Cost of Capital and Project Valuation

Size: px
Start display at page:

Download "Cost of Capital and Project Valuation"

Transcription

1 Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different legal and tax implications. In this handout, we focus only on the corporation. Corporate ownership Corporations have many owners; each owner owns only a fraction of the corporation. The ownership stake is divided into shares known as stock. The collection of all outstanding shares of stock is referred to as the equity of the corporation. An owner of a share of stock is called a shareholder, stockholder or equityholder. Shareholders are entitled to dividend payments. Dividend payments are made at the discretion of the corporation to its equityholders. The dividend share to each stockholder is typically in proportion to their ownership stake. Ownership is distinct from control. 1

2 Stock market A public company is one whose shares trade on a stock market or stock exchange. In the US, three national stock exchanges are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) and the National Association of Security Dealers Automated Quotation (NASDAQ). Stock markets provide two useful features: They determine a market price for a company s shares. They provide liquidity. A stockholder can quickly sell a portion of his/her ownership stake and for a price very close to the price at which someone else can buy it. (The difference is called the bid-ask spread.) Corporate financing Corporations raise funds in two ways: Raise new equity by issuing new shares of stock and selling them to investors. The shares are sold on the primary market. Shares continue to trade in a secondary market between investors without involvement of the firm. Borrow funds from banks or by issuing debt (corporate bonds) via the financial markets. A firm s capital structure refers to its relative proportions of equity and debt. A firm with no debt is said to be unlevered. Its equity is referred to as unlevered. A firm with debt is said to be levered. Its equity is referred to as levered. 2

3 2 Valuation Definitions Firm value Defined to be the sum of its market value of equity and its market value of debt: V L := D + E. (1) Debt is net of any cash and short-term investments and is referred to as net debt. V L represents the amount needed to acquire a firm to buy out the firm s shareholders and to pay off the firm s bondholders. An unlevered firm s value is denoted by the symbol V U. Here, V U = E as D = 0. Can be estimated as V L = Present Value (expected Free Cash Flows r W ACC (2) r W ACC = the firm s weighted average cost of capital (3) Free Cash Flow is the cash generated from a firm s business operations. It is the cash flow generated if the firm were unlevered. Equity value Can be estimated as E = Present Value (expected Free Cash Flows to Equity r E (4) r E = the firm s equity cost of capital (5) The equity cost of capital r E represents the risk-adjusted required rate of return demanded by shareholders. For an unlevered firm, r E is denoted by r U, the firm s unlevered or asset cost of capital. For public companies, it equals the company s Market Capitalization (Market Cap). Market Cap is the product of the firm s share price and the number of the firm s outstanding shares of stock. 3

4 Debt value Can be estimated as (excluding the cash and short-term investments) D = Present Value (expected Cash Flows to r D (6) r D = the firm s debt cost of capital (7) The debt cost of capital r D represents the risk-adjusted required rate of return demanded by bondholders. Corporate debt Not risk free defaults can happen. If so, a portion of the debt is repaid. Agencies like Moody s and S&P rate corporate debt. Ratings indicate their assessment of the likelihood of default. Due to the possibility of default a bond s yield to maturity (IRR) does not equal its expected rate of return. Many types of corporate debt. Difficult to determine market value. Standard practice is to use the book value of debt. 4

5 3 Analysis of an Unlevered Firm Market and firm data: Market data: Risk-free rate r f = 2% Market premium R M r F = 5% ABC, Inc. data: Expected EBIT (Earnings Before Interest and Taxes) = 2,000 in perpetuity Capital Expenditures (CapExp) = Depreciation (Dep) each year Net Working Capital (NWC) = 0 Corporate tax rate = 40% Equity beta = 1.2 Number of outstanding shares = 1,000 5

6 Analysis: 1. What is the cash flow to shareholders or Free Cash Flow to Equity (FCFE)? Profit before tax = 2,000 Tax = 0.40(2,000) = 800 Net income = 2, = 1,200 FCFE = Net income + Dep - CapExp + Increase in NWC = 1,200 ABC Inc. generates a cash flow to shareholders of 1,200 in perpetuity. Since there is no debt the FCFE equals the FCF. 2. What is the ABC Inc. s unlevered cost of capital? We use the Security Market Line (SML): 3. What is ABC, Inc. s market value? r U = r f + β( R M r f ) = (5) = 8%. (8) V U = E = Present Value (FCFE cash r U = 4. What is ABC, Inc. s share price? 1, = 15, 000. (9) Total firm value is 15,000. There are 1,000 shares, so each share is worth 15,000/1,000 = $15. 6

7 4 A Leverage Recapitalization ABC, Inc. is an unlevered firm. Suppose it decides to change its capital structure by taking on some debt. It announces it will undertake a leverage recapitalization. It will: Issue 7,500 of debt. The interest rate is 6%. The debt will be perpetual: Interest is repaid each year. No repayment of principal. Use proceeds to buy back shares of stock. 7

8 Cash flow analysis: 1. What is the new cash flow to shareholders or FCFE? Interest expense = 0.06(7,500) = 450 Profit before tax = 2, = 1,550 Tax = 0.40(1,550) = 620 Net income = 1, = 930 FCFE = Net income + Dep - CapExp + Increase in NWC = 930 ABC Inc. generates a cash flow to shareholders of 930 in perpetuity. 2. What is the cash flow to bondholders? Interest expense = What is the total cash flow or new Free Cash Flow (FCF) generated? FCF = = 1, How does this new FCF compare to the FCF when there was no debt? The old FCF = FCFE = 1,200 since there was no debt. The cash flow has increased by 1,380-1,200 = Why did the FCF increase? Look at the taxes. Before debt, the firm paid 800; after the debt issue, the firm will pay only 620. Difference is 180. This is the interest tax shield. Notice that 180 = T C r D D = (0.40)(0.06)(7, 500). (10) 8

