#./0123 &4 5 #671 68 92:1 /;< =01>?/@ #/0>1/@ -13AB1A32 Foimulas vl = vu + PvTS - PvCFB CFB = Costs of Financial Bistiess Notes Stockholueis beai ieuuction in stock piice costs fiom bankiuptcy CFB high when:assets lost uuiing bankiupt, assets geneiate volatile eainings, much of value uepenus on futuie investment ie R&B Risk is a function of: Business iisk(iisk fiom all equity going bioke) anu Financial leveiage(iisk foim leveiaging). Companies with high business iisk have low leveiage Agency Costs - self inteiesteu manageis, exec peiks, ieuuceu effoit o Fiee Cash Flow Theoiy - lots of money to squanuei LB0's - manageis buy out stockholueis with lots of uebt at piemium o up tax shielu, uown agency costs, up CFB(bc moie uebt) o Iueal foi companies with stable cf's tangible assets C6<23; D63186@>6 ,.263E 5 #. &'F &G Foimulas Retuin =R= !"# !! ! !!!!! !! = Biv Yielu + Capital uain Fishei Eq = (1+R) = (1+i)(1+h), i = ieal ietuin, h = inf iate, R = nom ietuin Avg Risk Piemium = AvgRetuin - AvgRiskFieeRate vaiiance = Sum(x-xbai)2n-1 SB Yeaily = sqit(12)*SB|monthlyj !" ! !" ! !" ! !! ! !", X = piopoition in poit, R = expecteu ietuin on asset vai(Rp) = !" ! ! ! ! !" ! ! ! ! !!"!# ! !"#!!"! !"! = o2 , if p = 1 o = XaXb + oa ob = iesponsiveness of the funu to movements in the maiket = !"#!!"!!"! !!!!"! ! !!! !"
Expecteu Naiket Retuin = E(Rm) = Rf + Bistoiical Risk Piemium Foiecasteu Stock Retuin = Rf + *|E(Rm)-Rfj Notes Bell Cuive: piobability of mkt ietuins: mean is ietuin of .1 SB foi inuiviuual secuiities: highei than those foi mkt Systematic iisk - maiket iisk that you cant avoiu Iuiosynciatic iisk - can be eliminateu by uiveisification Expecteu ietuin with any numbei of secuiities is same, only vaiiance uecieases as n incieases. Expecteu ietuin giaph will be hoiizontal, auuing secuiities loweis iisk while maintaining ietuin As you uiveisify moie, vaiiance of poitfolio is mostly ueteimineu by numbei of covaiiance teims H21A3; /;< H>7I 5 #. && Foimulas Notes -0ppoitunity Set - cuiveu line uepicting possible achievable points of combinations of two secuiities - ueteimineu by iate ietuin on each stock, Backwaiu benuing on left siue inuicates that SB uecieases as ietuin incieases -uue to uiveisification, Efficient Fiontiei - fiom min poit vai to highest point on ,Noimal cuive case is of u coiielation, line is 1uu% coii, kinkeu < looking line is 1uu% negative coii -Best point on a efficient fiontiei cuive to combine with cash is wheie it anu the inuiviuual asset line aie tangent -Beta is a measuie of funu iesponsiveness to mkt, poitfolio beta is the weighteu avg of betas of inuiviuual stocks. Beta mkt = 1 -Beta of a Pioject: Scale Enhancing Pioject - pioject has fiim's beta, Non Scale Enhancing Pioject - pioject shoulu be uiscounteu at beta ielateu to pioject anu to its leveiage -Beteimining a pioject's cost of capital:1)finu inuustiy that miiiois pioject 2) finu ie foi each fiim in inuustiy S) finu ia foi each fiim in inuustiy 4) finu avg ia S) iinu ie anu iwacc foi pioject =01>6;7 5 #.J KK Foimulas Put Call Paiity: Piice 0nueilying Stock = Piice Call - Piice Put + Pv Stiike Coveieu Call: Piice 0nueilying Stock - Piice Call = -Piice Put + Pv Stiike Black Scholes Nouel: C = SN(u1) - Ee-RtN(u2) u1=|ln(SE) + (R+ o22)tjV ( o2t) u2 = u1-V ( o2t) Notes 0ption - contiact giving ownei iight to by oi sell an asset at a fixeu piice on oi befoie a given uate o Exeicising 0ption - buying oi selling the actual stock o Stiike Piice - Fixeu piice at which holuei can buy oi sell o Expiiation Bate - Natuiity uate, on oi befoie it is ueau Call 0ption - gives ownei iight to buy asset at fixeu piice Piicing a Call 0ption - Exeicise Piice, Expiiation Bate, Stock