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FINMAN2 FINALS REVIEWER by Leona Sanchez

NOTE: unless specified, assume the ff: (i) interest rates are quoted on an annual basis, (ii) cash flows occurs at the end of each period, (iii) annuities are simple

Chapter 5 & 6: Time Value of Money SIMPLE INTEREST: Future Value (FV) FV=PV*(1 + ) where: i=interest rate n= no. of periods

End of the year 1 2 3 4 5 Total

CF

PVIF5%,n

PV of CF

NOMINAL &EFFECTIVE INTEREST RATES EAR or APY=1 + (


)

1 + ) = ,

Present Value (PV) PV=FV*(1 + ) where: (1 + ) = , COUMPOUNDING INTEREST and MIXED STREAM: Future Value (FV) FV=PV*(1 + ) where: i=interest rate n= no. of periods m=compounded periods Present Value (PV) PV=CF*(1 + ) End of the year 1 2 3 Total ANNUITIES: ORDINARY ANNUITY Future Value of Annuity (FVA) 1 FVA=PMT*[( ) (1 + ) -1] where: [( ) (1 + ) -1] =FVIFA

FOR CONTINOUS COMPOUNDING EAR or APY= 1 DEPOSITS NEEDED TO ACCUMULATE FUTURE SUM PMT= LOAN AMORTIZATION PMT= where: DP=down payment Period 1 2 PVIF(5%,n) PV of CF Loan Payment PMT PMT BP FVA Interest I1 I2 I3 P PMT-I1 PMT-I2 PMT-I3 EB Ending bal 1 Ending bal 2 Ending bal 3

CF (PHP)

Ending bal 1 3 PMT Ending bal 2 where: BP=Beginning Principal P=Principal EB=Ending Balance PMT= I1=PRT I2=EB1*i I3=EB2*i FVA-(PMT-I1)=EB1 EB1-(PMT-I2)=EB2 EB2-(PMT-I3)=EB3

Present Value of Annuity (PVA) 1 PVA= PMT*[( ) (1 (1 + ) ] where: [( ) (1 ( ) ]=PVIFA

FINDING INTEREST FOR A SINGLE SUM FVIFi,n = , = FINDING INTEREST FOR ANNUITY FVIFAi,n = or PVIFAi,n = FINDING THE NUMBER OF PERIODS FOR A SINGLE SUM FVIFi,n = , = FINDING THE NUMBER OF PERIODS FOR ANNUITY FVIFAi,n = , = Chapter 7 & 8: Risk and Return RANGE Range=|Optimistic Case-Pessimistic Case| RISK MEASUREMENT OF STANDARD DEVIATION

ANNUITY DUE Future Value of Annuity (FVA) 1 FVA=PMT*[( ) (1 + ) -1] *(1+i) where: [( ) (1 + ) -1] =FVIFA

Present Value of Annuity (PVA) 1 PVA= PMT*[( ) (1 (1 + ) ]*(1+i) where: [( ) (1

( ) ]=PVIFA

DEFFERED ANNUITY PVA=((PMT*PVIFAi,n)*PVIFi,n) PERPETUITY: PV= where: PP=cost of stock*dividend rate COMPLEX STREAM: PV=CF*PVIFi,n

=
=1

( ())2

or

=1

( ())2 1

where: =

k(bar)=expected value of the asset


=

where: () =
= = =

n=number of outcomes k(bar)= or

=1

PORTFOLIO BETA
= where: =

k(bar)= ( =1 )/ RISK MEASUREMENT OF COEFFICIENT OF VARIATION


CV= ( )

RISK-FREE RATE
() ( ())2 ( ())2 =k*+IRP(k*xIRP)

k(bar)

where: k*=real estate of interest IRP=inflation rate Compounding period Semi-annually Quarterly Bi-monthly Monthly Semi-monthly Weekly Daily # of times in a year (m) 2 4 6 12 24 52 365

Total of ( ())2

The higher , . Portfolio Risk


(ba

r)

k_p-k_p (bar)

( ())2

Pr

Chapter 9: Valuation & Characteristics of Bonds where: = + K=(( ())2 *Pr) Total of ( ())2 *Pr
2

CURRENT YIELD (CY) CY=


where: Annual Interest Payment=Par value*coupon interest rate BASIC VALUATION MODEL V= 1+ +
1 2 1+ 2

Return is the total gain or loss experienced on an investment over a given time horizon. RETURN ON ASSET ( )
= 1 + 1 + 1 1

