Cost Of Capital Foundations

Question 1

WACC

Answer 1

(Wd)[kd(1-t)]+ (wps)(kps) + (wce)(kce)

Wd = % of debt in capital structure

Wps = % preferred stock

Wce = % common stock

kd = before tax component cost of debt
Or YTM of debt
Or rate that a firm can issue a new debt

Kd(1-t) = AFTER tax cost of debt
t = marginal tax rate

Kps = cost of Preferred stock

Kce = cost of Common Eq. (Required rate of return) difficult to estimate

Question 2

Beta asset (unlevered beta)

Answer 2

B asset = b equity
——————-
1+ (1-t) Debt / equity (firm)

Question 3

Beta target (levered beta)

Answer 3

Beta Asset x {1+[ (1-t) (D/E)]} (project or firm)

Question 4

Variable that represents Additional Country Risk Equity premium for cost of equity:

Answer 4

Ke = RF + beta (eq. Risk primium + Country Risk premium)

Question 5

Cost of preferred stock

Answer 5

Kps = Dps
———
Current Price

Question 6

Least likely method to estimate Before-tax cost of debt capital

Answer 6

Anything related with Interest cupom rate

It has to be related with YTM

Question 7

Step by step of WACC with bonds and issued stocks

Answer 7

Separate in 2 parts: debt and equity

Structure of capital

Market value of equity: (Shares outstanding + new shares issued) * price

Market value of Debt: PV of bonds

Total mkt capit: Mkt value Debt + mkt value Eq

DEBT
1. Find the YTM. Be careful with semi annual payments (PMT/2)

2. Deduct the tax rate (1-t)

EQUITY

1. Attention to wich beta you should use (levered or Unlevered)
2. Use CAPM to estimate cost of equity
3. If you have Preferred stocks, use the D/P to know the cost of those stocks

FINAL

Put everything together 🙌

Question 8

Floating costs (IBD costs) 2 methods
And NPV effects

Answer 8

1. (MOST CORRECT)

Total flotation cost: $ total issuing x Fee

NPV = -initial outlay - total flotation cost

2. (INCORRECT)

Dividend
—————
Price x (1- fee)

NPV = -initial outlay + CFn
———
(1+r) ^ n

Question 9

Bond yield PLUS risk premium formula

Answer 9

BEFORE tax cost of Debt - premium Eq
(YTM)

Obs. Debt rating approach is most appropriate when market prices debt are UNRELIABLE

Question 10

Wd =

Answer 10

Weight of debt
1 - we

Question 11

Capital structure Debt and equity

Answer 11

Market value of DEBT
(Pv of bonds, etc…)

+

Market value of Equity
(Shares Outstanding x price)