CORPORATE FINANCE CHEAT SHEET

CAPITAL BUDGETING

Decision Rules (Ranked)

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For Mutually Exclusive Projects

When NPV and IRR conflict → Choose NPV (higher NPV is correct). Conflict occurs due to scale or timing differences in cash flows.

NPV Formula

$$\text{NPV} = \sum_{t=0}^{n} \frac{\text{CF}_t}{(1+r)^t} - \text{Initial Investment}$$

Key Cash Flow Adjustments

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COST OF CAPITAL

WACC Formula

$$\text{WACC} = \frac{E}{V} \times R_e + \frac{D}{V} \times R_d \times (1-T)$$

E = Market value of equity | D = Market value of debt | V = E + D

Tax shield factor (1 – T) applies only to debt (interest is tax-deductible)

Use market values, not book values

Cost of Equity: Three Approaches

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Best practice: Triangulate across all three; CAPM most commonly used.

Cost of Debt

Rd = YTM on company's new bonds (not coupon rate of old debt)

Pre-tax cost, then apply (1 – T) adjustment in WACC

No tax adjustment for preferred stock dividends

Cost of Preferred Stock

$$R_p = \frac{D_p}{P_0}$$

No tax adjustment (paid from after-tax dollars).

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EASILY CONFUSED PAIRS

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NPV	Accept if NPV > 0	Theoretically correct; accounts for TVM; assumes reinvestment at WACC (realistic)	Requires WACC estimate
Method	Decision Rule	Strengths	Weaknesses
IRR	Accept if IRR > hurdle rate	Intuitive %; comparable across projects	Fails with multiple sign changes; wrong ranking on mutually exclusive projects; unrealistic reinvestment assumption
MIRR	Accept if MIRR > hurdle rate	Corrects IRR reinvestment flaw; realistic	Less intuitive than IRR
Payback	Accept if payback < threshold	Simple; measures liquidity	Ignores TVM; ignores cash flows after payback; theoretically inferior
Include?	Item	Why
❌ Exclude	Sunk costs	Already spent; unrecoverable; not incremental
✅ Include	Opportunity costs	Foregone alternative benefit; true economic cost
✅ Include	Cannibalization	Lost sales on existing products; negative CF
✅ Include	Changes in working capital	Incremental investment/recovery
❌ Exclude	Financing costs	Reflected in discount rate (WACC), not CF
Method	Formula	Key Input
CAPM (primary)	Re = Rf + β(Rm – Rf)	Estimate market risk premium (4–6%)
DDM	Re = D₁/P₀ + g	Estimate sustainable growth rate g
Bond yield + spread	Re = YTM + spread	Typical spread 3–5%
Concept A	Concept B	Distinction
Coupon rate on old debt	YTM on new debt	Use YTM for cost of debt; coupon is historical
Book value weights	Market value weights	WACC uses market values (opportunity cost)
Payback period	Discounted payback	Both ignore terminal CF; DB applies TVM
Sunk cost	Opportunity cost	Sunk = exclude; opportunity = include
IRR (assumes reinvest at IRR)	MIRR (assumes reinvest at WACC)	MIRR is more realistic; IRR distorts ranking
Interest tax shield	No tax benefit on equity	Debt is tax-deductible; equity dividends are not

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HIGH-YIELD EXAM RULES

✅ Always use incremental cash flows in NPV ✅ Always use market values in WACC weights ✅ Always choose NPV for mutually exclusive projects, even if IRR disagrees ✅ Exclude sunk costs; include opportunity costs ✅ Debt gets a tax adjustment (1 – T); equity does not ✅ WACC is the discount rate for capital budgeting (hurdle rate)

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QUICK CALCULATIONS

Payback period (simple): Cumulative CF until initial investment recovered (no discounting) NPV > 0 → Accept; NPV < 0 → Reject IRR = r where NPV = 0 (solve by trial-and-error or calculator) WACC = weighted blend of all capital costs (most important formula in corporate finance)

Corporate Finance