# CORPORATE FINANCE COST OF CAPITAL. Reading

Save this PDF as:

Size: px
Start display at page:

## Transcription

1 CORPORATE FINANCE COST OF CAPITAL Reading

2 Popularity of Capital Budgeting Methods Location European companies follow payback period as decision making criteria. Size Bigger companies more likely to use NPV as selection criteria. Public v/s Private Companies Private companies more likely to use payback period. Management Educated managers more likely to use NPV 2

3 Cost of Capital It is the rate that suppliers of capital bondholders and owners require as compensation for their contribution of capital. It is the minimum rate of return that a company must earn on its investment, returns are required to satisfy various stakeholders. Failing on returns generation will result in the loss of the investors faith on the company and he may be compelled to pull his money out. As we use cost of capital in evaluation of investment opportunities we are dealing with a marginal cost what it would cost to raise additional funds for potential investment projects. 3

4 Components of Cost of Capital All the costs put together help us compute the Weighted Average Cost of Capital (WACC) Cost of Term Loan Cost of Debt Cost of Preference Share Cost of Equity WACC Cost of Term Loan Cost of Debenture Cost of Preference Share Cost of Equity 4

5 WACC Calculation WACC = w d r d (1 t) + w p r p + w e r e Where, w d weightage of debt in overall capital r d cost of debt t Company s tax rate w p weightage of preference shares r p cost of preference shares w e weightage of equity r e cost off equity 5

6 Taxes and Cost of Capital Company I Company II Remarks Method I Equity (10% dividend) Capital raised in form of equity Debt (10% Interest Rate) Capital raised in form of debt Total Capital Total Capital raised Operating Profit (EBIT) Interest PBT % PAT Dividend Retained Earnings Method II EBIT T NOPAT After Tax cost of debt 0 70 After tax cost of equity Cash Flow Interest 10% on the debt by Company II Savings of 30 in Tax due to Debt funding. Hence benefits wil be available only if debt is a part of the capital. Thus it reduces the cost of debt funding Net difference of 30 as interest on debt is tax deductible k d = I * (1-T) 6

7 Weights of WACC Target capital structure is the capital structure a company is striving to achieve Arrive at target capital structure Take it as current capital structure Examine trends in capital structure and look at management guidance Use averages of comparable companies target capital structure 7

8 WACC Example An analyst is estimating the cost of company Duke Ltd. The following information is provided Duke Ltd Market Value of debt = \$ 30 million Market Value of equity = \$ 40 million Competitor data: Competitor MV of Debt MV of equity A \$ 34 \$ 56 B \$ 123 \$ 170 C \$ 50 \$ Current Capital Structure? 2. Competitor Capital Structure? 3. Calculate the weights if Duke Ltd. Announces their target D/E ratio of 0.6? 8

9 WACC Solution: 1.) Current Capital Sturcture w d = 30 = ( ) w e = 40 ( ) = ) Competitor Capital Structure w d w e = = [34/(34+56)] + [123/( )] + [50/(50+70)] 3 [56/(34+56)] + [170/( )] + [70/(50+70)] 3 = = ) D/E = 0.6 w d = 0.6 ( ) = w e = 1 - w d = These would have been the preffered weights for the target D/E ratio. 9

10 Optimal Capital Budget MCC (Marginal Cost of Capital) A firm s MCC is the cost of an additional dollar of capital raised A firm s MCC increases as the firm increases the amount of capital it raises during a given period MCC curve slopes upward IOS (Investment opportunity schedule) We can order the opportunities for investment from highest to lowest IRR When we plot them we obtain the IOS Intersection of IOS and MCC identifies the optimal capital budget 10

11 Optimal Capital Budget 80 Project IRR 70 Cost of 60 Capital (%) Investment Opportunity Schedule Marginal Cost Of Capital 10 0 Optimal Capital Budget New Capital Raised (%) The WACC is the appropriate discount rate for projects that have same level of risk as that of the firm s existing projects. For projects with greater (lesser) risk use a discount rate greater (lesser) than the firm s existing WACC. 11