9 Market value analysis: 6. What is the market value of the interest tax shield? What is the value to the firm for generating an extra 180 in perpetuity? It depends on the choice of discount rate. One acceptable choice is the firm s unlevered cost of equity capital, 8%. With this choice the answer is 180/0.08 = 2,250. Notice that 7. What is the new value for ABC, Inc.? 2, 250 = T Cr D D r U. (11) When the announcement is made the market prices in the value of the interest tax shield. So, the new value is 15, ,250 = 17,250. Notice that 17, 250 = V L = V U + T Cr D D r U = 15, , 250. (12) 8. What is the market value of debt? Debt issue = 7,500. This is the market value of debt, D. 9. What is the new value of equity? V L = 17, 250 = D + E = 7, E = E = 9, What is the new share price? There are still 1,000 shares after the announcement but before the buyback. The new share price = 17,250/1,000 = $ How many shares will be repurchased and how many shares will be left? The total amount of the purchase is 7,500. At $17.25/share, 7, 500/17.25 = 435 shares will be repurchased. This leaves 1, = 565 shares. Note that at $17.25/share, E = 565(17.25) = 9, 750, which is the same answer as before. 9

10 Cost of capital analysis: 12. What is the new weighted average cost of capital? Firm value equals the present value of the FCF cash flow stream discounted at r W ACC. So, V L 1, 200 1, 200 = 17, 250 = = r W ACC = = 6.96%. (13) r W ACC 17, What is new levered cost of capital? Equity value equals the present value of the FCFE cash flow stream discounted at r E. So, It can be shown that in this setting E = 9, 750 = 930 = r E = 930 = 9.54%. (14) r E 9, 750 r E = r U + (r U r D ) D E (15) = 7, (8 6) = 9.54%. 9, 750 (16) 10

11 5 Cost of Levered Equity Capital ABC, Inc. s cost of unlevered equity is 8%. After leverage, however, the cost of levered equity increased to 8.86%. Since the equity cash flows are now riskier, equityholders should demand a higher expected rate of return to compensate for this risk. To drive home this point, we consider the following simple stylized example in which there is only one period and there are no corporate taxes. Before leverage: Market value of the firm is 1,000. At the end of the period the firm s free cash flow will either be 1,400 if the market is good, or 900 if the market is bad. Each market state is equally likely. The return on unlevered equity is 40% if the market is good, or -10% if the market is bad. The expected return on unlevered equity is 0.5(40) + 0.5( 10) = 15%. 11

12 After leverage: Firm issues debt of 5%. With no taxes there is no interest tax shield. Firm value remains at 1,000. E = 500 since V L = 1, 000 = D + E = E. At the end of the period, the shareholders have to pay back the principal plus interest = (1.05)500 = 525. At the end of the period, the cash flow to the shareholders or Free Cash Flow to Equity (FCFE) will either be 1, = 875 if the market is good, or = 375 if the market is bad. The return on levered equity is 875/500-1 = 75% if the market is good, or 375/500-1 = -25% if the market is bad. The expected return on the levered equity is 0.5(75) + 0.5( 25) = 25%. Due to leverage, the return distribution is more skewed (risky). Investors demand a higher risk-adjusted rate of return to compensate. The levered cost of equity capital is now 25%. Conclusion: Taking on debt does, in fact, increase the expected return on equity. But this is as it should be: the equity is now riskier. That is, the increase is not for free. 12

13 6 Weighted Average Cost of Capital Formula The market value of a levered firm or project is the present value of a firm s free cash flow discounted at the r W ACC. This is very useful as it allows a project manager to focus on forecasting the project s cash flows, letting the Chief Financial Officer (CFO) worry about how the firm will finance the project. It can be shown that the weighted average cost of capital is given by this formula: Observations: r W ACC := ( ) E r E + D + E ( ) D [(1 T C )r D ]. (17) D + E r E denotes the firm s cost of equity capital given the firm s leverage or capital structure. Do not use the firm s unlevered cost of equity capital, r U, in this formula. If the firm is unlevered, then D = 0, and so r W ACC = r U. Alternate formula: It can be shown that in this setting r W ACC = r U T C r D (D/V L ). (18) To use this formula you must use the unlevered cost of equity capital. Note that r U = r W ACC when T C = 0. 13

14 Example 1 XYZ, Inc. has 5 million shares outstanding at $10 per share. The market value of its debt is $25 million. The cost of equity capital (given the riskiness of the company s cash flow) is 12%. Its cost of debt is 7.5%. The company s tax rate is 40%. Given this data: Market value of the firm s equity is 5($10) = $50 million. After-tax cost of debt is (1 0.4)(7.5) = 4.5%. The company s weighted average cost of capital is r W ACC = ( ) 50 12% ( ) % = 9.5%. (19) The company s cost of unlevered equity capital can be obtained from the formula r E = r U + (r U r D )( D E ) (20) 12 = r U + (r U 7.5)( ) (21) = 1.5r U 3.75 = r U = 10.5%. (22) The company s weighted average cost of capital can also be computed as r W ACC = r U T C r D (D/V L )) (23) = (7.5)(25/75) = 9.5%. (24) Alert! To use this formula for r W ACC you have to use the unlevered cost of equity capital. If the company is levered, you will obtain the levered cost of equity capital. From this quantity, you must unlever it to obtain r U. 14

15 Example 2 Let s return to ABC, Inc. s leverage recapitalization. Recall that V L = 17, 250 D = 7, 500 E = 9, 750 r D = 6% T C = 40% r E = 9.54% The new weighted average cost of capital is r W ACC = ( ) 9, % + 17, 250 ( ) 7, 500 [(1 0.40)6%] = 6.96%. (25) 17, 250 This matches our earlier calculation using the market definition of r W ACC. Alert! When calculating r W ACC under leverage you must use the new levered cost of equity capital. A common mistake is to use the unlevered cost of equity capital in the formula, as in: ( ) ( ) 9, 750 7, 500 r W ACC = 8% + [(1 0.40)6%] = 6.09%. (26) 17, , 250 Of course, 6.09% 6.96%. Given an unlevered cost of equity capital, the weighted average cost of capital can also be computed as r W ACC = r U T C r D (D/V L ) (27) = (6)(7, 500/17, 250) = 6.96%. (28) 15

