FORMULAE

Stock (a.k.a equity)

Price (or value) of preferred stock1 = D/r

Required rate of return of preferred stock = D/P
Dividend of preferred stock = P*D

Price of (growing) common stock = D1/(r-g)

Required rate of return of (growing) common = D1/P + g
Growth rate of (growing) common = r - D1/P
Dividend next period of (growing) common = P*(r-g)

D1 = Dividend Next Period (paid at end of year, paid next year, paid in a year) = D0*(1+g)
D0 = Dividend this period (just paid, about to be paid, paid last year)

ROE = Return on Equity = g (growth rate, plowback ratze) + dividend rate [both rates in
terms of equity!!!]

ADDITIONAL NOTES: Please note that growth rate is usually expressed in terms of equity (ownership in
the company). If a company is growing at X%, that means its equity increases by X% each year. However,
growth rates are sometimes given in terms of earnings (example: the problem may say that the company
invests 30% of its net income back into the company). Dividend rates are even more commonly expressed in
terms of earning (example: the above company would pay out 70% of its earnings as dividends), and are
generally called “payout ratios” when so expressed. When a problem gives the percentages in terms of
earning, then look to see if it gives the RO When a problem gives the percentages in terms of earnings (net
income), then look to see if it gives the ROE. You can calculate the growth rate with this formula: ROE *
GrowthInTermsOfEquity. You can get the dividend rate in terms of equity with this formula: ROE *
PayoutRatio.

Cost of Capital

WACC = Weighted Average Cost of Capital =

(WeightOfCommonStock*CostOfCommon) + (WeightOfPreferredStock*CostOfPreferred)
+ (WeightOfDebt*AfterTaxCostOfDebt)

After Tax Cost of Debt = PreTaxCostOfDebt*(1 – MarginalTaxRate)

Total Capital = MarketValueOfCommonStock + MarketValueOfPreferredStock +

MarketValueOfDebt

Weight of Common Stock = MarketValueOfCommonStock/TotalCapital

Weight of Preferred Stock = MarketValueOfPreferredStock /TotalCapital
Weight of Debt = MarketValueOfDebt /TotalCapital

1
Preferred stock formulae also work for non-growing common stock.
Net Value of a Security (common stock, preferred stock, or debt) = Value*(1 –
FlotationCost)

Cost of Common Stock = D1/NetValueCommonStock + g

Cost of Preferred Stock = D/NetValuePreferredStock
Pre-tax Cost of Debt = Find “i” for debt using calculator, but plug in the Net Value instead
of the market value
After-tax Cost of Debt = PreTaxCostOfDebt*(1 – MarginalTaxRate)

Capital Budgeting

Know how to find IRR and NPV using the calculator.

NPV (net present value) is the sum of the present value of all cash inflows and outflows
across all points in time. If NPV is positive, then you should invest in the project. If NPV is
negative, you should not invest.

IRR (internal rate of return) is the rate of return necessary to make the NPV zero (you
would be indifferent between investing or not). If your required rate of return is higher than
IRR, then your NPV will be negative and you should not invest. If your required rate of
return is lower than IRR, then your NPV will be positive and you should invest.

PI (profitability index) = NPV/InitialInvestment + 1 . (For the purposes of this formula,

express your initial investment as a positive number). When PI > 1, accept the project.
When PI < 1, reject the project. When PI = 1, you should be indifferent between accepting
and rejecting the project (this is because NPV will be 0).

When operating under capital constraints, you should pick the set of projects within your
budget constraints that will maximize total NPV. This may take come guess-and-check
work.

With MIRR, find the present value (value at time 0) of all cash outflows (negative
numbers). Then, find the future value (value at the time of the last period) of all cash
inflows (positive numbers). Once you have the future value and present value, you can plug
the information into your calculator to find “i.”

Cash Flows

Keep in mind the accounting formula you were given.

A few quick notes:

Do not account for the change in a value when dealing with EBT or operating cash flows—
just deal with the values themselves. The only item you should be tracking the change for is
the change in working capital.

When finding the terminal free cash flow, add the following steps:
a. Add back in the salvage value of any equipment. Don’t forget to subtract
out the taxes you pay on the sale of that equipment.
b. Don’t keep track of the change in working capital. Add back in the total
working capital that was dedicated to the project at the time of the terminal
cash flow. The project won’t need it anymore.

Calculate the NPV by feeding all the cash flows into the NPV function of the calculator.