FIN 300 Lecture Notes - Capital Asset Pricing Model, Operating Cash Flow, Payback Period
14 Jun 2018
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Chapter 6 :Bonds –Debt Security DEFAULT: FV= 1000
Rules CSA (2/yr)
#1 IR (^) P (v) & IR (v) P(^)
#2 Longest maturity is most sensitive to change in interest rate (want)
#3 Zero coupon bonds are more sensitive than regular bonds (want)
#4 Lowest coupon rates will be most sensitive to change in interest rate (want)
Discount- PV < FV & YTM> CPN RATE
Par- PV =FV, YTM= CPN RATE
Premium- PV>FV & YTM < CPN RATE
Equations
$ of CPN PMT=
*As cpn rate or YTM gets smaller, %change in P gets
larger
Current Yield=
= Expected Rate= Income Return
Total Return (expected return)= Income return (current yield) = Capital gains return
Capital gains return=
YTM=
P=
(1+Nominal R) = (1+ real rate) * (1+Inflation Rate (h)
Rd(what company pays)= Rf + Risk Premium --→ Rf= (1+exp inflation) (1+real rate) -1
PV=
→ use he: ods sellig fo =uote
HPR= Holding period return- implicit rate of return between buying and selling period-
→If ou deide to sell the od i to eas from now, what rate of return you would
epet
HPR= Capital Gain Return + Interest Income Return
Annualized HPR= (HPR+1) ^1/N -1
“old the od fo → FV=1054 not the default
Chapter 7: Stocks – Equity Security Default: FV/PAR= 100
Common Shares- Dividends GROW = P0 =
→ D1 = D0 * (1+g)
P1=
→ Find stock price a year from now
Preferred Shares- Diideds DON’T go Pp =
Expected return on stock- r=
Any dividend at any point = Dn = D0 * (1+g)^n (constant growth)
P/E (Price- Earnings Ratio =
→ M/B ratio
Dividend Yield =
→ Current Yield=
→ P(current) is
current market price of stock
Div preferred share= Dividend Rate * Par
D is a diided just paid
The stok losed toda at pa→ P=100
NPVGO!!!!
Chapter 8
NPV= PV(cash inflows) –PV(cash outflows)
NPV of investment = -C0 +
+
+ …
Rules
NPV > 0 → Accept IRR > R → Accept
NPV < 0 → Reject IRR < R → Reject
NPV=0 indifferent (financial break even point) IRR = R Indifferent
IRR= Rate of return at which NPV is = 0
Payback method is biased towards difficult computations
Payback period= # of years it takes to payback the initial cost of an investment
1.Identify year during which investment is paid off 2. Identify the balance leftover to be paid
from the previous year 3. Divide the balance by the cash flow for the year in which it is paid off
4. Add back the number of years in full where the investment had not yet paid off (add
answers 3 &4)
Discounted Payback Period- Discounts all the cash flows first then compute payback as done
before
***or put the CF in list 1 (after tax) then compute for PBP
ARR=
=
→ Only acceptable if it exceeds a target level
Characteristics of NPV Profiles
1¤ Discounts rates (^) as NPV (v), inversely
2¤ The slope of NPV profile is an indication of the sensitivity of the investments NV
to changes in discount rate. The steeper the slope the more sensitive the NPV of
project is to rate fluctuation
3¤ IRR is found at point where the NPV profile intersects the x-axis
Mutually exclusive investment→ You pick the project with the highest NPV, and you pick only
ONE
Non-mutually exclusive investment→ Pick any and all investments which NPV>0
Profitability Index =
(never negative #) PI > 1→ Accept NPV> 0, IRR>R
PI < 1→ Reject (inverse^)
PI =1 is Indifferent NPV= PV of cash inflows Initial investment- PV of cash outflows
**EVERYTIME YOU “EE CA“HFLOW OR CO“T “AVING“ Must be taxed if there’s a tax rate
**Don’t use i when calculating payback period. Use it for only Discounted payback period
In this case i= Required rate= discount rate= cost of capital
-IRR is independent of an investments cost of capital, and will only change when cash flow
changes
-If ou hae to fid PI ad p do’t out iitial iestet i ashflos eause u alead
counting it in PI
Chapter 9
Cash flow estimation rules
Exclude sunk costs- A cost that has already been incurred and is independent of the
investment decision to be made osultig fees, o alead ee paid o just paid
Include opportunity costs- the most valuable alternative that we are giving up by
undertaking a particular investment
Include Erosion/ Side effects- The cash flows from the investment that may take away
from current cash flows being generated through a different avenue within the firm
Include NWC→ NWC= Current Assets- Current Liabilities
If NWC (^) AT TIME =0, CASH FLOWS IS NEGATIVE. If nwc (v) cash flow is positive
Exclude financing costs- dealt with later
What to include when computing NPV- Initial investment, Opp cost, change in NWC,
Operating cash flow, CCA Tax Shield, Salvage value
Capital Cost Allowance (AKA Depreciation) – deducted from firms taxable income
The Half-Year Rule: An adjustment made to the amount of CCA depreciation claimed in
the first year of a asset’s auisitio
Operating Cash Flow- [(Sales – Costs) * (1-Tc)] + [Depreciation*Tc]
PV OF OPERATING CF INCLUDES FIXED COST→N=x i=x pmt=op cost/yr fv=0 pv=?