16 7 Estimating the Weighed Average Cost of Capital We illustrate one approach to estimating r W ACC. The example firm is The Home Depot, Inc. Data was obtained from Yahoo! Finance on October 10, Data: Key Statistics page. Market Cap = E = 54.22B. beta = Balance Sheet Quarterly Data page. Short/Current Long Term Debt + Long Term Debt = 0.044B B = B (July 31, 2011). Cash and Cash Equivalents = 2.551B (July 31, 2011). Short/Current Long Term Debt + Long Term Debt = 0.043B B = B (May 1, 2011). Income Statement Quarterly Data page. Income Before Tax = 2.148B (July 31, 2011). Income Tax Expense = 0.785B (July 31, 2011). Interest Expense = 0.149B (July 31, 2011). Bonds Center page. US Treasury 2-yr bond rate yield = 0.30%. US Treasury 5-yr bond rate yield = 1.16%. US Treasury 10-yr bond rate yield = 2.21%. US Treasury 30-yr bond rate yield = 3.19%. Assumptions: Market risk premium = 5.1%. Reference: Market Risk Premium used in 2010 by Analysts and Companies: a survey with 2,400 answers. P. Fernandez and J. del Campo. Working paper, May Risk-free rate = 2.21%. 16

17 Calculations: E = 54.22B. D = 10.78B 2.55B = 8.23B. This is the net debt. r E = (5.1) = 6.39%. Average debt over the current quarter = (10.775B B)/2 = B. For the current quarter, r D = 0.149B/10.769B = %. Annual debt cost of capital r D = ( ) 4 1 = 5.65%. T C = 0.785B/2.148B = 36.5%. After-tax cost of debt = ( )(5.65) = 3.64%. An estimate of the weighted average cost of capital is ( ) ( 54.22B r W ACC = B B 8.23B 54.22B B ) 3.64 = 6.03%. (29) Remarks: Estimating beta is a non-trivial exercise. Several companies provide estimates (e.g. Bloomberg, Value Line, S&P). Highest quality corporate bond rates are sometimes used in lieu of treasury rates. Estimate of the cost of debt capital here uses the observed interest expense. Expected return on corporate debt is lower due to the possibility of default. An alternative approach is to estimate a firm s debt beta and then use the SML. Estimate of corporate tax here uses the effective tax rate. An alternative approach is to use the marginal tax rate. In principle, estimates should be forward looking. 17

18 8 Estimating Project Cost of Capital Example 3 A firm is considering investing in a construction-related business whose business risk is similar to that of The Home Depot, Inc. The firm s equity is valued at 30M and its debt is valued at 20M. Its debt cost of capital is 6% and its corporate tax rate is 30%. What is a good estimate of a weighted average cost of capital to be used for valuation of projects within this business? Home Depot, Inc. s r W ACC = 6.03%. Calculate The Home Depot, Inc. s r U from its r W ACC : r W ACC = 6.03% (30) = r U T C r D (D/V L ) (31) = r U 0.365(5.65)(8.23/62.45) = r U = 6.30%. (32) Calculate the firm s r W ACC from r U : r W ACC = (6)(20/50)) = 5.58%. (33) 18

19 Example 4 Let s go back to mid-year A firm has decided to start a new division that will specialize in general retail goods such as can be found in large department stores. It wishes to estimate a suitable weighted average cost of capital it can use to valuing projects within this division. Data and Assumptions: Security Market Line will be used to estimate the cost of equity and debt. A market premium of 5.1% and a risk-free rate of 2.21% will be used. Firm s tax rate is 36%. Firm s target debt-to-value ratio D/V L = Firm s debt is rated BBB. Data from seven department stores has been collected see Tables?? and??. Table 1: Data for US Department Stores, mid Reference: Example 12.7, p. 394 in Corporate Finance by Berk and DeMarzo. Company Ticker Equity Beta D/V Debt Rating Dillard s DDS B J.C. Penney Company JCP BB Kohl s KSS BBB Macy s M BB Nordstrom JWN BBB Saks SKS CCC Sears Holding SHLD BB Table 2: Average Debt Betas by Rating and Maturity. Reference: Table 12.3, p. 389 in Corporate Finance by Berk and DeMarzo. By Rating A and above BBB BB B CCC Avg. Beta < By Maturity (BBB and above) 1-5 year 5-10 year year > 15 year Avg. Beta

20 Analysis: Table?? shows the analysis. Corporate tax rates were obtained from the 2010 annual reports. The cost of unlevered equity in the last column can be inferred from the weighted average cost of capital or the equity cost of capital: r W ACC = r U T C r D (D/V L ) or r E = r U + (r E r U )(D/E). (34) Calculating r U from r E does not require knowledge of each company s corporate tax rate. r D = (5.1) = 2.72%. r W ACC = (2.72)(0.40)) = 7.75%. Table 3: Cost of Capital for US Department Stores, mid Company r E r D D/V L T C r W ACC r U Dillard s 14.35% 3.54% % 7.97% J.C. Penney Company 10.37% 3.08% % 9.13% Kohl s 9.20% 2.72% % 8.68% Macy s 13.23% 3.08% % 6.93% Nordstrom 12.10% 2.72% % 8.82% Saks 11.65% 3.79% % 7.72% Sears Holding 9.15% 3.08% % 7.75% Average 8.14% Remark: Define a firm s asset beta as β U = E V L β E + D V L β D. (35) It can be shown that in this setting r U = r f + β U ( R M r f ). (36) To obtain an average unlevered cost of capital, r avg U, proceed, as follows: Calculate the asset beta for each department store, β i U. Take the average of these asset betas to obtain β avg U. Use this average beta in the Security Market Line to obtain r avg U. You will obtain the same answer as above! 20

