Exam 1 Flashcards
(36 cards)
• Cost of Equity and Cost of Debt should
o Reflect current financial market conditions
o Should equal investors “anticipated” IRR on future cash flows associated with each form of capital.
• Risk free rate predominate practice
o 10 year treasuries
• Historical beta of a stock
o comes from a regression of the market’s historical excess returns against the security’s historical excess returns.
• Fundamental beta of a stock
o comes from a statistical model that measures risk using price as well as other market-related and financial data (company size, volatility, momentum, industry exposure, etc.
• Risk free rate (fwd or bkwd)
Forward looking
• Market-risk premium (fwd or bkwd)
Historical data
• WACC is the
o discount rate used for valuing projects
• Tax Rate for WACC
o Marginal tax rate
• What are the potential consequences of taking a composite (firm-wide) cost of capital and accepting projects that exceed this rate?
o High risk division projects are more likely to be accepted while lower risk divisions are starved for capital.
• WACC vs. Hurdle Rate
o WACC – Firm’s Actual Cost of Capital
o Hurdle rate – Target return somewhat higher than WACC
• Hurdle rate delta
o To create value by taking on projects that earn more than the cost of capital
• Why are hurdle rates so high?
o Perceive that low interest rates are “temporary”
o A perception that cash flows are inflated
• Economic Value Added = Economic Profit
o EVA is the incremental difference in the rate of return over a company’s cost of capital. Essentially, it is used to measure the value a company generates from funds invested into it. If a company’s EVA is negative, it means the company is not generating value from the funds invested into the business. Conversely, a positive EVA shows a company is producing value from the funds invested in it.
o Better than an accounting profit because it captures the investment required.
• Market Value Added
o MVA is an indication of its capacity to increase shareholder value over time. A high MVA is evidence of effective management and strong operational capabilities. A low MVA can mean the value of management’s actions and investments is less than the value of the capital contributed by shareholders
• As sales increase, so do
o Assets (proportionally), o Liabilities & equity (depending on financing)
• Ending Retained Earnings =
Beginning Retained Earnings + Net Income – Payouts
• Debt Ratios
o Debt to Revenue
o Debt to Equity Market Value
o Debt to EBIT
o Interest Coverage
• Interest Coverage
o EBIT / Interest Expense (want this ratio high!!)
• EFN = External Financing Needed
o This is in the form of debt
o Subtract dividends from net income
• Two growth rates useful for long term planning
o Internal growth rate – max with no EFN
o Sustainable growth rate – max rate without increasing financial leverage
• Free cash flow
o Cash flow that is free to distribute to creditors and stockholders because it is not needed for working capital or fixed asset investment
• Venture Capitalists
o Play an active role in overseeing, advising, and monitoring companies in which they invest
o Generally do not want to own the investment forever
• Stages of Financing
o 1. Seed-Money Stage o 2. Start-Up o 3. First-Round Financing o 4. Second-Round Financing o 5. Third-Round Financing o 6. Fourth-Round Financing
• IPO Basic Procedure
o Board approval
o File with SEC
o Wait
o Firm prepares and files an amended registration statement with the SEC
o Assuming all is cool, a price is set and a full-fledged selling effort gets underway.
