Cost Of Capital Flashcards
1
Q
What are the key assumptions of the capital asset pricing model?
A
- Investors are rational and risk-averse
- Investors have a common single-period planning horizon
- Investors have homogenous expectations
- All assets are publicly held and traded
- Investors can sell short
- There are no transaction costs
- Personal income taxation is zero
- Investors can all lend and borrow at the risk-free rate
2
Q
how to calculate weighted average cost of capital
A
%debt x (return on debt x (1-tax rate)) + %equity x return on equity = WACC
3
Q
How to estimate cost of debt if publicly traded
A
Pre tax cost of debt x ( 1 - tax rate) = cost of debt
4
Q
how yo estimate cost of debt when not publicly traded
A
estimate YTM with similar debt ratings then use linear interpolation
5
Q
What are the 3 methods of estimating cost of equity
A
- CAPM
2.Dividend discount method - bond yield plus risk premium
6
Q
how to calculate CAPM
A
beta x risk free rate + (Market return - risk free) = CAPM
7
Q
how to calculate dividend discount model
A
(current dividend x growth rate) / share price + growth rate = ddm
8
Q
Capital asset pricing theory asserts that portfolio returns are best explained by:
A
Systematic risk
