Fina 5133 Exam 2 Review Notes Essay

888 WordsJul 29, 20124 Pages
Chapter 9 Cost of Capital 1. What is the WACC? a. Weighted Average Cost of Capital- most firms employ different types of capital, and because of their differences in risk, the difference securities have different required rates of return. Typically=debt, preferred stock and common equity. 2. What precautions must we take when measuring the WACC to use for capital budgeting decisions (future investment)? b. The company’s current and recent past book and market value structures. As well as rates of returns. 3. What do we mean by "target capital structure"? (this is in the Web appendix to Ch. 11) 4. What is the "marginal cost of capital"? 5. Know how to calculate the cost of debt, before and after taxes,…show more content…
discounted payback- discounts the cash flows at the projects cost of capital. c. net present value (NPV)- Sum of all PV of all cash flows i. NPV=PV inflows –Cost ii. The project should be accepted if the NPV is positive because such a project increases shareholder value. d. internal rate of return (IRR) the discount rate that forces a project’s NPV to equal zero. The project should be accepted if the IRR is greater than the cost of capital. e. modified internal rate of return (MIRR) discount rate which causes the PV of a project’s terminal value (TV) to equal PV of costs. f. profitability index (PI) is the present value of future cash flows divided by the initial cost. It’s reciprocal to the cost-benefit ratio. It measures “bang for buck” g. The replacement chain approach- projects with unequal lives. So with this approach, we analyze both projects over an equal life. We repeat project one to equal the life of project B to have a full comparison. h. equivalent annual annuity (EAA) converting annual cash flows under alternative investments into a constant cash flow stream whole NPV was equal to the NPV of the initial stream. i. net present value profile- to make this profile, we find the project’s NPV at a number of different discount rates and then plot thos values to create a graph 2. Explain what is meant by "capital rationing." j. Only occurs when a company chooses not to fund

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