Cost of Capital

Question 1

Simplest and easiest way of estimating a default spread for a company?

Answer 1

Get bond rating from Moody’s or S&P and estimate default spread based on it.

Question 2

What is synthetic rating formula?

Answer 2

Interest Coverage Ratio = EBIT / Interest Expense

Use average from multiple years for EBIT and Interest Expense since number tend to fluctuate.

Higher Interest Coverage Ratios are better.

Question 3

What is formula for Cost of Debt?

Answer 3

Cost of Debt = Risk Free Rate + Country Risk + Company Risk

Country risk may be estimated.

Question 4

What is the formula for Cost of Capital (WACC)?

Answer 4

Cost of Capital = (Weight * Cost of Equity) + (Weight * After tax Cost of Debt)

Question 5

What is the formula for Cost of Equity?

Answer 5

Cost of Equity = Risk Free Rate + (Beta * Equity Risk Premium)

Question 6

How are weights determined for Cost of Equity and Cost of Debt

Answer 6

Cost of Equity = Market Value of Equity = Outstanding Shares * Share Price

Cost of Debt = Market Value of Debt = BV of debt converted to single coupon bond

Question 7

What is the Cost of Debt?

Answer 7

Current cost to the firm of borrowing funds to finance projects.

Damodaran, Aswath. Investment Valuation: Tools and Techniques for Determining the Value of any Asset, University Edition (Kindle Location 6489). Wiley. Kindle Edition.

Question 8

Formula to convert Cost of Capital to another currency?

Answer 8

Cost of Capital in new currency =

1 + Cost of Capital in old currency) * (1 + Inflation in new currency) / (1 + Inflation in old currency