Corporate Finance I

Question 1

Payback period

Answer 1

Length of time it takes for a projects cost to be paid back to the firm.

Question 2

Profitability Index

Answer 2

Present value of cash flows / initial cash outflow

> 1 = profitable project

Question 3

WACC

Answer 3

Use target capital structure

Wi * Cost + Wd * debt cost * (1-tax), etc

Based on average risk level, should be adjusted when used to discount risk project

Question 4

Marginal cost of capital

Answer 4

Only projects that have a return > marginal cost of capital should be undertaken

Question 5

Cost of debt

Answer 5

Calculated as the YTM of current debt (not coupon rate). Use after-tax value.

Question 6

Cost of equity

Answer 6

Can estimate with (1) CAPM, (2) dividend discount model or (3) bond + risk premium

Question 7

Pure play method

Answer 7

Using beta of a proxy company engaged in the same (pure) business to estimate CAPM return.

Question 8

Beta - formula to unlever

Answer 8

βunlevered = βlevered / [1+(1−t) * (D/E)]

Question 9

Beta - formula to lever

Answer 9

βlevered = βunlevered * [1+(1−t) * (D/E)]

Question 10

Country risk premium (CRP)

Answer 10

Sovereign yield spread * (annualized vol of equity in foreign country / annualized volatility of foreign govern bonds in USD)

Question 11

CAPM with CRP

Answer 11

RFR + Beta * (E(rmkt) - RFR + CRP)

Question 12

Flotation costs

Answer 12

Add to initial outflow for project - one time.

Question 13

Operating leverage

Answer 13

Magnifies changes in sales on operating earnings

Question 14

Financial leverage

Answer 14

Magnifies changes in operating earnings on net income

Question 15

Degree of operation leverage (DOL) simple

Answer 15

DOL = (% change in EBIT / % change in sales)

Question 16

Degree of operating leverage (DOL) longer

Answer 16

(sales - total variable costs) / (sales - total variable costs - fixed costs)

Question 17

Degree of financial leverage (DFL) simple

Answer 17

% change in EPS / % change in EBIT

Question 18

Degree of financial leverage (DFL) longer

Answer 18

EBIT / (EBIT - interest)

Question 19

Degree of total leverage (DTL) simple

Answer 19

DTL = DOL & DFL

Question 20

Degree of total leverage (DTL) longer

Answer 20

change in EPS / change in sales = (change in EBIT / change in sales) * (change in EPS / change in EBIT)

Question 21

Operating cycle

Answer 21

Days of inventory + days receivable

How long it takes to turn raw materials into cash

Question 22

Cash cycle

Answer 22

Days receivable + days of inventory - average days payable

Question 23

Discount-basis yield

Answer 23

% discount * (360/days)