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OCF=EBIT+ Depr

PER approach - valuaEon

own EPS x PER u want

In i/s - deduct int ex before taxing

> EBIT is operaEng income (sales - ops cost - depr)

lasts 10y. Another security (equal risk) also has maturity of

10y, and pays 10% comp mthly. Price of security u should pay?

- Start by calc EFF on 2nd security. Then, convert EFF to a

semiann rate, then calc the value of the 1st security

WEEK 4: BONDS AND VALUATION

X deposited 10 in bank acct that has 12% nom int rate, int compounded mthly. X also plans to

cont another 10 to the acct 1y from now and 20, 2y from now. How much will be in the account

3y from now?

- Calc FV of ea contribuEon and add tgt

X is planning to make 36 cont to her acct at beg of ea of the next 36y. 1st cont will be made today

(t=0) and nal cont will be made 35y from today (t = 35). 10% int. If each cont she makes is 30,

how much will be in the reErement account 35 years from now (t = 35)?

- Calc FV of 35 payments and + 30 to ans for the last payment

fund lower required ror

(coup rate), but call feature

raise rate

Face value of $1,000 means FV = $1,000. If no FV menEoned, FV = $1,000

Solving for YTC = same as YTM but Eme to call (N) call prem (FV)

Fischer eect: real int rate = nom int rate - expected inaEon rate

All else constant, a bond will sell at disc when the coupon rate is < the yield to maturity

If interest rate = 5% but coupon rate 10%, will call bond

If interest rates decline, the price of both bonds will increase, but the 15-year (8%) bond will have

a larger percentage increase in price (than 10-year (12%))

Expect to earn YTC (prem bonds), YTM (par/disc bonds); eg. bonds are selling @ premium, i/r

have fallen since the bonds were originally issued. Assuming i/r dont change from the present

level, expect YTC/YTM

A 10-year corporate bond has an annual coupon payment of 9 percent. The bond is currently

selling at par. d a. The bonds YTM, current yield is 9%

- If the bonds YTM remains constant, the bonds price will remain at par

All else equal, long-term bonds have more interest rate risk than short-term bonds

All else equal, high-coupon bonds have more reinvestment rate risk than low-coupon bonds

- RelaEve to coupon-bearing bonds, zero coupon bonds have more interest rate risk but less

reinvestment rate risk

All else equal, short-term bonds have more reinvestment rate risk than do long-term bonds

Since YTM remains unchanged, the bondholders total return over the next year is the YTM and

we have the following equaEon: total return = CY + CGY = YTM. Since this is a disc bond, coupon

rate < current yield < YTM. So CGY has to be posiEve, i.e., bond price will appreciate over next yr.

As it gets closer to maturity date, bond price will approach par value. Since this is a disc bond, the

price has to go up if the YTM is kept constant

WEEK 4: INTEREST RATES

r<nom/quoted rate>(corp) = r*(real rF) + inaEon (expected) + default risk prem (0 for US treasury

but incr as riskiness of issuer incr) + liquidity prem + maturity risk prem

- rF = r* + inaEon

r (treasury) = r*+ inaEon (expected) + maturity risk prem

(1+inom) <inom aka equil ror> = (1+ireal)(1+in) = 1 + ireal + in + irealin <cross prod term,

mostly negligible>. inom = ireal + in (+ ireal x in)

Term structure = r/s btw LT& ST int rate (btw yields and maturiEes). Generally LT > ST (due to

MRP) > norm upward-sloping curve. Lower int more ppl borrow, spend more in incr

ie. FV = PV(1.06<EAR>)N

CF

di rates/ comp periods

What is remaining bal on loan aQ making 30th pmt (remaining loan balance)? (1) Find PMT using

TVM (2) Enter the PMT no: eg. AMORT (30 > P1 & P2) (3) Enter, scroll down to bal

- To nd amt going towards repayment of int/prin - key in the exact Eme eg. 3, 3 for (3rd mth)

30y, $165 mortgage, mthly PMT and iNOM of 8%. What is total $ of int paid in 1st 3Y of

mortgage? (1) Find PMT using TVM (2) Enter the PMT no 3y=36mth eg. AMORT (1 for P1 & 36 for

P2)(3) Enter, scroll down to int

AmorEsaEon table

Uneven CF stream

compounded more oQen

ie. ann income from investment as proporEon of original invest

variance = SD2

[shows standalone risk]

ie. if 5 numbers, divide by 4

SML > raise inaEon line shiQ up. incr risk-aversion grad incr

diversiable up to 40 stocks - SD of

porxolio tends to converge > 20%

If g>rs, -ve stock price:

DDM (gordons constant growth model)

Not reasonable for a rm to grow indenitely at a rate

Constant growth stock:

higher than its required return. Such a stock, in theory,

would become so large that it would

eventually overtake the whole economy

If g=rs, undened stock price

Both do not make sense

> DDM can only be used if rs>g, g expected to be

> value of the stock is not dependent

constant forever

upon the holding period

Dividend yield:

Div yield + cap gains yield

!"## < % >= !! !! < % > 1 ! < !"# > + !! !! + !! !!

Reects risk of avg proj taken by rm

Cost of debt (aXer tax)

!! (1 !)