21 Example 5 Let s revisit the previous example with current data see Table??. Analysis is shown in Table??. Table 4: Data for US Department Stores, Oct Company Ticker Equity Beta D/V L Debt Rating Dillard s DDS BB- J.C. Penney Company JCP BB+ Kohl s KSS BBB+ Macy s M BBB- Nordstrom JWN A- Saks SKS BB Sears Holding SHLD B+ Table 5: Cost of Capital for US Department Stores, Oct Company r E r D D/V L T C r W ACC r U Dillard s 16.08% 3.08% % 13.09% J.C. Penney Company 12.10% 3.08% % 10.39% Kohl s 6.49% 2.72% % 5.89% Macy s 11.34% 2.72% % 8.67% Nordstrom 11.54% 2.47% % 10.27% Saks 16.29% 3.08% % 14.70% Sears Holding 12.00% 3.54% % 9.55% Average 10.37% New r W ACC = (2.72)(0.40)) = 9.97%. 21

22 9 Project Valuation The Weighted Average Cost of Capital (WACC) method: Most common approach. Estimate the project s free cash flows. (Ignore financing.) Estimate the project s r W ACC : Find comparable firm s whose business risk is similar. Estimate the unlevered cost of equity capital, r U. Calculate r W ACC from r U using a target or estimated D/V L ratio. Use firm s r W ACC if project risk is similar to firm s overall risk. Not an exact science! Estimate project value by discounting free cash r W ACC. Perform sensitivity analysis! The Adjusted Present Value (APV) method: Most useful when Firm does not maintain a constant D/V L ratio. When debt is tied to project (e.g. real estate). It has been argued that a firm s or project s levered value is V L = V U + P V (interest tax shield). (37) Estimate the project s free cash flows. (Ignore financing.) Estimate the project s r U : Find comparable firm s whose business risk is similar. Not an exact science! Estimate project s unlevered value V U by discounting free cash r U. Estimate PV(interest tax shield) using unlevered cost of equity capital. Estimate project value by adding PV(interest tax shield) to V U. Perform sensitivity analysis! 22

23 10 Remarks Costs of leverage. Benefit of debt is the value of the interest tax shield. But there are costs to financing. Banks that provide the loan or underwrite the sale of the securities charge fees. Higher debt levels increase the likelihood of financial distress, which can lower the free cash flow of the firm. Potential loss of customers, suppliers, employees. Fire sales of assets to generate cash. Loss of receivables. Personal taxes were ignored. This effect will lower the benefits of the interest tax shield. For these reasons some argue the costs offset the benefits. Firms do issue debt. It is typically easier to raise capital via debt than equity. Interest tax shield valuation. Most debt is not perpetual. One can still calculate the PV(interest tax shield). If the company issues permanent debt, then the debt cost of capital is an appropriate discount rate to value the interest tax shield. Assuming perpetual debt, using r D to discount the interest tax shield cash flow stream will generate somewhat different formulae, as follows: Hurdle rates. V L = V U + T C D (38) r E = r U + (r U r D )(1 T C )(D/E) (39) ) r W ACC = r U (1 T C (D/V L ) (40) ( ) ( ) E D = r E + [(1 T C )r D ] as before (41) D + E D + E A firm s target rate-of-return Higher than the theoretical risk-adjusted rate of return (cost of capital). Applicable in capital budgeting: Capital constraints impose limitations on funds. Implicitly values option to invest in future possibly more profitable projects. 23

24 11 Key Formulae V L = V U + T Cr D D r U. r E = r U + (r U r D )(D/E). ( ) ( ) r W ACC = E D+E r E + D D+E [(1 T C )r D ]. r W ACC = r U T C r D (D/V L )). r i = r f + β i ( R M r f ), i = E, U and D. 24

GESTÃO FINANCEIRA II PROBLEM SET 4 - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE

GESTÃO FINANCEIRA II PROBLEM SET 4 - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE GESTÃO FINANCEIRA II PROBLEM SET 4 - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 2010-2011 Chapter 12 Estimating the Cost of Capital 12-1. Suppose

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2. DUK UNIRSITY Fuqua School of Business FINANC 351 - CORPORAT FINANC Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%. Consider a firm that earns $1,000

More information

CHAPTER 18. Capital Budgeting and Valuation with Leverage. Chapter Synopsis

CHAPTER 18. Capital Budgeting and Valuation with Leverage. Chapter Synopsis CHAPTER 18 Capital Budgeting and Valuation with everage Chapter Synopsis 18.1 Overview of Key Concepts There are three discounted cash flow valuation methods: the weighted average cost of capital (WACC)

More information

GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE

GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 2010-2011 Chapter 18 Capital Budgeting and Valuation with Leverage

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2. DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax

More information

Use the table for the questions 18 and 19 below.

Use the table for the questions 18 and 19 below. Use the table for the questions 18 and 19 below. The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price

More information

Chapter 14 Capital Structure in a Perfect Market

Chapter 14 Capital Structure in a Perfect Market Chapter 14 Capital Structure in a Perfect Market 14-1. Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required

More information

EMBA in Management & Finance. Corporate Finance. Eric Jondeau

EMBA in Management & Finance. Corporate Finance. Eric Jondeau EMBA in Management & Finance Corporate Finance EMBA in Management & Finance Lecture 5: Capital Budgeting For the Levered Firm Prospectus Recall that there are three questions in corporate finance. The

More information

CFAspace. CFA Level II. Provided by APF. Academy of Professional Finance 专 业 金 融 学 院

CFAspace. CFA Level II. Provided by APF. Academy of Professional Finance 专 业 金 融 学 院 CFAspace Provided by APF CFA Level II Equity Investments Free Cash Flow Valuation Part I CFA Lecturer: Hillary Wang Content Free cash flow to the firm, free cash flow to equity Ownership perspective implicit

More information

Finance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012. Part One: Multiple-Choice Questions (45 points)

Finance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012. Part One: Multiple-Choice Questions (45 points) Finance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012 Part One: Multiple-Choice Questions (45 points) Question 1 Assume that capital markets are perfect. Which of the following statements

More information

Principles of Corporate Finance

Principles of Corporate Finance Principles of Corporate Finance Chapter 18. Does debt policy matter? Ciclo Profissional 2 o Semestre / 2009 Graduaccão em Ciências Econômicas V. Filipe Martins-da-Rocha (FGV) Principles of Corporate Finance

