Fin 201 Test 2
WACC =
(weight of debt*Rate of Debt)(1-Taxrate) + (weight of preferred stock*rate of PS) + (Weight of CS*Rate of CS)
If return of assets > Cost of capital
A project adds value to the firm
How to find Rate of Debt
BOND TVM finder
How to find Rate of Common Stock?
CAPM
Of the following types of securities, which is typically considered to be most risky?
Common stock of large companies (bonds are the least risky)
Perpetuity formula for preferred stock with flotation cost (Finding cost of preferred stock)
Cost of Preferred Stock = D / Price of ps(1-Flotation%)
Cost of retained earnings =
Cost of equity
in FCFE, when finding the value of the stock...
DONT add debt!! IGNORE debt!
Which one of the sources of finance typically reduces WACC
Debt
In order to find a value of a firm with FCFE, you would:
Discount all FCFE's, sum them up, and add the market value of debt.
If you want to value the price per share of a firm's common stock with FCFF, you would
Discount all FCFF's, sum them up, subtract the market value of debt, and then divide by the numbers of shares outstanding.
Returns on stocks A and B have equal standard deviations and are perfectly negatively correlated. In a two-stock portfolio with equal dollar investments in both stocks the portfolio standard deviation will be
Equal to Zero
The weakness of using replacement cost method is:
Estimating intagibles
External Cost of Equity with Floatation costs:
Get CAPM, then multiply by 1 + Floatation percentage
When Steve Jobs died, Stock of Apple fell. What kind of risk?
Idiosyncratic, diversifiable, firm-specific risk
The Security Market Line (SML) is a graphical representation of returns associated with beta. Choose the correct statement regarding to the SML
If your estimated return is below the SML, the stock is overvalued
After-tax cost of debt is equal to (Cost of Debt) X (1 - Tax Rate). Why do you have to multiply be one minus tax rate for the cost of debt while you do not for the cost of equity?
It is because bonds create a tax shield to a company.
Flotation costs make your cost of capital...
MORE EXPENSIVE
Changes in the general economy, such as changes in interest rates or tax laws, represent what type of risk?
Market risk (OR systematic, non-diversifiable, beta risk)
Does internal equity have flotation costs?
NO!!! When Q asks about cost of retained earning IGNORE flotation costs!!!
The most expensive source of capital normally is
New Common Stock
Stock A has an expected return of 11% and a standard deviation of 18%. Stock B has an expected return of 8% and a standard deviation of 20%. If the correlation of the stocks is 1, can you reduce the unsystematic risk?
No: the standard deviation of the two-stock portfolio will be the same as the average standard deviation of two.
Besides long-term debt, which one of the following typically reduces WACC?
Notes Payable
Which one of the following assets is hard to determine its value?
Patent
Which one of the following is the simplest way for a firm to finance itself?
Retained earnings
If CAPM > Holding Period Return..
Sell
The standard deviation for an individual stock measures
Total risk
How to find Rate of Preferred Stock?
V = Dividend1 / Price V = D/Net price (see chapter 9 #20) (if flotation costs... V = D/(P-$F)
When you use the discounted cash flow method with free cash flow to the firm to value a company, what discount rate should you use?
WACC
In which situation would a project add some value to a company?
When firm's return on assets is higher than the project cost of capital.
The capital structure weights used in computing the weighted average cost of capital are:
based on the market value of the firm's debt and equity securities.
What measures systematic risk
beta
tax shield only applies to ...
debt financing (bonds)
NOT a name for market risk
idiosyncratic
When you find CAPM...
it IS the SML line!!! (CAPM = required rate of return)
if a firm's beta is 1 then..
it is the same as the market, so the expected return should be the same as the return on the market
Market risk premium is measured by
market return - risk free rate
A stock with a beta greater than 1.0 has returns that are ____________ volatile than the market, and a stock with a beta of less than 1.0 exhibits returns which are ____________ volatile than those of the market portfolio.
more, less
Which of the following ratio is often used to value those tech firms during the bubble because of negative earnings?
price to sales ratio
Zero correlation
risk free
What has a beta of zero?
risk free asset
positive 1 correlation
stocks are the same... no diversifying away risk
negative 1 correlation?
the stocks are opposite of each other (get pretty high return)