12 Cost of Debt Method I : Yield to Maturity Approach YTM is the annual return that an investor earns on a bond if the investor purchases the bond today and holds it until maturity. PMT 1 PMT 2 PMT 3 PMT n FV P 0 = (1 + kd) 1 (1 + kd) 2 (1 + kd) 3 (1 + kd) n (1 + kd) n Where, t = n PMT t FV = + t = 1 (1 + kd) t (1 + kd) n P 0 = Current value of Bond PMT = Interest Payment for a given period kd = Cost of debt FV = Future value of the bond 12

13 Cost of Debt Method II : Debt-Rating Approach When market price of debt is not available, debt rating approach is used. Based on company s debt rating estimate the before tax cost of debt by using the yield on a similarly rated bond for maturities that closely match with that of the company After Tax Cost of Debt = kd * ( 1 Tax Rate) Example Market price of debentures of company ABC is Rs.70. Debentures pay an interest rate of 7% and have a maturity of 5 years. Face value of the debentures is Rs.100 and the applicable tax rate for the company is 30% Solution PV = -70, FV = 100, N = 5, PMT = 7% * 100 * (1-30%) CPT I/Y = 13.54% 13

14 Cost of Preferred Stock Cost committed to the preferred stock holders while issuing preferred stock For nonconvertible, noncallable preferred stock that has a fixed dividend rate P p = D p / r p P p = Price of preferred stock D p = Dividend to preferred stock holder r p = cost of preferred stock r p = D p / P p Example ABC Corp has preferred stock outstanding, \$5 cumulative preferred stock. The current price of this stock is \$87. What is the cost of preferred equity? Solution: Cost of Preferred Equity = \$5 / \$ 87 = 5.75% 14

15 Cost of equity There are various measures by which cost of equity can be calculated. They are: Capital Asset Pricing Model (CAPM) Dividend forecast approach Bond yield plus risk premium 15

16 CAPM K e = R f + β (R m R f ) Where, Ke = Cost of Equity Rf = risk free rate of return Rm = market return β = beta of the stock (R m R f ) = Also called as Risk Premium To Remember Cost of equity as per the CAPM model is given as Ke = Rf + β (Rm Rf) Example ABC Corp wants to know the cost of equity? Its finance department believes the risk free rate is 5%, equity risk premium is 8% and beta is 2. Find the cost of equity? Solution: Cost of Equity = Rf + β (Rm Rf) = 5% + 2*(8%) = 21%. 16

17 Dividend forecast approach Where, K e = D 1 + g P 0 Ke = cost of equity D 1 = expected dividend at the end of year 1 P 0 = price per equity share g = growth rate g = Retention Ratio * Return on Equity g = b * ROE 17

18 Bond Yield plus risk premium Assumes Ke = bond market yield + risk premium Investors require higher return on a firm s equity than on its debt Risk premium normally ranges from 3% to 5% It is judgment based and hence imprecise 18

19 Estimating Beta and Project Beta Pure-Play Method (4 Steps) 1. Select a comparable company 2. Estimate the beta of the comparable company 3. Unlever the comparable s beta 4. Lever the beta for the project s financial risk Asset (Project) Unlevered Beta β Levered = β Unlevered * [ 1 + ( 1 - T ) D / E] β Unlevered = β Levered [ 1 + ( 1 - T ) D ] 19 E

20 Estimating Beta and Project Beta Example Estimate the WACC for the following details of XYZ Corp Nominal Risk Free Rate for 10-year government bond is 4% Average risk premium is 6% Corporate tax rate is 35% Target D/E = 0.6 Cost of Debt for XYZ Corp is at 275 bps premium to the government bond Following are the details of a comparable company Comparable MV of Tax Rate Mcap Company Debt D/E Beta ABC 40% 5,600 3, PQR 33% 13,000 15, STU 38% 2,300 3,

