Chapter 4 Flashcards
What are the 2 components of discount rates?
risk-free rate and risk premium
What is risk-free rate?
The return on government bonds for countries whose governments have the highest credit worthiness.
Discount rate = ?
risk-free rate + risk premium
What is the difference between uncertainty and risk?
Risk can be quantified, uncertainty cannot.
Capital asset pricing model (CAPM) is the most used method to calculate ________________.
Cost of equity or discount rate on equity cash flows.
Cost of equity (Re) = ?
Re = risk free rate (Rfree) + Beta * equity risk premium (ERP)
Equity risk premium (ERP) = ?
ERP = return on stock market index - risk-free rate or Rmarket - Rfree
What beta is used in CAPM
Levered beta
How do you find levered beta?
Levered beta = Unlevered beta * 1 + (1 - tax rate) * debt / MCAP
What is effective tax rate?
The tax expense in the income statement divided by the pre-tax profit
What is the cash tax rate?
The cash taxes paid as a percentage of pre-tax income
What tax rate should be used in CAPM?
The tax rate should be set to the larger of the two estimates: effective tax rate or industry average effective rate.
Leverage in the levered beta formula is a ratio of ____ to _______
debt to market capitalization (MCAP)
MCAP = ?
price per share * number of shares
Debt = ?
short-term borrowings + current portion of long-term debt + long-term debt
