Reflections on the concept of the cost of capital and the cost of funds
Sixth, the cost of capital is the necessary rate of compensation required by investors
China's financial textbooks on the cost of funds in the measurement of the formula, most of them are consistent with the Western formula for measuring the cost of capital. When we examine these measures in detail, we can see that they are not the cost of raising capital for the enterprise, in essence, they are the rate of compensation required by investors. The author to representative of the cost of debt and the cost of equity to be argued and analyzed.
(a) the cost of debt measurement of the common formula
The above formula, Kb for the cost of capital, Rf for the risk-free rate of return, Rp for the risk rate of return, It for the annual interest ③, T is the corporate income tax rate, B0 for the total liabilities of the enterprise, Pn for the principal amount of corporate debt returned to creditors at maturity, f for the funding fee rate. In order to illustrate the essence of the problem, omit the impact of the narrative and thinking of the side issues, assuming that does not take into account the fund-raising fees and corporate income tax, the above formula can be evolved as follows:
The above three formulas, the formula clearly refers to the rate of return required by the creditor investor; the numerator of the formula two is the creditor investor to get the annual interest (annual earnings), the denominator is the amount of the investment, Kb is the rate of return of the investment, but the formula did not Consider the time value of money; formula three in essence, Kb is the investment program of the embedded rate of return, because B0 is the creditor to invest in the present value of cash outflows, the right side of the formula is the creditor's future cash inflows of the present value of the formula, this formula is the creditor investor to make an investment in Kb that is the discount rate of net present value (NPV) of zero, that is, the investment program of the embedded rate of return IRR. /p>
(ii) the cost of equity common measurement formula
The above three formulas are known as the discounted dividend model, the capital asset pricing model, the risk-free rate plus risk premium model. Where P0 is the net financing of common stock, Dt is the dividend in year t, ? for a company's stock return relative to the expected rate of return of the market portfolio of the magnitude of change, Rm for the expected rate of return of the market portfolio, other letters have the same meaning as before. Needless to say, colleagues in finance generally know the meaning of these three formulas, which Kc for the cost of capital of common stock, that is, the necessary rate of return on investment in common stock.
It is worth thinking about is that our financial academic community in the definition of the cost of capital is emphasized? The cost of raising and using funds? , while in measuring the cost of capital but invariably used to describe the return on investment capital asset pricing model. This contradictory logic is another example of the immaturity of the understanding of the cost of capital.
The three formulas above are called the discounted dividend model, the capital asset pricing model, and the risk-free rate plus risk premium model. Where P0 is the net financing of common stock, Dt is the dividend in year t, ? for a company's stock return relative to the expected rate of return of the market portfolio of the magnitude of change, Rm for the expected rate of return of the market portfolio, other letters have the same meaning as before. Needless to say, colleagues in finance generally know the meaning of these three formulas, which Kc for the cost of capital of common stock, that is, the necessary rate of return on investment in common stock.
It is worth thinking about is that our financial academic community in the definition of the cost of capital emphasizes the ? The cost of raising and using funds? , while in measuring the cost of capital but invariably used to describe the return on investment capital asset pricing model. This contradictory logic is another example of the immaturity of the understanding of the cost of capital.
seven, abandon the concept of the cost of capital, the use of the concept of the cost of capital
Through the above analysis, I believe that China's financial sector should abandon the traditional concept of the cost of capital, the full acceptance of the Western financial sector on the concept of the cost of capital, that is, the cost of capital is the investor (creditors, owners, enterprises, etc.) on the input of capital requirements necessary rate of return, is the opportunity cost of investment. The rationale for defining the concept of the cost of capital in this way lies in the following: first, it reflects the essential feature that the cost of capital is the necessary rate of return for investors to make investments. Secondly, it emphasizes the connotation that the cost of capital is an opportunity cost. Third, it is from the perspective of the necessary rate of return, from the perspective of different investment subjects to study the cost of capital at different levels, can highlight the role of the cost of capital in financial decision-making and applicability: enterprise financing decision-making should be based on the requirements of creditors and owners to determine the cost of debt and the cost of equity of the enterprise. Because this time the enterprise is the fund-raiser, creditors and shareholders are investors. It should be emphasized here that, due to the influence of various uncertainties, the actual rate of return and the expected rate of return of debt and equity investors are not completely consistent, and the enterprise, as a subject of interest and decision-making, also has to follow the principle of low-cost financing, but this does not deny that the enterprise financing should take into account the requirements of the investor's rate of return. On the contrary, in the long run, an enterprise that does not consider the requirement of investor's remuneration and cannot meet the requirement of investor's remuneration in the long run will eventually fail to raise funds and cannot escape from the fate of termination. More importantly, it highlights the role and applicability of the cost of capital in enterprise investment decision-making. Enterprises as the main body of investment decision-making, according to the project (including project risk factors) to determine the cost of capital (discount rate), rather than not ask about the project and its risk, uniformly used? Weighted average cost of capital (WACC)? To evaluate the feasibility of the project. For different projects and their risks to determine the cost of capital corresponding to the project (discount rate), which can achieve the purpose of optimizing investment decisions. Fourth, abandon our traditional concept of the cost of capital, the concept of the cost of capital with the mainstream of Western finance, not only can reveal the nature and connotation of the cost of capital, but also help us and the Western financial theory community exchanges and communication.
References
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