Cfa Level I: Cost Of Capital

Front 1

WACC

Back 1

Firm's discount rate / marginal cost of capital

Front 2

Cost of Debt

Back 2

Tax deductible, so pre-tax cost of debt must be reduced by the firm's MARGINAL TAX RATE to get an after-tax cost of debt

Front 3

Should WACC be based on current or target capital weights?

Back 3

Target

Front 4

Does WACC increase or decrease at each level of capital investment?

Back 4

WACC increases as firm needs to raise larger amounts of capital

Front 5

Marginal Cost of Capital Curve

Back 5

Upward sloping

Front 6

X and Y Axes for MCC and Investment Opp Schedule Graphs

Back 6

Y-axis: project IRR cost of capital

X-axis: new capital raised/invested

Front 7

Intersection of Firm's Investment Opportunity Schedule with Marginal Cost Curve

Back 7

Optimal amount of capex/amount of investment required to undertake all positive NPV projects

Front 8

How should cost of capital be adjusted for riskier projects?

Back 8

Should be adjusted upward

Front 9

YTM Approach for Estimating Cost of Debt

Back 9

Assumes before-tax cost of debt is the YTM on the firm's existing publicly traded debt

Front 10

Debt Rating Approach for Estimating Cost of Debt

Back 10

Estimates before-tax cost of debt capital based on market yields for debt with the same rating and average maturity as the firm's existing debt

Front 11

Cost/yield of noncallable, nonconvertible preferred stock

Back 11

Annual dividend/market price of preferred shares

Front 12

CAPM Approach to Estimating Cost of Equity

Back 12

RF + Beta * (Exp. Market Return - RF)

Front 13

Dividend Discount Model Approach to Estimating Cost of Equity

Back 13

(D1 / P0) + g

Might need to increase dividend by growth rate to get D1 instead of D0

Front 14

Bond Yield + Risk Premium Approach to Estimating Cost of Equity

Back 14

Add risk premium of 3-5% to market yield on firm's long-term debt

Front 15

Pure-Play Method of Determining Beta

Back 15

Unlevering a comparable firm's beta and then re-levering subject firm's data

Front 16

Unlevering Beta Formula

(BETA OF ASSET FORMULA)

Back 16

Beta of asset = Beta of equity * (1/ (1+(1-t)*D/E))

Front 17

Re-Levering Beta Formula

(BETA OF PROJECT FORMULA)

Back 17

Beta of project = Beta of asset * (1+(1-t)*(D/E))

Front 18

Country Risk Premium

Back 18

Should be added to market risk premium in CAPM to reflect added risk associated with investing in a developing market

Front 19

Break Point Formula

Back 19

$ amount where cost of debt/equity changes / weight of component in capital structure

Front 20

Correct Method of Accounting for Flotation Costs

Back 20

1) Amount of equity capital raised (weight of equity * total capital raised)

2) Flotation costs * amt. of equity capital raised

3) Cash outlay + flotation cost outlay

4) Compute NPV with this additional cash outlay