The most comprehensive educational resources for finance

Introductory Capital Budgeting Remarks

Capital budgeting is the diligence process that a company performs to determine what investment projects it will undertake. Application of these principles is relevant as an internal corporate finance analyst or as an external debt or equity analyst at a financial services company. Theoretically, a company will only commence projects which are expected to increase

Introduction to Capital Structure and Leverage

Capital Structure A firm’s capital structure represents its mix of capital sources, i.e. its mix of debt financing and equity financing. In theory, companies should seek an optimal capital structure with the objective of minimizing the cost of capital. The cost of capital is typically its weighted average cost of capital (WACC), applying the marginal

Marginal Cost of Capital (MCC) Schedule

MCC Schedule is a graph that relates the firm’s weighted average of each dollar of capital to the total amount of new capital raised. It reflects changing costs depending on amounts of capital raised. As more funds are raised, the cost of various sources of capital can change because of various reasons: The firm may

Estimating the Country Risk (Country Equity Premium)

In developed nations, the beta of a stock adequately captures the country risk (Historical evidence). However, this doesn’t hold true for developing nations. Therefore, the calculation of cost of equity using CAPM requires adding a country risk spread to the market risk premium. This is also called the country equity premium. The Country Risk Premium

Calculating Beta Using Pure Play Method

In the previous article, we learned about how to calculate the beta of a publicly traded company’s stock. However, the same method cannot be used for calculating the beta of a company or project that’s not traded in the market. In this article we will see how to calculate the beta of such a company

Calculating Beta Using Market Model Regression (Slope)

While calculating the cost of equity, it is important for an analyst to calculate the beta of the company’s stock. Beta of a publicly traded company can be calculated using the Market Model Regression (Slope). In this method, we regress the company’s stock returns (ri) against the market’s returns (rm). The beta (β) is represented by

Estimating the Cost of Common Stock

The cost of common equity is represented as re, and it is the rate of return required by the common shareholders. The cost of common equity can be measured using the following methods: 1. Capital Asset Pricing Model (CAPM) 2. Dividend Discount Model 3. Bond Yield plus Risk Premium Method Let’s discuss each of these

Estimating the Cost of Preferred Stock

Cost of preferred stock is the cost that the company has committed to pay to the preferred stockholders in the form of preferred dividends. For a plain vanilla preferred stock (No convertibility or callable features), the cost is calculated as follows: Cost of preferred stock, Where, D = Preferred stock dividend per share P =

Issues in Estimating Cost of Debt

We discussed that the cost of debt for a company can be measured using the YTM or Debt-Rating approach. An analyst faces certain issues while estimating the cost of debt. These issues are discussed below: Floating/Fixed Rate Debt: In our previous article, our calculations assumed a fixed rate for debt. However, in reality, a firm

Calculating Cost of Debt: YTM and Debt-Rating Approach

Cost of debt refers to the cost of financing a company using debt such as a bond issue or bank loan. It is stated as an interest rat rD. Since there is a tax shield on the interest component of debt, the component used in WACC is rD (1 –t) In this article, we will