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Canada (161,877)
Finance (37)
MGFC10H3 (13)
Derek Chau (13)
Chapter 13

Chapter 13 Notes

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Derek Chau

Chapter 13 Risk Return and Capital Budgeting Notescost of equity rrequired return on the companys common stock in capital markets it is also called equity holders required Srate of return because it is what equity holders can expect to obtain in a capital market it is a cost from a firms perspective131 The Cost of Equity Capitalwhenever a firm has extra cash it can take one of two actionsit can pay out the cash immediately as a dividend or the firm can invest extra cash in a project paying out the future cash flows of the project as dividendsthe project should be undertaken only if its expected return is greater than of a financial asset of comparable risk132 Estimation of Beta2beta of a security iCov R RVar RiMMiMMin words the beta is the covariance of a security with the market divided by the variance of the market133 Determinants of Betaif the firm is not traded on an exchange because it is a subsidiary of a larger firm or too small to be listed examining these characteristics may be the best way to estimate beta the cyclical nature of revenues operating leverage and financial leverageCyclicality of Revenuesrevenues of some firms are quite cyclical that is these firms do well in expansion phase and do poorly in contraction phasehightech firms retailers and mining firms fluctuate with cycle firms in industries such as utilities and food are less dependentsince beta is standardized covariability of stocks return with markets return highly cyclical stocks have high betasstocks with high standard deviations need not have high betasOperating Leverageoperating leveragedegree to which firms costs of operation are fixed as opposed to variable firm with high operating costs when compared to firm with low operating leverage has fairly larger changes in EBIT with respect to change in sales revenuebusiness risk depends both on responsiveness of the firms revenues to the business cycle and on the firms operating leveragethose projects whose revenues appear strongly cyclical and whose operating leverage appears high are likely to have high betasconversely weak cyclicality and low operating leverage imply low betasFinancial Leverage and Betaoperating leverage refers to the firms fixed costs of productionfinancial leverage is the extent to which a firm relies on debtbecause levered firm must make interest payments regardless of sales financial leverage refers to firms fixed
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