Topic 10- Cost of Capital

Question 1

Shares are …

Answer 1

equity

Question 2

Bonds are …

Answer 2

debt

Question 3

The discount rate is made of

Answer 3

debt capital and equity capital

Question 4

Debt capital is the return to

Answer 4

bondholders

Question 5

Equity capital is the return to

Answer 5

shareholders

Question 6

Bondholders payouts explained

Answer 6

paid 1st
contractual obligation for set paid amount every t with the principal paid at the end (coupon and face value)
there is still some uncertainty

Question 7

Shareholders payouts explained

Answer 7

paid 2nd
no contractual obligation ( board decided divs if going well)

Question 8

For NPV CFs belong to

Answer 8

firm/project

Question 9

For NPV COC expected by

Answer 9

investors

Question 10

Cost of capital

Answer 10

hurdle rate/rate of return

Question 11

coc helps determine if and where businesses(3pts)

Answer 11

should invest, borrow and return to stockholders

Question 12

req ror on asset depends

Answer 12

upon the risk of CFs generated by asset

Question 13

interest rates =

Answer 13

cost of money

Question 14

COC is req r for

Answer 14

for investment porjects

Question 15

COC measures

Answer 15

how market assesses risk of asset composite cost to firm (project=mini firm) of raising finance to fund projects

Question 16

Cost of equity

Answer 16

coe cap is the return req to stockholders (eq) given the risk of the CFS flowing from holders to eq

Question 17

Cost of equity formulas

Answer 17

expected retrun = risk free rate + (beta(market risk-risk free rate)) or r= (D1/P0)+g

Question 18

CAPM model is preferred for COE why?

Answer 18

it includes more risk factors not just market returns

Question 19

Cost of debt

Answer 19

cod cap is the int rate company pays on its debt given risk of CFs flowing from debt to holders

Question 20

before tax cod estimated by

Answer 20

YTM (using familiar bond valuation eq)

Question 21

Tax benefits to…

Answer 21

debt

Question 22

for COD bank loan or bond what parts

Answer 22

r or YTM

Question 23

Pre tax COD

Answer 23

int rate

Question 24

After tax COD formula

Answer 24

ir x(1-TR)

Question 25

After tax COD is true

Answer 25

effective COD of company

Question 26

Cost of preferred equity

Answer 26

preferred divs are a fixed div amount promised to shareholders at regular interval for indefinite t

Question 27

the cost of preferred stock is the

Answer 27

preferred div yield

Question 28

COPE formula

Answer 28

r= D1/P0

Question 29

COPE explained (voting rights...)

Answer 29

no voting rights, its a share paid before shareholders if going bankrupt after debt holders dividends are a contractual obligation

Question 30

WACC

Answer 30

weighted average cost of capital

Question 31

WACC is the

Answer 31

weighted average of after-tax costs of each source of capital

Question 32

WACC can be used to value a project how?

Answer 32

using NPV it is the r

Question 33

WACC E, D, V We, Wd formulas

Answer 33

E= n shares x price per share D= n bonds x bond price V= E + D We= E/V Wd= D/V

Question 34

WACC formula

Answer 34

(We x Re) + (Wd x Rd(1-T))

Question 35

The value of debt/equity is determined by

Answer 35

the value of assets

Question 36

Book Value of D/E

Answer 36

based on historical costs

Question 37

Markert value D/E

Answer 37

the fair value that is reflective of current worth of bonds/shares based on PV of future CFs

Question 38

The WACC Rw is the cost...

Answer 38

of cap across both sources of capital for a company