4 Flashcards
(28 cards)
Term
Definition
What is the cost of capital?
The minimum required return on a new investment.
What are the sources of capital?
Debt, Equity (common stock), and Preferred stock.
What does ‘RE’ represent?
Cost of equity capital.
What does ‘RD’ represent?
Cost of debt capital.
What is Rps?
Cost of preferred stock capital.
What is the Dividend Growth Model formula?
RE = D1 / P0 + g
What does ‘g’ represent in the Dividend Growth Model?
The dividend growth rate.
What are the advantages of the Dividend Growth Model?
Simple to use and understand.
What are the disadvantages of the Dividend Growth Model?
Only applicable to dividend-paying firms with constant growth.
What is the CAPM formula?
RE = RF + βE × (RM − RF)
What are the components of CAPM?
RF: Risk-free rate, RM: Market return, βE: Company beta.
What are the advantages of CAPM?
Adjusts for risk, usable for non-dividend paying firms.
What are the disadvantages of CAPM?
Requires estimates of market risk premium and beta.
How is the cost of debt estimated?
As the yield to maturity (YTM) on existing bonds.
What is after-tax cost of debt formula?
RD × (1 − TC), where TC is the corporate tax rate.
What does WACC stand for?
Weighted Average Cost of Capital.
What is the formula for WACC?
WACC = (E/V) × RE + (D/V) × RD × (1 − TC)
What does ‘V’ represent in WACC?
Total market value of equity and debt (V = E + D).
How are capital structure weights determined?
By calculating E/V and D/V from market values.
How do you calculate total equity value?
Number of shares × price per share.
How do you calculate market value of debt?
Price of one bond × number of bonds.
How is WACC adjusted for preference shares?
Add (PS/V) × Rps to the WACC formula.
