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Exam 3 Cheat Sheet

Exam 3 Cheat Sheet - Chapter 10 Rd(YTM interest rate on the...

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Chapter 10 Rd (YTM): interest rate on the firm’s new debt WACC= Rs: cost of common equity raised by =R d (1-T)(D/A) + R s (E/A) retained earnings, or internal equity(RoR) =W d R d (1-T) + WeRe Re: cost of common equity raised by issuing =W d R d (1-T)+WcRs new stock, or external equity Three approaches to cost of equity: Cost of debt = YTM CAPM : R s =R rf + RP M *b OR Rrf + (r m -r rf )*b Wd: weight of debt Dividend growth model : D 1 /P o + g We: weight of equity Rs = Bond Yield+ Risk Premium To estimate g : ROE (NI/Equity) x Retention Ratio (1- dividend payout ratio) Cost of preferred stock: D p /P p Cost of common stock : D 1 /P o + growth rate (if given) After tax cost of debt : interest rate- tax savings= r d (1-T) Required rate of return = Expected rate of return: Rs = Rrf +RP = D1/(Po+g) = Rs P n =P 0 *(1+g) n Cost of equity from new stock issues: r e = (D 1 /P o (1-F))+g , D 1 =D o (1+g) ; D 0 = E 0 *dividend payout ratio F is the % flotation cost R.E Breakpoint =(Addition to RE)/Equity Fraction When choosing an optimal capital budget, choose those are above the WACC Each component of WACC represents the opportunity cost of that component and WACC represents the opportunity cost of capital for the company as a whole. WACC is weighted average of the marginal cost of each relevant capital component Chapter 11 NPV(WACC,Cfo, {Cf1, Cf2…}) IRR(Cfo, {Cf1, Cf2…}) An NPV profile has the discount rate on the X axis and the NPV on the Y axis. As the discount rate increases, NPV declines. Intersects x axis at IRR. If mutually exclusive the crossover point represents the point that NPVs of both are equal. To find crossover, find difference in cash flows and then take IRR. To find Y axis, add and subtract all cash flows. To find x axis, do IRR. NPV WILL ALWAYS GIVE YOU THE CORRECT ANSWER Examples of unconventional cash flows are borrowing projects & strip mines MIRR: use Cf0 as PV in calculator; for FV do Cf1 x (1+WACC)^(n- 1)+Cf2*(1+WACC)^(n-2)... Plug N and PMT of 0 and solve for I to get MIRR IRR must be greater than the cost of capital to be accepted, whereas NPV must just be greater than zero. Projects can be independent and mutually exclusive If the IRR of two projects is higher than the cost of capital, than they both have a positive NPV MIRR uses a more reasonable assumption about reinvestment rates than the IRR. IRR and NPV can conflict on mutually exclusive projects if different in size Year 0 1 2 3 Revenues $80,000,000 $83,200,000 $86,528,000 Expenses $40,000,000 $41,600,000 $43,264,000 Depreciation $6,000,000 $6,000,000 $6,000,000 Leasing cost $1,000,000 $1,000,000 $1,000,000 Pretax income $33,000,000 $34,600,000 $36,264,000 Taxes $13,200,000 $13,840,000 $14,505,600 Net income $19,800,000 $20,760,000 $21,758,400 Opportunity cost $0 $0 $0 $19,800,000 $20,760,000 $21,758,400 Plus depreciation $25,800,000 $26,760,000 $27,758,400 Capex -$20,000,000 $1,200,000 Working capital -$900,000 $900,000 Tax impact of sale $320,000 Cash flow -$20,900,000 $25,800,000 $26,760,000 $30,178,400 Depreciation = (20000000-2000000)/3 = 6000000 Tax impact of sale Market value 1,200,000 Book value 2,000,000 Hamada Problems : 1. Find unlevered beta using { Β L = Β U [1 + (1-T)*(D/E)]} 2. Relever beta using new ratio { Β L = Β U [1 + (1-T)*(D/E)]} 3. Use new B L , CAPM to find new K E [K RF + β*(K M - K RF )] 4. Use new K E and plug into WACC ***K E =K S WACC=(W d )(r d )(1-T) + (W s )(r s ) WACC Expansion will produce a rate of return on 11%. Debt to Equity Ratio is 0.8. Bond issue outstanding that will mature in 25 years and has a 7% annual coupon rate. The bond is currently selling
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