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Cost of equity
The return a firm must earn on its equity to satisfy its shareholders.
Security Market Line (SML)
A graphical representation of the Capital Asset Pricing Model (CAPM) which depicts the relationship between systematic risk and expected return.
Weighted Average Cost of Capital (WACC)
A calculation of a firm's cost of capital in which each category of capital is proportionately weighted.
Market risk premium
The additional return expected from holding a risky market portfolio instead of risk-free assets.
Pre-tax cost of debt
The interest rate a company pays on its existing debt before taking taxes into account.
After-tax cost of debt
The actual cost of debt after accounting for the tax deductibility of interest payments.
Venture capital
Financing for new firms which generally entails high levels of risk.
Red Herring
A preliminary prospectus for a security offering that includes important but incomplete information.
Tombstone
Advertisements in a financial newspaper announcing a public offering of securities and listing the investment banks handling the offering.
Seasoned Equity Offering
The sale of newly issued equity shares by a firm that is currently publicly owned.
Underwriter
An entity that buys shares from the issuer and sells them to the public.
Firm Commitment Underwriting
A type of underwriting where the issuer sells the issue to a syndicate, which resells it to the public and assumes the risk of unsold shares.
Shelf Registration
Allows a corporation to register a large issue with the SEC and sell it in small portions, reducing flotation costs.
Green Shoe Provision
Allows the underwriters to purchase additional shares from the issuer in the event of oversubscription.
Lockup Agreements
Restrictions that prevent insiders from selling their shares of an IPO for a specified time period.
Best Efforts Underwriting
An underwriting agreement where the underwriter must make their best effort to sell the securities at an agreed-upon price.
Types of Issuance Costs
spread, other direct expenses, indirect expenses, underpricing, Green Shoe option
Types of long-term debt
Bonds, private issues, term loans, private placements
All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line (CAPM) approach? Assume the firm currently pays an annual dividend of $2.10 a share and has a beta of 1.1.
an increase in the market rate of return
When calculating the weighted average cost of capital (WACC) an adjustment is made for taxes because
interest on debt is tax-deductible, reducing the overall cost of capital.
What best describes the role of taxes on the after-tax cost of
capital in the U.S. from the different capital sources?
Common Equity Preferred equity Debt
A) No effect No effect Decrease
Assume that a company has equal amounts of debt, common stock, and preferred stock. An increase in the corporate tax rate of a firm will cause its weighted average cost of capital (WACC) to:
fall
interest paid on corporate bonds in the US is
tax deductible, so the after-tax cost of debt capital is less than the before-tax cost of debt capital.
Dividend payments are
not tax deductible, so taxes do not decrease the cost of common or preferred equity.
What is an underlying assumption of the dividend growth
model?
A stock's value is equal to the discounted present value of the future cash flows which
it generates.
a decrease in all stock values
based on the dividend growth model, if you expect the market rate of return to increase across the board on all equity securities, then you should also expect:
Early stage financing consists of these 3 parts:
friends & family, angel investors, venture capital
Advantages of Direct listings
cost effective, fast process, liquidity to owners who wish to cash out, no dilution of existing stockholders
Disadvantages of Direct listings
no research analysts, no road shows, no investment banks to help price the stock-less transparency for investors
Types of Long-term Debt
Bonds, Private issues
What are the 2 types of private issues
Term loans, private placements
why does underpricing exist?
to induce more investors to participate in the IPO
