THE COST OF CAPITAL The investor-supplied items- debt, preferred stock, and common equity- are called capital components. Increases in assets must be financed by increases in these capital components. The cost of each component is called its component cost. For example, Allied can borrow money at 10%, so its component cost of debt is 10%. These costs are then combined to form a weighted average cost of capital, which is used in the capital budgeting process. rd interest rate on the firm’s
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Identify the components of a stock’s realized return. A realized return is the amount of actual gains that is made on the value of a portfolio over a specific evaluation period. This takes into consideration any earnings generated by each of the assets contained in the portfolio, as well as any losses that were incurred as a result of a shift in the value of the individual assets. It is possible to identify the realized return associated with each asset that is held in the portfolio. Components
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acceptable rate of return on new capital investments, The company’s basic capital budgeting approach was to accept all proposed investments with a positive net present value when discounted at the appropriate cost of capital. At issue was how the appropriate discount rate would be determined. The company was weighing two alternative approaches for determining a minimum rate of return: (1) a single cutoff rate based on the company’s overall weighted average cost of capital, and (2) a system of multiple
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(Weighted average cost of capital) The target capital structure for QM Industries is 45% common stock, 6% preferred stock, and 49% debt. If the cost of common equity for the firm is 17.9%, the cost of preferred stock is 10.6%, the before-tax cost of debt is 8.9%, and the firm’s tax rate is 35%, what is QM’s weighted average cost of capital? QM’s WAAC is _%? 2).(Weighted average cost of capital)Crypton Electronics has a capital structure consisting of 45% common stock and 55% debt. A debt issue
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these cash flows till infinity is known as the terminal values. Weighted Average Cost of Capital and Discounting of Terminal Values However, the weighted average cost of capital represents the overall cost of financing the company’s operations and this value represents the returns required by the equity holders and the returns required by the debt holders. In case of AirThread, the cost of equity would be calculated using the average returns offered by the market for an equity share with similar
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million Malaysian ringgit (MYR) after any taxes. • Murphy expects a strong Malaysian economy. The estimates for revenue for the next year are MYR200 million. Revenues are expected to increase by 8% in each of the following two years. • Cost of goods sold is expected to be 50% of revenue. • Selling and administrative expenses are expected to be MYR30 million in each of the next three years. • The Malaysian tax rate on the target's earnings is expected to be 35 percent
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CHAPTER 12 Risk, Cost of Capital, and Capital Budgeting Multiple Choice Questions: I. DEFINITIONS WACC e 1. The weighted average of the firm’s costs of equity, preferred stock, and after tax debt is the: a. reward to risk ratio for the firm. b. expected capital gains yield for the stock. c. expected capital gains yield for the firm. d. portfolio beta for the firm. e. weighted average cost of capital (WACC). Difficulty level: Easy CAPM b 2. If the CAPM is used to estimate
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WACC or Weighted Average Cost of Capital: Summary “Cheat Sheet” by MBAbullshit.com Money (capital) needed to run a company comes from either borrowing (debt) or the owners’ money (equity). The COST of capital is either the interest payment on the debt, or the required profit that the owners want in return for their investment (in MBA bullshit language: “expected return”). The expected return or COST OF EQUITY is determined by another financial model, the CAPM or the CAPITAL ASSET PRICING MODEL
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ef Concepts • Cost of capital is the rate of return that a firm must earn on its project/ investments to maintain its market value and attract funds. • Business risk is the risk to the firm of being unable to cover fixed operating costs. • Financial risk is the risk of being unable to cover required financial obligations such as interest and preference dividends. • Explicit cost is the rate that the firm pays to procure financing. • Implicit cost is the rate of return associated with the best
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Question 3 Explain why the total risk of a portfolio is not simply equal to the weighted average of the risks of securities in the portfolio. On this I will explain with an example you have two groups of stock that 40% is firm A and 60% is B both have different return to a complete total of 100% in a relation to wish one is 60 % or 40 %, it will carry a weight and the combination of both and the average of risk that is in the two different firm create a risk to that portfolio just
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