++

1+

BOND VALUATION GENERAL FORMULA:

or
=

=
=1

(1 + )

where: =

(1 + )

1 = 1 = =

FOR COUPON BONDS:


= , + ,

HOLDING PERIOD RETURN (HPR) HPR= where: EV=Ending Value CF=Cash Flow(s) BV=Beg. Value HOLDING PERIOD YIELD (HPY) HPY=HPR-1 ANNUAL HPY
+

where: I=Interest (Par value * Coupon rate) M=Par value kb=required return n=years to maturity BOND PRICE (BP) BP= 1+ where: YTM=Yield to Maturity
+

AHPY= 1 where: n=no. of years of investment Arithmetic Mean=


1

Geometric Mean=[1 2 ] Capital Asset Pricing Model (CAPM):

-1

EXPECTED OR REQUIRED RETURN ON ASSETS ( )


=

As kb increases, Vb decreases

BOND VALUATION: INTEREST IS PAID MORE THAN ONCE A YEAR GENRAL FORMULA:

ZERO-GROWTH MODEL
= 1 =

=
=1

+ (1 + ) (1 + )

where: kps=required return preferred stock CONSTANT-GROWTH (GORDON) MODEL


=
1

1+

FOR COUPON BONDS:


= , + ,

where: g=projected growth rate D1=expected/projected/future Do=current/historical/past D=par value*interest on dividends PRICE/EARNINGS (P/E) MULTIPLE APPROACH Vcs=Expected EPSfirm x P/E Ratioindustry = #

YIELD TO MATURITY (YTM) YTM=


1+

1 1

YTM default=

1+

YTM expected=(YTM no default*(1-Pd))+(YTM default*Pd) where: Pd=Probability of default


Approx. YTM= [ + ]*m

where: EPS firm=Estimated earnings per share of firm NIAT=Net income after taxes PD=Preferred dividends EXPECTED RATE OF RETURN kps(bar)= kcs(bar)= +g where: D=dividend Po=selling price of stock RATE OF GROWTH IN DIVIDENDS g=retention ratio (b) x rate of return on equity (ROE)
formula:
1 1

YTM= + [

| |

( )

where: = ; = Steps for Promised YTM


Step 1: Compute for Approx. YTM then get the round down and up of the value. Step 2: Use round down and up of the value in this
= , + ,

Step 3: Find the difference between the bond values got in step 2. Step 4: Find the absolute difference between the desired value and the bond value associated with the lower rate Step 5: Divide the answer in step 4 and step 3 Step 6: Multiply the answer in step 5 by the interval width. Step 7: Add the answer in step 6 to the lower rate.

where: b=1-1

=dividend payout ratio reflecting the ratio of cash dividends to be 1 paid next period divided by the firms earnings NOTE: make an investment if expected return > required return Chapter 14: Cost of Capital
Steps in determining the cost of capital 1. Calculate the specific costs of capital. 2. Determine the break points. 3. Compute for the WACC/WMCC. 4. Prepare an IOS. 5. Decide which projects to accept.

DURATION (D) D=

1 (1+ )

MACAULAY DURATION (MD) MD= T 1 2 2


1 ++

COST OF LONG-TERM DEBT (kd) Weights (W)


100 ( )

CF I I P

PVIFkb,t See FT

PV of CFs PVIF*C F T(PV of CFs)

WM
( )

BEFORE-TAX: kd=
+
+ 2

T(W)

Duration (D)

where: I=par value x coupon interest rate M=par value Nd=selling price of bond n=age of bonds AFTER-TAX: kj=kd*(1-T) where: T=tax rate COST OF PREFERRED STOCK kp= where: Dp=dividend % x selling price of stock Np=selling price of stock cost of issuing COST OF COMMON STOCK ks= + GORDON MODEL ks=Rf + [b*(km-Rf)] CAPM
1

where: I=AIP(Coupon bond rate*par value) P=Par value or Principal Lower D=less sensitive to interest risk STOCK VALUATION SINGLE HOLDING PERIOD MODEL
1 1 + = (1 + ) 1 +

where: D1=expected dividends P1=projected market price kb=kcs=required return common stock = security value

where: D1=expected dividend Po=market price of cs g=growth rate Rf=risk-free rate COST OF RETAINED EARNINGS kr=ks COST OF NEW ISSUES OF COMMON STOCK kn= + = 1 + where: Nn=net proceeds Po=market price F=quotation cost BREAK POINT It is a level of total new financing at which the cost of one of the financing component rises. BPj=
1 1

