Advantages and disadvantages of financing by equity and debt

In business world, debt financing is paradoxically cheaper than from equity, because: the cost of debt is interest, which is lower than the dividend (profit sharing) paid to shareholders – it is mainly due to the fact that equity holders are satisfied in case of liquidation either after deb

The indicator of overcapitalization / undercapitalization

The indicator of overcapitalization / undercapitalization is one of the indicators of indebtedness and financial structure and possibly also liquidity. The ratio indicates the proportion in which are fixed assets financed by long-term funds. The analysis provides similar result as the analysi

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

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

Weighted average cost of capital (WACC)

WACC is the mixed cost rate of all possible sources of finance that the company uses (equity, debt, preference shares, retained earnings…). It is calculated as the sum of the rates for each capital type that are weighted by the proportion of each capital type on the total capital amount. WAC

Unlevered beta

Unlevered beta is beta of the traded company exposed to the similar business risk as our company or our new investment which has been adjusted (unlevered or ungeared) for the effect of financial risk by using a formula (41):     βu – unlevered beta βi – beta of

Net working capital

Net working capital is obtained by subtracting short-term borrowings from (gross) working capital.   Calculation formula working capital - short-term borrowings = current assets - short-term borrowings = long-term debt capital + equity – non-current assets   General interpretati

Debt-service coverage ratio (DSCR)

Debt-service coverage ratio (DSCR) is one of the indicators of indebtedness and financial structure. It shows the proportion of cash-flow (calculated simply from profit after tax) for the reporting period on all future installments of loans, including interest payments.   Calculation for

Unsystematic risk

Unsystematic risk is the diversifiable risk specific to the considered company, e.g. risk resulting from geographic location. Since unsystematic risk is diversifiable risk, the risk can be eliminated by holding a well-balanced portfolio and the total risk is equal just to the level of systematic ris

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

Coefficient beta

Coefficient beta (β) is a measure of systematic risk of the company and its shares compared to systematic risk present in the market. In other words, it measures the proportion of undiversifiable risk present within the company capital that is compared to the overall market (systematic) risk. B

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

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