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Exam 3 review and cheat sheet(use)

# Exam 3 review and cheat sheet(use) - Chapter 10 Formulas...

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Chapter 10 Formulas Must Know: WACC= weighted average cost of capital (measures marginal CoC) =r d (1-T)(D/A) + r s (E/A) (rd = YTM on out. Ex>>) = w d r d (1-T) +w p r p + w c r s =w d r d (1-T) + w e r s or = w d r d (1-T) + w c r s when given Debt/Equity, Debt/Asset= D/(D+E) and E/A= E/(D+E) 1-D/A=E/A -Debt considered in WACC is only LT and bank debt (N/P) r d : int. rate on firm’s new debt| r s : component cost of common equity Three approaches to cost of equity: CAPM - r S =r RF + RP M (r M - r RF ) x b Dividend growth model - D 1 /P 0 +g (D 0 =EPS(or E 0 )*div. payout ratio) Bond Yield+ Risk Premium ( RP usually 4 ) (r =BY+RP) To estimate g : ROE (NI/Equity) x Retention Ratio (1- dividend payout ratio) OR solve for I using calc Cost of preferred stock - Dp/Pp Cost of common stock : r S = (D 1 /P 0 ) +g or D 0 (1+g)/P 0 +g ( P 0 =D /r s -g) Expected stock price in n yrs: P 0 *(1+g) n EPS 0 x Payout Ratio = D 0 PV of expected Future Dividends= D1/ (1+rs) 1 + D2/ (1+ rs) 2 + …. Equilibrium Stock: r s =r RF + RP (req) = D 1 /P 0 + g = r s ^ (expected) After tax cost of debt - interest rate- tax savings= rd(1-T) Cost of equity from new stock issues : r e = (D 1 /(P (1-F)) + g , (F=Float) if they give you D 0 , they you must do D 0 (1+g), using g as a decimal Cost of common stock= D 0 (1 +g) / P 0 RE BE = Addition to RE for the year/Equity fraction When choosing an optimal capital budget, choose those returns that are above the WACC. Then add up the \$ amounts. 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 When risk increases, WACC increases -Cost of debt is cheaper than cost of equity for particular firm -Cost of RE is always more than cost of debt -Cost of new outside equity is more than cost of RE for a given firm -If congress raised tax rate, it increases value o the corporate tax shield, and more corporate debt would be demanded. -If congress increased personal tax rate, investors would be taxed more on debt income and would demand less corporate debt income and more equity income, which is taxed a lower rate. -A decrease in a firm’s degree of operating leverage would encourage that firm to use more debt in its capital structure -If WACC is less than project’s ROR, take the project -No RE, CAPM to find cost of equity capital, consisting of common stock, pref. stock, and debt. A reduction in MP r will reduce the company’s WACC Chapter 11 NPV(wacc,cfo, {Cf1, Cf2…}) OR inflow-outflow 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. NPV is positive if the IRR is GREATER than WACC -Two projects with same cost, NPV, A:uDCF=\$12k B:uDCF=\$10k, project A is more sensitive to discount rate changes To find crossover find difference in cash flows in projects A and B and then take IRR of the difference To find y axis add and subtract all cash flows. To find x axis just do IRR (Y-int is NPV when r=0%)
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