WACC- Weighted average cost of capital, annual percentage cost of financing a project of average risk. The WACC is not a reflection of all projects and divisions only for specific projects. Factors that affect WACC- Market conditions, firm’s capital structure, firm’s investment policy. Riskier policies= Higher WACC Ways companies can raise common equity- Issue new shares of common stock, reinvest earning that are not paid out as dividends. CAPM- Rs= Rrf+B(Rm-Rrf); Rrf+B(RPm)
DCF- Rs= D1/Po+G
Project risk= Stand alone risk, Corporate risk, and Market risk. Steps in capital budgeting- Estimate cash flows, assess risk of cash flows, determine required return, evaluate cash flows. NPV= CFo + (CF1/(1+r)^1) + (CF2/(1+r)^2) +….
IRR= internal rate of return on a project. MIRR= The % return on a project if the cash flows are reinvested at the cost of capital. Mutually exclusive= if one project is taken then the other must be rejected. Normal CF= initial cost of project followed by series of positive CF. Nonnormal CF= CFs of project switch back and forth from positive to negative. Incremental CF- Sunk costs are irrelevant, Opportunity costs are relevant Cannibalization- If a new product line were to decrease the sales of the firms other products. (Externality) Always adjust for inflation when estimating cash flows. Risk in Capital Budgeting means an uncertainty in the projects future returns or CFs. Stand alone Risk- The projects risk if it were its firms only asset, ignores firm and shareholder diversification. Corporate risk- reflects projects effect on stability of firms CFs. Considers firms other assets, Market risk- Reflects projects effect on a well diversified stock portfolio. Measured by projects market beta. Scenario analysis- considers several possible outcomes, usually worst case, most likely case, and best case Sensitivity analysis- Shows how changes in single cariable such as unit sales affect NPV or IRR Sensitivity and scenario only measure stand...
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