Financial Management: Weighted Avg. Cost of Capital & Optimal Capital Structure Flashcards Preview

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Flashcards in Financial Management: Weighted Avg. Cost of Capital & Optimal Capital Structure Deck (23):
1

WACC=

(Cost of Equity X Equity Capital Structure Percentage)+ (Weighted Avg. Cost of debt X Percentage debt in capital structure)

2

YTM

Effective Annual Interest Payment/ Debt Cash Available

3

Long-term elements

Long-term debt, preferred stock, common stock and retained earnings

4

Short-term elements

Interest-bearing debt, other forms of current liabilities A/P & Accruals

5

3 common methods of computing Costs of retained earnings

a) CAPM
b) Discounted Cash Flow
c) Bond yield plus risk premium

6

After tax cost of debt Or Net cost of Debt

YTM X(1-T)

7

Pretax ncost of debt Weighted Average interest Rate

Effective annual interest payments/ Debt Cash available


Par X C Outflow/ Net Inflow

8

After- Tax cost of debt

Pretax cost of debt X (1- Tax rate)

9

Cost of Preferred Cost > Cost Debt

-Dividends are not tax deductible
-PS assume more risk, bc they are paid last

10

Cost of Preferred stock formula

Preferred stock dividends/ Net proceeds of pref. stocks

=Par x%/ Net Inflow

Ex: Dividend paid ($20 par value × 9% dividend) $ 1.80

Net proceeds ($40 selling price − $5 floatation) ÷ 35.00

Cost of preferred shares 5.1%

11

CAPM

Beta> 1 riskier
Beta

12

CAPM Formula

Risk-free rate+ Risk Premium
Risk- free rate + (Beta X Market Risk Premium)
Risk free rate + (BetaX(Market Return - Risk free return)

13

Discounted Cash Flow Formula
-Cost of Retained Earnings

D/P +G
P= Current Market Price
D= Dividend per share expected at the end of the year
G= The constant rate of growth in dividends

14

Bond yield plus risk premium
"Pre-tax"

Pretax cost of long-term debt ( you can use YTM)+ Market risk premium
Market risk premium = reward for buying riskier CE

15

The over all cost of capital is the WACC

Rate of return on assets that covers the costs associated with the funds employed

16

The benefits of debt financing over equity financing are likely to be highest

High marginal tax rates and few noninterest tax benefits.

17

Weighted-average cost of capital

rate is most commonly compared to the internal rate of return to evaluate whether to make an investment

18

If a firm has an increase in the corportae income tax rate. What will that cause them to do?

It will cause the firm to increase the debt in its financial structure

19

The cost of debt most frequently is measured as:

Actual interest rate minus tax savings

20

What is a company's objective when it comes to WACC?

To minimize the WACC

21

Which one of a firm's sources of new capital usually has the lowest after tax cost

Bonds

22

The three elements needed to estimate the cost of equity capital are:

Current dividends per share (D)

Expected growth rate in dividends (G) and

Current market price per share of common stock (P)

23

Are Dividends tax deductible?

No, Dividends are NOT tax deductible