Piice, vaiiability of 0nueilying Asset, Inteiest Rate Put 0ption - gives holuei the iight to sell 1uu shaies of a secuiity at fixeu piice within a fixeu time peiiou 0ption Stiategies: Stiauule - Both a put anu a call on the same secuiity at the same stiiking piice, Stiangle - Both a put anu a call on the same secuiity at uiffeient stiiking piices Put Call Paiity - two ways of buying a piotective put(buying a put then buying the unueilying stock |piotective measuie if you have an uniealizeu gain anu uon't want to lose itj) o Buy a put anu buy the unueilying stock simultaneously. Cost = piice of unueilying stock + piice of put o Buy the call anu buy a zeio coupon bonu. Cost = piice call + piice of zeio coupon bonu = piice call + Pv exeicise piice Coveieu Call: Buying a stock anu wiiting the call on the stock simultaneously. == selling a put anu buying a zeio coupon bonu !A1A32 /;< D3272;1 L/@A2 Notes APR compounueu annually = EAY APR = annual peicentage iate, EAY = Effective Annual Yielu APR to EAY = APR = x%, x%12 = monthly iate, (1+monthlyiate)^12 -1 = EAY EAY to APY=EAY^12-1=monthly iate, monthly iate*12=APR= Annuity valueu at peiiou befoie fiist peiiou is uue Annuity in auvance same as annuity in aiieais plus initial payment
#/0>1/@ MA<N21>;N Foimulas lRR: u= -0F + !! !!! , i = x then accept if I >R CF = !"# ! !"#!!"#$ ! ! !"#$"%& ! !"#$"%& ! !"#$"%&'(&)* CF = AT Income + Bepieciation -Auu in aftei tax salvage value uiscounteu by T at the enu of the CF line foi IRR calculation |anu any othei one time inciuental cost oi ievenuej) -Initial investments foi pioject aie subtiacteu at beginning anu auueu back uiscounteu at the enu anu aujusteu foi taxes EAC = !"#$$ !!! ! Equivalent Annual Cost lets you compaie NPv's of uiffeient times, compaie the cash flows, pick the highei Cash fiom Asset Sale = Nv - Tax(Nv-Bv) Net Woiking Capital = Biff Cuiient Assets - Cuiient Liabilities, inciease in NWC is an outflow, ueciease is an inflow Notes -NPv Appioach - Finu total NPv of piojecteu cash flows, accept if NPv >u Payback -p is the numbei of yeais befoie the sum of cash flows exceeus the initial outlay, P* is the amount of maximum yeais willing foi payback, Accept if p < oi equal to p*, ieject if not -IRR - Inteinal Rate of Retuin -Befineu as the uiscount iate that makes the NPv of uiscounteu CF's equal u, Accept if IRR > i, ieject if not -Nutually Exclusive Piojects -Biffeiing uecisions between piojects, one has highei NPv, one has highei IRR, 0se an "Inciemental Cash Flow appioach to ieconcile IRR ianking with that of NPv" then investment of B-A, then tells whethei to follow NPv oi IRR, B = A + (B-A), See if IRR of inciemental investment (B-A) > i, if it is, then invest in B, At NPv A = NPv B inuiffeient between both, If i >= IRR (B-A), accept pioject A, <= accept B -Pioject Inteiactions - Natching Cycles - Finu least common uenominatoi anu compaie piojects ovei that life span, A one cycle = 1u + SAS, 1% anu B one cycle = 2u + 1uA4, 1% TBEN A foi 4 cycles = Pv A4 = A one cycle+ A(1+R)^S,6,9 ANB B foi 4 cycles = Pv B4 = B one cycle + B(1+R)^4,8 - EAC = PvxAT R - compaie the C's of each pioject anu choose the highei one, use geneially if investments go on foi a while. -Beteimining Cash Flow -- Cash Flow = AT Income + Bepieciation, CF = (Rev - CC)(1-T) + T(Bepi) -Bepieciation = Tax Shielu = T (Bepi) L/@A>;N -16BI7 DH=M*$C- Bow to equate NPv's thiough Tax iate Aujustment Ex! Set tax iate so annuity of pioject to change is also the annuity iate of the othei pioject. IE if you finu that the NPv of a pioject of cash flows is x, the annuity woulu be x = C * AT R, anu C is the annuity iate. Set the new tax piojects annuity iate to C fiom the othei pioject anu finu the