Exam 3 Flashcards
WACC equation
Wdrd(1-T)+WpRp+Wc*Rs
Government gives tax break on interest paid to debt so
Cost of issuing bond(interst to bond holders) is tax desuctable
Should analysis be focused on historical cost or marginal costs
Marginal cost
Rp is
The marginal cost of preferred stock which is the return investors require on a firms preferred stock
Cost of preferred stock formula
Dp/Pp
Is preferred stock more or less risky
More because they are not required to pay dividends
Why is the yeild on preferred lower than debt
Corps own most preferred and 70% are excluded from tax so BT yield will be lower
Rs is
The marginal cost of common equity using retained earnings
Three ways to determine the cost of common equity
CAPM, DCF, and bond yield plus risk premium
CAPM formula
Rs=Rrf+ (Rm-Rrf)b
DCF equation
Rs= (D1/P0) +g
Bond yield plus risk premium equation
Rs=Rd+RP
Direct cost related to retained earnings and stock
When a company issues new CS they also have to pay a flotation cost to the underwriters
Indirect cost related to RE and CS
Issing new stick may send a neg message signal to the markets wish may depress the stock price
Price of equity with flotation cost equation
Re=D0(1+g)/P0(1-F) +g
Flotation cost depend
On the firms risk and the type of capital being raised and amount being raise
Floation cost are highest for
Common equity but per project cost are small
What factors influence a companys composite WACC
Market conditions, captial structure and dividend policy, investment policy, interest rate and stock price
Riskier projects will have a higher
WACC
What is capital budgeting
Analysis of potential additons to fixed assets. Long term decisions with large expenditures
Steps to capital budgeting
Estimate CF, assess riskiness of CF, determine appropriate cost of capital, find NPV or IRR, accept or decline
Accept project if
NPV>0 and or IRR>WACC
Independent projects
If the cash flows of one are unaffected by the acceptance of the other
Mutually exclusice projects
If the cash flows of one can be adversly impacted by the acceptance of the other