21 Estimating Beta and Project Beta Solution: WACC = w d r d (1 t) + w e r e D/E 0.6 w d = = (D/E + 1) ( ) w e = 1 = 1 (D/E + 1) ( ) k d = I * (1 - t) = 4% % = 6.75% k e = R f + β (R m R f ) k e = R f + β (R m R f ) = 4% * 6% = 9.19% = = Following the 4 Steps of the Pure Play Method Unlever the beta of the given comparable companies Comparable β Unlevered = β Levered Company [ 1 + ( 1 - T ) D ] E β Unlevered = β Levered = β Unlevered * [ 1 + ( 1 - T ) D / E] β L = * [ 1 + (1-0.35) * 0.6)] β L = Unlevered Beta ABC PQR STU Average WACC = w d r d (1 t) + w e r e WACC = 8.28% 21

22 Country Risk Premium Use of CAPm becomes difficult for developing countries. Hence a country risk premium needs to be added while calculating Ke with this method The country spread is referred to as a country equity premium K e = R f + β *[ (R m R f ) + Country Risk Premium] Country Risk Premium Soverign yield = * spread Annualized Standard Deviation of equity Index Annualized Standard Deviation of the soverign bond market in terms of the developed market currency 22

23 Country Risk Premium Example Given the following details regarding a project: Indian 10-yr sovereign bond yield = 7.7% 10-yr US Treasury Bond yield = 3.2% Annualized std. dev. Of Sensex = 23% Annualized std. dev. Of 10-yr USD denominated Indian sovereign bond = 12% Beta of project = 1.5 Expected Market Return = 11% Risk Free Rate = 5% Compute Cost of Equity 23

24 Country Risk Premium Solution: Market Risk Premium = 11% - 5% = 6% Country Risk Premium Soverign yield = * spread Annualized Standard Deviation of equity Index Annualized Standard Deviation of the soverign bond market in terms of the developed market currency Country Risk Premium = (7.7% - 3.2%) * (23% / 12%) = 8.625% Cost of Equity K e = R f + β *[ (R m R f ) + Country Risk Premium] K e = 5% * [ 6% %] K e = % 24

25 Marginal Cost of Capital MCC (Marginal Cost of Capital) A firm s MCC is the cost of an additional dollar of capital raised A firm s MCC increases as the firm increases the amount of capital it raises during a given period MCC curve slopes upward Breakpoint: The amount of new capital investment for which WACC increases because the cost of one of the component costs of capital increases is termed as breakpoint. Break Point = Amount of capital at which the sourc's cost of capital changes Proportion of new capital raised from the source E.g. cost of debt increases past \$2 million. Raised debt is 40% of the target capital structure, Breakpoint = 2 /.4 = \$5 million 25

26 Floatation Costs Fees charged by the investment banker when a company raises external equity capital is called as Floatation Cost These fees range between 2% to 7% Incorrect Method: Adjust cost of equity Formula D 1 ke = + g P 0 * (1 - f) Where, f is the floatation cost as a percent of issue price However cost gets incorrectly carried through the life of the project in this method Preferred Method: Adjust the initial cash outflow while computing NPV Correctly shows floatation cost as a cash outflow at inception of project. 26

### Estimating Cost of Capital. 2. The cost of capital is an opportunity cost it depends on where the money goes, not where it comes from

Estimating Cost of Capal 1. Vocabulary the following all mean the same thing: a. Required return b. Appropriate discount rate c. Cost of capal (or cost of money) 2. The cost of capal is an opportuny cost

### The Cost of Capital. Chapter 10. Cost of Debt (r d ) The Cost of Capital. Calculating the cost of obtaining funds for a project

The Cost of Capital Chapter 10 (def) - Cost of obtaining money to fund asset purchase - use as estimate of r (discount rate) If we can earn more than the cost of capital (r) from a project than company

FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal year-ended February 1, 2015 (the 2014 fiscal

### 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,

### 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

### CHAPTER 8 INTEREST RATES AND BOND VALUATION

CHAPTER 8 INTEREST RATES AND BOND VALUATION Solutions to Questions and Problems 1. The price of a pure discount (zero coupon) bond is the present value of the par value. Remember, even though there are

