Corporate Finance (MAIB FIN 101) Aug 2022

Corporate Finance (MAIB FIN 101) Aug 2022 1

Cost of Capital- 2

Cost of
Cost of Equity Equity

Corporate Finance (MAIB FIN 101) Aug 2022 2

Cost of Capital
Cost of Debt

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The Cost of Capital

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The Cost of Capital

Evaluating
investments with
risks that are
substantially
different from those
of the overall firm

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The Cost of Capital
DIVISIONAL COST OF CAPITAL

THE PURE PLAY APPROACH : The use of a WACC that is unique to a particular
project, based on companies in similar lines of business.

THE SUBJECTIVE APPROACH : Because of the difficulties that exist in objectively

establishing discount rates for individual projects, firms often adopt an approach
that involves making subjective adjustments to the overall WACC.

Corporate Finance (MAIB FIN 101) Aug 2022 6

The Cost of Capital
Company Valuation with the WACC

Vt is the value of the firm at Time t, which we again calculate using the growing
perpetuity formula:

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The Cost of Capital
Company Valuation with the WACC

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Raising Capital
All firms must, at varying times, obtain capital. To do so, a firm must either borrow
the money (debt financing), sell a portion of the firm (equity financing), or both.
How a firm raises capital depends a great deal on the size of the firm, its life-cycle
stage, and its growth prospects.

The Financing Life Cycle of a Firm: Early-Stage Financing and Venture Capital

VENTURE CAPITAL
Does not have a precise meaning, but it generally refers to financing for new, often
high-risk, ventures

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Raising Capital
VENTURE CAPITAL

financing is available in stages

is contingent on specified goals being met and therefore is a powerful motivating force
for the firm’s founders

CHOOSING A VENTURE CAPITALIST

Financial strength is important
Style is important
References are important
Contacts are important
Exit strategy is important

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 Raising Capital
Selling Securities to the Public:

The Basic Procedure

Registration statement prospectus
A statement filed with the A legal document describing
SEC that discloses all details of the issuing
material information corporation and the proposed
concerning the corporation offering to potential investors.
making a public offering.

red herring
A preliminary prospectus
distributed to prospective
investors in a new issue of
securities.
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Raising Capital
CROWDFUNDING
Two types of crowdfunding—project crowd- funding and equity crowdfunding

INITIAL COIN OFFERINGS (ICOs)

A company can raise funds by selling
tokens. These tokens often grant the holder the right to use the company’s service in the
future.

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Raising Capital
Alternative Issue Methods

A Company can sell a new security, as a public issue or a private issue.

There are two kinds of public issues: a general cash offer and a rights offer.

The first public equity issue that is made by a company is referred to as an initial public
offering (IPO) or an unseasoned new issue.

A seasoned equity offering (SEO) is a new issue for a company with securities that have
been previously issued.4 A seasoned equity offering of common stock can be made by
using a cash offer or a rights offer

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Raising Capital
Underwriters
Investment firms that act as intermediaries between a company selling securities and the
investing public

Syndicate
A group of underwriters formed to share the risk and to help sell an issue.

Gross spread
Compensation to the underwriter, determined by the difference between the
underwriter’s buying price and the offering price.

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Raising Capital
CHOOSING AN UNDERWRITER
Competitive underwriting is cheaper to use than negotiated un- derwriting

TYPES OF UNDERWRITING
1. Firm Commitment Underwriting

In firm commitment underwriting, the issuer sells the entire issue to the underwriters, who
then attempt to resell it

2.Best Efforts Underwriting In best efforts underwriting, the underwriter is legally bound to
use “best efforts” to sell the securities at the agreed-upon offering price

3.Dutch Auction Underwriting With Dutch auction underwriting, the underwriter does not
set a fixed price for the shares to be sold. Instead, the underwriter conducts an auction in
which investors bid for shares. Corporate Finance (MAIB FIN 101) Aug 2022 15
Raising Capital
Rights
When new shares of common stock are sold to the general public, the proportional
owner- ship of existing shareholders is likely to be reduced. If a preemptive right is
contained in the firm’s articles of incorporation, the firm must first offer any new issue of
common stock to existing shareholders.

An issue of common stock offered to existing stockholders is called a rights offering (or
offer, for short) or a privileged subscription

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