More information

CORPORATE FINANCE REVIEW FOR THIRD QUIZ. Aswath Damodaran

CORPORATE FINANCE REVIEW FOR THIRD QUIZ. Aswath Damodaran CORPORATE FINANCE REVIEW FOR THIRD QUIZ Aswath Damodaran Basic Skills Needed What is the trade off involved in the capital structure choice? Can you estimate the optimal debt ratio for a firm using the

More information

CHAPTER 8. Problems and Questions

CHAPTER 8. Problems and Questions CHAPTER 8 Problems and Questions 1. Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): Assets Liabilities

More information

t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3 MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

More information

If you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60

If you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60 Problems Relating to Capital Structure and Leverage 1. EBIT and Leverage Money Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes [EBIT] are projected

More information

Copyright 2009 Pearson Education Canada

Copyright 2009 Pearson Education Canada The consequence of failing to adjust the discount rate for the risk implicit in projects is that the firm will accept high-risk projects, which usually have higher IRR due to their high-risk nature, and

More information

Equity Analysis and Capital Structure. A New Venture s Perspective

Equity Analysis and Capital Structure. A New Venture s Perspective Equity Analysis and Capital Structure A New Venture s Perspective 1 Venture s Capital Structure ASSETS Short- term Assets Cash A/R Inventories Long- term Assets Plant and Equipment Intellectual Property

More information

Financial Markets and Valuation - Tutorial 6: SOLUTIONS. Capital Structure and Cost of Funds

Financial Markets and Valuation - Tutorial 6: SOLUTIONS. Capital Structure and Cost of Funds Financial Markets and Valuation - Tutorial 6: SOLUTIONS Capital Structure and Cost of Funds (*) denotes those problems to be covered in detail during the tutorial session (*) Problem 1. (Ross, Westerfield

More information

SOLUTIONS. Practice questions. Multiple Choice

SOLUTIONS. Practice questions. Multiple Choice Practice questions Multiple Choice 1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has 10,000 shares outstanding and a stock price of $10. If the unlevered beta

More information

NIKE Case Study. Professor Corwin. An overview of the individual questions and their relation to the lecture topics is provided below.

NIKE Case Study. Professor Corwin. An overview of the individual questions and their relation to the lecture topics is provided below. NIKE Case Study Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the most important

More information

Often stock is split to lower the price per share so it is more accessible to investors. The stock split is not taxable.

Often stock is split to lower the price per share so it is more accessible to investors. The stock split is not taxable. Reading: Chapter 8 Chapter 8. Stock: Introduction 1. Rights of stockholders 2. Cash dividends 3. Stock dividends 4. The stock split 5. Stock repurchases and liquidations 6. Preferred stock 7. Analysis

More information

The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1

The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A-1 Appendix 17A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition

More information

The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction

The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction Chapter 18 Valuation and Capital Budgeting for the Levered Firm 18A-1 Appendix 18A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition

More information

Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)

Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,

More information

Chapter 11. Stocks and Bonds. How does this distribution work? An example. What form do the distributions to common shareholders take?

Chapter 11. Stocks and Bonds. How does this distribution work? An example. What form do the distributions to common shareholders take? Chapter 11. Stocks and Bonds Chapter Objectives To identify basic shareholder rights and the means by which corporations make distributions to shareholders To recognize the investment opportunities in

More information

VALUATION JC PENNEY (NYSE:JCP)

VALUATION JC PENNEY (NYSE:JCP) VALUATION JC PENNEY (NYSE:JCP) Prepared for Dr. K.C. Chen California State University, Fresno Prepared by Sicilia Sendjaja Finance 129-Student Investment Funds December 15 th, 2009 California State University,

More information

Chapter 13, ROIC and WACC

Chapter 13, ROIC and WACC Chapter 13, ROIC and WACC Lakehead University Winter 2005 Role of the CFO The Chief Financial Officer (CFO) is involved in the following decisions: Management Decisions Financing Decisions Investment Decisions

More information

THE STOCK MARKET GAME GLOSSARY

THE STOCK MARKET GAME GLOSSARY THE STOCK MARKET GAME GLOSSARY Accounting: A method of recording a company s financial activity and arranging the information in reports that make the information understandable. Accounts payable: The

More information

Midland Energy/Sample 2. Midland Energy Resources, Inc.

Midland Energy/Sample 2. Midland Energy Resources, Inc. Midland Energy Resources, Inc. Midland Energy Resources, Inc. is a global energy company that operates in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals.

More information

CHAPTER 15 Capital Structure: Basic Concepts

CHAPTER 15 Capital Structure: Basic Concepts Multiple Choice Questions: CHAPTER 15 Capital Structure: Basic Concepts I. DEFINITIONS HOMEMADE LEVERAGE a 1. The use of personal borrowing to change the overall amount of financial leverage to which an

More information

Chapter 17 Does Debt Policy Matter?

Chapter 17 Does Debt Policy Matter? Chapter 17 Does Debt Policy Matter? Multiple Choice Questions 1. When a firm has no debt, then such a firm is known as: (I) an unlevered firm (II) a levered firm (III) an all-equity firm D) I and III only

More information

University of Pennsylvania The Wharton School

University of Pennsylvania The Wharton School University of Pennsylvania The Wharton School FNCE 100 PROBLEM SET #6 Fall Term 2005 A. Craig MacKinlay Capital Structure 1. The XYZ Co. is assessing its current capital structure and its implications

More information

: Corporate Finance. Valuation and Capital Structure

: Corporate Finance. Valuation and Capital Structure 380.760: Corporate Finance Lecture 9: Advanced Valuation with Capital Structure Professor Gordon M. Bodnar 2008 Gordon Bodnar, 2008 Valuation and Capital Structure In the real world with market imperfections,

More information

FN2 Ron Muller 2007-08 MODULE 4: CAPITAL STRUCTURE QUESTION 1

FN2 Ron Muller 2007-08 MODULE 4: CAPITAL STRUCTURE QUESTION 1 MODULE 4: CAPITAL STRUCTURE QUESTION 1 Gadget Corp. manufactures gadgets. The average selling price of this finished product is $200 per unit. The variable cost for these units is $125. Gadget Corp. incurs

