Missing steps in Cost of Capital Calc? Anyone else? concepts, versus, noticed, members

lxwarr30

I'm not sure if anyone has noticed but in the Corporate Finance section of book 4 Examples and questions are missing steps.

I know these books are written by diffrent board members but there is a lot less detail covered on how they arrive at certain calculations versus lets say Book 3.

I've had to read Schweser to assist with calculation concepts.

Anyone else notice?

nitoha

Ya I noticed the different writing style too but I don't think it makes any material difference... Since book 4 is easier than book 3, you can arrive at the missing steps on your own...

RobertA

feel free to give any examples of specifically what's messing you up

lc26mizzou

Example of a concept which intuitively seems straight forward where I am hung up a bit in the execution is on Page 70 Book 4. Flotation Costs example.

Unsure why they add 5% to the dividend amount of $2 on the numerator. Can't seem to reference that step. 5% is listed as the growth rate but shouldn't that only be added after?

moving forward to page 71

the third NPV could have shown the steps needed to arrive at the new cost of capital of 7.3578 and PV of $69089

Maybe I don't understand something that should be fundamental.

Any help greatly appreciated. Thanks.

sgupta0827

Page 70 - Notice in the formula, it is D1 i.e. next year's dividend. $2 is this year's dividend so you need to increase it by 5% (growth rate) to get next year's dividend.

Page 71 -
There are basically 2 methods of adjusting for flotation costs:
1. Adjusting cost of equity, re
2. Adjusting initial outlay

For the 3rd NPV, they have shown what happens when you put flotation costs in the cost of equity formula. Like they have shown on the top of this page re = 10.47% by adjusting this re = 10.25 from previous page for flotation costs.

The following calculations are the ones you are looking for in the second example:
Cost of equity calculated was 10%.

Cost of equity adjusted for flotation costs, re = (1/20*(1-0.05)) + .05 = 10.263%
1 - dividend next year
20 - price of stock
5% - flotation cost
5% - growth rate

Find Wacc = .4*.03 + .6*.10263 = .073578

Cashflows of $10,000 for 10 years using this Wacc will give PV of $69089
So NPV = 69089 - 60,000 = 9089

So they are showing that using this method is not a good idea since here the NPV is different from NPV of $7791 shown previously.

Anyway, gist is that stick to the previous NPV method (of adding to initial outlay)... This method isn't that good. That is why probably they haven't shown it. So I wouldn't worry much about it... But yeah, they could have been more explicit here.

thisisbrianly

Anish,
Thankyou for your clear explanation. This will be a section I will need to review. Calculations are a bit of a struggle for me but I see it now.

For page 70 I figured the D1 meant at the year end but didn't see it referenced and wasn't confident enough to assume.

Again much appreciated.