REVIEW_EXAM3_FIN202 - FIN202:001 Instructor Yudan Zheng...

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FIN202:001 Instructor: Yudan Zheng REVIEW LIST FOR EXAM 3 Cost of Capital: 1. The approach to calculate the cost of capital (1) Compute the cost of each source of capital. (2) Assign weights to each source. (3) Compute the weighted average of the component 2. Calculation: WACC (1) Cost of each source of capital (a) Cost of common equity (i) Dividend growth model approach: R E = D 1 /P 0 +g (ii) SML/CAPM approach: R E =R f + E *(E(R m )-R f ) (b) Cost of debt (i) Pre-tax cost of debt R D =YTM for bonds YTM can be calculated from bond pricing formula: (ii) After-tax cost of debt= R D (1-T c ) (c) Cost of preferred stock R p =D/P p (2) Weight of each source: use market value Market value of debt MVD=# of bonds * bond price Market value of common stock MVE=# of common stocks * common stock price Market value of preferred stock MVP= # of preferred stocks * preferred stock price Total firm value V=MVD+MVE+MVP Weight of debt W D =MVD/V Weight of common stock W E =MVE/V Weight of preferred stock W P =MVP/V (3) WACC WACC= W E R E +W D R D (1-T c ) +W P R p 3.
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