Component cost of preferred stock

MV LT debt = BV

MV common eq = mkt price x # of share

rd > YTM

EPS1 = EPS0 (1 + g <dec>) = $5.40(1.03)

Not tax-deducAble

Sustainable growth rate/expected future growth rate

g = (1 - payout<dec>)(ROE<%>)

Only applicable for long term; situaAon expected to cont

Component cost of equity (reasonable est. take avg of the 3)/ cost of RE

1. CAPM (rs)

2. DCF (DDM eqn making r the subject)

ans change to %

3. Bond yield + risk prem

Premise: cost of equity > cost of debt; since coupon rate xed by contract

Cost of issuing new stock

Corporate valuaAon (FCF) model

Add otaAon cost (cost of issue ie. fees to IB, underwriAng fee)

Horizon value (HV): similar to DDM aka D1

P0/D1 model

Factors inuencing WACC

MV of equity = MV of rm - MV of

Market cond, capital structure, div policy, investment policy (riskier proj higher WACC)

debt

Use debt 1st unAl opAmal pt where thereager rm may not be able to meet debt

Pecking order: managers prefer to use RE > debt > new equity (may send -ve signal and depress

Gain on sale = 5-4=1

Value/share = MV of equity # of

stock price)

Tax on gain = 1(0.4) =0.4

shares

AT salvage value = 5-0.4 = 4.6

WEEK 11: CAPITAL BUDGETING AND PROJECT ANALYSIS

WEEK 11: CASH FLOW ESTIMATION AND RISK ANALYSIS

Tax SV always, may incur cost in disposiAon of

Normal CF (-ve followed by posi6ve CF); non-normal (2 or more sign changes)

NOWC = CA - CL (excl n/p)

asset (if SV -ve then tax +)

1. NPV

Best method since it address directly the central goal of maximising shareholder wealth

Sum of the PVs of all cash inows and ouIlows of a proj

Choose NPV > IRR

exclude: research

(The conict between NPV and IRR

for project last

occurs due to the dierence in the

year *sunk cost

(PV of inows - cost = net gain in wealth)

size of the projects.

OR

Project B is 3X larger than Project A)

Add CFs into calc CF; enter I/R <%>; press NPV

Then nd ops cash ow like SCF

INT

BONDS

Independent proj - CF of 1 unaected by acceptance of other

Accept if NPV > 0

Dependent proj - CF of 1 can be adversely aected by other > each of the projects is

equally risky and as risky as the

Accept proj with highest +ve NPV

SL dont take into acc salvage val

rms other assets

2. IRR

Disc rate that forces PV of inows to be = cost; NPV = 0. Cannot use for non-normal since >1 IRRs

Ways to nd g: take arithmeAc/

weighted avg, forecast nancial

statements

Indep: accept if IRR > WACC (returns > costs). Mutually ex: accept higher IRR (and IRR > WACC)

> if = sAll can take on cos may have future benets

3. MIRR

!! = !! + !!

on investors exp of future in

rates. Term struc = r/s btw int

rate (yields) & maturiAes YTM

Finally, enter CFs into calc and I = WACC <%>. Press NPV

SensiAvity analysis

Eect of changes in a variable on projects NPV

ConsideraAons:

- +/- ( )% risk adjustment - for eg. cost of capital, +/- to get new NPV dep on whether low or high

NPV

risk proj

- Financing eects like div and int ex should not be incl (alr in WACC)

If we have unlimited capital, we

would just choose

Sunk costs irrelevant, only take into acc incremental CF

- Opp costs, erosion costs relevant

project 1 since it oers higher NPV.

- CannibalisaAon (ager-tax) and complementary CF relevant and should be considered

Since we have limited capital, we

- Consider subj risk factors - potenAal for lawsuit, whether assets can be redeployed or sold,

look at the total

NPV that $2000 can generate (eg.

country/poliAcal/currency risk

other investment opp)

WEEK 12: DERIVATIVES - FI whose value depends on value of underlying instrument (bond/share)

4. Regular payback

Leverage - pay low amt but potenAal payos high

Payback period: no. of years required to recover projs cost

Call opAon

NPV proles

Incr stock price - incr opAon value | incr ex price - decr | incr Ame to exp - incr | incr rF - incr | incr

Graphical rep of proj NPVs at di costs of

stock ret variance - incr

capital > downward sloping

- Why NPV proles cross? size (smaller free Comparisons

- Forward vs futures: asset exchanged at specied Ame in future at prices specied today (simi).

funds at t=0 for invest) and Ame (faster

Fut standardised trading on organised exchanges w daily rese^lement through clearinghouse

payback more CF earlier invest) di

- Call: right to buy; put: right to sell | short = sell; long = buy

5. Discounted payback

- Call: Spot (mkt) > strike (exercise) - in the money; put: s < x - in the money

- Call: bullish, can gain unlimited but limited downsides risk, put: bearish, max gain strike price -

cost of put but loss also limited to price paid for put

- PV dividends = (Div)e-rt

ST

- Black-Scholes OPM assumpAons: stock underlying call opAon no div during call opAon life, no

LT

transact costs, rF known and constant during op life, buyers can borrow any frac of purch price @

Comparing

ST rF rate, no penalty for short sell, call opAon only exercised on expiraAon date

NPV v IRR: indep proj 2 methods same decision(also when WACC > crossover rate). If < di decision Payback period

MIRR v IRR: MIRR assumes cash inows reinvested at WACC, IRR at projs IRR. MIRR avoids mulAple Strengths: Provides indicaAon of projects risk and liquidity, easy to calc and understand. Weakness:

ignores TVM. Requires arbitrary cuto point, ignores CFs occurring ager payback period - proj can

IRR prob when 2 or more sign changes in CF

have low CF in earlier yrs

In situaAon where there is non-normal CF (can also use for normal). IRR (but not MIRR) can relate to

NPV. Disc rate ^ causes PV of proj terminal value = PV of costs

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