CCA Tax shield= CCA * TC
PV(CCA Tax Shield) = [
] (if salvage =0
C= Initial cost of asset second half =0)
d=CCA depreciation rate T=Tax rate k=discount rate(required rate)
S= Salvage Value n= Useful life of the asset
UCC= C
Salvage value gets added on at the end of cashflow
HALF YR RULE- Says you can only claim 50% of max cca allowable in yr 1 (divide by 2)
*When calculating NPV, If it sas the pojet ill iitiall euie a iease i
et okig apital of $ & A additional investment of 50000 in nwc wil
e euied fo the fist ea
→You’d sutat fo the iitial iestet , ad sutat fo CF
of year 1.
→Add both 70000 & 50000 to the last CF value, also adding salvage amount
Lets sa it does’t sa a additioal iestet of , If it sas NWC at t=
is 120 000, you would subtract 120 000 from 70 000 to get (-50000) included in
CF of year 1.
PV of salvage value= do the tvm n=4, i=9, pv=?, pmt=0, fv= # the machine could
have been sold for
**If you see CCA rate, calculate PVCCATS so u can add it to initial investment
ost he alulatig NPV, AL“O if u do’t see CF do sales-cost
*Depreciation must be calculated on a declining basis, asset class must remain op
Chapter 10
Arithmetic Average= x̄
Geometric Average= [(1+r1)(1+r2)(1+r3)..(1+rn)^(1/n) -1 x 100
Standard Deviation= Sx
Variance = in decimals
Example: Stock A is expected to return 75% in a boom and lose 5% in a recession
Stock B is expected to return 30% in a boom and 10% in a recession
The likelihood of a boom is Pb= 30% and recession Pr=70%
Expected Return on a stock=E(R)= Pb*E(Rb)+ Pr * E(Rr)
*Stock with the higher risk premium is the one with the riskier investment
*Also go for one with the more less variance and SD
Chapter 11
SD= x
Expected return= x̄
Expected return on a portfolio= E(Rp)= [Wa * E(Ra)]+[Wb*E(Rb)] w= weight of stock A
Systematic Risk: Risks that affect all stocks in the market – risk premium is related to only this
Unsystematic Risk: Risks that affect one or a small number of stocks
CAPM (The Capital Asset Pricing Model)- E(R)a= Rf+Ba * [E(R)m – Rf] or E(R)a= Rf + Ba
*[Market risk premium]
Where: E(R)m= Expected Market Return, Rf= Risk-free rate of return, B = Beta of stock
Default
Bmarket= 1.00 (the systematic risk of the market is a standard value)
B risk-free asset= 0.00 (A risk free security has no risk or systematic risk)
Beta tells us how sensitive a stock is to the market risk premium and how the stock is
correlated to the returns of the market
Beta of a risky asset- Ba =
= Correlation coefficient of stock in market
= SD of stock (risky asset)
= SD of market returns
Portfolio beta=(Wa*Ba)+(Wb*Bb) ..
Reward to risk ratio= slope of SML=
SD of the portfolio=
Highest SD means the most volatility
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Document Summary
Chapter 6 :bonds debt security default: fv= 1000. #1 ir (^) p (v) & ir (v) p(^) #2 longest maturity is most sensitive to change in interest rate (want) #3 zero coupon bonds are more sensitive than regular bonds (want) #4 lowest coupon rates will be most sensitive to change in interest rate (want) Discount- pv < fv & ytm> cpn rate. # (cid:2198)(cid:2195)(cid:2202)(cid:2201)/(cid:2207)(cid:2200) *as cpn rate or ytm gets smaller, %change in p gets. Ytm= (cid:4666)(cid:2162)(cid:2178)(cid:2172)(cid:4667)(cid:2778)/(cid:2170) p= (cid:2172)(cid:2777) (cid:2162)(cid:2178) (cid:4666)(cid:2778)+(cid:2169)(cid:4667)(cid:2170)(cid:4667) (cid:2869)(cid:2868)(cid:2868) (cid:1844) use (cid:449)he(cid:374): (cid:862)(cid:271)o(cid:374)ds selli(cid:374)g fo(cid:396) (cid:1005)(cid:1004)(cid:1012) =(cid:395)uote(cid:863) Pv= (cid:3018)(cid:3048)(cid:3042)(cid:3047)(cid:3032) (1+nominal r) = (1+ real rate) * (1+inflation rate (h) Rd(what company pays)= rf + risk premium -- rf= (1+exp inflation) (1+real rate) -1. Hpr= holding period return- implicit rate of return between buying and selling period- (cid:862)if (cid:455)ou de(cid:272)ide to sell the (cid:271)o(cid:374)d i(cid:374) t(cid:449)o (cid:455)ea(cid:396)s from now, what rate of return you would e(cid:454)pe(cid:272)t(cid:863) Hpr= capital gain return + interest income return.