### Chapter 11 Calculating the Cost of Capital

Chapter 11 Calculating the Cost of Capital (def) - Cost of obtaining money to fund asset purchase - use as estimate of r (discount rate) If we can earn more than the cost of capital (r) from a project

### The cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction

The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal

### Exam 1 Morning Session

91. A high yield bond fund states that through active management, the fund s return has outperformed an index of Treasury securities by 4% on average over the past five years. As a performance benchmark

### Sample Problems Chapter 10

Sample Problems Chapter 10 Title: Cost of Debt 1. Costly Corporation plans a new issue of bonds with a par value of \$1,000, a maturity of 28 years, and an annual coupon rate of 16.0%. Flotation costs associated

### 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

### A Basic Introduction to the Methodology Used to Determine a Discount Rate

A Basic Introduction to the Methodology Used to Determine a Discount Rate By Dubravka Tosic, Ph.D. The term discount rate is one of the most fundamental, widely used terms in finance and economics. Whether

### 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

### Some common mistakes to avoid in estimating and applying discount rates

Discount rates Some common mistakes to avoid in estimating and applying discount rates One of the most critical issues for an investor to consider in a strategic acquisition is to estimate how much the

### Estimating Beta. Aswath Damodaran

Estimating Beta The standard procedure for estimating betas is to regress stock returns (R j ) against market returns (R m ) - R j = a + b R m where a is the intercept and b is the slope of the regression.

### Spring 2012. True/False Indicate whether the statement is true or false.

Corporation Finance Spring 2012 Sample Exam 2B True/False Indicate whether the statement is true or false. 1. The total return on a share of stock refers to the dividend yield less any commissions paid

### 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

### 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

### MGT201 Solved MCQs(500) By

MGT201 Solved MCQs(500) By http://www.vustudents.net Why companies invest in projects with negative NPV? Because there is hidden value in each project Because there may be chance of rapid growth Because

### ( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100

Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded

### 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.

### Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document)

Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document) 1. Portfolio risk & return. Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

### BUSINESS FINANCE (FIN 312) Spring 2009

BUSINESS FINANCE (FIN 31) Spring 009 Assignment Instructions: please read carefully You can either do the assignment by yourself or work in a group of no more than two. You should show your work how to

### Cost of Capital and Project Valuation

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

Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual

### 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

### 1. What are the three types of business organizations? Define them

Written Exam Ticket 1 1. What is Finance? What do financial managers try to maximize, and what is their second objective? 2. How do you compare cash flows at different points in time? 3. Write the formulas

### 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

### GESTÃO FINANCEIRA II PROBLEM SET 2 - SOLUTIONS

GESTÃO FINANCEIRA II PROBLEM SET - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 010-011 Yield to Maturity Chapter 8 Valuing Bonds 8-3. The following

### Bonds, Preferred Stock, and Common Stock

Bonds, Preferred Stock, and Common Stock I. Bonds 1. An investor has a required rate of return of 4% on a 1-year discount bond with a \$100 face value. What is the most the investor would pay for 2. An

### DCF and WACC calculation: Theory meets practice

www.pwc.com DCF and WACC calculation: Theory meets practice Table of contents Section 1. Fair value and company valuation page 3 Section 2. The DCF model: Basic assumptions and the expected cash flows

### 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

### Chapter 12. Preferred Stocks - 1. Preferred Stocks and Convertibles

Preferred Stocks - 1 Chapter 12 Preferred Stocks and Convertibles Preferred Stocks Valuing and Investing in Preferreds Convertibles Valuing and Investing in Convertibles Preferred stocks have preference

### Chapter 8. Step 2: Find prices of the bonds today: n i PV FV PMT Result Coupon = 4% 29.5 5? 100 4 84.74 Zero coupon 29.5 5? 100 0 23.

