Cost of Capital

Question 1

Weighted Average Cost of Capital

Answer 1

WACC = Wd x Cd x (1-t) + Wps x Cps + Wce x Cce

Where t = marginal tax rate

Weightings should be based on target capital structure or market values if N/A, or industry avg if N/A

Question 2

Investment opportunity curve

Answer 2

Schedule of IRRs and the amount of capital required to fund the project

Intersection with MCC curve = the optimal amount of capex = amount of investment needed to undertake all positive NPV projects

Question 3

Cost of PS (Kps)

Answer 3

= Annual dividend/market price of PS

Question 4

Cost of CS (Kce)

Answer 4

CAPM = RFR + B x ( ERM - RFR)

or

Kce = (D1/P0) + g

or

Bond yield + Equity risk premium

Question 5

Beta

Answer 5

= Covariance of market / Variance of stock

Question 6

Pure-play beta estimation

Answer 6

1) Unlever the Beta = 1 / (1 + (1-t)xD/E) using marginal tax rate and d/e of the comparable company
2) Relever the Beta = 1 + ((1-t) x D/E) using tax rate and d/e of the target company

Question 7

Foreign Equity Risk Premium (FRP)

Answer 7

FRP = SYS x (STD Equity/STD Bond)

Where SYS = Yield developed - Yield Developing

Question 8

MCC Breakpoints

Answer 8

Debt = Amount of Debt that Inc WACC / Target debt weighting