AFM373 Lecture Notes - Lecture 8: Risk Aversion, Fixed Cost, Net Present Value
28 Jun 2018
School
Department
Course
Professor
Fonderia
February 5, 2018 2:25 PM
AFM 373 Page 1
Employee union factor
•
Future economies slowdown •
Two risks of investing in the Vulcan
ROE = 18%
55% of the firm is owned by the family
so they are risk averse and want more
ROE since a lot of their wealth is tied
to the business. Unlike other investors
they have eggs in multiple baskets,
more diversified, so the market ROE is
lower.
•
The cost to this risk aversion is that
they will miss out on profitable
projects because WACC is too high if
they use 18% as the cost of equity.
•
The cost of equity is calculated to be 12.8%
which is below 18%. Why does the family
require a higher ROE than the market?
AFM 373 Page 2
Document Summary
The cost of equity is calculated to be 12. 8% which is below 18%. 55% of the firm is owned by the family so they are risk averse and want more. Roe since a lot of their wealth is tied to the business. Unlike other investors they have eggs in multiple baskets, more diversified, so the market roe is lower. The cost to this risk aversion is that they will miss out on profitable projects because wacc is too high if they use 18% as the cost of equity. Real cash flows is adjusted for inflation e. g. bank pays 5% interest on deposits = nominal return. If inflation is 3%, real return is 5-3=2% Therefore, in the case we expected 3% inflation, we put it in to find the nominal cash flows. Because real cash flows are already given to us with 38,170 each year so we have to reverse adjust for inflation and turn it back to nominal cash flows.
