Equity Valuation & Inv Appraisal & Real Options & Cap 1 & Cap 2 Flashcards
Gordon Growth (constant G)
P = D_O(1+G)/(R-G)
What is G equal to
G = b(ROI)
Growth vs Income Stocks
Growth -> Investors care about future earnings growth not next period dividend
Income -> next period divided
When will PVGO be +
When ROI > cost of equity, PVGO will be +
When will you use valuation based on comparable firms?
When after a point growth of the company indefinitely = avg stock growth in the economy + p/e ratio is the same
P/E ratios expected indicator of what?
E Growth opportunities
P/E ratios increase with what
Increase with b, given ROI>R
Increase with ROI
In doing NPV analysis which cash flows do you consider?
Incremental cash flows
How do you calculating net cash flows
op cf - capex- opp cost - delta WC - taxes on profits
what is opportunity cost
cost of foregoing opportunity to use asset elsewhere. assets which are owned by the firm can be sold or let
Are investment costs tax deductible at origin?
No they are not, tax authorities use Capital allowances to reduce tax burden
impact on after tax incremental cash flows due to corp tax?
Op(1-Tc) + TcxCA
what do you pay taxes on?
operating profits
What is the formula for written down value?
WDVn = WDVn-1 - CA + Inv Cost - Sales Proceeds
Final CA is known as?
Balancing capital allowance
Formula for balancing CA?
Bal CA = WDVn-1 - Sales Proceeds
what is final WDV?
0
What is R ( OCC)
R is the minium required rate of return to take on the project. this R would be the same of investing that amount of money in a well diversified portfolio of financial assets with the same level of systematic risk
what do use to d dividends?
CAPM
what do use to use to discount interest payments or principal repayments?
CAPM but debt where Rd = Rf
What is firms R
r = WACC
WACC equals to what?
R on assets WACC = RA
Pre tax WACC, Post Tax WACC
Pre tax WACC = RA, Post Tax WACC < RA
When does a firm use own WACC = Ra to discount its project?
When firm and project have the same level of systematic risk AND d/e ratio remains constant at the target
what does asset beta represent?
operating risk of the company
what does equity beta represent
represents the financial risk of the company w having debt on the ball sheet
when do you use method of similars, describe
say the ans
difference between american call option and european call option
american - exercise anytime within the next year, European - exercise in the next year
what is pi*
pi * is the risk neutral probability of an upjump (1-pi*)..
E(total return on project) - options
risk free rate of return
real options do what to value of firm?
increase value
growth options increase what BV or MV
Growth options increase MV of firms not BV
What does MM1 say
firm value is independent of capital structure choice, value depends on on net operating income or FCF
What does that imply (MM1)
investing and financing decsisions are seperate
We know that MM1 holds, is WACC of R_L = WACC of R_U
Yes, under MM1 WACC between the two remains the SAME.
Is the cost of equity going to be higher for a leverd firm under MM1? (hint MM2)
Yes, it increases linearly with an increase in D/E (MM2)
R_E = R_A + D/E(R_A-R_D)
Under PCM of MM (1958) assumptions what all remain the same
WACC and R_D remain the same GIVEN R_D is riskless. R_E increasing linearly with leverage (MM2) under MM (1958) assumptions.
How do we model risky debt?
assumption of risky debt?
We use real options on firms equity (already risky) and now firms debt
Assumption - zero coupon
How do we model firms equity as an option, specify strike price (MM 1953)
Equity is a long call option with strike equal to FV of debt and expiry as maturity date of firms debt
How do we model firms risky debt?
Long a riskless bond + short the value of debt.
K = F
Maturity = maturity of firms debt
What is the put call parity under MM1?
C + PV(F) = V + P
What is EAC, equalised annual cost and how is it calculated?
EAC = PV/Annuity factor used to calc present value
Under MM2 what assumption do we break?
PCM - taxes. Taxes create a tax shield which create a wedge between V_L and V_U
What is the PV(TS)
PV(TS) = TcxD
If debt is perpertual what is the V_L
V_L = V_u + PV(TS)
What happens to WACC when you have taxes?
WACC would decrease as WACC = R_A(1-tc(D_l/V_l))
When do we use WACC over APV
When D/E ratio at the target remains constant or very close to the target
Which companies should have more debt?
Higher profitability companies should have more debt. Companies with higher NTDS should have lower debt
With personal taxes what is the value of my firm?
V_L = V_U + gD
Without V_L = V_u + TcxD
What is the relationship between PV(BS) and PV(TS)
it is a 1-1 increase
what is the static trade off theory
there is a trade off for having debt vs having more of it due to COFD. This means cost of capital depends on capital structure
What can static trade off theory not explain?
why leverage is negatively related to profitability and statistically negative abnormal returns when firms issues equity
