ADMS 3530 Lecture Notes - Lecture 11: Dividend Discount Model, Preferred Stock, Capital Asset Pricing Model

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mag0sea

13 Feb 2017

School

York University

Department

Administrative Studies

Course

ADMS 3530

Professor

King Lois

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Document Summary

Capm: rj = rf + j(rm rf) If firm is all equity financed use rj as the cost of capital for the firm. Reason: if the firm is all-equity financed, then: Sha(cid:396)eholde(cid:396)s o(cid:449)(cid:374) (cid:1005)(cid:1004)(cid:1004)% of the fi(cid:396)(cid:373)(cid:859)s assets, a(cid:374)d. The return required by the shareholders will equal the rate of return earned on the fi(cid:396)(cid:373)(cid:859)s e(cid:454)isti(cid:374)g ope(cid:396)atio(cid:374)s. We can using rj to discount new projects if. The risk of the new project is the same risk level as the firm"s existing business. A fi(cid:396)(cid:373)(cid:859)s cost of capital is the weighted average of returns demanded by debt, preferred and equity investors. Where v is the market value of the entire firm. D, p, & e are the market value of the debt, preferred and equity components. Note: rdebt is multiplied by (1-tc) to reflect the fact that interest expense, unlike dividends, (cid:272)a(cid:374) (cid:271)e dedu(cid:272)ted f(cid:396)o(cid:373) a fi(cid:396)(cid:373)(cid:859)s i(cid:374)(cid:272)o(cid:373)e to (cid:396)edu(cid:272)e ta(cid:454)es pa(cid:455)a(cid:271)le.

Related Questions

The calculation of WACC involves calculating the weighted average of the required rates of return on debt and equity, where the weights equal the percentage of each type of financing in the firm's overall capital structure.

Re is the symbol that represents the cost of raising capital by issuing new stock in the weighted average cost of capital (WACC) equation.

Reymond Co. has $1.1 million of debt, $1 million of preferred stock, and $2.1 million of common equity. What would be its weight on common equity?

a) 0.19

b) 0.24

c) 0.50

d) 0.22

beigemacaw797

Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide a return of 5 percent and can be financed at 2 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a return of 12 percent but would cost 14 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firmâs capital structure.

a.	Compute the weighted average cost of capital. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Weighted average cost of capital

Which project(s) should be accepted?

	New machine
	Piece of equipment

1.Following are three independent projects Peanut/ Pecan Processing (PPP) is evaluating:

Project	IRR	RISK
P	10%	Low
Q	12%	Average
R	14.5%	High

PPP generally considers risk when examining projects by adjusting its average required rate of return, r, which equals 11 percent. A 4 percent adjustment is made for high-risk projects, and a 2 percent adjustment is made for low-risk projects. Which project(s) should PPP purchase?

2.The CFO of Lazy Loungers is evaluating the following independent, indivisible projects:

Project	Cost	IRR
A	$10,000	21.0%
B	15,000	20
C	25,000	16

Lazy's weighted average cost of capital (WACC) is 14 percent if the firm does not have to issue new common equity; if new common equity is needed, its WACC is 17 percent. Lazy's capital structure consists of 40 percent debt. If Lazy has no preferred stock and expects to generate $24,000 in retained earnings this year, which project(s) should be purchased?

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ADMS 3530 Lecture Notes - Lecture 11: Dividend Discount Model, Preferred Stock, Capital Asset Pricing Model

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