FIN300 Chapter 12

The rate used to discount project cash flows is known as the:

Required return, discount rate, & cost of capital

The cost of capital depends primarily on the ______________ of the funds, not the _____________.

use; source

Cost of debt....

1. Can be observed either directly or indirectly b/c the cost of debt is interest rate the firm must pay on new borrowing, and we can observe interest rates in financial markets.`

SML advantages:

1. Explicitly adjusts for risk 2. Applicable to companies other than just those with steady dividend growth.

To estimate dividend yield of a particular stock we need:

1. Forecasts of dividend growth rate, g 2. current stock price 3. the last dividend paid, D0

Growth rate of dividends can be found using:

1. Security analysts' forecasts 2. Historical dividend growth rates

Components used in construction of WACC:

1. cost of debt 2. cost of preferred stock 3. cost of common stock

Some risk adjustments to a firm's WACC for projects of differing risk, even if it is subjective, is probably..

Better than no risk adjustment

Cost of equity capital using the dividend growht model

P0=[D0*(1+g)]/(Re-g)

SML disadvantage

The SML approach requires that two things be estimated, the market risk premium and the beta coefficient.

WACC equation

[E/V] * Re + [D/V] * Rd * (1-Tc)

Dividends paid to common stockolders __________ be deducted from the payer's TI for tax purposes.

cannot

The return an investor in a security receives is __________ _________________ the cost of the security to the company that issued it.

equal to

Other companies that specialize only in projects similar to the project your firm is considering are called

pure plays

If an all-equity firm discounts a project's cash flows with the firm's overall weighted avg cost of capital even though the project's beta is less than the firm's overall beta, it is possible that the project might be:

rejected, when it should be accepted

The WACC is the overall _______________ the firm must earn on its existing assets to maintain the ___________ of its cost

return; value

Cost of preferred stock:

-Has fixed dividend paid every period forever so share of preferred stock is perpetuity. Rp=D/P0= Cost of preferred stock

If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions it will accept______________ projects

too many