Leverage and Cost of Capital

Question 1

Degree of Financial Leverage

Answer 1

% Change in EPS/ % Change in EBIT

Measures how much a business relies on Debt financing

Question 2

Cost of Debt Financing

Answer 2

Yield to Maturity X (1 - Effective Tax Rate)

Or

Net Interest Expense after Tax Break/Carrying VU of Debt

Question 3

Cost of Preferred Stock Financing

Answer 3

Dividend/Net Issue Price

Question 4

Common Stock Equity Financing - What are the types

Answer 4

CAPM
Arbitrage (like CAPM but more complex)
Bond Yield Plus (add 3% to 5% onto IRate)
Dividend Yield Plus Growth Rate
Cost of New Common Stock
WACC

Question 5

CAPM Formula

Answer 5

Beta X Excess of Normal Market Return - Risk Free Return/Risk Free Rate

Question 6

Degree of Operating Leverage

Answer 6

DOL = % Change in EBIT (Earnings B4 Interest and Taxes)/ % change in Sales Volume

Measures how much fixed cost is affect performance when revenues change.