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Management accounting > Revision > Flashcards

Revision Flashcards

1
Q

What is the WACC Formula ?

A

WACC = (E/(D+E))Ke + (D/(D+E)KD(1-t)

Kd= Cost of debt
Ke = Cost of ordinary equity
t= Marginal tax rate
D = Market Value of Debt
E = Market value of ordinary equity
V= Market value of the firm

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2
Q

What are the 3 main advantages of debt over equity :

A
  1. Leverage concept.

Ie, then the company is earning more than the interest charged - the profits are levered so that the return on shareholders funds is higher than the return on assets.
Converse is also true.

  1. Tax deducibility of the interest
  2. Cost of debt is usually less than the cost of equity
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3
Q

Capital structure.
1. What are the three components of capital structure

A
  1. Enterprise risk
  2. Business risk
  3. Financial risk
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4
Q

Steps to consider when choosing a capital structure :

A
  1. What is the capital structure based on the current market values of debt and equity ?
  2. What are the capital structures of firms in the same industry ?
  3. What is management’s target capital structure ?
  4. IF no specific target, what is implied by their financing activities ? What is implied by potential financial restructuring ?
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5
Q

Cost of debt calculation:

A

Interest rate (1 - tax rate)

  • Non-redeemable debt instruments and Redeemable debt instruments
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6
Q

When a debenture is in perpetuity, how would you calculate that?

A

(Coupon rate of debenture/market rate on date of issue) x Rand value of debenture at inception

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7
Q

What is the cost of redeemable debentures?

A

The cost is the yield to maturity

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8
Q

What are the 2 types of cost of debt :

A
  1. Non- Redeemable debt instruments
  2. Redeemable debt instruments
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9
Q

What are the three types of preference share?

A
  • Not redeemable
  • Redeemable
  • Convertible preference shares
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10
Q

Formula for value of preference shares :

A

Vpf = Expected dividend rate/required rate x issue price

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11
Q

What are the methods of calculating the cost of equity :

A
  • Dividend growth model
  • Capital asset pricing model
  • Bond yield plus risk premium
  • Divisional cost of equity
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12
Q

What is the formula for sustainable growth models :

A

SGR = ROE x b(retention ratio)

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13
Q

What is the formula for Gordons growth model?

A
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14
Q

What is the formula for Gordons growth model?

A

Po = Do(1+g)/ r-g
= D1/ r-g

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15
Q

What makes up D1?

A

(EPS x Dividend payout ratio) x Expected growth rate

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16
Q

What is the CAPM Formula ?
What is the market risk premium ?
What is the risk free rate ?

A

Ke = Rf + (Rm - Rf) x B

(Rm + Rf)

Risk free rate used is the long term government bond rate

17
Q

Advantage of Gordons’s Dividend Growth Model ?

A

Easy to understand and use

18
Q

Disadvantage of Gordons Dividend growth model?

A
  • Only applicable to companies currently paying dividends
  • Not applicable if dividends are not growing at a constant rate
  • Extremely sensitive to the estimated growth rate - and increase in g of 1% increases the cost of equity by 1 %
19
Q

Definition of a beta ?

A

Beta is a measure of the volatility or systematic risk, of a share in comparison to the market as a whole.

20
Q

Advantages of the CAPM Model ?

A
  • Explicitly adjusts for systematic risk
  • applicable to all companies as long as we can compute the beta
21
Q

Disadvantages of CAPM?

A
  • Have to estimate the expected market risk premium, which does vary over time
  • We have to estimate beta, which also varies over time
    We are relying on the past to predict the future, which is not always reliable
22
Q

Bond Yield Formula :

A

Cost of equity = Bond Yield (AKA Borrowing cost) + risk premium

23
Q

Other points to consider in WACC :

A

Leases
- May increase the debt/ equity of an entity
- If already not factored into the Beta, then we need to reflect it by using a higher beta and we can do this by levering and releveling the firm’s beta. This will increase risk and thereby increase WACC.
- Lower cost of debt financing is mainly offset by increase in the cost of equity

Break points in the WACC

24
Q

General WACC points to remember :

A
  1. Focus on target capital structure -otherwise use market values as a guide
  2. Only use book values if this reflects the target capital structure.

Management accounting (4 decks)

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