Professional Documents
Culture Documents
)
capital structure (debt vs. equity), working capital
management decision (CA, CL; capital structure can affect
the value of the assets, e.g. tax deductibility of interest)
Risk: To determine whether return is adequate, compare to
benchmark
r tr avg
r D ( 1T c )
rD
D
E
+r
V EV
t=1
D1
>r
P0 E
D
r^ e = 1 <r E
P0
r^ e =
Estimate
WACC=
Covariance
S
r ir ) 2Pi=
( XY )= XY X Y
Pr ( s )( R i ,sE ( R i ) )( R j ,s E ( R j ) )
s=1
Correlation coefficient =
XY
X Y
=1.0
(standardizes
cov (r i , r m)
2
M
i M
2
M
o Operational leverage: higher proportion of market portfolio. You cannot combine points on the CML to get
anything lower than a weighted average S.D. their
fixed costs of production and lower variable
correlations are +1.
costs = higher operational leverage =
Market portfolio: portfolio at the tangent line of the risk free
change operating profit
asset with the efficient frontier of all risky assets available
(included in proportion to their market value, and because all
change sales
risky assets are included, it is a completely diversified
Financial Risk (bankruptcy risk): higher cost of
portfolio)
financing, higher financial leverage; In absence of tax,
For market portfolio, M =1
<1: less systematic risk than market
>1: more systematic risk than market
Determinants of (stable if stays in the same
A=
D
D
D
E
D +
E =
E , E= A (1+ )
D+ E
D+ E
D+ E
D
Goal:
shareholder wealth maximization maximize by 1.)
3.
PMT1
Annuity PV =
1
( 1+r )t
r
PV Annuity due= Annuity PV( 1+r )
n
PMT(1+ r) 1
Annuity FV =
r
FV Annuity due= Annuity FV(1+r )
Growing annuity
payment1(
PV =first
1+ g n
)
1+r
rg
PV =
C ( period payment )
r
Growing perpetuity
PV =
C1
rg
EAR=[1+
APR m
] 1
m
year
Different types of loans
1.) Pure discount loans: interest and principal payment made
at the end
, r^ e
D1
+g
p0
(estimate dividends
) = required returns
(from CAPM) r E ,
Required return = Dividend yield + Capital yield
Stock prices (decided by expected future CFs) change
because:
Bond: long-term debt instrument sold to raise money
(creditor); coupon: periodic interest payment, par-value: face 1. r E could change: R E=R f + i ( RmR f ) , and
value of a bond, maturity: specified date on which the bonds
Rf =r (real risk free interest rate)+inflation premium
par amount is paid, term: time remaining until the principal
2. g could change due to macroeconomic or firm-specific
repayment made
situation
Callability: issuer can redeem the bond before it matures
Corporate value model: value of the entire firm = PV of the
Sinking fund: pool of money set aside to help repay a bond
firms free cash flows, i.e. use DCF to find value today; MV of
issue, allow repurchasing its bonds periodically and at a
firm = PV of the firms future CFFA; MV of common stock =
specified sinking fund price pay off loan over life; Bond
MV of firm MV of firms debt preferred stock; Intrinsic
indenture: contract between company and bondholders
stock price = MV of common stock / # of shares [method is
1
Coupon1
preferred to dividend growth model, esp for firms that dont
N
(1+r d )
pay dividends assumes that free cash flow will grow at
Bond-value (PV) =
Face Value
+
N
constant rate]; TV n represents value of firm at the
rd
(1+r d )
point that growth becomes constant: for corporate project
Overall rate of return =
and corporate valuation model, dividends and interest
Annual Coupon+(Current pricebeginning price)
expenses should NOT be included in the estimate of relevant
CFs (financing effects are accounted for by the discount rate
Beginning bond price
using WACC)
Yield to maturity (bonds yield): rate earned if a bond is
All CFs must be on an after-tax & incremental basis.
held to maturity, interest rate required in the market on the
Whether to undertake a project (TVM? Risk-adjusted? +
bond, rate implied by current bond price; yield which equates
value?):
the PV of all cash flows from a bond to the price of a bond;
1. NPV decision making: a. Estimate the expected cash
increases with inflation useful for comparison with other
potential investments with the same risk level: Bond pricing flows, b. Estimate the required return for projects of this risk
theorem: bonds of similar risk (and maturity) will be priced to
yield about the same return (the same YTM), regardless of the
coupon rate
-Price of bond (premium) > face value if coupon rate >
discount rate
-YTM < Current yield < Coupon rate: bond sell at premium
-Price of bond (discount) < face value if coupon rate <
discount rate
-Coupon rate < Current yield < YTM: bond selling at discount
Current yield: annual interest paid a by a bond, expressed as
a % of its current market price doesnt care about capital
gain/loss
Bond rating affected by financial performance, bond contract
provision
Floating rate bonds coupon rate depends on some index
value less price risk, coupon less likely to differ from the
YTM
Term structure: relationship between time to maturity and
yields, for bonds of the same risk and holding all else equal
(default risk)
**when solving questions, I/Y = (YTM + i/r change) / number of
periods
Longer maturity + lower coupon rate bond more i/r sensitive
Factors that affect bond yields: real interest rate, expected
future inflation, interest rate risk, default risk, taxability, lack of
liquidity
Value of bond = PV of expected CFs =
D t +1
D t +2
^
Pt =
+
+
(1+ r E ) (1+r E)2
P 0=
D
rE
D1
; limitation: r E > g
r E g
P0=
D 0 (1+ g)
=
r Eg
NPV =
t=1
CF t
(1+r )t
CF 0
(difference
Total PV of futureCFs
Initial Investment
L
SM ( S1 )(RR)
S0
A
S
S0
*Ta
ke the average for A/P, inventory, A/R
Minimizing cash cycle = minimizing external financing
A/P period = Payables deferrable period = 365 / Payables
turnover
Payables turnover =
C+
X
=S0 +P
T
(1+ r f )
P=C +
X
S 0
(1+r f )T
max ( S0 X , 0 ) C 0 S0
Time value of an option (speculative premium)= difference
between the option price and the intrinsic value; most of time
value is volatility value
In the money: option with positive intrinsic value
Call
Put
Stock Price
+
Exercise
+
Price
Interest rate
+
-