Reading #36 2015 - Cost of Capital Flashcards
FORMULA: WACC
w(d)[(cost(d)(1-t(] + w(ps)(cost(ps) + w(ce)cost(ce)
CALCULATE cost of equity capital using CAPM
=RFR+ beta(Rm - RFR)
CALCULATE cost of equity using DDM
P0= D1/cost of equity - growth. goes to (D1/P0)+g
what is growth formula (g)?
g = RRxROE, g = (1-payout rate)(ROE)
CALCULATE cost of equity using bond yield plus risk prem
bond yield + risk premium
FORMULA for projects Beta
Bproject = Basset[1+ (1-t)D/E0]
define marginal cost of capital (MCC)
“cost of the last new dollar of capital a firm raises” WACC can also be referred to as MCC
FORMULA for a break point
amount of capital when cost of capital changes / weight of the component in capital structure
define flotation costs
“fees charged by investment bankers when a company raises external equity capital”
define the cost of capital
rate of return required by bondholders, etc, for their contribution to capital
calculate the weights of D and E using D/E
(D/E) / (1+ (D/E) ) solves for Debt
define relationship of MCC and investment opportunity schedule
as MCC goes up, investment opp goes down. the optimal budget is where they intersect
define debt-rating approach for calculating cost of debt
if we do not have the yield to determine cost of debt, use a comparable bond’s yield but use the company’s marginal tax rate
how should options in debt features be treated when determining cost of debt?
if they are already in the bond prices (i.e. paying prem for a call bond), use that YTM. if analyst thinks option will be taken down, they can adjust