Chapter 8 Bond Valuation with a Flat Term Structure 1. Suppose you want to know the price of a 10-year 7% coupon Treasury bond that pays interest annually. a. You have been told that the yield to maturity

### 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

### 380.760: Corporate Finance. Financial Decision Making

380.760: Corporate Finance Lecture 2: Time Value of Money and Net Present Value Gordon Bodnar, 2009 Professor Gordon Bodnar 2009 Financial Decision Making Finance decision making is about evaluating costs

### CIS September 2013 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Level 2

CIS September 2013 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Level 2 SECTION A: MULTIPLE CHOICE QUESTIONS Corporate Finance (1

### 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

### Chapter 10 Risk and Capital Budgeting

Chapter 10 Risk and Capital Budgeting MULTIPLE CHOICE 1. Operating leverage describes the relationship between... a. EBIT and sales b. taxes and sales c. debt and equity d. fixed costs and variable costs

### Things to Absorb, Read, and Do

Things to Absorb, Read, and Do Things to absorb - Everything, plus remember some material from previous chapters. This chapter applies Chapter s 6, 7, and 12, Risk and Return concepts to the market value

### 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

### Excellence in Financial Management. Prepared by: Matt H. Evans, CPA, CMA, CFM

Excellence in Financial Management Course 6: The Management of Capital Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides an overview of concepts related to the management of capital. This

### Bond Valuation. What is a bond?

Lecture: III 1 What is a bond? Bond Valuation When a corporation wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities called bonds. A bond

### Forecasting and Valuation of Enterprise Cash Flows 1. Dan Gode and James Ohlson

Forecasting and Valuation of Enterprise Cash Flows 1 1. Overview FORECASTING AND VALUATION OF ENTERPRISE CASH FLOWS Dan Gode and James Ohlson A decision to invest in a stock proceeds in two major steps

### 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

### NIKE Case Study Solutions

NIKE Case Study Solutions 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

### 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

### E. V. Bulyatkin CAPITAL STRUCTURE

E. V. Bulyatkin Graduate Student Edinburgh University Business School CAPITAL STRUCTURE Abstract. This paper aims to analyze the current capital structure of Lufthansa in order to increase market value

### Exercise. Exam Aid: All calculators are allowed but empty memory. Paper dictionaries are allowed. No other aids allowed in the exam room.

Exercise Exam Aid: All calculators are allowed but empty memory. Paper dictionaries are allowed. No other aids allowed in the exam room. Note: No formula sheets are allowed in the exam. Exercise: 01 Exercise

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

### INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK

INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK Bank of Tokyo-Mitsubishi Professor of Economics and Finance Sloan School of Management Massachusetts Institute

### FinQuiz Notes 2 0 1 5

Reading 5 The Time Value of Money Money has a time value because a unit of money received today is worth more than a unit of money to be received tomorrow. Interest rates can be interpreted in three ways.

### CFS. Syllabus. Certified Finance Specialist. International benchmark in Finance profession

CFS Certified Finance Specialist Syllabus International benchmark in Finance profession Certified Finance Specialist Summary: This award will provide candidates the opportunity to gain advanced level knowledge

### Chapter 5: Valuing Bonds

FIN 302 Class Notes Chapter 5: Valuing Bonds What is a bond? A long-term debt instrument A contract where a borrower agrees to make interest and principal payments on specific dates Corporate Bond Quotations

### Calculation of Return on Equity (Ke) Presentation to Stakeholders 8 th October 2008

Calculation of Return on Equity (Ke) Presentation to Stakeholders 8 th October 2008 1 Overview (1) Tariffs set by Energy Regulator based on Allowable Revenue Tariff 1 Tariff 2 Tariff 3 Allowable Revenue

### 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,

### Chapter Review Problems

Chapter Review Problems State all stock and bond prices in dollars and cents. Unit 14.1 Stocks 1. When a corporation earns a profit, the board of directors is obligated by law to immediately distribute

