Corporate Finance: Cost Of Capital Flashcards
Asset Beta
The unleverer beta; reflects the business risk of the assets; the assets systematic risk
Bond Yield plus risk premium approach
An estimate of the common equity that is produced the before tax cost of debt and risk premium that captures the additional yield on a companies stock relative to its bonds. The additional yield is often estimated using historical spreads between bond yields and stock yields
Break Point
The amount of capital at which the the cost of one or more of the sources of capital changes, leading to a change in the WACC
Business Risk
The risk associated with operating earnings. Operating earnings are uncertain because total revenues and many of the expenditures contributed to produce those revenues are uncertain
Comparable company
A company that has similar business risk; usually in the same industry and preferably with a single line of business
Component cost of capital
The rate of return required by suppliers of capital for an individual source of a companies funding, such as debt or equity
Cost of capital
The rate of return that suppliers of capital require as compensation for the contribution of capital
Cost of debt
The cost of debt financing to a company, such a me when it issued a bond or takes out a bank loan
Cost of Preferred Stock
The dividend yield that a company must commit to pay preferred stockholders
Debt incurrence test
A financial covenant made in conjunction with existing debt that restricts a companies ability to incur additional debt as the same seniority based on one or more financial test or conditions
Debt-Rating approach
A method for estimating a companies before-tax cost of debt based upon the yield comparably rates bonds for maturities that closely match that of the companies existing debt
Dividend discount model based approach
An approach for estimating a country’s equity income is premium. The market rate of return is estimated as the sum of the dividend yield and the growth rate in dividends for a market index
Equity risk premium
The expected return on equities minus the risk free rate; the premium that investors demand for investing in equities
Financial risk
The risk that environmental, social or governance risk factors will result in significant costs or other losses to a company and its shareholders; the risk arising from a companies obligations to meet required payments under its financing agreements
Fixed rate perpetual preferred stock
Nonconvertible, non callable preferred stock that has a fixed dividend rate and no maturity date
Flotation cost
Fees charged to companies by investment bankers and other costs associated with rasing new capital
Historical equity risk premium approach
An estimate of a countries equity risk premium that is based upon the historical averages of the risk-free rate and the rate of return on the market portfolio
Investment opportunity schedule
A graphical depiction of a companies investment opportunities ordered from highest to lowest expected return. A company’s optimal capital budget is found where the investment opportunity schedule intersects with the companies marginal cost of capital
Matrix pricing
Process of estimating the market discount rate and price of a bond based on the quoted or flat prices of more frequently trade comparable bonds
Operating risk
The risk attributed to the operating cost structure, in particular the use of fixed costs in operations m; the risk arising from the mix of fixed and variable costs; the risk that a company’s operations may be severely affected by environmental social, and governance risk factors
Priced risk
Risk for which investors demand compensation for bearing (equity risk company specific factors, macroeconomic factors)
Pure-play method
A method for estimating the beta for a company or project; it requires using a comparable company’s beta and adjusting it for financial leverage differences
Sales risk
Uncertainty with respect to the quantity of goods and services that company is able to sell and the price it is able to achieve; the risk related to the uncertainty of revenues
Sovereign yield spread
An estimate of the country spread (country equity premium) for a developing nation that is based on a comparison of bond yields in country being analyzed and a developed country.
Survey approach
An estimate of the equity risk premium that is based upon estimates provided by a panel of finance experts
Sustainable growth rate
The rate of dividend (and earnings growth that can be sustained over a given level of return on equity, keeping capital structure constants and without issuing additional common stock
Target capital structure
A companies chosen proportions of debt and equity
Weighted average cost of capital
A weighted average of the aftertaste required rates of return in a companies common stock, preferred stock and long term debt Where the weighs are the fraction of each source of financing in the target capital structure