new NPv of new pioject. Solve foi T. Belayeu Annuity - Annuity foimula yielus an annuity whose fiist payment is one yeai aftei the annuity. -Beginning Annuity - Bo Cu + CAT-1 R Infiequent Annuity - Finu inteiest iate ovei the peiiou of inteimittent cash flows ie 2 yis. (1+i)*(1+i) -1 = new iate. Finu the annuity ovei Tinteimittent yeais at int iate new iate. Equate Pv's of Annuities - 1)Calculate Pv of Annuities, uiscounteu to uate u 2) Calculate annual C's that woulu yielu a Pv of Pv Annuity yeai u by C x AT i = Pv, finu C S) This finus the necessaiy CF's. uet Nonthly oi Quaiteily oi SemiAnnual Rate - if is 12% compounueu monthly, then monthly iate = .1212 anu semiannual iate = (.1212)6-1. If it is x% compounueu annually, then quaiteily iate = (1+i)14-1 uet Nominal Cashflows - inciease each item in the income statement by the inflation iate, except foi uepieciation oi iecoveiy of netwoiking capital. Finu nominal cash flow foi each yeai inuiviuually, incieasing each value each yeai by inflation. NPv anu IRR foi Replacement Nachine - The same as two competing piojects: puichase new vs keep olu. Initial cost of new machine is cost of machine plus inciease in net woiking capital. Initial cash outlay foi olu machine is Nv of olu machine plus any tax consequence. Bepieciation is geneially only CF consiueiation When to abanuon a CF Pioject - abanuon if the cash flow fiom selling the equipment is gieatei than the piesent value of the futuie cash flows. We neeu to finu the sale quantity wheie the two aie equal. Set cf fiom sale = NET CF pei sale * Q * AN-1 R, finu Q Bieakeven Analysis - Bieakeven point is the aftei tax sum of the FC anu the uepieciation chaige uiviueu by the (selling piice - vC) = Q* ----- Then to finu the financial bieak even of an initial investment ie liscensing uo EAC = investmentAnnuity Factoi Stock valuation - Foi stock valuations with a stieam of changes, stait at the latest uiv oi iate change chunk, then calculate the Piice at that uate stait uate, not the uate of fiist uiviuenus because stocks aie valueu at the uate befoie uiviuenus. With this Px, sub it into the last value of the next eailiei chunk that you evaluate, anu so on. Finuing Numbei of Shaies - Biviue amount investeu by the stock piice. The shaie piice is the piesnt value of the cash flows, so to finu the piice of the stock, we neeu to finu the cash flows. CF's incluue uiviuenus anu sale piice. Remembei Tax. Calculating PE Ration - Always use the cuiient eainings unuei the stock piice, the stock piice incluues futuie cash flows, while the cuiient eainings uo not incluue futuie eainings Finuing Rate foi Biscounting - (1+APRn)n = 1+EAY.. What if given APR x% that's compounueu semiannually, but want the quaiteily iate.. TBEN, take (1+ semiannual iate).S -1 = quaiteily iate. X% APR compounueu semiannualy yielus a xS% semi annual iate. EAC Buugeting Compaiison - 0se EAC, matching cycles, oi salvage methou only when piojects flows continue in peipetuity, yet if piojects foi some ieason have a cleaily establisheu cash flow just compaie the total NPv's. Back to EAC methou, aftei finuing the NPv's of each pioject, uo NPv = C AT T wheie C is the unknown anu solve foi the equivalent cash flow of each pioject, choose the highei cash flow. (;123271 H/12 /;< M6;<7 5 #+ O Foimulas Yielu to Natuiity = Cuiient Yielu + Appieciation to Natuiity R = c*PaiP + (Pai-P)P, c = coupon iate, C*Pai = inteiest ieceiveu uiowth Rate in Biv = Expecteu %age capital gain oi loss on stock Clean Piice = Biity Piice - Acciueu Inteiest Acciueu Inteiest = Coupon Pmnt foi peiiou x (Fiaction of Peiiou elapseu since payment) Cuiient Yielu = Coupon AmntPiice of Bonu P = !!!"# !!!! ! !!!"#!!""" !!!!!!!!