More information

1 Pricing options using the Black Scholes formula

1 Pricing options using the Black Scholes formula Lecture 9 Pricing options using the Black Scholes formula Exercise. Consider month options with exercise prices of K = 45. The variance of the underlying security is σ 2 = 0.20. The risk free interest

More information

Homework Solutions - Lecture 2

Homework Solutions - Lecture 2 Homework Solutions - Lecture 2 1. The value of the S&P 500 index is 1286.12 and the treasury rate is 3.43%. In a typical year, stock repurchases increase the average payout ratio on S&P 500 stocks to over

More information

Fundamentals Level Skills Module, Paper F9

Fundamentals Level Skills Module, Paper F9 Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2008 Answers 1 (a) Calculation of weighted average cost of capital (WACC) Cost of equity Cost of equity using capital asset

More information

Valuating the levered firm

Valuating the levered firm Valuating the levered firm Valuation and Capital Budgeting for the Levered Firm 18-0 Introduction In a strict MM world, firms can analyze real investments as if they are all-equity-financed. Under MM assumptions,

More information

Napoli Pizza wants to determine its optimal capital structure

Napoli Pizza wants to determine its optimal capital structure Napoli Pizza wants to determine its optimal capital structure ABSTRACT Brad Stevenson Daniel Bauer David Collins Keith Richardson This case is based on an actual business decision that was made by a small,

More information

BUS303. Study guide 2. Chapter 14

BUS303. Study guide 2. Chapter 14 BUS303 Study guide 2 Chapter 14 1. An efficient capital market is one in which: A. all securities that investors want are offered. B. all transactions are closed within 2 days. C. current prices reflect

More information

Practice Exam (Solutions)

Practice Exam (Solutions) Practice Exam (Solutions) June 6, 2008 Course: Finance for AEO Length: 2 hours Lecturer: Paul Sengmüller Students are expected to conduct themselves properly during examinations and to obey any instructions

More information

MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the

MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the following 33 questions designed to test your knowledge of the

More information

MM1 - The value of the firm is independent of its capital structure (the proportion of debt and equity used to finance the firm s operations).

MM1 - The value of the firm is independent of its capital structure (the proportion of debt and equity used to finance the firm s operations). Teaching Note Miller Modigliani Consider an economy for which the Efficient Market Hypothesis holds and in which all financial assets are possibly traded (abusing words we call this The Complete Markets

More information

USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE

USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE Graduate School of Business Administration - University of Virginia USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE Planned changes in capital structure over time increase the complexity of

More information

CHAPTER II LITERATURE REVIEW

CHAPTER II LITERATURE REVIEW CHAPTER II LITERATURE REVIEW 2.1 Financial Ratios Analysis Financial ratios are important to analysts due to conquer the little meaning of typically numbers. Thus, ratios are intended to provide meaningful

More information

Leverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview

Leverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for

More information

U + PV(Interest Tax Shield)

U + PV(Interest Tax Shield) CHAPTER 15 Debt and Taxes Chapter Synopsis 15.1 The Interest Tax Deduction A C-Corporation pays taxes on proits ater interest payments are deducted, but it pays dividends rom ater-tax net income. Thus,

More information

Leverage and Capital Structure

Leverage and Capital Structure Leverage and Capital Structure Ross Chapter 16 Spring 2005 10.1 Leverage Financial Leverage Financial leverage is the use of fixed financial costs to magnify the effect of changes in EBIT on EPS. Fixed

More information

Chapter 7: Capital Structure: An Overview of the Financing Decision

Chapter 7: Capital Structure: An Overview of the Financing Decision Chapter 7: Capital Structure: An Overview of the Financing Decision 1. Income bonds are similar to preferred stock in several ways. Payment of interest on income bonds depends on the availability of sufficient

More information

LECTURE 09. Valuation Berk, De Marzo Chapter 18

LECTURE 09. Valuation Berk, De Marzo Chapter 18 1 LECTURE 09 Valuation Berk, De Marzo Chapter 18 2 Overview of Key Concepts Assumptions in this chapter The project has average risk. The firm s debt-equity ratio is constant. Corporate taxes are the only

More information

Midterm exam financiering/finance.

Midterm exam financiering/finance. <Front page> Midterm exam financiering/finance Question 1 An agency problem can be alleviated by: A) requiring all organizations to be sole proprietorships. B) compensating managers in such a way that

More information

LOS 42.a: Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity (FCFE).

LOS 42.a: Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity (FCFE). The following is a review of the Equity Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Free Cash Flow Valuation This

More information

ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure

ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for $40/share. Your analysis of the company

More information

Answers to Chapter Review and Self-Test Problems

Answers to Chapter Review and Self-Test Problems CHAPTER 15 Cost of Capital 517 Chapter Review and Self-Test Problems 15.1 Calculating the Cost of Equity Suppose stock in Watta Corporation has a beta of.80. The market risk premium is 6 percent, and the

More information

SampleFinal Finance 320 Finance Department

SampleFinal Finance 320 Finance Department SampleFinal Finance 320 Finance Department Name Chapters: 1, 2, 3, 4, 5, 6, 7, 8, 9, 11, 12, and 13 1) A C corporation earns $4.50 per share before taxes. The corporate tax rate is 35%, the personal tax

More information

E15-1. Understanding Shareholders Equity

E15-1. Understanding Shareholders Equity E15-1. Understanding Shareholders Equity Preferred stock is a class of capital stock that pays dividends at a specified rate and that has preference over common stock in the payment of dividends and the

More information

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.

More information

INTERVIEWS - FINANCIAL MODELING

INTERVIEWS - FINANCIAL MODELING 420 W. 118th Street, Room 420 New York, NY 10027 P: 212-854-4613 F: 212-854-6190 www.sipa.columbia.edu/ocs INTERVIEWS - FINANCIAL MODELING Basic valuation concepts are among the most popular technical

More information

Chapter 5 Valuing Stocks

Chapter 5 Valuing Stocks Chapter 5 Valuing Stocks MULTIPLE CHOICE 1. The first public sale of company stock to outside investors is called a/an a. seasoned equity offering. b. shareholders meeting. c. initial public offering.

