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12 Cards in this Set
- Front
- Back
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cost of preferred stock |
-not tax deductible -company bears their full cost -if don't pay preferred stock, can't pay common stock component cost of preferred stock = r_ps = Dps/Pn Dps - divident Pn = net issuing price flotation costs are higher for preferred stock than debt, so they are incorporated in the cost |
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cost of common stock |
- investors require r, but a company must earn more than r_s on new external equity to provide this rate of return (commissions and fees) few mature firms issue new stock -flotation cost are high -investors recieve issuing equity as negative signal about the true value of the company's stock -capital raised indirectly by retained earnings has an opportunity cost - should earn its reinvested earnings at least as much as its stockholders themselves could earn on alternative investments of equal risk = r_s |
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cost of equity estimates (3) |
CAPM discounted cash flow bond-yield-plus-risk premium capm is generally the preferred choice |
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CAPM |
1. estimate risk free rate, r_FR 2. estimate the current expected market risk premium, which is the expected market return - risk free rate 3. estimate the stock's beta and use it as index of stock risk 4. r_s = r_rf + (RPm)bi |
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estimating risk-free rate |
rate of long-term treasury bonds |
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estimating the market risk premium |
expected market return minus the risk free rate expected rate of return: r_hat_m = D1/Po +g = D0(1+g)/Po g = expected growth |
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dividend yield plus growth rate (DCF) |
price stock = D1 / (rs-g) D1 = expected divident rs = D1/Po + g g = retention ratio = 1 - payout ratio payout ratio = total dividends paid/net income |
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WACC |
wd*rd(1-t) +wps*rps + wcs*rs wd = weight of debt wps = weight of preferred stock wcs = weight of common stock wacc is the current weighted average cost the company would face for a new dollar of capital |
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factors that affect WACC |
beyond control: 1. the level of interest rate - higher interest rates increase the costs of common and preferred equity 2. market risk premium 3. tax rates can control: 1. capital structure policy: 2. dividend policy 3. investment policy |
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what does cost of capital reflect |
average risk and overall capital structure of the entire firm |
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divisional cost of capital |
many firms use capm to estimate rs = rrf + RPm*bi = cost of equity |
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measuring divisional betas |
pure play method: find single-product companies in the same line of business as the division being evaluated, then averages those companies betas to determine the cost of capital of own division accounting beta method: betas are found by regressing the returns of a particular company's stock against return on a stock market index. insead, run a regression of the divisions accounting return on assets against the average return on assets for a large sample of companies |