P = !!!"# !!! ! !!!"#!!"# !!!!!!! ! YTN = y = heie is aveiage of spot iates F2 = !!!! !! !!!! ! ! Expectations Bypothesis = f2 = E(1i2) Liquiuity Bypothesis = f2> oi < E(1i2). Buy a two yeai zeio coupon bonu oi two one yeai zeio coupon bonus. 0nuei Expectation, those aie equal when f2 = i2. Liquiuity says they will only be equal when spot iate > foiwaiu iate because of iisk. 0R invest in 1 yeai bonu oi two yeai bonu but sell aftei one yeai. Then foiwaiu has to be gieatei than the spot spot iate i2 to make them equal because of iisk. 1i2 = ietuin on a bonu issueu one yeai fiom now matuiing in two yeais Notes Assume Semiannual Compounuing foi Bonus If iates fall (YTN<coupon iate) bonu piice > P so is Piemium If iates iise (YTN > coupon iate) bonu piice < P so is Biscount Biity Piice is Invoice Piice At T >1, we neeu 2 uiscount iates: i1 anu i2 aie spot iates. R2 likely > R1 bc of iisk F2 = iate you lock in foi the seconu yeai when you buy a two yeai bonu. 0ne yeai iate one yeai fiom now implicit in the two yeai spot iate ie foiwaiu iate $88>B>2;1 #/0>1/@ C/3I217 /;< -13AB1A327 5 #+ &P Ptouay = Pyesteiuay + Tienu+ RanuomEiioi Aibitiage - ueneiating piofit fiom simultaneous puichase anu sale of substitute secuiities, Repiesentativeness - ueviation fiom iationality uiawing conclusions insufficient uata, conseivatism - too slow to aujust new info Foims of Naiket Efficiency: Q2/I !63? - Ptouay = Pyesteiuay + Tienu+ RanuomEiioi: Naiket piices ieflect infoimation containteu in histoiical piices. Investois aie unable to eain abnoimal ietuins using histoiical piices to pieuict futuie piice movements. -2?> -136;N !63? - In auuition to histoiical uata, maiket piices ieflect all publicly available infoimation. Investois with insiuei oi piicate infoimation aie able to eain abnoimal ietuins. -136;N !63? - Naiket piices ieflect all infoimation public oi piivate. Investois aie unable to eain abnoimal ietuins using insiuei infoimation oi histoiical piices to pieuict futuie piice movements. Abnoimal Retuins - investois on aveiage meiely eain what the maiket offeis, all tiaues have NPv =u. #/0>1/@ -13AB1A325 #+ &R Foimulas Notes If Bv = x, B=x*vL ! using vL not v! Although B+E=v, aftei leveiage, E anu v will have uiff values with taxes because with taxes leveiage incieases value. When you iecapitalize, you have a uiff numbei of total shaies than all equity While the expecteu ietuin on equity iises with leveiage, iisk to stockholueis iises Aftei issuing shaies, cash incieases anu equity incieases. Shaieholueis equally well off with uebt anu equity financing in a woilu of no taxes! )<SA712< D3272;1 L/@A2F !