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Intermediate Finance > Chapter 11 > Flashcards

Chapter 11 Flashcards

1
Q

What are the components of the cost of capital

A

debt
preferred stock
common equity

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2
Q

capital budgeting decisions

A

you compare the expected rate of return with the cost of capital

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3
Q

how compensation plans relate to cost of capital

A

you can compare the return of invested capital and cost of that capital

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4
Q

what are component costs

A

the required rate of return on each capital component

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5
Q

what is the WAAC

A

weighted average of the various components of cost

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6
Q

What is Rd

A

interest rate on long term debt (cost of new debt)

  • required return on bond, YTM for previously issued bonds
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7
Q

what is Rstd

A

interest rate on short-term debt, such as notes payable

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8
Q

what is T

A

the firms marginal tax rate

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9
Q

what is Rps

A

the required return on preferred stock

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10
Q

what is Rs

A

required return on common stock

  • cost of common equity raised internally as reinvested earnings
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11
Q

what is Re

A

component cost of external equity, or equity raised by issuing new stock

Re is rarely relevant consideration except for very young growing firms

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12
Q

what do the W’s in the WAAC formula stand for

A

the weights the firm plans to use when it raises capital in the future

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13
Q

Short term debt should be included in the capital structure only if…

A

it is a permanent source of financing

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14
Q

what do some companies use as a source of short term financing

A

commercial paper

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15
Q

what rate is the cost of new debt

A

marginal rate

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16
Q

what is the cost of previously issued debt

A

historical or embedded rate

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17
Q

what cost is relevent during the planning period

A

the cost of new debt

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18
Q

what do investment decisions hinge on

A

a projects expected future returns vs the cost of the new or marginal capital that will be used to finance the project

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19
Q

Is the required return to debt-holders equal to the companies cost of debt

A

NO

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20
Q

do debt offerings usually have a high or low flotation cost

A

low

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21
Q

what are flotation costs

A

the percentage of proceeds paid to the investment bankers

  • commissions, legal expenses, fees and any other costs that a company incurs when it issues new securities
22
Q

do you need to do a tax adjustment for debt

A

yes need after tax rate

23
Q

do you need a tax adjustment for preferred stock

24
Q

What is Dps

A

preferred dividend

25
what is Pps
preferred stock price
26
which is riskier to investor preferred stock or debt
preferred stock
27
what are the two ways companies can raise common equity
1. selling newly issued shares to the public (external) 2. retaining and reinvesting earnings (internal)
28
what do few firms with moderate or slow growth issues new shares of common stock
- high flotation cost - investors perceive issuance as a negative signal - an increase in supply of stock will put pressure on stock prices
29
does reinvesting earnings come at a cost to the firm>
yes opportunity costs
30
what are the two methods to figure out cost of common stock
1. the capital asset pricing model (CAPM) 2. discounted cash flow method (DCF)
31
what is the rate that is typically used for the risk free rate
rate on 10-year treasury bonds
32
what is the market risk premium
required return on the stock market minus the risk-free rate "how much return do investors require to induce them to invest in stock"
33
what are the three approaches to estimating Market Risk Premium Rate
1. use historical premiums 2. survey experts 3. use current market value
34
what are the issues with estimating Market Risk Premium by using historical premiums
- stock returns are quite volatile - the historical average is extremely sensitive - changes in the risk premium can occur if investors tolerance for risk changes
35
what is the required return on the market
the markets expected dividend yield + expected constant growth rate in dividends
36
how can beta be estimated
historical betas or industry beta
37
When should a company use the Discounted Cash Flows approach to estimate price of common stock (Rs)
if an investor expects dividends to grow at a constant rate If the company makes all payout in the form of dividends
38
in an equilibrium market the expected return and intrinsic value is equal to what
the market price
39
What three inputs are needed for the DCF approach
1. current stock price 2. the current dividend 3. marginal investors expected dividend growth rate
40
how can you estimate the growth rate
- use historical growth rate - use earnings retention model - obtain analyst estimates
41
What is the retention model
way of estimating growth rate - the more companies retain, the higher the earned rate of return on those R.E, the higher the growth rate
42
for companies that issue new stock is the cost of external or internal equity more expensive
external
43
what is the Re equation on the equation sheet
cost of new common stock for a constant growth firm
44
are flotation costs higher for equity or for debt
for equity
45
Is WAAC... the cost the company would incure to raise each new or marginal dollor of capital OR the average cost of dollars raised in the past
the cost the company would incure to raise each new or marginal dollor of capital
46
Divisional Cost of Capital
estimating the cost of capital that a division would have if it were a standalone firm
47
What are the two ways to find a divisons BETA
-pure play method - Accounting Beta Method
48
what is pure play method
method for estimating divisions beta - find publicly traded companies exclusively in projects business and use averages of their betas
49
what is the accounting beta method
estimates divisions beta - found by regressing the return of a particular companies stock against the return on a stock market index
50
What are the three types of project risk
1. standalone risk 2. Corporate risk 3: Market Risk (beta risk)
51
What are factors that affect WAAC that a firm cannot control
1. Interest Rates 2. Credit Crisis 3. Market Risk Premium 4. Tax Rates
52
What are factors that affect the WAAC that a firm can control
1. Capital structure policy 2. Dividend policy 3. Investment (capital budgeting) polciy

Intermediate Finance (15 decks)

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