ACYFMG2
Formula
UNIT II
2.1 Cost of Capital
Cost of long- Find rd in equation below:
term debt
(calculation)
where: net proceeds- bond price less floatation cost
n- number of period
note: we will use calculation approach if problem is silent; if bonds pay
interest for period of less than a year, rd is periodic cost only and would
have to be annualized by multiplying it with number of times paid in a year
Cost of long-
term debt
(approximation
)
where: net proceeds- bond price less floatation cost
Interest- annual interest;
n- number of years to bond’s maturity
note: we will use calculation approach if problem is silent
After tax cost rdAT = rd ´ (1 – T)
of debt
Cost of rps= Dps/ Nps
preferred stock where: Dps – dividend amount;
Nps –net proceeds
if dividends are paid for a period of less than a year, rps is periodic cost
only and would have to be annualized by multiplying it with number of
times paid in a year
Cost of common
equity
(dividend
growth model) where: rre- cost of retained earnings
rcs – cost of new issuance of common stock
D1 – dividend amount next period
P0- current price per share of common stock
Ncs –net proceeds from issuance of common stock
g- constant growth rate
if dividends are paid for a period of less than a year, rre or cs is periodic cost
only and would have to be annualized by multiplying it with number of
times paid in a year
Cost of common
equity (CAPM) rcs = Rf + β(rm – Rf)
where: Rf – risk-free rate of return
β- company’s common stock beta
rm- Expected return of market portflio
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ACYFMG2 Formula
Weighted WACC= (rdAT x wd) + (rps x wps) + (rre or cs x wcs)
average cost of where: w – capital structure weight (for each source of capital)
capital
(WACC)
Break point BP = Available funds / capital structure weight
2.2 Capital Budgeting and Cash Flow Principles (cont’d)
Initial =-installed cost of the new asset + after-tax proceeds
investment from sale of the new asset – net working capital
requirements + after-tax avoidable costs; or
=-cost of new asset – installation cost + sales
proceeds – tax liability from gain on sale (or + tax
savings from loss on sale) – additional currents assets
+ additional current liabilities + expenses avoided –
related tax savings from the expense avoided
Operating = [EBIT (1- tax rate)] + depreciation and
cash flows amortization; or
=NOPAT + depreciation and amortization; or
=EBITDA – taxes + depreciation tax savings
where: EBIT- earnings before interest and taxes
NOPAT – net operating profit after tax
EBITDA- earnings before interest, taxes, depreciation and amortization
Terminal = after-tax proceeds from sale of the new asset +
cash flow release of net working capital; or
=salvage value or proceeds from sale – tax liability
from gain on sale (+ tax savings from loss on sale) –
removal or clean-up cost + reversion of investment in
net working capital
2.3 Capital Budgeting Techniques
Accounting
rate of
return
Note: we will use average investment if problem is silent
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ACYFMG2 Formula
Payback
period
(annuity)
2.3 Capital Budgeting Techniques (cont’d)
Payback
period
(mixed
stream) where: recovery year – year where cumulative cash flow is equal or more than
initial investment
*Unrecovered investment= Initial investment less cumulative cash flows of years
prior to recovery year
Payback
reciprocal
rate
Bailout
payback
period
where: recovery year – year where cumulative cash flow is equal or more than
initial investment
*Unrecovered investment= Initial investment less cumulative cash flows of years
prior to recovery year
Discounted
payback
period
where: recovery year – year where cumulative cash flow is equal or more than
initial investment
*Unrecovered investment= Initial investment less cumulative cash flows of years
prior to recovery year
Net present
value NPV = CF1/(1+x)+..+CFn/(1+x)n-CF0
Where: x – discount rate
Profitability
index
Modified IRR
(combination
) Where: TV- terminal value or positive cash flows compounded to the end of the
project
PV – present value or negative cash flows discounted to the present
Note: we will use combination approach in computing MIRR if problem is silent
Crossover Solve for x:
rate (Fischer NPV of Project A= NPV of Project B
intersection) CF1/(1+x)+..+CFn/(1+x)n-CF0 = CF1/(1+x)+..+CFn/(1+x)n-
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ACYFMG2 Formula
CF0
Annualized
NPV
Equivalent
annual cost
where: net cost is a negative NPV the project
2.4 Capital Budgeting and Risk Analysis
Breakeven
cashflow
Breakeven
point
(accounting)
BEP (cash)
NPV under
risk-adjusted
discount rate
where: RADRproject= Rf + Risk Indexproject [Rm – Rf]
NPV under
certainty
equivalents
where: certain CF = CF x certainty equivalent factor
Value of the = NPV (with options) - NPV (without options)*
option
*except when negative, in which case, value of option is equla to NPV
(with options)
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