Finance Note Sheet Final

Finance Note Sheet Final - Risk Level Low Risk Same Risk as...

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Risk Level Discount Rate Low Risk WACC less 2% Same Risk as Firm WACC High Risk WACC plus 2% Advantages and Disadvantages of Dividend Growth Model Advantage – easy to understand and use Disadvantages Only applicable to companies currently paying dividends Not applicable if dividends aren’t growing at a reasonably constant rate Extremely sensitive to the estimated growth rate – an increase in g of 1% increases the cost of equity by 1% Does not explicitly consider risk Advantages and Disadvantages of SML (CAPM) Advantages Explicitly adjusts for systematic risk Applicable to all companies, as long as we can estimate beta Disadvantages Have to estimate the expected market risk premium, which does vary over time * Have to estimate expected beta, which also varies over time * We are using the past to predict the future, which is not always reliable Capital Structure Weights E = market value of equity = # shares outstanding x price per share D = market value of debt = # bonds outstanding times bond price P = market value of preferred stock = # shares outstanding x price of preferred V = market value of the firm = D + E + P Weights w E = E/V = percent financed with equity WACC = w E R E + w D R D (1-T C )+ w P R P w D = D/V = percent financed with debt w P = P/V = percent financed with preferred stock How do we know WACC for individual project? The Pure Play Approach: Find one or more companies that specialize in the product or service that we are considering. Compute the beta for each company. Take an average. Use that beta along with the CAPM to find the appropriate return for a
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This note was uploaded on 01/23/2012 for the course FINANCE 300 taught by Professor Mucklow during the Spring '10 term at University of Wisconsin.

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Finance Note Sheet Final - Risk Level Low Risk Same Risk as...

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