
        Reviews and report to the board on management proposals for large or projects, sale or other disposal of company assets or segments, and the performance of acquired assets and other large capital expenditures.
- - - - Make a hostile takeover more costly and difficult.
    - - Common-law system: The Judges take an active role in shaping the law here, since the decisions a court makes are then used as a precedent for future cases.
        
        Shareholders' and creditors' interests are considered to be better protected with common-law system.
      - Civil law system: rely on written statutes and other legal codes that are constantly updated and which establish legal procedures, punishments, and what can and cannot be brought before a court.
      - Generally, the right of creditors are more clearly defined than those of shareholders and therefore, are not as difficult to enforce through the courts.
  - - - Oversight system will be weakened. --- Some stakeholders may get Unfair advantage at cost of other stakeholders.
      - May choose less-than-optimal risk and Reduce the company value --- May seek their own benefits instead of focusing on company's benefits.
      - Legal and reputational risks
        
        Stakeholder rights --- lawsuits
        
        Failed to comply with government regulations --- Reputation damages.
    - - Avoid legal and regulatory risks
      - Better operating result from less party transactions
      - Decreased risk of debt or bankruptcy --- reduce the cost of debt financing.
  - - - Voting control is typically proportional to share ownership because each share entitles its holder to vote ONE.
      - Dual Class structure --- one class of shares may be entitled to several votes per share, while another class of shares is entitled to one vote per share.
        
        This structure is used to ensure that founding shareholders can maintain control of the board of directors even when ownership is below 50%
        
        On average, this structure is traded at a DISCOUNT.
    - - Factors to consider the make-up of a company's board of directors.
        
        Relationship with the company (executive, independent directors)
        
        Relationship with other's company / stakeholders
        
        Expertise that qualified
        
        Experienced
    - - In addition to salary, senior managers receive cash bonuses based on SHORT-term performance & LONG-term equity performances, such as company shares
      - Concerns on remuneration plans:
        
        Offer greater CASH incentives than long-term equity incentives.
        
        Targets are easy to achieve
        
        Remuneration is high relative to comparable companies.
        
        Incentives are not aligned with current company strategy and objectives.
    - - If one company's outstanding shares are held by an affiliated company or institution, those shareholders may be able to exert enough influence to dictate the company's policies and direction.
        
        But can also protect the company against hostile takeover.
    - - Staggered board, anti-takeover laws, super voting shares --- all restrict the rights of shareholders to affect change.
    - - Affect company's sustainability
  - - - Green bonds: Bonds for which funds raised are used for projects with a positive environmental impact.
    - - Stock managers may seek to reduce the environmental pollution or carbon footprint of their portfolio as a whole.
- - - - Greater Leverage --- greater variability of operating earnings and income
        
        Operating leverage:* A given change in sales will lead to a greater change in operating earnings when the firm employs operating leverage
        
        Financial Leverage: A given change in operating earnings will lead to a greater change in net income when the firm employs financial leverage.
    - - Sales Risk: Uncetainty about the firm's sales
      - Operating Risk: Additional operating earnings caused by fixed operating costs.
        :warning: The greater the proportion of fixed costs to variable costs, the greater a firm's operating risk.
  - - - To calculate a firm's DOL for a particular level of unit sales, Q
        $DOL = \frac{Q(P-V)}{Q(P-V)-F}$
        where Q is the quantity of units sold / P is the price per unit / V is the variable cost per unit / F is the fixed costs
        
        ! DOL is Highest at low levels of sales and declines at higher levels of sales.
    - - For a particular level of operating earnings, DFL is calculated as: $DFL = \frac{EBIT}{EBIT-\text{interest}}$
  - - - Breakeven quantity of sales: $Q_{BE}=\frac{\text{fixed operating costs + fixed financing costs}}{\text{price-variable cost per unit}}$
      - Operating breakeven quantity of sales: consider only the fixed operating costs and ignored fixed financing costs:
        $Q_{OBE} = \frac{\text{Fixed operating costs}}{\text{price-variable cost per unit}}$
- - - - Reasons for budgeting to be an important responsibility for financial managers.
        