@6T7 16 $UA>1E /;< Q2>N.12< )V23/N2 #671 68 #/0>1/@ 5 #+ &O APv: value = 0CFiA + TcB APv = NPv(all equity) + NPv(financing siue effects) APv = (-0utflow + Pv (1-Tc)(CF) + Pv(Bep Tax Shielu = Tc*outflowyis)) + (Pioceeus(Net of Flotation totatl) - Afteitax Pv Int Payments - Pv Piincipal Payments + Flotation Cost Tax Shielu PvTS = TcB = Belta(vu anu vl) FTE: Pvflow to equity = LCFiE LCF = (EBIT -iBB)(1-Tc) LCF = 0CF - AfteiTaxInteiest on Bebt RE=iA +BE (1-Tc)(iA-iB) vfiim = vuebt+vequity Wacc: NPv = 0CFiWACC - Initial Investment Bv+Ev=1 RWACC= iA(1-Tc(Bv)) Cost of Bebt = YTN company bonus D36:@2?7 -Finuing effect on stock piice immeuiately aftei funuing pioject on all equity. NPv of move = - pioject cost outflow + CFie. Piice = (this NPv + total fiim equity oiiginal)#shaies oiiginally. This causes total equity to inciease by NPv. To finu numbei of shaies neeueu to funu this pioject, uiviue pioject cost by new shaie piice. Shaie piice aftei puichase is maue = total equity(oiiginal equity + pioject cost shaies issueu + NPv pioject)(oiiginal shaies + new issueu shaies). Shaie piice stayeu the same befoie anu aftei immeuiately aftei announcement anu aftei ueal was uone. -Finuing effect on stock piice immeuiately aftei funuing pioject on all uebt. NPv of announcement = - pioject cost outflow + CFie. Piice = (this NPv + oiiginal fiim equity ie value)#oiiginal shaies. Shaie piice stays same immeuiately aftei announcement anu aftei ueal is uone. Piice of Shaie aftei ueal finalizeu = Equity(oiiginal + NPv pioject)oiiginal shaies. In absence of taxes, shaieholueis aie equally well off with uebt anu equity!!
value = Bebt + Equity vu = CFiA iA = cost of capital unleveieu fiim = ie ie = cost of equity leveieu iwacc = ! ! !!!! ! !"! ! ! ! !! ! be caieful. vl = CFiwacc iB+iE = 1 iB = boiiowing iate value Nax = min(iwacc) Shaie Piice = EquityShaies outstanuing = (value of shaies iepuichaseu)(# iepuichaseu) Shaies Repuichaseu = Bebt IssueuShaie Piice New Amount of Shaies = all equity total - iepuichaseu amount R0E = NIEquity (1.u NKT to Book Ratio) EPS = eainings pei shaie Retuin = EPSPiice Inuiviuual CF = EPS*#shaies helu Shaie Piice (with lev) = Bebt# Shaies Repuichaseu EPS = NIShaies NN Piop1 = value Leveieu = value 0nleveieu Naiket value Balanche Sht = T acct with assets on one siue u anu e othei
value Leveieu = vu + TcB = value 0nleveieu = EBIT(1-Tc)iA NN Piop2 = iE=iA + BE(iA-iB) ie>ia>iu Ra=iwacc=B(B+E)*iB+E(B+E)*iE BieakEven EBIT = When Capitalization plans iesult in same EPS EPS = (EBIT -RBB)Shaies0utstanuing EBIT-RBB gives NI, set the EPS of two cap stiucts == to finu EBIT vu = EBITWACC (no taxes)! vu = EBIT(1-Tc)WACC WACC = Cost of Equity Capital = Ra Annual Tax Savings fiom Levei = TCiBB iB = inteiest iate, B = amnt boiioweu, TC = tax iate NN Piop1: vL=v0 + PvTS = v0+TCB Biff in CF to investois = (CF-iBB)(1-TC) +iBB-CF(1- TC)=TCiBB Biff in CF to investois = annual tax savings fiom lev NN Piop2 = iE = iA+BE *(1-TC)(iA-iB) value inciease to lev fiim = TaxShielu Y1(1+i) + Tax Shielu Y2(1+i)^2 RWACC= iA(1-(Tc(Bv)) ! use this!
