What capital structure shoudl you assume for capital raises
Always look at the target capital structure, this is what they are likely to be raising int the future.
Waht is the tax rate that you use in the WACC
You use the marginal rate of tax
What are some top down factors that affect the cost of capital
What is this also referred to as
Also referred to as Systematic factor
Capital availability
Market conditions
Legal
Tax
What are some bottom up factors that affect the Waac
Revenue and cashflow variability
Asset nature and liquidity - how quickly could someone get their money out if they needed to
Financial strength, profitability, more profit, interest cover
Security features (features of the debt product itself) calls and puts change the required return on the debt
What is leasing classed as
How woudl you work out the implied interest rate on a lease deal
Leasing is classed as debt financing
You do this from the bank’s perspective.
You work out the irr of the lease contract from the banks point of view.
What is the historical rate of the ERP
You take the mean of the broad based equity index return - government debt return
This means that survivorship bias will increase the ERP estimates
What are the problems with using the ERP historical
Problem is that you don’t know which average to use (geomtric or arethmetic)
Don’t know which risk free rate proxy should be used.
what is the forward approach for the ERP
You estimate the ERP, you do this using surveys and analyst expectations. There is a recency bias to surveys.
What is the dividend method for estimating the ERP
ERP = E(D/V) +E(G) -R
You do the expected return on dividend on average for the index, plus the expected growth of the index, then you take away the risk free rate to get the equity risk premium
What is the macroeconomic model for estimating the ERP
It’s the grinold kroner model
Basically says the dividend yield plus the multiple expansion plus earnings growth which comes from inflation and real earnings growth. This is all subtracted from the expected risk free rate.
You have to make sure that you take away the earnings growth per share
What are the limitations on estimating the ERP
Surveys have recency bias
DDM asssumes constant PE
What is a basic way oyu could estimate the cost of equity
By taking the cost of debt and just adding the equity risk premium onto the cost of debt. This gives you the total cost of equity
What is the three factor farmer french
The cost of equity equal the ris free plus the beta times the equity risk premium plus the size and value premium that you add onto the CAPM formula.
Basically 3 factors
Market size and valeu
What are the 5 factors in a 5 factor farmer french
Market
Size
Value
Profitability
Style
The profitability is robust versus weak
And the style is conservative or agressive
What is the sensitive of the farmer french model to the market in a 3 factor versus a 5 factor
In a 3 factor modle the sensitivity to the market is slightly lower becuase you only have 3 factors to focus on rather than 5
How do you estimate the cost of equity for a private company
For a private company you use the expanded CAPm
This means oyu use a peer public company, which has a beta to the market, so you just do the CAPM for the peer company, and then you add in all the risks assosiated with investing in a private company.
This is called the Specific company risk premium
Size premium is also added which is inversely related to the size of the business
What is the second approach for working out the cost of equity for a private company
You use the build up aproach
You start with the average company, and a beta of one
Then oyu bring in the risk premiums which include:
Size premium
Industry premium
And finally a specific company risk premium
What is the modle for the cost of equity of an EM equity
You use the equity risk premium for the company, plus the exposure to the emerging market times the country risk premium.
You get the equity risk premium for the developed market then just add the exposure to the local risky country
The country risk premium is equal to:
The soverign yield spread over the home country * the volatility of the equity market/the volatility of the bond market
What is the beta of the global CAPM model
You use the volatility of the local market divided by the volatility of the gloabl index.
How can international CAPM be expanded
By using the sensitivity to exchange rates via imports and exports. This si show by Bc and is multiplied by the expected return ont he currency which is measured by the wealth weighted foreign currency index.