### MBA (3rd Sem) 2013-14 MBA/29/FM-302/T/ODD/13-14

Full Marks : 70 MBA/29/FM-302/T/ODD/13-14 2013-14 MBA (3rd Sem) Paper Name : Corporate Finance Paper Code : FM-302 Time : 3 Hours The figures in the right-hand margin indicate marks. Candidates are required

### Time Value of Money. 2014 Level I Quantitative Methods. IFT Notes for the CFA exam

Time Value of Money 2014 Level I Quantitative Methods IFT Notes for the CFA exam Contents 1. Introduction...2 2. Interest Rates: Interpretation...2 3. The Future Value of a Single Cash Flow...4 4. The

### Cost of Capital, Valuation and Strategic Financial Decision Making

Cost of Capital, Valuation and Strategic Financial Decision Making By Dr. Valerio Poti, - Examiner in Professional 2 Stage Strategic Corporate Finance The financial crisis that hit financial markets in

### Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 9-1 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as

### FIN 432 Investment Analysis and Management Review Notes for Midterm Exam

FIN 432 Investment Analysis and Management Review Notes for Midterm Exam Chapter 1 1. Investment vs. investments 2. Real assets vs. financial assets 3. Investment process Investment policy, asset allocation,

### Discounted Cash Flow Valuation: Basics

Discounted Cash Flow Valuation: Basics Aswath Damodaran Aswath Damodaran 1 Discounted Cashflow Valuation: Basis for Approach Value = t=n CF t t =1(1+r) t where CF t is the cash flow in period t, r is the

### Interest Rates and Bond Valuation

Interest Rates and Bond Valuation Chapter 6 Key Concepts and Skills Know the important bond features and bond types Understand bond values and why they fluctuate Understand bond ratings and what they mean

### Exam 1 Sample Questions

Exam 1 Sample Questions 1. Asset allocation refers to. A. the allocation of the investment portfolio across broad asset classes B. the analysis of the value of securities C. the choice of specific assets

### BF 6701 : Financial Management Comprehensive Examination Guideline

BF 6701 : Financial Management Comprehensive Examination Guideline 1) There will be 5 essay questions and 5 calculation questions to be completed in 1-hour exam. 2) The topics included in those essay and

### THE TIME VALUE OF MONEY

QUANTITATIVE METHODS THE TIME VALUE OF MONEY Reading 5 http://proschool.imsindia.com/ 1 Learning Objective Statements (LOS) a. Interest Rates as Required rate of return, Discount Rate and Opportunity Cost

### Fundamentals Level Skills Module, Paper F9. Section A. Monetary value of return = \$3 10 x 1 197 = \$3 71 Current share price = \$3 71 \$0 21 = \$3 50

Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2014 Answers Section A 1 A Monetary value of return = \$3 10 x 1 197 = \$3 71 Current share price = \$3 71 \$0 21 = \$3 50 2

### CHAPTER 16. Dilutive Securities and Earnings Per Share ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Concepts for Analysis

CHAPTER 16 Dilutive Securities and Earnings Per Share ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems Concepts for Analysis 1. Convertible debt and preferred

### Topics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk

Bond Valuation 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Determinants of Intrinsic Value: The Cost of Debt Net operating profit after taxes Free cash flow

### 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

### MCQ on Financial Management

MCQ on Financial Management 1. "Shareholder wealth" in a firm is represented by: a) the number of people employed in the firm. b) the book value of the firm's assets less the book value of its liabilities

### 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises.

1. Solutions to PS 1: 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises. 7. The bill has a maturity of one-half year, and an annualized

### 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

### FSA Note: Summary of Financial Ratio Calculations

FSA Note: Summary of Financial Ratio Calculations This note contains a summary of the more common financial statement ratios. A few points should be noted: Calculations vary in practice; consistency and

### Option Pricing Applications in Valuation!

Option Pricing Applications in Valuation! Equity Value in Deeply Troubled Firms Value of Undeveloped Reserves for Natural Resource Firm Value of Patent/License 73 Option Pricing Applications in Equity

### 3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction.

Spring 2012 Finance 3130 Sample Exam 1A Questions for Review 1. The form of organization for a business is an important issue, as this decision has very significant effect on the income and wealth of the