DISCOUNT PAYBACK PERIOD (DPP) DPP= A discounted +| | Accept: DPP Year FCFs PVIFi,n PV of FCFs A=year when last negative CFCF occurred b=last negative CFC occurred c=last FCF NET PRESENT VALUE (NPV) NPV=
=1 1+

Cumulative PV of FCFs

Accept: NPV 0 Year FCFs PVIFi,n *then Total of PV of FCFs less Initial Investment to get NPV If Annual FCFs are constant: Annual FCFs Multiply: PVIFAi,n Total PV of FCFs Less: Initial Investment NPV PROFITABILITY INDEX (PI)
=1 PI= 1+

PV of FCFs

XX XX XX XX XX

where: AFj=amount of financing Wj=weight WEIGHTED AVERAGE COST OF CAPITAL (WACC) ka=(wj*kj) + (wp*kp) + (ws*k r or n) where: w=weight WEIGHTED MARGINAL COST OF CAPITAL (WMCC) Range of total new financing 0 to 600K >600K 1M >1M to Source Capital LTD PS CS LTD PS CS LTD PS CS of Weight 0.4 0.1 0.5 0.4 0.1 0.5 0.4 0.1 0.5 Cost (%) 5.53 10.61 13 5.63 10.61 13.99 8.40 12 13.99 Weighted Cost (%) 2.252 1.061 6.5 2.252 1.061 6.995 3.360 1.200 6.995

Accept: PI 1

*Use total PV of FCFs in NPV then divide it by the initial outlay INTERNAL RATE OF RETURN (IRR) MIXED STREAM: =1 IRR= 1+ = ANNUITY: IRR= Accept: IRR required return Year FCFs PVIFi,n PV of FCFs *our target here is find the i that will make NPV equl to zero MODIFIED INTERNAL RATE OF RETURN (MIRR)

Chapter 11: Capital Budgeting


STEPS IN THE CAPITAL BUDGETING PROCESS Step 1: Proposal generation Step 2: Review & analysis Step 3: Decision making Step 4: Implementation Step 5: Follow-up

1 + = 1 + 1 +
=0

Or

MIRR=PV outflows= 1+ Accept: MIRR required return Year FCFs FVIFi,n FV of FCFs *Total of FV of FCFs divided by Initial Investment to get FVIF i,n; [FVIFi,n=(1 + ) ] to get exact MIRR Chapter 12: Cash flows & other topics in capital budgeting INITIAL OUTLAY Cost (purchase price) of the asset Add: Incidental Expenses Installed Cost of the Asset (ICA) or Depreciable Cost of the Asset Less: Proceeds from the sale of old asset Add/Less: Taxes on sale of old asset Sub-total Add/Less: Net Working Capital (NWC) Initial Outlay XX XX XX XX XX XX XX XX

AVERAGE OR ACCOUNTING RATE OF RETURN (ARR) ARR=


2

Accept: ARR minimum acceptable ARR PAYBACK PERIOD (PP) PP=A+| /

PP annuity= Accept: PP maximum acceptable PP Year FCFs A=year when last negative CFCF occurred b=last negative CFC occurred c=the FCF after getting the last negative CFC

Cumulative FCFs

INCIDENTAL COTS Shipping Cost Handling Cost Insurance while in Transit Cost of Trial Rally/Run Taxes & Customs Duties Installation Costs Incidental Costs TAXES ON SALE OF OLD ASSET Selling PriceBook Value Multiply: Tax Rate Taxes on Sale of Old Asset BOOK VALUE ICA Less: Accumulated Depreciation Book Value FREE CASH FLOWS (FCF) Projects OCFs Less: NWC Less: Capital Spending FCF OCF PRO FORMA APPROACH
EBIT Less: Taxes

XX XX XX XX XX XX XX

CE APPROACH ( )
=

CE NPV CE NPV= Year


t =1 1+krf

Initial Outlay

FCFs

XX XX XX

Riskless FCFs

PVIFi,n

PV of Riskless FCFs

*Then Total PV of Riskless FCFs less Initial Investment to get CE NPV Risk-adjusted Discount Rates (RADR)

XX XX XX

RADR NPV= where:

t =1 1+RADR

Initial Outlay

= =

or RADR= ; RI=risk index XX XX XX XX Year FCFs PVIFi,n PV of FCFs

*Then Total PV of FCFs less initial investment to get RADR NPV Chapter 15: Planning the Firms Financing Mix CURRENT PRICE OF A FIRMS COMMON STOCK

