Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CPA Exams - BEC B2 > Capital Structure: Part 1_M1 > Flashcards

Capital Structure: Part 1_M1 Flashcards

1
Q

What is the overall cost of capital?

“Hurdle Rate”

A
  • Debt plus equity
  • The overall cost of capital, also referred to as a company’s “hurdle rate,” is the minimum return a company must achieve in order to make an investment financially feasible.
  • This is a concept typically used in capital budgeting when companies are evaluating options, such as which capital project to undertake or types of new assets to acquire.
  • The weighted average cost of capital (WACC) can be used as a measure of the overall cost of capital, because it factors the company’s proportion of its cost of debt and its cost of equity.
  • The overall cost of capital is the rate of return a company requires in order to exceed the cost of employing that capital in the form of equity and debt.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What are the assumptions that Capital Assumption Pricing Model makes?

A
  • The capital asset pricing model (CAPM) is a method used to estimate the cost of equity capital for an individual stock.
  • The model is calculated by taking the risk-free rate (assumed to be a single rate) and adding the risk premium.
  • The risk premium is equal to an individual stocks beta coefficient (a measure of risk relative to the overall market) multiplied by the difference between the estimated market rate of return and the risk-free rate.
  • Note that the difference between the market return and the risk-free rate is called the “market risk premium.”
  • The CAPM assumes that the variability of returns is related to the overall market and volatility in stock prices.
  • The CAPM assumes that the required rate of return can be measured.
  • At a high level, the CAPM involves two components: the risk-free rate and the risk premium
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

How to calculate interest income payable semiannually?

A

The amount of cash disbursed on each interest payment date is equal to the face amount of the bonds multiplied by the coupon rate and then adjusted for the frequency of
payment. With $3 million as the face amount for the bonds, an annual coupon rate of 9 percent, and semiannual payments, the cash disbursement on each interest payment date is equal to $3 million × 9% × ½ (to represent 6 months in a year) = $135,000.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

How to calculated the cost of debt percentage?

A

The cost of debt capital associated with a bond issuance is appropriately calculated as an after-tax cost, which accounts for the tax deductibility associated with interest costs. The after-tax cost of debt is equal to the Pretax cost of debt × (1 –Tax rate). With 7 percent as the pretax cost of debt and a 37 percent tax rate, the after-tax cost of debt is equal to 7% × (1 – 37%) = 4.41%.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

How does the tax rate effect the WACC?

Weighted Average Cost of Capital

A

The weighted average cost of capital incorporates the after-tax cost of debt and the cost of equity. If tax rates are expected to decrease, the after-tax cost of debt will increase, which will increase the weighted average cost of capital.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What are the different marketable securities?

A
  • The riskier an investment is, the higher the expected return. Of the four choices given, commercial paper poses the greatest risks to an investor, and therefore offers the highest expected return.
  • Negotiable CDs are less risky than commercial paper and will offer a lower expected return.
  • U.S. Treasury bills are the safest investment choice of the four and will offer the lowest expected return.
  • Banker’s acceptances are riskier than U.S Treasury bills and negotiable CDs, but they will offer a lower return (due to lower risk) than commercial paper
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What are the different types of bonds?

A
  1. Floating-rate.
  2. Zero-coupon.
  3. Callable.
  4. Convertible.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What are Floating Bonds?

1 of 4 Bond types Produce constant market rates.

A
  • Floating-rate bonds would automatically adjust the return on a financial instrument to produce a constant market value for that instrument.
  • No premium or discount would be required since market changes would be accounted for through the interest rate.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What are Zero-Coupon Bonds?

2 of 4 bond types

A

Fixed stated rate of a premium or discount to the underlying security to produce a market rate of interest if that market yield is different from the stated rate.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What are Callable Bonds?

3 of 4 bond types

A
  • Fluctuate in value.
  • Advantages to the issuer is having the ability to call or refinance the bonds if interest rates become favorable.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What are Convertible Bonds?

4 of 4 Bond Type

A
  • Fluctuate in value.
  • Advantages to the investor (and potentially the issuer) is having the ability to convert or swap the bonds for equity if market conditions become favorable (equity returns exceed fixed return on debt).
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

How to calculate the market rate of interest for the Treasury Bill?

A

Risk-free rate of interest + Inflation Premium = Market rate of interest for Us Treasury Bill

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

How many ways to calculate the cost of retained earnings

A

1.Weighted Average Cost of Capital (WACC)
2.Capital Asset Pricing Model (CAPM)
3.Discounted Cash Flow (DCF)
4.Bond Yield plus Risk Premium (BYRT)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What is the formula to calculate CAPM?

Capital Asset Pricing Model (Cost of Common Equity)

A

Risk Free Rate + Risk Premium
Risk Free Rate + (Beta x Market Risk Premium)
Risk Free Rate + [Beta (Market Ret. - Risk Free Rate)]

Only appliable to Equity Calculation.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is the formula to calculate WACC?

Use when given debt and equity values or use CAPM to get equity to plug

A

Cost of CS (weighted avg% of 100%) + Cost of PS (weighted avg% of 100%) + [Cost of Debt (1 - Tax Rate)] (weighted avg% of 100%).

Cost of total capital Debt + Equity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is the formula for DCF?

Discounted Cash Flow

A

[CS Dividends x (1+ g)] / current market price + g

17
Q

What is the formula for BYRP

Bond Yield plus Risk Premium

A
  • Mkt Rate + Risk Free rate + Pre-tax debt
18
Q

What is commercial paper?

A
  • It is usually sold to the money markets by highly creditworthy companies.
  • The maturity dates are less than 270 days.
  • Sold to the money markets through brokers, dealers, and investment brokers, and sold from one company to another.
  • The interest rate is below the prime rate but above the Treasury bill rate
  • Avoids the expense of maintaining a compensating balance with a commercial bank.
  • Provides a broad distribution for borrowing.
  • Accrues a benefit to the borrower because its name becomes more widely known.
19
Q

What is Market Capitalization?

A
  • Is equal to the number of common shares outstanding multiplied by the fair market value per share. 1,000 shares x $80 per share =
    $80,000.
    or M-CAP= BV of C.S./shares outstanding
  • Bonds are not factored into this calculation.
20
Q

What is relevant when considering the risk premium on a specific security?

A
  • Relative seniority is important because the more senior the security is, the less risk associated with future cash flows for the investor.
  • Length of maturity is a factor in the risk premium, as the longer the time period is until the security matures, the higher the risk associated with the investor receiving his/her cash flows.
  • Liquidity is a key component of the risk premium as the investor must be compensated for the extent to which a security can be sold without risking loss of principal. Higher (lower) liquidity will cause the risk premium to decrease (increase)
21
Q

Which marketable securities have the greatest returns from highest to least?

More risk higher returns, less risk lower returns

A
  1. Commercial paper.
  2. Banker’s acceptances.
  3. Negotiable CDs.
  4. U.S. Treasury Bills.
22
Q

What are the differences in Operating kease and financing lease?

A

Both have assets, liabilities, amortization, and interest expense to book.

Operating Lease

  • Less than a year term
  • Book the asset and liability on the B/S
  • Book the Lease Expense Account which includes amortiztion and interest expense only (I/S).

Finance Lease

  • More than a year term.
  • Book the asset and liability on the B/S.
  • Book the Interest Expense and Amortization Expense seperately on the I/S.

CPA Exams - BEC B2 (9 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions