B2 - M1: Working Capital Structure I

Question 1

Beta Coefficient

Answer 1

represents the volatility (risk) of a stock relative to the volatility of the overall market

B = % Change of the Stock Price / % Change of the Market Price

B = 1 means the stock is as volatile as the market
B > 1 means the stock is more volatile than the market
B < 1 means the stock is less volatile than the market

Question 2

Three common methods of computing Cost of Retained Earnings

Answer 2

• Capital Asset Pricing Model (CAPM)
• Discounted Cash Flow (DCF) or Dividend Yield plus Growth Rate Method
• Bond yield plus Risk Premium (BYRP)

Question 3

Capital Asset Pricing Model (CAPM)

Answer 3

= risk free rate + [Beta x (Market return - risk free rate)]

Question 4

Discounted Cash Flow (DCF) or Dividend Yield plus Growth Rate Method

Answer 4

= (D1 / P0) + G

D1 = Dividend/share expected at end of one year
P0 = current market value or price of the stock
G = Constant growth rate in dividends

D1 = D0 x (1 + G)

D0 = dividend that was “just paid”. this represents the amount paid this year and D1 will represent the amount of the dividend expected next year assuming it grows by G%

Question 5

Bond Yield plus Risk Premium (BYRP)

Answer 5

= Pretax cost of LT Debt + Market risk premium

estimates the required return on an equity by adding the equity’s risk premium to the yield to maturity on company’s long-term debt

Question 6

Optimal Capitalization rate

Answer 6

the best mix of debt and equity financing that maximizes a company’s market value while minimizing its cost of capital

Lowest WACC

Question 7

Net cost of debt

Answer 7

= effective interest rate x (1 - TR)

use the coupon rate instead of EIR if the coupon rate is equal to the EIR and there are no flotation costs

Question 8

Flotation Costs

Answer 8

costs incurred when a company issues new stock or bonds

• underwriting fees, legal fees, registration fees, etc.