More information

TIP If you do not understand something,

TIP If you do not understand something, Valuing common stocks Application of the DCF approach TIP If you do not understand something, ask me! The plan of the lecture Review what we have accomplished in the last lecture Some terms about stocks

More information

Finding the Right Financing Mix: The Capital Structure Decision

Finding the Right Financing Mix: The Capital Structure Decision Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran Stern School of Business Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum

More information

FNCE 3010 (Durham). HW2 (Financial ratios)

FNCE 3010 (Durham). HW2 (Financial ratios) FNCE 3010 (Durham). HW2 (Financial ratios) 1. What effect would the following actions have on a firms net working capital and current ratio (assume NWC is positive and current ratio is initially greater

More information

The Adjusted-Present-Value Approach to Valuing Leveraged Buyouts 1)

The Adjusted-Present-Value Approach to Valuing Leveraged Buyouts 1) IE Aufgabe 4 The Adjusted-Present-Value Approach to Valuing Leveraged Buyouts 1) Introduction A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company

More information

a) The Dividend Growth Model Approach: Recall the constant dividend growth model for the price of a rm s stock:

a) The Dividend Growth Model Approach: Recall the constant dividend growth model for the price of a rm s stock: Cost of Capital Chapter 14 A) The Cost of Capital: Some Preliminaries: The Security market line (SML) and capital asset pricing model (CAPM) describe the relationship between systematic risk and expected

More information

Discount rates for project appraisal

Discount rates for project appraisal Discount rates for project appraisal We know that we have to discount cash flows in order to value projects We can identify the cash flows BUT What discount rate should we use? 1 The Discount Rate and

More information

STUDENT CAN HAVE ONE LETTER SIZE FORMULA SHEET PREPARED BY STUDENT HIM/HERSELF. FINANCIAL CALCULATOR/TI-83 OR THEIR EQUIVALENCES ARE ALLOWED.

STUDENT CAN HAVE ONE LETTER SIZE FORMULA SHEET PREPARED BY STUDENT HIM/HERSELF. FINANCIAL CALCULATOR/TI-83 OR THEIR EQUIVALENCES ARE ALLOWED. Test III-FINN3120-090 Fall 2009 (2.5 PTS PER QUESTION. MAX 100 PTS) Type A Name ID PRINT YOUR NAME AND ID ON THE TEST, ANSWER SHEET AND FORMULA SHEET. TURN IN THE TEST, OPSCAN ANSWER SHEET AND FORMULA

More information

Finance 2 for IBA (30J201) F.Feriozzi Regular exam December 15 th, 2010. Part One: Multiple-Choice Questions (45 points)

Finance 2 for IBA (30J201) F.Feriozzi Regular exam December 15 th, 2010. Part One: Multiple-Choice Questions (45 points) Finance 2 for IBA (30J201) F.Feriozzi Regular exam December 15 th, 2010 Question 1 Part One: Multiple-hoice Questions (45 points) Which of the following statements regarding the capital structure decision

More information

Chapter 3 Free Cash Flow Valuation

Chapter 3 Free Cash Flow Valuation Solutions Chapter 3 Free Cash Flow Valuation 1. $100 increase in: Change in FCFF Change in FCFE A. Net income +100 +100 B. Cash operating expenses 60 60 C. Depreciation +40 +40 D. Interest expense 0 60

More information

MBA Financial Management and Markets Exam 1 Spring 2009

MBA Financial Management and Markets Exam 1 Spring 2009 MBA Financial Management and Markets Exam 1 Spring 2009 The following questions are designed to test your knowledge of the fundamental concepts of financial management structure [chapter 1], financial

More information

Cash Flow Analysis Venture Business Perspective

Cash Flow Analysis Venture Business Perspective Cash Flow Analysis Venture Business Perspective Cash Flow (CF) Analysis What is CF and how is determined? CF Operating CF Free CF Managing CF Cash Conversion Cyclical CF Break-even Valuing venture businesses

More information

AFM 372 Fall 2007 Midterm Examination Friday, October 26. This exam has 11 pages including this page. A separate formula sheet will be provided.

AFM 372 Fall 2007 Midterm Examination Friday, October 26. This exam has 11 pages including this page. A separate formula sheet will be provided. Student name: Student number: Instructor: Alan Huang Duration: 2 hours AFM 372 Fall 2007 Midterm Examination Friday, October 26 This exam has 11 pages including this page. A separate formula sheet will

More information

CHAPTER 14 COST OF CAPITAL

CHAPTER 14 COST OF CAPITAL CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,

More information

Corporate Finance: Final Exam

Corporate Finance: Final Exam Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate

More information

Corporate Finance: Final Exam

Corporate Finance: Final Exam Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. 1. DayTop Inns is a publicly traded company, with 10 million shares

More information

CHAPTER 20. Hybrid Financing: Preferred Stock, Warrants, and Convertibles

CHAPTER 20. Hybrid Financing: Preferred Stock, Warrants, and Convertibles CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 1 Topics in Chapter Types of hybrid securities Preferred stock Warrants Convertibles Features and risk Cost of capital to issuers

More information

Chapter 4 Common Stocks

Chapter 4 Common Stocks Chapter 4 Common Stocks Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Fixed-Income securities. Stocks. Real asset (capital budgeting). Part C Determination

More information

Chapter 1 The Scope of Corporate Finance

Chapter 1 The Scope of Corporate Finance Chapter 1 The Scope of Corporate Finance MULTIPLE CHOICE 1. One of the tasks for financial managers when identifying projects that increase firm value is to identify those projects where a. marginal benefits

More information

Current Ratio: Current Assets / Current Liabilities. Measure of whether company has enough cash to cover immediate expenses

Current Ratio: Current Assets / Current Liabilities. Measure of whether company has enough cash to cover immediate expenses 1 Beta: a measure of a stock s volatility relative to the overall market (typically the S&P500 index is used as a proxy for the overall market ). The higher the beta, the more volatile the stock price.

