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20 Cards in this Set
- Front
- Back
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Financial Structure
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Right-hand side of the balance sheet, includes both LT and ST sources of financing
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Capital Structure
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how the firm finances its assets, such as bank loans, LT debt, common stock and retained earnings. Excludes accruals and A/P
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How to convert from book value to market value
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multiply by market-to-book (M/B) ratio
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Present value of perpetuity
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PV perpetuity (S) = X/Ke
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Return on invested capital
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=EBIT(1-T)
return available to bondholders and SH after tax |
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Market value of firm
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=D + Preferred Equity + Common Equity
V= D+P+S |
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WACC
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= Ke(S/V) + Kp(P/V) + Kd(1-T)(D/V)
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Procedure for estimating the Weighted Average Cost of Capital
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1. Estimate mkt values for firm's sources of capital
2. Estimate current required rates of return for different sources 3. Weight costs of all sources of capital on same corporate tax basis |
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Estimating market value of equity
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Common shares
S = Po x n Preferred shares Po = Dp/kp |
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Marginal Cost of Capital (MCC)
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= Weighted Average cost of next dollar of financing.
At low levels of financing, MCC=WACC As level goes up, might need to use higher cost sources of capital |
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Cost of Debt
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= (Kd( 1-T))/(1-fd)
fd= Floatation cost of debt |
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When calculating after-tax/floatation cost of debt, remember:
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-take floatation cost directly out of net proceeds (i.e. instead of receiving $1,000, receive $980)
-Solve for i/y ***If calculated for semi-annual period, to convert to equivalent annual rate: (1+i/y)^2 |
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When calculating cost of preferred shares. remember
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-use net proceeds (after floatation costs)
i.e. Kp = Dp/Po-Floatation costs |
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Operating Leverage
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increased volatility in operating income caused by fixed operating costs. if firm chooses to become more capital intensive and less labour intensiev
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Financial Leverage
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increased volatility in operating income cause by fixed financial costs and can be increased by taking on financial obligations with fixed annual claims on cash flow (eg bonds/preferred stock)
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Two methods to find cost of common equity
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1. Dividend Discount Model
Cost of internal equity = Ke=D1/Po+g Cost of new equity = Ke=D1/NP+g = (X1(1-b))/Po + (b*ROE) b=retention ratio ***Can only be used in cases where growth rate can be sustained in very LT 2. CAPM |
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Problems with DDM growth model
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-dependent on investors' expectations about future growth rate: difficult to observe
-assumes dividends will grow at constant rate indefinitely -only works for dividend-paying firms |
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Uses of WACC
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-can serve as hurdle rate for comparing IRR of various investments
-can serve as discount rate for NPV analysis |
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Earnings Yield
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=EPS/Market price of shares
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Break Point
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Amount of financing at which the cost of a particular component of equity rises (with a given capital structure). E.g. the cost of new equity once internal equity is used up
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