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FNBK 3250 Review Sheet for 3rd exam
CHAPTER 10 COST OF CAPITAL
Calculate cost of each capital source:
After-tax (AT) cost of debt = rd(1 - T), where rd is the before-tax cost of debt and T = tax rate. Likewise, rd = AT/(1 – T). (rd = YTM on bonds)
Cost of preferred stock= rp =Dp/Pp; where Dp is annual dividend payment per share and Pp is the preferred stock price per share.
Cost of Retained Earnings= rs Constant growth model: rs = D1/Po + g; D1 = Do(1 + g) CAPM model rs = rrf + (rm – rrf)b
Cost of New Common Stock (re): D1 re = --------- + g where Pn = net price = Po(1 – F%) or $Po - $F Pn F% or $F= flotation cost per share

re typically higher than rs because of flotation costs.
Weighted Average Cost of Capital (WACC) = wdrd(1 - T) + wprp + wc(rs or re) calculate WACC with retained earnings calculate WACC with new common stock

Capital structure weights (wd, wp, wc) based on book values. The weight is the dollar amount of the capital type divided by total assets. The sum of the weights must equal 100%.

Calculate the breakpoint: the amount of new capital a firm can raise before it uses up its level of retained earnings and has to issue new common stock to finance its investments.

$retained earnings $net income x (1 – dividend payout ratio) Breakpoint = -------------------------------- = -------------------------------------------------------- Common equity weight wc

Determine relevant source of common equity (retained earnings vs. new common) based upon the capital budget and the breakpoint.

CHAPTER 11 BASICS OF CAPITAL BUDGETING
Know the effect of understated/overstated WACC on project

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