More information

Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011. Part One: Multiple-Choice Questions (45 points)

Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011. Part One: Multiple-Choice Questions (45 points) Question 1 Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011 Part One: Multiple-Choice Questions (45 points) Assume that financial markets are perfect and that the market value of a levered

More information

Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management

Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management Final Mock Exam 1 Marking scheme and suggested solutions DO NOT TURN THIS PAGE UNTIL YOU HAVE COMPLETED THE MOCK EXAM ii Financial

More information

According to Modigliani-Miller Proposition II with corporate taxes, the value of levered equity is:

According to Modigliani-Miller Proposition II with corporate taxes, the value of levered equity is: Homework 2 1. A project has a NPV, assuming all equity financing, of $1.5 million. To finance the project, debt is issued with associated flotation costs of $60,000. The flotation costs can be amortized

More information

Financial ratio analysis

Financial ratio analysis Financial ratio analysis A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Liquidity ratios 3. Profitability ratios and activity ratios 4. Financial leverage ratios 5. Shareholder

More information

Freeze Partnerships: Establishing the Preferred Rate

Freeze Partnerships: Establishing the Preferred Rate Freeze Partnerships: Establishing the Preferred Rate Aaron M. Stumpf, CPA/ABV astumpf@srr.com Brian A. Hock bhock@srr.com Overview n n n Partnership freezes involving related party transfers are generally

More information

Cash Flow Analysis Venture Business Perspective

Cash Flow Analysis Venture Business Perspective Cash Flow Analysis Venture Business Perspective Cash Flow (CF) Analysis What is CF and how is determined? CF Free CF Managing CF Cash Conversion Cyclical CF Break-even Valuing venture businesses based

More information

Finance 3130 Corporate Finiance Sample Final Exam Spring 2012

Finance 3130 Corporate Finiance Sample Final Exam Spring 2012 Finance 3130 Corporate Finiance Sample Final Exam Spring 2012 True/False Indicate whether the statement is true or falsewith A for true and B for false. 1. Interest paid by a corporation is a tax deduction

More information

Valuating the levered firm. Ch. 18 Valuation and Capital Budgeting for the Levered Firm

Valuating the levered firm. Ch. 18 Valuation and Capital Budgeting for the Levered Firm Valuating the levered firm Ch. 18 Valuation and Capital Budgeting for the Levered Firm I. Introduction In a strict MM world, firms can analyze real investments as if they are all-equity-financed. Under

More information

SAMPLE FACT EXAM (You must score 70% to successfully clear FACT)

SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) 1. What is the present value (PV) of $100,000 received five years from now, assuming the interest rate is 8% per year? a. $600,000.00 b.

More information

Chapter 5: Valuation. Albert Banal-Estanol

Chapter 5: Valuation. Albert Banal-Estanol Corporate Finance Chapter 5: Valuation Company valuation Valuation methods: Based on comparables or multiples Discounting cash flows: Weighted average cost of capital (WACC) Adjusted present value Flow

More information

Test3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -15

Test3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -15 Test3 1. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its riskfree debt is $5 million. The beta of the company's common stock is 1.25, and the market

More information

Company Financial Plan

Company Financial Plan Financial Modeling Templates http://spreadsheetml.com/finance/companyfinancialplan.shtml Copyright (c) 2009-2014, ConnectCode All Rights Reserved. ConnectCode accepts no responsibility for any adverse

More information

WACC and APV. The Big Picture: Part II - Valuation

WACC and APV. The Big Picture: Part II - Valuation WACC and APV 1 The Big Picture: Part II - Valuation A. Valuation: Free Cash Flow and Risk April 1 April 3 Lecture: Valuation of Free Cash Flows Case: Ameritrade B. Valuation: WACC and APV April 8 April

More information

Cost of Capital. Katharina Lewellen Finance Theory II April 9, 2003

Cost of Capital. Katharina Lewellen Finance Theory II April 9, 2003 Cost of Capital Katharina Lewellen Finance Theory II April 9, 2003 What Next? We want to value a project that is financed by both debt and equity Our approach: Calculate expected Free Cash Flows (FCFs)

More information

Chapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.)

Chapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.) Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing

More information

Direccio Financiera II

Direccio Financiera II Direccio Financiera II Year 2014-15 Degree/study: 2013-14- GRAU EMPRESARIAL Course: 3-4 Term: Third Number of ECTS credits: 5 Hours of student s dedication: 125 Language or languages of instruction: English

More information

LECTURE- 4. Valuing stocks Berk, De Marzo Chapter 9

LECTURE- 4. Valuing stocks Berk, De Marzo Chapter 9 1 LECTURE- 4 Valuing stocks Berk, De Marzo Chapter 9 2 The Dividend Discount Model A One-Year Investor Potential Cash Flows Dividend Sale of Stock Timeline for One-Year Investor Since the cash flows are

More information

Dealing with Operating Leases in Valuation. Aswath Damodaran. Stern School of Business. 44 West Fourth Street. New York, NY 10012

Dealing with Operating Leases in Valuation. Aswath Damodaran. Stern School of Business. 44 West Fourth Street. New York, NY 10012 Dealing with Operating Leases in Valuation Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 adamodar@stern.nyu.edu Abstract Most firm valuation models start with the after-tax

More information

HHIF Lecture Series: Discounted Cash Flow Model

HHIF Lecture Series: Discounted Cash Flow Model HHIF Lecture Series: Discounted Cash Flow Model Alexander Remorov University of Toronto November 19, 2010 Alexander Remorov (University of Toronto) HHIF Lecture Series: Discounted Cash Flow Model 1 / 18

More information

Review for Exam 1. Instructions: Please read carefully

Review for Exam 1. Instructions: Please read carefully Review for Exam 1 Instructions: Please read carefully The exam will have 21 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation

More information

Financial Statement Analysis!

Financial Statement Analysis! Financial Statement Analysis! The raw data for investing Aswath Damodaran! 1! Questions we would like answered! Assets Liabilities What are the assets in place? How valuable are these assets? How risky

More information

Chapter 7. . 1. component of the convertible can be estimated as 1100-796.15 = 303.85.

Chapter 7. . 1. component of the convertible can be estimated as 1100-796.15 = 303.85. Chapter 7 7-1 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders

More information