FIN 475 Lecture Notes - Lecture 1: Risk Premium, Dividend Discount Model, Capital Asset Pricing Model

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limecricket928

24 Aug 2016

School

PSU

Department

Finance

Course

FIN 475

Professor

Oranee Tawatnuntachai

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Document Summary

Firm valuation cost of capital is used as the discount rate to calculate pv of cash flows. Costs to firm / cost of capital: bonds cost of debt. Return on ps: preferred equity cost of preferred stock. Return on cs: common equity cost of equity. Seo (seasoned equity offering) weighted average based on capital structure. Wacc = cost of debt (1-tax rate) + cost of ps + cost of equity. Rule of thumb: re < rps < rd (1-t) bonds are least risky, ps less risky than cs. Estimate cost of debt short-term debt is typically not included; short-term debt is not used to finance long-term projects. Premium bonds = coupon rate > yield, if the bond"s coupon is paying you more then you are willing to pay a higher price. Capm = rf + (rm rf) beta risk premium. Add premium to bond returns (before tax, investor"s perspective)

Related Questions

The Cost of Capital: Weighted Average Cost of Capital

The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings is used in the firm's WACC calculation. However, if the firm will have to issue new common stock, the cost of new common stock should be used in the firm's WACC calculation.

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 40%. Assume that the firm's cost of debt, rd, is 7.5%, the firm's cost of preferred stock, rp, is 7% and the firm's cost of equity is 11.5% for old equity, rs, and 11.87% for new equity, re. What is the firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermadiate calculations.
%

What is the firmâs weighted average cost of capital (WACC2) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermadiate calculations.
%

raspberryyak84

Given the following information for Lightning Power Co., find the WACC. Assume the companyâs tax rate is 35 percent.

Debt: 8,000 6.5 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 106 percent of par;the bonds make semiannual payments.

Common stock: 310,000 shares outstanding, selling for $57 per share; the beta is 1.05.

Preferred stock: 15,000 shares of 4 percent preferred stock outstanding, currently selling for $72 per share.

Market: 7 percent market risk premium and 4.5 percent risk-free rate.

1. If a firm plans to issue debt to finance their next project then, they should discount the project's cash flows by:

The weighted cost of debt

The after tax cost of debt

The YTM

The historical cost of debt

None of the above

2. The WACC is:

The historical cost of raising funds in the market.

The arithmetic average cost of raising capital.

The marginal cost of raising funds in the market today.

The discount rate only if we raise funds from all sources of capital.

None of the above.

3. What is the weighted cost of capital?

4. Equity is what portion of the capital structure of the firm?

5. The weighted cost of debt is?

Junior Interiors market value capital structure of 62% Common Equity, 3% Preferred Stock (PS) and 35% Debt. The company does not pay dividends, and evaluates its operations as approximately 30% more risky than an âaverageâ company in the industry. The overall rate of return on average industry investments is 8.4% and risk-free investments currently return 1.7%.

Company Bonds sell for 97% of $2,000,000 Face value; carry a 6% annual interest rate with interest only payments made monthly. Currently outstanding debt obligations are due in 4 years. The firmâs PS has a current annual yield of 7.1%. It applicable tax rate is 32%.

What is Juniors Weighted Average Cost of Capital (WACC)?

If the regular PS dividend is $1.35 per quarter, for what does the stock currently sell?

A firm has a target Debt to Equity ratio of .85. It WACC is 10.2% and the applicable tax rate is 35%. If the company Cost of Equity is 13.4%, what is its PRE-TAX Cost of Debt?

Stock B has a Beta of 1.1 and an expected return of 12.3%. If the risk-free rate is 3.7% and MRP is 7%, is Stock B priced correctly?

FIN 475 Lecture Notes - Lecture 1: Risk Premium, Dividend Discount Model, Capital Asset Pricing Model

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