finance final chapter 14

risk-free rate

R_f

risk-free rate, market risk premium, systematic risk of the asset relative to average

Th required or expected return on a risky investment depends on 3 things:

adjusted cash flow

The _____ _____ _____ of assets, CFA, can be calculated as: CFA = EBIT x (1 - T_c) + Depr. - ΔNWC - Capital spending

systematic risk of the asset relative to average

beta coefficient, β

market risk premium, beta coefficient

first drawback of the SML approach: requires that two things be estimated -- the _______ ______ _______ and the ______ _______.

cost of preferred stock

has a fixed dividend pay forever, and so it is a perpetuity and can be solved for using R_p = D / P_0

r = d / p + g

how to solve for the required rate of return for a constant growth rate stock

price per share

market value of firm's equity = number of shares outstanding x ______ ______ ______.

pay dividends

One disadvantage of the dividend growth model is that it is only applicable to companies that...

line of business

Problems with the WACC can also arise in a corporation with more than one...

same risk class

Projects that have the same risk are said to be in the _____ ______ ______.

WACC

(E/V) x R_e + (P/V) x R_p + (D/V) x R_d X (1 - T_c)

risk, steady dividend growth

2 advantages of SML approach: it explicitly adjusts for _____, and it is applicable to companies other than just the ones with ______ _______ ______.

rated

A firm's bonds are _____. (ex. AA)

greater returns

A riskier business tends to have ______ ______.

market risk premium

E (R_m ) - R_f

V_t

Firm value at time period, t, can be calculated as: ___ = CFA _ (t+1) / WACC - g

risk class, discount rate

No direct way of coming up with beta... Instead, examine other investments outside the firm that are of the same _____ ______ as the one we are considering, and use the market-required return on those investments as the ______ _______.

pure play approach

approach in which we try to find companies that focus as exclusively as possible on the type of project in which we are interested to estimate the required return on an investment

preferred stock

define P/V as the percentage of the firm's financing that comes from _______ ______.

cost of capital

used interchangeably with required return and apprpriate discount rate

E

variable for the market value of the firm's equity

estimated growth rate

Another problem with the dividend growth model is that the estimated cost of equity is very sensitive to the...

past

As with the dividend growth model, we rely on the _____ to predict the future in the SML approach -- bad because economic conditions can change quickly.

subjective approach

Because of difficulties with objectively establishing discount rates for the individual projects, firms often adopt an approach that involves making subjective adjustments to the overall WACC, called the...

number of bonds outstanding

For long term debt, market value of firm's debt = market price of a single bond x ______ _____ _____ ______.

cost of debt

R_D

cost of preferred stock

R_p

tax

Take earnings before interest and taxes (EBIT) and multiply is by the firm's tax rate (T_c) to get the firm's "would-have-been" ____ bill. Taxes* = EBIT x T_c

funds

The cost of capital depends primarily on the use of _____, not the source.

risk

The dividend growth model does not consider ______.

simplicity

The primary advantage of the dividend growth model approach is its _______.

terminal value

The value of the firm in the future, V_t, is often referred to as the _____ _____.

weighted average cost of capital

To calculate the firm's overall cost of capital, we multiple the capital structure weights by associated costs and add them up. The total is the...

growth rate

To use the dividend growth model, we must come up with an estimate for the _____ _____.

observed

Unlike cost of equity, a firm's cost of debt can normally be ______, either directly or indirectly.

E + D

V = ....

overall firm

When we are evaluating investments with risks that are substantially different from those of the _____ ______, use of the WACC will potentially lead to poor decisions.

WACC

Whether or not we can use ______ to value the warehouse project depends whether the warehouse project is in the same risk class as the firm.

firm value today

______ ______ ______ can be calculated as: V_0 = CFA / WACC - g

performance evaluation

_______ _______ is another use of the WACC.

capital structure weights

percentages of the total capital represented by debt and equity, can be interpreted just like portfolio weights

cost of equity

return that the firm's equity investors require on their investment; no way to directly observe it, have to estimate it

V

symbol for the combined market value of debt and equity

D

symbol for the market value of a firm's debt

cost of equity

the divided growth model approach and the security market line (SML) approach are two approaches to determining the...

p = d / r-g

the price per share of stock, of a firm with a dividend that is growing at constant rate, can be written as...

cost of debt

the return the firm's creditors demand on new borrowing

100% = E/V + D/V

we can calculate the percentages of the total capital represented by debt and equity using...