Cost of capital/capital strucutre

Question 1

Change in BR

Answer 1

Diversifying due to new BR

-ungear a proxy beta eq (their financial risk/cap structuring risk + business risk of sector)
-regear our beta asset –> beta eq (our FR + new BR)

beta asset = ungeared systematic risk = BR
beta equity = geared systematic risk = BR + FR (cap structure)

Question 2

Change in FR

Answer 2

Change in capital structure : APV = Adjusted Present Value

Calculate NPV as if there were no gearing = use Ke (not WACC) : BASE CASE NPV
For calculating Ke - use ungeared asset beta (represents only BR)
PV of cash flows:
-add: tax shield of interest
-deduct: debt issuance costs

APV = base case NPV + tax savings (PV) - issuance costs (PV)

Question 3

Ke

Answer 3

CAPM model

Dividend growth model:
Gordon’s growth model: G=RB (ARR * proportion of profits retained)
(ARR : PAT/opening SHs funds)

Historical growth model
sq rt(new/old) - 1 = g

Question 4

Kd

Answer 4

Redeemable debt: use yield-to-maturity
-interest paid twice a year: double nper + then multiple result % by 2!
-remember: tax shield!!!! tf * 83

Irredeemable debt:
=interest(1-tax)/MV of interest (use formula sheet)

Convertible
For redemption value - higher of:
PV

Question 5

Kp

Answer 5

Preference shares - treat as equity for all the calculations!!!

= current div per share/current ex-div share price
No tax shield!