FORMULA SHEET – PRINCIPLES OF FINANCE (N1560 & N1560E)

Present value of an annuity

⎡1 1 ⎤
p0 = c ⎢ − t⎥
⎣ r r(1+ r) ⎦

p0 is the present value of the annuity; c is the annuity––a constant cash flow per period; r is
the rate of discount per period and t is the number of periods.

Future value of annuity

⎡ (1+ r)t 1 ⎤
ft = c ⎢ − ⎥
⎣ r r⎦
ft is the future value of the annuity at time t.

Present value of a constant-growth perpetuity

c0 (1+ g) c
p0 = = 1
r−g r−g

c0 is the cash flow today (time zero); the cash flow grows indefinitely at the constant rate g
per period, that is, c1 = c0(1+g) is the cash flow at time 1.

Net present value of an investment

c1 c2 cn n
ci
NPV = −I 0 + +
(1+ k) (1+ k) 2
+ ... +
(1+ k) n
= −I 0
+ ∑
i=1 (1+ k)
i

NPV is net present value; I0 is the initial investment at time zero; ci is the cash flow at time i;
k is the cost of capital and n = number of periods (the time horizon)

Internal rate of return (IRR)

n
c1 c2 cn ci
0 = −I 0 + + + ... + = −I 0 + ∑
(1 + IRR) (1 + IRR) 2
(1 + IRR) n
i=1 (1 + IRR)i

IRR is the discount rate setting NPV = zero.

1
Value of a bond

c c c+F
P= + 2
+ ... +
(1+ y) (1+ y) (1+ y) n

P is today’s bond price; c is the coupon per period; F is the face-value or redemption value of
the bond; y is the periodic yield to maturity and n is the number of periods.

Valuing common stocks by the dividend discount model

d0 (1 + g) d1
p0 = =
( re − g ) ( re − g )

p0 is the ex-dividend market price of the stock at time zero; d0 is today’s dividend; g is the
expected constant growth rate of dividends forever, and re is the required equity rate of return.

The same model solved for the required equity rate of return:

d0 (1+ g) d
re = +g= 1 +g
p0 p0

The same model expressed in yet another format:

⎛ d0 ⎞
(1 + re ) = (1 + g) ⎜1 +
⎝ p0 ⎟⎠

The equity rate of return is comprised of the growth rate of dividends and the dividend yield.

Capital asset pricing model (CAPM)

re = rf + β e (rm − rf )

The rate re is the required rate of return on the asset under investigation; rf is the current rate
of return on a risk-free asset; rm is the current rate of return on an average asset (the rate of
return on the market index) and β e is the beta coefficient of the asset under investigation.