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Equity Risk Premium (ERP) and Required Return on Equity

The ERP is the amount of return required by an investor above and beyond the risk free rate, where the risk free rate is commonly the rate of return from a sovereign government bond with a maturity comparable to the investor’s time horizon. Historical Estimates for ERP: this approach calculates the ERP based on historical

Evaluating Capital Structure Policy

Analysts can compare a company’s capital structure to that of its primary competitors. Analysts can also compare a company’s current capital structure to its historical capital structure. If a company is trending toward higher financial leverage, this may signal future bankruptcy. Company management may never publicly state its target capital structure, but the analyst knows

Applications of Cost of Capital

The marginal cost of capital plays an important role in capital budgeting and investment decisions. As a firm raises more and more capital, it’s marginal cost of capital (MCC) increases. However, when a firm makes more investments, the returns from additional investments decrease. This is represented by the investment opportunity schedule (IOS). The MCC schedule

Weighted Average Cost of Capital (WACC) – Practical Example and Issues

In the previous article we review the concept of weighted average cost of capital and its formula. This video provides a detailed example of WACC calculation and also discusses some of the issues while using it. The video also discusses in detail the concept of marginal cost and why a firm can’t finance itself only

Value of a Firm (Using Operating Free Cash Flows)

The value of the firm is measured as the sum of the value of the firm’s equity and the value of the debt. Any firm’s objective is to maximize its value for the shareholders. The value of the firm can be measured as the present value of the operating free cash flows over time. The