Discounting is the method that transforms future value (future cash flows) into present value (PV).  Because of the time value of money concept, the present value of equivalent future value is lower because money possessed now is worth more than those earned in the future (it is not certain and

Systematic risk

Systematic risk is the undiversifiable risk to which are exposed all companies in the market. An example can be the risk of changes of most macroeconomic factors. (43) The fact that systematic risk cannot be diversified does not mean that it cannot be dealt with – it can be for example insured

Hurdle rate

Hurdle rate is the minimum return rate that the company wants to exceed when it undertakes an investment project. It is often (but not always) the company´s cost of capital (WACC). Hurdle rate is therefore often used as a discount rate in DCF calculations and the project´s IRR % shall ex

Capital Asset Pricing Model (CAPM)

Capital Asset Pricing Model (CAPM) is used to calculate the expected rate of return on particular security.  As such, it is used to estimate the cost of equity. The variables of CAPM can be drawn by Security market line (SML).   CAPM formula: risk-free rate + β * market risk premiu

Cost of retained earnings

Retained earnings are the profit that has not been distributed to shareholders and it is certainly not for free.  It is the money that could have been paid out as dividend, but was not – probably due to the fact that the stockholder was not able to achieve better return on investments tha

Risk adjusted WACC

Risk adjusted WACC is the adjusted WACC which is used to evaluate projects exposed to different systematic business risk than other activities currently undertaken by the company. The steps used in calculation are (41): 1. Find beta of traded company with similar business characteristics (and the

Cost of capital

Cost of capital is the cost rate of the funds that the company uses as its capital, therefore the rate that mixes costs of various sources of finance. It usually has the form of Weighted Average Cost of Capital (WACC), but all the components mentioned below can be also called with the broader term &

Security market line (SML)

Security market line (SML) reveals the relationship between the level of systematic risk and the expected return and as such presents the outputs of Capital Asset Pricing Model (CAPM). The slope of the curve represents coefficient β. (42) SML line is used to derive expected (= well priced) ret

Cost of equity

Cost of equity (COE) is: the return required by the shareholders the component of cost of capital (WACC) Cost of equity can be calculated by using several methods, each of which may result in different cost of equity rates: CAPM – Capital Asset Pricing Model Dividend discount model

Cost of debt

Cost of debt is: the return required by the debtholders the component of cost of capital (WACC)   Cost of debt is the interest paid reduced by the tax deduction on the interest.    Cost of debt is calculated separately for each type of debt: irredeemable debt redeemable

Marginal cost of capital (MCC)

Marginal cost of capital (MCC) is the rate calculated based on the same formula as WACC, but compared to WACC considers both the existing capital finance as well as all the effects of undertaking the project.   Therefore, there are two adjustments to traditional WACC to obtain MCC recalcul

Discounted cash-flow (DCF)

Discounted cash-flow is the technique based on the concept of time value of money on which a number of investment appraisal methods are based. It comes out from future relevant cash-flows projections, discounts them to present value which is further used to calculate for example: Net present valu

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