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1

WACC equation

Wd*rd(1-T)+Wp*Rp+Wc*Rs

2

Government gives tax break on interest paid to debt so

Cost of issuing bond(interst to bond holders) is tax desuctable

3

Should analysis be focused on historical cost or marginal costs

Marginal cost

4

Rp is

The marginal cost of preferred stock which is the return investors require on a firms preferred stock

5

Cost of preferred stock formula

Dp/Pp

6

Is preferred stock more or less risky

More because they are not required to pay dividends

7

Why is the yeild on preferred lower than debt

Corps own most preferred and 70% are excluded from tax so BT yield will be lower

8

Rs is

The marginal cost of common equity using retained earnings

9

Three ways to determine the cost of common equity

CAPM, DCF, and bond yield plus risk premium

10

CAPM formula

Rs=Rrf+ (Rm-Rrf)b

11

DCF equation

Rs= (D1/P0) +g

12

Bond yield plus risk premium equation

Rs=Rd+RP

13

Direct cost related to retained earnings and stock

When a company issues new CS they also have to pay a flotation cost to the underwriters

14

Indirect cost related to RE and CS

Issing new stick may send a neg message signal to the markets wish may depress the stock price

15

Price of equity with flotation cost equation

Re=D0(1+g)/P0(1-F) +g

16

Flotation cost depend

On the firms risk and the type of capital being raised and amount being raise

17

Floation cost are highest for

Common equity but per project cost are small

18

What factors influence a companys composite WACC

Market conditions, captial structure and dividend policy, investment policy, interest rate and stock price

19

Riskier projects will have a higher

WACC

20

What is capital budgeting

Analysis of potential additons to fixed assets. Long term decisions with large expenditures

21

Steps to capital budgeting

Estimate CF, assess riskiness of CF, determine appropriate cost of capital, find NPV or IRR, accept or decline

22

Accept project if

NPV>0 and or IRR>WACC

23

Independent projects

If the cash flows of one are unaffected by the acceptance of the other

24

Mutually exclusice projects

If the cash flows of one can be adversly impacted by the acceptance of the other

25

Normal cash flow streams

Cost followed by a series of positive cash inflows

26

Nonnormal cash flows

Two or more changes of signs

27

Net present value

Sum of the PV of all cash inflows and outflows of a project

28

IRR is

The discount rate that forces PV of inflows equal to cost and the NPV equal 0

29

IRR formula

Sum of (CF/(1+IRR)^t

30

If IRR>WACC

The projects return exceeds its costs and there is some return left over to boost stockholders returns