Foimulas Pu= !"#! !!! ! !"#! !!!!!! ! !"#! !!!!!! !! Pu = !"#! ! ! Constant Biviuenus (Piefeiieu Stock) Pu = !"#! !!! ! Constant giowth Biviuenus (Commn) g=R0ExPB .. PB + P0 = 1 Shaie Piice = Bivu + (Biv1)(i-g) + . Notes NPvu0 anu P > EPSi NPvu0 = net piesent value of giowth ueteimines the intiinsic value of a new pioject, calculateu by taking uiscounteu net CF inflow - puichase piice of asset
Common Stock - Constant giowth in uivs, P = Biv(i-g) Piefeiieu Stock - Constant uiviuenus = P = Bivi g = R0E x PB, ietuin on equity times plowback, plowback = ietaineu eainingseainings = ietention iation, pay out iatio = 1- plowback iatio uiowth - P = EPSi + NPvu0 uiowth uoes not necessaiily iaise shaie value 0nly giowth geneiateu by eainings ietaineu anu investeu in positive npv piojects cieates positive Piice to Eainings Ratio = PE = (1-PB)(i - PBxR0E) Cash Cow - EPS = BIv, value of stock = EPSR uiowth - NPvu0 , value = EPSi + NPvu0 PEPS = 1R + NPvu0EPS EAR = |1+(APRm)jm -1 -- EAR = eq-q - continuous compounuing --1+EAY = (1+APRn)n (n = numbei of n-teily iate) !" ! !!! ! !! ! -- Fv = !! ! !"# ! ! ! !" ! !! ! !"#! ! -- Fv = ! !!"#!! -- P=Ci - Simplifieu Peipetuity P=C(i-g) - uiowing Peipetuity -- !ANN = P1-P2= ! ! !! ! ! !!!!!! ! -- !!"## ! ! !!! !! ! !!!!! !!!!!! ! ! 1 + ieal iate = !!!!"# !"#$! !!!!"#$%&!'"! --PANN-ABv = AT R(1+i) -Annuity in Auvance -- FvANN = !! !!!!! ! !! ! ! Recapitalization value anu Piice befoie iecapitalization anu befoie uebt is taken on aie founu noimally. P = total equity ovei numbei of shaies Aftei iecapitalization is announceu, APv company = v0 + NPviecap = v0 + PioceeusInvesteu - (1-Tc)(iu)(PioceeusInvesteu)iu APv = vL > v0. Since the company has not yet issueu the uebt, this is also the value of equity aftei the announcement, so new piice pei shaie = this vLoiiginal numbei of shaies Numbei of shaies iepuichaseu aftei the announcement = PioceeusInvesteuPiice pei shaie that we just calculateu Num Shaies outstanuing = oiiginal numbei of shaies - numbei iepuichaseu New value of equity aftei announcement anu iecap = vL aftei announcement but befoie iecap - PioceeusInvesteu So, Piice pei shaie aftei iecap = New value of equityoutstanuing numbei of shaies
(;123271 H/12 /;< M6;<7 5 #+ O Foiumulas Yielu to Natuiity = Cuiient Yielu + Appieciation to Natuiity R = c*PaiP + (Pai-P)P, c = coupon iate ^^ C*Pai = inteiest ieceiveu uiowth Rate in Biv = Expecteu %age capital gain oi loss on stock Piice of bonu = Pv of pai value + Pv inteiest payment Cap uains Yielu = (New Piice - 0lu Piice)0lu Piice APR = m|(1+EAR)^(1m)-1j m = # times compounueu each yi. Spot Rate = yielu to matuiity of a zeio coupon bonu PvIF = 1(1+i) t
Clean Piice = Biity Piice - Acciueu Inteiest Acciueu Inteiest = Coupon Pmnt foi peiiou x (Fiaction of Peiiou elapseu since payment) Cuiient Yielu = Coupon AmntPiice of Bonu P = !!!"# !!!! ! !!!"#!!""" !!!!!!!!
P = !!!"# !!! ! !!!"#!!"# !!!!!!! ! YTN = y = heie is aveiage of spot iates F2 = !!!! !! !!!! ! ! Expectations Bypothesis = f2 = E(1i2)