Capital budgeting Flashcards

1
Q

describe the Risk-adjusted Discount Rate Method

A

Expected cash flows discounted by risk-adjusted discount rate

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2
Q

From the firm’s perspective, the expected return on equity is the?

A

Cost of Equity Capital:

RI=Rf+Bi*(Rm-Rf)

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3
Q

To estimate a firm’s cost of equity capital, we need to know?

A

The risk Free Rate = (Rf)
Market Risk Premium = (Rm-Rf)
Equity Beta = Bi

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4
Q

what can be used for risk free rate

A

Gov Bond Yield

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5
Q

what are the two ways to calculate the Market Risk Premium ?

A

Using Historical Data - using historical average excess return on the market over the risk-free rate

Using the Dividend Discount Model (DDM)
 This approach estimates the market risk premium using dividend yield and expected dividend growth rate

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6
Q

What are the key points for using historical data to calculate the MRP

A

We face a trade-off in selecting the amount of data we use
 It takes many years of data to produce even moderately accurate estimates of expected returns
 Yet very old data may have little relevance for investors expectations of the market risk premium today

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7
Q

Determinants of BETA

A

Business Risk
(1) Cyclical nature of Revenues (2) Operating Leverage

Financial Risk
(3) Financial Leverage

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8
Q

implication of cyclical revenues on beta

A

While stocks with high volatility (standard deviation) have high betas
 Stocks with high standard deviations do not always have high betas

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