5 - Cost of Capital Flashcards
1
Q
WACC
A
[(Ke x MVe) + (Kp x MVp) + (Kd x MVd)] / (MVe + MVp + MVd)
2
Q
Dividend growth - Historic model
A
g = [(D0/Dn) - 1]^1/n
3
Q
Dividend growth - Gordon growth model
A
g = r x b
Where:
r = ARR b = Earnings retention
4
Q
Cost of preference shares
A
Kp = D/P0
Where P0 is the ex-dividend price
5
Q
Cost of a bank loan
A
Kd = i(1-T)
Where i = interest rate on loan
6
Q
Cost of irredeemable debentures
A
Kd = [i (1 - T)] / P0
Where P0 is the ex-interest price
7
Q
Cost of redeemable debentures
A
Krd = IRR(1 - T)
8
Q
Assumptions made when using DVM
A
- perfect markets
- all investors have same expectations
- constant dividend growth
- interim dividends ignored
- personal tax issues ignored
9
Q
Assumptions made when using WACC as discount rate
A
- constant gearing
- constant business risk
- finance is not project specific
- plus DVM assumptions on perfect markets etc
10
Q
WACC hurdle rate
A
- cost of funds that a company raises and uses/return that investors expect to be paid
- minimum return that a company must make on its investments in order to pay return to investors
- if the firm does not meet the hurdle rate then it will be investing in projects with a negative NPV
