Can anyone comment on the low fed funds and discount rate making the cost of capital lower for firms borrowing? Or, historically speaking, are corporate bond yields at lower levels that would lower the cost of capital? Anything would help, thanks.
cost of capital is the cost of your borrowing. If the interest rate in economy are low (today’s scenario), company can get the loans at cheaper rate as spread (corporate yield - treasure yield) is lower too.
pupdawg82 Wrote: ------------------------------------------------------- > cost of capital is the cost of your borrowing. Actually, more common def is WACC which has also cost of eq, but if you can finance through bonds then yes. If > the interest rate in economy are low (today’s > scenario), company can get the loans at cheaper > rate as spread (corporate yield - treasure yield) > is lower too. Nope, actually the opposite is true. In recession (which prompts the FED to lower rate), the spread tends to increase. See pg 94 v3 CFAI. However, the absolute rate tends to decrease since the FED rate normally decreases more than the spread increase.
right now, spreads have narrowed making cost of capital lower correct?>
Yep. The spread on junk-rated securities narrowed to 565 basis points as of last week the tightest since Dec. 27, 2007. The extra yield investors demand to own corporate bonds rather than government debt was at 146 basis points last week, or 1.46 percentage point, the lowest since November 2007, the Merrill Global Broad Market Corporate Index shows
Because expected debt costs are lower for shorter maturities, the apples-to-apples convention (per Damodaran, and most others) is to use the 10y cost of debt for CoC calculations. (Shorter duration indeed gives you a cheaper expected cost of debt, but at higher risk. Risk in funding rates isn’t allowed in the WACC framework.) Separately, to correct an earlier misstatement: WACC is not your cost of borrowing. (The old finance professors’ joke is “the cost of capital has nothing to do with your cost of capital”.) WACC is the opportunity cost relative to funding your assets. As for market trends: yes the marketplace seems to be pricing risk (of several asset classes) lower, so capital costs are also decreasing.
DarienHacker Wrote: > Separately, to correct an earlier misstatement: > WACC is not your cost of borrowing. (The old > finance professors’ joke is “the cost of capital > has nothing to do with your cost of capital”.) > WACC is the opportunity cost relative to funding > your assets. Did not say “WACC is not your cost of borrowing”. I was referring to the fact that the normal definition one uses in connection of Cost of Capital is WACC. I am quoting from CFAI v4 level I pg 41 edition 2010, chapter “Cost of Capital” “The cost of capital is the required rate of return that investors demand for the average-risk investment of a company. The most common way to estimate this required rate of return is… WACC” But come on guys, I thought we are now level III, not level I to discuss about this Finance 101 stuff?