FM Flashcards
ARR of an investment into a project
Acc rate return = avg annual prof
/ 0.5(initial investment + scrap value)
Growing perpetuity
PV = 1/(R-G)
IRR
= L + (NPVL / (NPVL-NPVH)) x (H-L)
Pros/Cons of PP ARR NPV IRR
+pp simple
+pp recognises importance of liquidity
-pp ignores time value of money
-pp encourages ST decisions (ignores LT)
+ARR looks at whole life of proj
-uses dodgy accounting profs
+NPV time value of money
+clear decision
-COC estimate unreliable
-hard
+IRR Like NPV but doesn’t need a coc estimate
-ignores size and cashflows
Relevant cashflows
Incremental (direct impact)
Future
Cash flow
(Include a line for irrelevant costs as Nil)
(Exclude divs and interest)
Money Vs Real cashflows
Money = inflation taken into account (x(1+i)^2).
Real = Cashflow in today’s terms.
Shareholder value analysis: 7 value drivers to increase NPV
Lines on the NPV
- Increase sales
- Improve the margin
- Pay less tax, buy asset before ye to get CA sooner
- Reduce capital investment
- Reduce working capital
- Reduce COC rate
- Make project last longer
Sensitivity analysis
%=NPV of project / PV of cashflows impacted by the variable.
The lower the % the more sensitive.
CAPM calculates a required level of return at a specified risk Beta. What are the other 2 theories?
Arbitrage pricing - like CAPM done for a number of factors.
Fama and French - like Arbitrage but specifically looked at size and value factors.
Bond Yeild Plus - we just want a higher rate than if we lent the money as a loan.
Behavioural finance
- Over confidence
- Over reaction to news
- Don’t like new things
- Narrow view focussed on one thing to much
COC how do you calculate the growth rate (G)?
Either:
Nth root(new div / old div) - 1
Or:
PAT/Opening sh funds x proportion of profits retained
Return on debt (Rd) and cost of debt (Kd) formulas
Rd = I/Po
Po is current ex intst price of the bond
Kd = Rd x (1-T)
How to calculate WACC
Table
Source - MV - K - MVxK
Bottom. Top.
Real option
Real world considerations:
Follow on income, Early exit possibility, Delay timing, Growth start small maybe, Flexibility change parts of project,
Should we use debt or equity?
Matching
- Time, Match how long you need the money for. RE very quick, debt is quicker than shares.
- Stability, if project will have varying profits, don’t use fixed intst, use shares.
- Currency, which do you need and can you get debt to match.
Cost
- Debt has lower issue costs than shares (RE has none).
- Debt is cheaper than equity (less risk for investor so lower required return).
- Debt is tax deductible so Kd
