CFA Flashcards
Corporate Governance
A system of internal controls and procedures through which companies are managed
NPV Net Present Value
Initial outlay (negative) plus every cash flow discounted to today
IRR (Internal Rate of Return)
Rate needed for all cash flows of a period to equal the initial outlay
Payback Period
Time it takes for cash flows of a project to equal initially outlay. Cash flows can be discounted (discounted payback period)
AAR (Average Accounting Rate of Return)
Average of cash flows / average book value
PI (Profitability Index)
Present values of future cash flows / initial outlay
Cross Over Rate
The rate (cost of capital) at which the NPV of two projects are equal
Cost of Capital
Rate of return that the suppliers or providers of capital need to agree on investing, also known as their opportunity cost
WACC (Weighted Average Cost of Capital)
Marginal cost of capital = WACC = (Wd)(Rd)(1-t) + (Wp)(Rp) + (We)+(Re)
Tax Shield
Interest expense * tax rate
Target Capital Structure
Capital structure that the company aims to maintain
D/E ratio to weight
Wd = D / (D + E) or (D / E) / (1 + D/E)
Current market price of bond
Po = sum of payments discounted to today plus future value discounted to today
YTM (Yield to Maturity)
Interest rate needed for bond’s current market value to become future value at a given number of periods and payment amounts
Debt rating approach
Using yields of similarly rated bonds to estimate cost of debt when current market prices are not available
Cost of preferred stock (perpetuity)
Dividend per share / current price of stock
Current value of preferred stock (perpetuity)
Dividend per share / cost of preferred stock
Perpetuity
Noncallable, nonconvertible, no maturity date, dividends paid at a fixed rate, preferred stock value
Cost of Equity Capital
Rate of return required by common stock holders
CAPM (Capital Asset Pricing Model)
States that the expected rate of return from a stock equals the risk free interest rate plus a premium for bearing risk
re = Rf + Bi[E(Rm) - Rf]
Dividend discount model approach
Value of a stock equals present value of expected future dividends
Po = D1 / re - g
Bond yield plus risk premium approach
Re = rd + risk premium
CAPM company’s cost of equity
Ri = a + bRmt
Company’s stock returns = estimate of the intercept + beta*market returns over a given period
Pure play method to estimate beta
Take beta of similar publicly traded company, unlever the financial risk (leverage) and lever in financial risk of project under study
Unlever = 1 / 1 + ((1-t) D/W)
CRP (Country Risk Premium)
(Sovereign yield spread * (annualised standard deviation of equity index) / (annualised s.d of sovereign bond market in terms of the developed market currency))
Break point
(Amount of capital at which a component’s cost of capital changes) / proportion of new capital raised from the component)
