DOS Security Analysis

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Determinants of Intrinsic Value: The Weighted Average Cost of Capital Value = + + ··· + FCF 1 FCF 2 FCF ∞ (1 + WACC) 1 (1 + WACC) ∞ (1 + WACC) 2 Free cash flow (FCF) Market interest rates Firm’s business risk Market risk aversion Firm’s debt/equity mix Cost of debt Cost of equity Weighted average cost of capital (WACC ) Net operating profit after taxes Required investments in operating capital − =
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Weighted Average Cost of Capital  Cost of capital refers to overall cost of financing to firm  It is also relevant Discount Rate or Hurdle Rate used to analyze an investment  It is also related to the opportunity cost which the investor has forgiven by investing the firm  Overall cost of capital is a weighted average of various sources, including debt, preferred stock, and common equity : WACC = Weighted Average Cost of Capital WACC = After - tax costs x weights
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Sources of Capital Long - Term Capital Long - Term Debt Preferred Stock Common Stock Retained Earnings New Common Stock • Account Payable, accruals, and deferred taxes are not sources of funding that come from investors & not included in the calculation of the cost of capital • These items are adjusted for when calculating project cash flows, not when calculating the cost of capital

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