𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑤 𝐶1 𝑎𝑛𝑑 𝐶0 2

Payback Period: 1𝑜𝑟𝑋𝑦𝑟𝑠 + 𝐶2 𝑉𝑎𝑟(𝑅𝐶) = β𝐶 * 𝑉𝑎𝑟(𝑅𝑀) + 𝑉𝑎𝑟(ε𝐶)

Discounted Payback Period: PP w/ discounted CFs ** aka: risk = systematic (nondiversifiable) risk + non-systematic
𝑃𝑉 𝑜𝑓 𝑓𝑢𝑡𝑢𝑟𝑒 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠
Profitability Index: PI 𝑃𝐼 = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 Accept if PI>1 (diversifiable) risk
After tax CF: R * (1 -τ) - CE * (1 - τ) β𝑃quantifies amount of systematic risk (amount of wealth put into
After tax CF w Deprec.: R * (1 -τ) - CE * (1 - τ) + ( τ* NCE) the market) [the higher, the higher the expected returns]
1 1 𝑃𝑉𝑐𝑜𝑠𝑡𝑠
EAC: PV = EAC * [ 𝑟 - 𝑟(1 + 𝑟)𝑇 ], EACnew = 𝐴𝐹 Average Return:
𝑇
1
Reject the higher EAC Arithmetic: 𝑅 = ∑ 𝑅𝑡, good for estimating next year’s return
1 1 𝑇
AF: [ 𝑟 − 𝑇 ]
𝑡=1
𝑟(1+𝑟) 𝐺 1/𝑇
Matching Cycles: adding together multiple sums of PV all costs, Geometric: (1 + 𝑅 ) = [(1 + 𝑅1) * (1 + 𝑅2)... (1 + 𝑅𝑇)]
each discounted for the start time: 𝐺
𝑃𝑉𝐴 𝑃𝑉𝐴 Good for estimating future growth 𝑅 > 𝑅
𝑃𝑉3𝐴 = 𝑃𝑉𝐴 + 𝑡 + 2𝑡 , t = length of project A **with salvage value, make to subtract book value and taxes and
(1+𝑟) (1+𝑟)
1+ 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑟𝑎𝑡𝑒 bring back to PV
𝑅𝑒𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 = 1 + 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒
−1
St. Dev.: 68.26%, 95.44%, 99.74%
𝑁
E(R): 𝐸(𝑅𝐴) = ∑ 𝑃(𝑖) * 𝑅𝐴(𝑖)
𝑖=1
𝑁
2
Var: 𝑉𝑎𝑟(𝑅𝐴) = ∑ 𝑃(𝑖) * [𝑅𝐴(𝑖) − 𝐸(𝑅𝐴)] , given x
𝑥=1
possibilities (example: rain or shine)
2
Var: 𝑉𝑎𝑟(𝐵) = Σ 𝑃𝑖(𝑅𝑖 − 𝐸(𝑅 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜)
SD: 𝑆𝐷(𝑅𝐴) = 𝑉𝑎𝑟(𝑅𝐴)
Cov (for 2 possible outcomes):
𝐶𝑜𝑣(𝑅𝐴, 𝑅𝐵) = 𝑝(𝑟𝑎𝑖𝑛) * [𝑅𝐴(𝑟𝑎𝑖𝑛) − 𝐸(𝑅𝐴)] * [𝑅𝐵(𝑟𝑎𝑖𝑛) − 𝐸(𝑅𝐵)
+ 𝑝(𝑠𝑢𝑛) * [𝑅𝐴(𝑠𝑢𝑛) − 𝐸(𝑅𝐴)] * [𝑅𝐵(𝑠𝑢𝑛) − 𝐸(𝑅𝐵)]
𝐶𝑜𝑣(𝑅𝐴,𝑅𝐵)
Corr: 𝐶𝑜𝑟𝑟(𝑅𝐴, 𝑅𝐵) = 𝑆𝐷(𝑅𝐴)*𝑆𝐷(𝑅𝐵)
*St. Dev. of portfolio w/ 2 stocks is less than weighted avg. of each
st. dev. (if corr < 1)
1 1
Var Port: 𝑉𝑎𝑟(𝑅𝑃) = 𝑁 * 𝑣𝑎𝑟 + (1 − 𝑁 ) * 𝑐𝑜𝑣
Var. Large Port: 𝑉𝑎𝑟(𝑅𝑝) = 0. 5 * 𝑣𝑎𝑟 + 0. 5 * 𝑐𝑜𝑣
** as 𝑁 → ∞, 𝑉𝑎𝑟(𝑅𝑃) = 𝑐𝑜𝑣
Efficient set: given the desired risk of port., hold port. w/ highest
expected returns
𝐸(𝑅𝐴)−𝑅𝐹
E(R): 𝐸(𝑅𝑃) = 𝑅𝐹 + σ𝑃 * ( σ𝐴
)
Homogeneous expectations: 𝑅𝐹, 𝐸(𝑅𝑀), σ𝑀are economy-wide
parameters

Efficient Set:
σ𝑃
𝐸(𝑅𝑃) = 𝑅𝐹 + σ𝑀
(𝐸(𝑅𝑀) − 𝑅𝐹)
** this is CML (capital market line) (efficent portfolios with a
mix of some efficient set and risk-free asset)
***SML is a line with all stocks on it with their E(R) based off
their Beta
𝑅𝑃 = 𝑤 * 𝑅𝑀 + (1 − 𝑤) * 𝑅𝐹
2
𝑉𝑎𝑟(𝑅𝑃) = 𝑤 * 𝑉𝑎𝑟(𝑅𝑀)
𝐶𝑜𝑣(𝑅𝑖,𝑅𝑀) 𝐶𝑜𝑣(𝑅𝑖,𝑅𝑀)
Beta: β𝑖 = 𝑉𝑎𝑟(𝑅𝑀)
= 2
σ(𝑅𝑀)
𝑁
β𝑃 = ∑ 𝑥𝑖β𝑖, x = weight of i
𝑖=1
**β𝑀 = 1, β𝑅𝐹 = 0
*** ↑ β𝑠𝑡𝑜𝑐𝑘 = ↑ 𝐸(𝑅𝑠𝑡𝑜𝑐𝑘)
CAPM: 𝐸(𝑅𝑖) = 𝑅𝐹 + β𝑖 * (𝐸(𝑅𝑀) − 𝑅𝐹)
Realized Return: 𝑅𝐶 = 𝑅𝐹 + β𝐶 * (𝑅𝑀 − 𝑅𝐹) + ε𝐶
**episol is not explained by CAPM