Corporate Finance

Question 1

WACC

Answer 1

w_d[k_dbt(1-t)] + w_psk_ps + w_cek_ce

or

w_dk_d+ w_psk_ps + w_cek_ce

= weight * after tax cost of debt

+ weight * cost of preferred stock

+ weight * cost of common equity

Question 2

After Tax Cost of Debt

k_d

Answer 2

k_dbt(1 - t)

Market interest rate (YTM) at which firms can issue new debt (k_d) net of the tax savings.

Question 3

Cost of Preferred Stock

k_ps

Answer 3

D

———

P

Question 4

Cost of Common Equity

k_ce

CAPM Model

Answer 4

ß[E(r_mkt) - r_rf] + r_rf

Question 5

Cost of Common Equity

k_ce

Dividend Discount Model

Answer 5

k_ce = (D₁ / P) + g

or

P = D₁ / (k_ce - g)

Question 6

Cost of Common Equity

kce

Bond-Yield-Plus-Risk-Premium Approach

Answer 6

k_dbt + Risk Premium

or

[k_d/(1 - t)] + Risk Premium

Before tax cost of debt plus risk premium of equity over debt.

Question 7

Growth Rate

g

Answer 7

RR * ROE

Question 8

Dividend Payout Rate

D_p

Answer 8

1 - RR

Question 9

Retention Rate

RR

Answer 9

1 - D_p

Question 10

Profitability Index

PI

Answer 10

NPV / CF₀ + 1

Question 11

Break Point for

Marginal Cost of Capital

MCC

Answer 11

Dollar Amount

————————

Weight

Question 12

Bank Discount Yield

BDY

Answer 12

[(F - P) / F] * (360/n)

Question 13

Cost of Trade Credit

(Payables with discounts)

Answer 13

(1 + %Disc/(1 - %Disc)^(365/n) - 1

The cost of not paying based on discount terms

eg:2/10 net 40

Question 14

Operating Cycle

Answer 14

DOP + DOH

Question 15

Operating Break-Even Point

Answer 15

Fixed Costs

———————————

Contribution Margin

Question 16

Optimal Capital Budget

Answer 16

The amount of new capital required to undertake all investment projects with an IRR greater than the MCC.

MCC = IOS

The point where the Marginal Cost of Capital (MCC) intersects the Investment Opportunity Schedule (IOS)

Question 17

Cash Flow Forecasting Techniques

Answer 17

Short Term

• Simple Projections

Medium Term

• Project Models & Averages

Long Term

• Statistical Models

Question 18

Business Risk

Answer 18

Sales Risk + Operating Risk

Question 19

Equity Beta

ß_Equity

Answer 19

ß_Asset^*[1 + (1 - t)(D/E Ratio)]

Question 20

Degree of Financial Leverage

DFL

Answer 20

Operating Income

——————————

EBT

Question 21

Degree of Total Leverage

DTL

Answer 21

(Revenue - Variable Costs)

——————————————

Net Income

Question 22

Degree of Operating Leverage

DOL

Answer 22

Q * Contribution

—————————————

Q * Contribution - Fixed

Question 23

Book Value

Answer 23

Owners Equity

———————————

Shares Outstanding

Question 24

The amount of new capital required to undertake all investment projects with an IRR greater than the MCC.

MCC = IOS

The point where the Marginal Cost of Capital (MCC) intersects the Investment Opportunity Schedule (IOS)

Answer 24

Optimal Capital Budget