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
When to use the WACC
Small project
Not project specific financing
Same level of gearing
Same business risk
Strong form market vs Weak form
Strong- info impacts price BEFORE announcement.
Semi-strong- info impacts price when announced.
Weak- OLD info impacts price late.
Green finance
Green bank loans - get low intst rate if you meet environmental criteria.
Green bonds - issue bonds to finance an environmentally sustainable project.
Intrinsic value and time value of an option
The premium is made up of these 2 things:
Intrinsic value is the difference between the the strike and current spot.
Time value is the rest of the premium.
(Impacted by length of option, intst rates, and volatility of price).
Dividend policy theory
MM - Doesn’t matter, any loss in dividend is made up for in better RE so future growth.
Traditional - Divs now is better than future growth.
Communication is key manage the signal.
Capital structure theories
Traditional - There is an optimum.
M&M - it doesn’t matter, but tax.