### Chapter 4 Valuing Bonds

Chapter 4 Valuing Bonds MULTIPLE CHOICE 1. A 15 year, 8%, \$1000 face value bond is currently trading at \$958. The yield to maturity of this bond must be a. less than 8%. b. equal to 8%. c. greater than

### Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 36)

Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required

ANSWERS TO STUDY QUESTIONS Chapter 17 17.1. The details are described in section 17.1.1. 17.3. Because of its declining payment pattern, a CAM would be most useful in an economy with persistent deflation

### LOS 56.a: Explain steps in the bond valuation process.

The following is a review of the Analysis of Fixed Income Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Introduction

1.0 FINANCING PRINCIPLES Module 1: Corporate Finance and the Role of Venture Capital Financing Financing Principles 1.01 Introduction to Financing Principles 1.02 Capitalization of a Business 1.03 Capital

### Key Concepts and Skills Chapter 8 Stock Valuation

Key Concepts and Skills Chapter 8 Stock Valuation Konan Chan Financial Management, Spring 2016 Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices

### 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

### CHAPTER 7: FIXED-INCOME SECURITIES: PRICING AND TRADING

CHAPTER 7: FIXED-INCOME SECURITIES: PRICING AND TRADING Topic One: Bond Pricing Principles 1. Present Value. A. The present-value calculation is used to estimate how much an investor should pay for a bond;

### LO.a: Interpret interest rates as required rates of return, discount rates, or opportunity costs.

LO.a: Interpret interest rates as required rates of return, discount rates, or opportunity costs. 1. The minimum rate of return that an investor must receive in order to invest in a project is most likely

### Methodological Tool. Draft tool to determine the weighted average cost of capital (WACC) (Version 01)

Page 1 Methodological Tool Draft tool to determine the weighted average cost of capital (WACC) (Version 01) I. DEFINITIONS, SCOPE, APPLICABILITY AND PARAMETERS Definitions For the purpose of this tool,

### Practice Questions for Midterm II

Finance 333 Investments Practice Questions for Midterm II Winter 2004 Professor Yan 1. The market portfolio has a beta of a. 0. *b. 1. c. -1. d. 0.5. By definition, the beta of the market portfolio is

### 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

### Gordon Guides For the CFP Exam. Financial Math

Financial Math For the CFP Exam, candidates are expected to have a high degree of understanding of time value of money principles, security valuation and basic statistics. Formulas are provided on at the

### Achievement of Market-Friendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development

Achievement of Market-Friendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development Abstracts of Required Readings and Comments on Learning Outcomes (CFA

### ] (3.3) ] (1 + r)t (3.4)

Present value = future value after t periods (3.1) (1 + r) t PV of perpetuity = C = cash payment (3.2) r interest rate Present value of t-year annuity = C [ 1 1 ] (3.3) r r(1 + r) t Future value of annuity

### FNCE 301, Financial Management H Guy Williams, 2006

REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including

### Direct Transfer. Investment Banking. Investment Banking. Basic Concepts. Economics of Money and Banking. Basic Concepts

Basic Concepts Economics of Money and Banking 2014 South Carolina Bankers School Ron Best University of West Georgia rbest@westga.edu Risk and return: investors will only take on additional risk if they

### The Lee Kong Chian School of Business Academic Year 2012/13 Term 1

The Lee Kong Chian School of Business Academic Year 2012/13 Term 1 FNCE101 FINANCE Instructor Name : Daniel A Stone Title : Adjunct Tel : Email Office : TBD : dstone@smu.edu.sg COURSE DESCRIPTION This

Chapter Two Determinants of Interest Rates Interest Rate Fundamentals Nominal interest rates - the interest rate actually observed in financial markets directly affect the value (price) of most securities

### CHAPTER 8 INTEREST RATES AND BOND VALUATION

CHAPTER 8 INTEREST RATES AND BOND VALUATION Answers to Concept Questions 1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial