Capital budgeting Flashcards
Define internal capital
IC originates within the firm, it is cash flows from the firm’s existing operations
Define external capital
External capital originates outside the firm, and comes in the form of debt or equity
What is the discount rate for an all equity firm?
The cost of equity capital
What is the market risk premium?
The return offered by the market portfolio above the risk free rate
For perpetual cash flows, what is NPV?
NPV = C/r
If cash flows aren’t perpetual, what is NPV?
-Cash outlay + (C1/1+r) + (C2/(1+r)^2)….
How do we calculate the beta of security i?
Cov(Ri,Rm)/ Var(Rm)
What is equity beta?
The beta for a levered firm
What is asset beta?
The beta for an unlevered firm
What is the formula for converting BEquity into Basset?
Basset = (E/D+E)*Bequity
What is the formula for converting BAsset into Bequity?
Bequity = Basset(1+D/E)
When do we convert asset (unlevered) beta to equity (levered) beta?
When a firm adds debt to it’s capital structure
What’s the difference between a project (Different beta to company) that’s financed with all equity vs debt and equity?
- All equity > CAPM formula
- Debt + equity - CAPM to find RE, WACC to find discount rate
If the project is financed with debt and equity and the comparable company is an all equity company, what do we do?
Find equity beta using Basset*(1+D/E) to get beta for the debt-financed project.
