Cost of capital

The price has to be higher than the value, right? Let's say your star business is your AI business.

It's earning well above the cost of capital, right? It's also the business most likely to be the business where people will overpay for.

Divestitures, just like acquisitions, it all depends on the price.

Getting rid of bad businesses does not make you a better company in terms of creating value.

Third step.

Maybe I can lengthen my growth period.

Remember during the growth period, I'm earning above the cost of capital, right? Maybe I can find ways to extend that period from five years to 10.

It's another way of saying, maybe I can build new competitive advantages, barriers to entry.

The government is ready to lend you money right now long-term at 6%.

Should I use the 6% or the 9.25% in my cost of capital calculation? Obviously, it's going to make a big difference.

If I use 6%, I'm going to end up with a much lower cost of capital.

Which one should I use? How many think I should use the 9.25%? In fact, if I do the 9.25%, I'm going to come up with a higher cost of capital.

I'm going to come up with a lower value.

In effect, what am I saying? There's a subsidy, but I'm going to act like it's not there, right? As an investor, do you still benefit from the subsidy? Absolutely.

So what you'll be missing if you use the nine and a quarter percent is you'll be missing that this company is subsidized.

If I use the six percent, I have a different problem.

And then you have the economics of delivery.

Uh, Lola, can you please spend some time explaining how construction timelines and the cost of capital shape nuclear project economics? And further, can you please tell us what the nuclear sector can learn from other infrastructure markets?

Yes.

So, uh, this is really key to understand nuclear, but also many other industries.

That was also true in the early days of renewables, where the capital costs were pretty high at the beginning, right? Uh, and because so much of nuclear projects' lifetime cost is upfront capital, 'cause it's k- very capital ex- uh, intensive-

Mm

... uh, then the cost of capital, of course, is, is a large determinant of a project economics, as you were saying.

Because it takes a while to build a nuclear reactor, then construction timelines matter, and they matter quite a bit.

If you're in the foundation world, it's program-related investment.

That capital, that second category, can be used to generate – the primary purpose is impact and financial is – With the $1 billion, just to add more precision, because I know public pension funds will have a specific cost of capital to properly service their retiree beneficiaries.

So our cost of capital is today roughly 9.5%.

So if we're not making 9.5% with our $1 billion endowment, then we are eroding our corpus.

So as a perpetual foundation, it means you need to make... a financial hurdle rate of our legal spend rate, which is 5%, we spend more than that, plus inflation.

But that probably actually is the natural clearing price of money.

capital and the equilibrium rates have moved materially upwards especially at the long end long-term money so if you want to if the government wants to borrow money at you know 20 30 years that's moved up materially so why would the natural price of capital still be rising and this is where it starts to get quite dark indeed for the uh for the government You see, because I'm sticking mainly to the US government.

This is all true.

If you live in any G7 country, this is going to be true for you.

here.

You might say, what's the cost of capital? The cost of capital is a weighted average of your cost of equity and your after-tax cost of debt.

Weighted by what? How much of each you use.

Now, of course, you can go with the accounting measures of how much of each you use, debt and equity, from a balance sheet.

But I think if you're computing cost of capital right, those numbers have to be updated market value numbers, market value of equity, market value of debt.

So that's essentially what I'm trying to estimate in this data set.

Now the cost of capital, I've often called the Swiss army knife of finance because it shows up all over finance.

I teach corporate finance and valuation, and it's amazing how many times I reference cost of capital, often in very different contexts.

So what has economists and central bankers really nervous right now is that these haven't been at these levels since 2007, when the market sensed that something wasn't quite right in the economy.

Now, remember, these are just reflections of sentiment on top of the cost of capital and inflation expectations.

So how much does money cost today? How much do I think it's going to cost tomorrow? And what's my spread relative to how risky things are? In 2007, the markets knew before everyone else, but we weren't listening.

Well, people are listening now and they're listening because these are the new floors and the floor keeps rising.

So these consumers are doing fine.

But those yields are a big problem, and so is the PPI, because they both show that the factors for inflation are already in the numbers.

High yields means high cost of capital.

You're not the only one with a variable rate loan like a mortgage or a personal loan.

And if they tighten, it's gonna make more things competitive as to what yield you need to have on these things to attract money.

I think we're still in that thematic move towards higher yields, where the cost of capital is moving up, and we're going to start a competition for capital going on.

So whilst I'm with Mark, that I think in the short term you'll see some relief if you see these moves, I think this is a longer term theme, and we will probably want to take advantage of those rallies to maybe get our portfolio a little bit more defensive than we've had it, um, up to this point.

Mentioned before that this time of year is never good for markets, and the, clearly, the markets are showing us that.