Equity Valuation, Risk & Return in Capital Project Financing

Abstract

In this paper a case study was performed for evaluating the risk and returns from capital projects.  Companies ABC and XYZ Ltd were assumed with different capital structure ratios in equity, fixed rate debt investments. The cases for the cash flows to equity investors, debt borrowing along with the total funds are discussed in capital budgeting. The present value of cash flows is estimated for the company ABC Ltd and its relationship with change in cost of capital, the NPV of firm's investments is considered for three different cases using discounted cash flow valuation. The returns from both companies' stocks prices traded on the market index are computed using relative valuation or earnings method (P/E) to compare the risk –return variations on investments made into the portfolio of stocks. The portfolio risk was measured using the correlation coefficient for asset portfolio and standard deviation for two assets in the portfolio. The returns from investment into portfolio of stocks are calculated for different values of correlation in order to observe the sensitivity of risk. The required rate of return from CAPM model and dividend growth models are compared for assessment of model variations.