MBA 643 - Notes

TVM EAR (1+r)n-1 Annuity - PVIFA = ( 1 – (1/(1+r)n)/r FVIFA = ((1+r)t -1)/r Growing Annuity - PVo = (C1/ r – g) - ((C1 ( 1 + g )t/( 1 + r )t)/r – g) Bond Valuation Fisher 1+R = (1+r) (1+h) R- Nominal, r= real, h = inflation, EAR

= (1+(APR/m))m -1 Stocks Valuation Po = Div1/r, Po = Div1/(r-g), Est. Growth Rate g = retention ratio x return on ret earnings, r = Div1/P0 + g = dividend yield + growth in earnings (or growth of dividends or capital gains yield)Just before dividend is paid – Pt = Pt + Div-t CAPM Expected Return on Single Security  P R Variance = R N M N Expected Return on Portfolio R p =  W i Ri or R p =  P j R pj Variance [ R pR  Pj [ R pj  R p ]2  P = 2 ]
N j 1 j j

2

N

2

Variance for 2 stock portfolio =  2 = W 2  2 +W 2  2 + 2 W A W B  A,B Co-variance  A,B =  P j [ R Aj - R A ][ RBj - R B ] Corr. of Return  A,B = A A B B  A B j=1 CAPM Assumptions - Riskless Borrowing and Lending, Homogenous Expectations, Security Market Line, The Capital Asset Pricing Model
i=1

j=1

j 1

j

j

j 1

N

 A,B

Riskless Borrowing and Lending – Separation Principle, CML, Opportunity set, R port

 Wrf xRrf  Wriskyport x R riskyport
2 m

& 2port = W2risky port x 2risky port

Homogenous Expectations - TOTAL RISK OF A STOCK = SYSTEMATIC + UNSYSTEMATIC RISK i = i,m / 

SML – Beta Vs Return, Beta = 0 should earn risk free rate, Beta =1 for all risky asset market portfolio, relation is linear and is CAPM CAPM - R i  R f   i x[ R m  Rrf ] Return on portfolio E(P) = Wa * E (a) + Wb * E(b) Beta of portfolio = Wa * Beta(a) + Wb * Beta(b) BETA is measure of systematic risk. Capital Budgeting NPV, Payback Period, Discounted Payback Period, IRR Discount rate which makes NPV = 0. , Mutually Exclusive projects – The scale problem – IRR Ignores the scales Vs NPV, Use incremental IRR – Sum the cash flows and calculate NPV of increments. Incremental IRR > Required Rate of Return The timing problem – Two projects NPV profiles may intersect each other. PICK project with higher NPV along the curves

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