3. The WAAC Flashcards
What is the formula of the WAAC
See cahier
Investors expect on average
- A return equal to the risk-free rate for safe investement
- A higher return for risky investments
What reduces volatility
Diversification
Total Risk
Systematic (Undiversifiable Risk) + Idiosyncratic Risk (Diversifiable Risk)
What does ß measure ?
Systematic Risk and sensitivity to market-wide forces
Opportunity Cost of Capital
- Find a financial asset with the same risk as the project
- Find the financial asset’s expected return
- Use that expected return as hurdle rate
Cost of Capital
Minimum Return that would be necessary in order to justify undertaking a capital project (new building…)
What is the WAAC
expresses, in a single number, the return that bondholders and shareholders demand to provide the company with capital.
What does volatile stock mean ?
Often the higher the volatility, the higher the risk
What is the cost of equity ?
It is the return a company requires to decide if an investement meets capital return requirements
What is the market premium
The difference between the expected return on a market portfolio and the risk-free rate
CAPM formula
Re = rf + ß * market premium
True or False : Using the same discount rate for all cash flows ignores the fact that the more distant cash flows are often more risky than cash flows occurring sooner.
False : discount rates are risk-adjusted. they usually exceed the risk-free rate to to take into account risks
Yield to maturity
Other name for rate of return