        Involve purchasing of costly long-term assets
        
        The same process also applies to other corporate decisions, including working capital management and market strategic merger & acquisition
        
        align with goal of maximizing shareholder's value
    - - STEP1. Idea generation :
      - STEp2. Analyzing project proposals: based on cash-flow forecasts/
      - STEP3.Create the firm-wide budget: prioritize projects according to the timing of the CFs, availability of resources, and overall strategic plan
      - STEP4. Monitoring decisions and conducting a post-audit: Compare projections and actual result ---> adjust model
    - - Replacement projects to maintain the business :
        made without detailed analysis
        -- issues: whether the existing operations should continue & whether existing procedures / processes should be maintained.
      - Replacement projects for cost reduction:
        Determine whether equipment that is obsolete, but still usable, should be replaced.
        -- A fairly detailed analysis is necessary
      - Expansion projects:
        To grow the business and involve a complex decision-making process because *require an explicit forecast of future demand
        -- A VERY detailed analysis is required.
      - New Product or market development
        complex decision-making & detailed analysis required
        -->because of the large amount of uncertainties.
      - mandatory projects:
        Requirements made by government /insurance company as a MUST for certain projects to progress (environmental, safety, etc.).
        -- generate little-to-0 revenue, but accompany other revenue-producing projects
      - Other projects:
        Not easily analyzed through the capital budgeting process.
        Involves: A pet project for a senior management (non-cash compensation fund) & high-risk endeavor (eg. research and development projects)
  - - - Decisions are based on cash flows, not accounting income.
        -- Consider the incremental cash flows: change in CF that will occur if the project in undertaken.
        
        DO NOT consider sunk cost: the cost that are not affected by the accept/reject decision
        
        externalities: the effects that acceptance of a project may have on other firm cash flows.
        
        Cannibalization:
        -- Primary negative externality
        -- A new project takes sales from an existing product.
        -- Would decrease the incremental CFs.
        
        Conventional Cash Flow Pattern: The sign of the cash flows changes only once.
        
        Unconventional cash flow pattern: more than one sign changes (series of cash inflows/outflows throughout the life of the project)
      - Cash flows are based on opportunity costs: Cash flows that a firm will lose by undertaking the project under analysis. (the cash flows generated by an asset the firm already owns that would be forgone if the project is undertaken)
        
        Opportunity costs should be included in the project costs.
      - Timing of the cash flows matter: Capital budgeting decisions account for the time value of money ---> CF received earlier worth more than the CF received later.
      - CFs are analyzed on an after-tax basis: the impact of taxes must be considered when analyzing all capital budgeting projects.
      - Financing costs are reflected in the project's required rate of return
        
        Do not consider financing costs specific to the project when estimating the incremental cash flow
        
        the discount rate in the capital budgeting process take account of the firm's cost of capital
        
        Only Projects with EXPECTED RETURN HIGHER THAN COST OF CAPITAL will increase the value of the firm.
  - - - Independent projects: projects are unrelated to each other and if both are profitable, the company could accept both projects.
      - Mutually Exclusive projects: only ONE project in a set can be accepted and projects are competing with each other.
    - - If a firm has unlimited funds, the firm can undertake all projects with positive net returns
      - Capital rationing: Prioritize with standard of achieving the maximum increase in value for shareholders given its available capital.
  - - - For a normal project with conventional cash flows:
        $NPV = CF_0 +\frac{CF_1}{(1+k)^1}+...+\frac{CF_n}{(1+k)^n} $
        *CF₀ is negative --- initial investment
      - A positive NPV project is expected to increase shareholder wealth.
        
