Cost of Capital, Risks and Returns, Leverage

Question 1

What value and rate to use?

Answer 1

Market Value over Book Value
Effective Rate over Nominal Rate

Question 2

How to know if discount/premium?

Answer 2

Effective > Nominal = Discount
Net Proceeds > Face Amount = Premium

Question 3

Formula for WACC
- source, weight, cost

Sources : Debt, Preferred Stock, Common Stock

Answer 3

Debt
- weight x (yield rate * (1 - tax rate))

Preferred Stock
- weight x yield rate

Common Stock
- weight x (yield rate + growth rate)

Question 4

Formula
- Current Yield Rate for Debt
- Yield to Maturity for Debt

Answer 4

Current Yield
- Annual Interest / Market Price

Yield to Maturity
- (Interest +/- Amortization) / (Simple Average of Net Proceeds + Face Value)

Question 5

Formula
- Yield Rate for Preferred Stock
- Yield Rate for Common Stock
- Yield Rate for Retained Earnings

Which is net of flotation costs?

just like in FS analysis

Answer 5

Yield Rate for Preferred Stock
- Dividend per Share / Market Price per Share
- MP is net of flotation costs

Yield Rate for Common Stock
- Expected Dividend per Share / Market Price per Share (+ Growth Rate)
- MP is net of flotation costs

Yield Rate for Retained Earnings
- Expected Dividend per Share / Market Price per Share (+ Growth Rate)

Since only RE is not issued (so walang issuance/flotation costs)

Question 6

Diversifiable Risk is also called systematic risk. True or False?

Answer 6

False (unsystematic)
- Non Diversifiable yung systematic since market-related risks

Diversiable Risk (BDL) → Business, Default, Liquidity Risk

Question 7

If I want to compare investments with different expected returns, what should I use? SD or COV?

Answer 7

COV (used for comparing)
- SD → measure of dispersion of potential returns from average returns

higher SD / COV = higher risk

Question 8

It is a measure of relative risk. SD or COV?

Answer 8

COV (SD is measure of absolute risk)

Question 9

How to compute SD and COV?
- you need to first get ER and Variance

Answer 9

Expected Return (ER)
- Sum of Expected Values = probability % x value
- Step 2 - subtract each value from ER

Variance
- Sum = step 2 squared x probability %

SD
- square root of variance

COV
- SD / ER

Question 10

Formula
- DOL
- DFL
- DTL

DTL = DOL x DFL

Answer 10

DOL
- CM / EBIT

DFL
- EBIT / EBIT less FFC
- FFC = Interest + Pretax Preferred Dividends

DTL
- CM / EBIT less FFC
- FFC = Interest + Pretax Preferred Dividends

Question 11

Formula
- DOL
- DFL
- DTL

if what is given is % change

Answer 11

DOL
- Δ% EBIT / Δ% Sales

DFL
- Δ% EPS / Δ% EBIT

DTL
- Δ% EPS / Δ% Sales