Less: Depreciation OCF ADD BACK APPROACH Net Income Add: Depreciation OCF DEFINITIONAL APPROACH Revenue Less: Cash expenses Less: Taxes OCF DEPRECIATION TAX SHIELD APPROACH Revenue Cash expenses Multiply: 1-Tax rate Sub-total Add: Depreciation * Tax rate OCF TERMINAL CASH FLOW (TFC) After-tax salvage value of the project Less: Cash outlays associated with the Projects Termination Less: Recapture of non-expense outlays that occurred at the projects initiation TCF EQUIVALENT ANNUAL ANNUITY (EAA or ANPV) EAA= , Chapter 13: Capital Budgeting and Risk Analysis
3 MEASURES OF A PROJECTS RISK 1. Project standing alone risk 2. Projects contribution-to-firm risk 3. Systematic risk METHODS OF INCORPORATIONG RISK INTO CAPITAL BUDGETING 1. Certainty Equivalent (CE) Approach 2. Risk-adjusted Discount Rates (RADRs) 3. Simulation 4. Scenario Analysis 5. Sensitivity What if? Analysis 6. Probability Trees

XX XX XX XX XX XX XX XX XX XX XX XX XX XX XX XX XX XX XX XX

Po=

EBIT-EPS (EBIT-UEPS) APPROACH EBIT-EPS APPROACH: PLAN A


1 #

=
=

PLAN B
1 #

EBIT UEPS APPROACH:


1 = # 1 #

where: I=(under LTD bonds) # bonds issued*interest rate # of CSO=(under Common Equity) # of shares Plan A EBIT Less: interest NIBT Less: Taxes (%*NIBT) NIAT Less: PD NIAT Available for Common Stock holders Divide: # of CSO EPS *Project with higher EPS should be chosen. MARKETPRICE Plan A EPS Multiply: P/E Ratio Market Price *Project with lower EPS but same with another projects market price less risky. Plan B Plan B

MAXMIZING SHAREHOLDER VALUE APPROACH Po= = Debt Ratio of % EBIT Less: interest NIBT Less: Taxes (%*NIBT) NIAT Less: PD NIAT Available for Common Stock holders Divide: # of CSO EPS Divide: Required Return Market Price *Investors are not comfortable with a debt ratio higher that 30% RECESSIONARY CASH FLOWS CBr=Co+NCFr-FC where: NCFr= (Cs +OR) Pa+RM++En CBr=Cash balance at the end of the recession Co=Cash balance at the beginning of the recession NCFn=Net of total cash receipts and other non-discretionary expenditures FC=Fixed financial charges associated with a specific capital structure Cs=Collection from sales OR=Other cash receipts Pa=Payroll RM=Raw Matls En=Non-discretionary expenditures *Do not issue bonds when the CBr is negative Chapter 16: Dividend Policy and Internal Financing DIVIDEND PAYOUT RATIO (DPR) DPR= RESIDUAL DIVIDEND THEORY Earnings available for reinvestment Less: Equity investments Earnings available for dividends Investment amount needed Multiply (1-Debt %) Equity Investments CASH DIVIDENDS REnew=RE (# of CSO*Dividend per share) STOCK DIVIDENDS CSnew= # of CSO*(1+%of SD)*Par PCEPnew=PCEP+[# of CSO* % of SD)*(MPSPar)] REnew=RE [(# of CSO*Dividend per share)*MPS] TOTAL STOCKHOLDERS EQUITY Preferred Stock Common Stock Paid-in Capital in Excess of Par Retained Earnings Total Stockholders Equity

EPS of the firm EPS=


#

WARRENS CURRENT OWNERSHIP % of PSO=#


#

WARRENS OWNERSHIP AFTER STOCK DIVIDEND % of PSOnew=# (1+% ) NEW MARKET PRICE MPSnew=1+% STOCK SPLITS (SS) -2 new shares for 1 old share # of CSOnew=
# # (1+% )

PARnew= REVERSE STOCK SPLITS (RSS) -1 new share for 2 old shares # of CSOnew= PARnew=
#

STOCK REPURCHASE (BUYBACK) 3 METHODS FOR STOCK REPURCHASE -buy in the open market -make a tender offer -purchase on a negotiated basis Repurchase Price=MPS(after the ex-dividend rate) + Dividend per share # of shares to repurchase= *round down

# of CSOnew=# of CSO - # od shares repurchased EPSnew=


#