# corporate finance

 crossover rate The return at which two alternative projects have the same net present value. The crossover rate is the discount rate at which the NPV profiles for two projects cross; it is the only point where the NPVs of the projects are the same. With regard to net present value (NPV) profiles, the point at which a profile crosses the vertical axis is best described as: the sum of the undiscounted cash flows from a project With regard to net present value (NPV) profiles, the point at which a profile crosses the horizontal axis is best described as: The horizontal axis represents an NPV of zero. By definition, the project’s IRR equals an NPV of zero. With regard to capital budgeting, an appropriate estimate of the incremental cash flows from a project is least likely to include: Costs to finance the project are taken into account when the cash flows are discounted at the appropriate cost of capital; including interest costs in the cash flows would result in double-counting the cost of debt. The cost of equity is equal to the rate of return required by stockholders after-tax cost of debt For a given company, the after-tax cost of debt is generally less than both the cost of preferred equity and the cost of common equity div discount model (DDM) r=(div/payout%)+g g=growth g=(1-div payout %)(roe) Dot.Com has determined that it could issue \$1,000 face value bonds with an 8 percent coupon paid semi-annually and a five-year maturity at \$900 per bond. If Dot.Com’s marginal tax rate is 38 percent, its after-tax cost of debt is closest to: FV \$1,000; PMT \$40; N 10; PV \$900Solve for i. The six-month yield, i, is 5.3149% YTM 5.3149% 2 10.62985% rd (1 t) 10.62985%(1 0.38) 6.5905% fixed-rate perpetual preferred stock price \$1.75/.065=\$26.92 The weighted average cost of capital, using weights derived from the current capital structure, is the best estimate of the cost of capital for the average-risk project of a company In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is: cost of capital use forecasted market value for both debt and equity asset beta and equity beta Asset risk does not change with a higher debt-to-equity ratio. Equity risk rises with higher debt capital asset pricing model risk free rate+ (beta)*(equity risk premium) cost of capital for equity, there is zero, for debt it is (1-t) cost of capital is market value based, not book value based cost of capital should be forward looking…target capital structure cost of capital preferred stock div/curr price of pfd stock cost of equity cap M is a risk return model cost of equity Capm pricing model is risk free rateXmarket risk premiumXbeta cost cost of equity dividend discount model d/p+g (growth) cost of capital bond yield appproach bond yield plus risk premium degree of operating leverage dol % change in operating income/% change in sales = Q-(P-V)/Q(P-V)-F degree of financial leverage dfl % change in net income/% change in operating income = Q(P-V)-F/Q(P-V)-F-C degree of total leverage dtl % change in net income/% change in sales= Q(P-V)/Q(P-V)-F-C leverage= use of fixed cost (financing or operating) leverage = magnifies the impact of sales volatility on earnings volatility revenue [QXP] Q=Quantity P=Price variability = sales risk -variable costs [QXV] V= Variable … =net sales [Q(P-V))] same as variability as sales -fixed costs[F] presence creates operating risk =pre tax operating profit [Q(P-V)-F] variability = business risk – interest expense[C] presence creates financial risk =taxable earnings [Q(P-V)-F-C]-taxes same volatility as NI = net income bottom line earnings volatility financial leverage and net income financial leverage, all else equal, lowers the level of net income and raises the variability of net income financial leverage and roe financial leverage, all else equal, raises the level and variability of roe breakeven sales quantity Q b e net income=(1-t)[Q(P-V)-F-C] Q b e Q b e = F+C/P-V operating breakeven sales Quantity Q b e operating profit= Q(P-V)-F at breakeven Q b e(P-V)-F=0 Q b e=F/P-V share repurchase made at market value if mv>bv- repurchase will decrease bv per shareif mv
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