        For independent projects, the NPV decision is simply to accept any project with a positive NPV and to reject any project with a negative NPV.
    - - IRR is calculated from: $ 0=CF_0+\frac{CF_1}{(1+IRR)}+...+\frac{CF_n}{(1+IRR)^n}$
      - Decision rule:
        -- if IRR > the required rate of return ---> accept the project
        -- if IRR < the required rate return, reject the project
        
        Hurdle Rate: the minimum IRR that a firm requires for a project to be accepted.
      - When IRR is less than the cost of capital --- NPV <0
        
        When IRR is larger than the cost of capital --- NPV>0
    - - The payback period is a measure of liquidity, for a firm with liquidity concerns, the shorter the project's payback period the better.
      - Payback period is useless as a measure of profitability:
        
        Do not consider TVM
        
        Do not consider the cash flows beyond the payback period--- including terminal or salvage value
      - *
    - - Calculation: Net cash flow ---> discounted cash flow ---> cumulative discounted cash flows.
      - mitigate one of the drawbacks of payback period, but still not address the issue of further cash flow. --- still as a measure of liquidity only.
    - - PI is closely related to NPV: NPV is the difference between PV of outflows and inflows, and PI is the Ratio between outflows and inflows.
      - Decision rules:
        
        if PI>1, accept
        
        if PI <1, reject.
- - - - If not publicly traded --- use pure-play method: find beta of a company or group of companies that are purely engaged in a business similar to that of the project and are therefore comparable to the project.
        
        Do NOT use conglomerate that in the same business
      - The beta of a firm is a function not only of the business risks but also of its financial structure
        
        The greater a firm's reliance on debt financing, the greater its equity beta.
        
        Must adjust the pure-play beta from a comparable company from the company's leverage (unlever it) and then adjust it (re-lever it) based on the financial structure of the company evaluating the project.
        
        The get the asset beta for a traded company : $\beta_{ASSET} = \beta_{EQUITY}*{\frac{1}{1+[(1-t)\frac{D}{E}]}}$
        
        Use the subject firm's tax rate and debt-to-equity ratio to get the EQUITY BETA for the project:$\beta_{PROJECT} = \beta_{ASSET}*{1+[(1-t)\frac{D}{E}]}$
        
        Problems in this method:
        
        Beta is estimated using historical returns data, estimate is sensitive to the length of time and the frequency of the data.
        
        The estimate is affected by which index is chosen to represent the market return.
        
        Beta are believed to revert toward 1 over time
        
        Estimates of beta for small-capitalization firms need to be adjusted upward to reflect risk inherent in small firms that is not captured by the usual estimation methods.
  - - - General country risk is reflected in its sovereign yield spread:
        Sovereign yield spread = difference between the yields of government bonds in the developing country and Treasury bonds of similar maturities.
        
        CPR (country risk premium) = sovereign yield spread * (annualized standard deviation of equity index of developing country / annualized standard deviation of sovereign bond market in terms of the developed market currency)
        
        Revised CAPM:
        $k_{ce} = R_f\ +\beta[E(R_{mkt})-R_f+CRP]$
  - - - incorrect treatment of flotation costs:
        if we incorporate flotation rate directly into the cost of capital
      - *Correct Treatment of Flotation costs: Adjust the initial project cost
- - - - For unconventional cash flow, IRR method could provide multiple IRR or no IRR
      - NPV does not have these problems --- using NPV method.
  - - - IRR = intercepts with x-axis (NPV=0)
    - - NPV:
        
        Advantages: 1. direct measure of value ---theoretically the best method.
        
        Disadvantages: 1. no consideration of the size of the project (eg. $100 NPV on a $1 Million project :frowning_face:
      - IRR:
        
        Advantage: measure profitability as a percentage. 2. provides information on the margin of safety (how much below IRR the NPV could fall to negative)
        
        Disadvantages: 1. probably producing rankings of mutually exclusive projects different from those from NPV analysis. 2. Project can have multiple IRRs or no IRR.