L2 Flashcards
What is impact investing
Idea that investors have return objectives but have capital that has purpose and it matters
purpose and return driven capital in the industry
governments and foundations with the idea of catalytic capital
there are certain regions or part of the company lifecycle where investors are best placed to take on risks
Can you speak to the history of clean tech investments?
Since 2012 technology costs have reduced, change in conviction and attitude towards the social and economic impact of climate change
cleantech returns have disappointed for several years but falling costs for cleantech and decreased competition for deals have turned this around
poor until 2013 due to …
-poor regulatory framework - governments were not subsidising research and high uncertainty
-Spain supported then changed mind - large losses for investors
- first capital investment is expensive
- micro condition flight to safety
- unproven processes
- uncertainty in valuation of firms and business models
-global financial crisis
- valley of death - early stage long way to get to profitability
now
- consensus achieved of problems that need addressing
- supportive regulatory framework eg. IRA in US
- wind and solar have achieved price parity
- long duration storage technologies
- Tesla - high returns and esg landscape
Where has money been made and lost in clean tech subsectors?
IRR high in renewable power deployment, energy optimization tech and resource subsittions
money lost in renewable power manufacturing
Where has the money been invested into clean tech subsectors
Mainly renewable power deployment and resource solutions
high (~8bn dollars) in renewable power manufacturing despite loses
What is an investment? How should investment types be organised?
= exchange of money for a claim of benefits to be generated by some assets
real and financial assets
Real assets - eg. steel structures, land and heavy machinery - foundations upon which economic activity is built
Finanical assets = less tnagible - have no physical properties - constitute an agreement between parties eg. equity derivated
What are the different kinds of asset classes?
- Equities = shares in a plc. company
- Fixed income = lend directly to clean energy projects
- Real estate = ownership in manufacturing or producing facilities
- Commodities = speculate on the price of outputs like electricity
- Derivates
RE is not a class but a sub-category of these asset classes
Who is an investors? How can investors be categorised?
any person or entitiy who commits capital with the expectation of receiving financial returns
strategic - already a presence in the sector eg. oil and gas going into renewables
= already have operational teams, boots on the ground
financial - pre funds or vs or institutions like pensions funds
What is the risk profile likely to be for a utility company?
Have the opperational capacity - can take risks at an earlier stage
higher risk when you look at an investment but get a much higher return and have the skill set to manage that risk - compared to a fund with no operational capacity
Can you speak to a debt?
- instruments
-buyers
-priority
-repayment
-control
Instruments
- assets that require a fixed payment to the holder usually with interest
Buyers
- lenders that recoup their investment in the form of interest and then principal paid by the company on the debt
Priority
- priority in liquidation some times even secured a specific asset
Repayment
- fixed repayment and reutnr - upside is capped
- sometimes can be repaid without cost
- classified as a fixed cash flow
Control
- can exercise passive negative control
Can you speak to equity?
- Insturments
- buyers
- priority
- control
Instruments
- common stocks are securities that are a claim on the earnings of an assets of a corporation
Buyers
- become shareholders in that company. Can recover their investment when the company’s value increases - their shares rise in values - or when a company pays a dividend
- more volatile
Priority
- lower in the pecking order - pre and post liquidation
-upside is uncapped
Control
- exercise control and direction over the company
How are risks and returns correlated in capital structure?
highest risk = higher returns
low priority of payment = highest share of profits/losses
lowest risk = lowest returns
highest priority of payment = lowest share of profits and losses
What is highest to lowest on risk and returns in a capital structure
Highest —> lowest
Equity
Hybrid debt/equity
subordinated debt
senior debt/bonds
What does a discounted cashflow valuation relate to?
value of an asset to the present value of expected future cashflows on that asset
What is a relative vlaution?
estimates the value of an asset by looking at hte pricing of comparable assets relative to a common variable like earnings, cashflows, book value or sales
What is a contingent claim valuation?
uses option pricing models to measure the value of assets that share option characteristics
if don’t have a measure of profitability
What is the assumption around assets in a DCF?
every asset is assumed to have an intrinsic value that can be estimated, base dupon its characteristic in terms of cash flows, growth and risk
What info is required to have a DCF valuation?
need to estimate:
the life of an asset
the cash flows during the life of the asset
the discount rate to apply to these cash flows q
What are the two most common analytical techniques used in estimating an investment?
NPV and IRR
What are the conceptual foundations behind NPV and IRR?
time value of money and the opportunity cost of capital
What is the NPV rule
If NPV>0 accept investment in the project
if capital is constrained the rule is to prioritse according to the amount of NPV generated
What is the NPV equation?
NPV = Investment - Sum of number of year Cn/1+r^n
What is the Value Improvement Ratio?
complimentary to the NPV measure of value creation
can’t be used in isolation but v helpful in ranking the attractiveness of competing investment projects
VIR = capital employed/NPV
How do you approximate the oppertunity cost of capital?
This is the best available expected reutnr offered in the market on an investment of comparable risk and term of cash flow being discounted
use a WACC
What is the CAPM equation?
re = riskfree asset + beta x (rmarket - rfree)
What is the WACC equation?
D/D+E x rd * (1-t) + E/D+E x re
where D+E are capital structures evaluated at market value based on target cap structure
t is the marginal tax rate
rd is the cost of debt
re is the required rate of return on equity
Why do we use the WACC?
- measures the returns demanded by all providers of capital - investments must offer this return to be worth using the capital providers money
- represents the opportunity cost of capital employed - the rate of return investors could earn elsewhere on projects with the same risk and capital structure
- represents the true discount rate for the project, after accounting for capital structure and risk
What is the difference between corporate and project WACC?
Corporate is not necessarily the cost of capital for a project within a firm
- the systematic risk of the project could differ from the average systematic risk of the firms projects
- the target capital structure for the project - a company within a firm - could differ from the corporate target capital structure
- each project will have its own wacc and unique hurdle rate
What is the relationship with debt to WACC?
increaseing debt lowes the wacc
but there is a risk of insolvency
debt can make the equity more attractive and make your project a positive NPV
What are the three approaches to international equity risk premiums?
- Assume that every company in the country is equally exposed to country risk
E(Return) = Riskfree Rate + Country ERP + beta (US Premium) - Assume that a companies exposure to a country risk is similar to its exposure to other market risk
E(Return) = Riskfree rate + beta (US Premum + Country ERP) - Treat country risk as a separate risk factor and allow firms to have different exposures to country risk - perhaps based upon the proportion of their revenues come from non-domestic sales
E(return) = risk-free rate + b(US premium) + I (country (ERP)
country erp: additional country equity risk premium
What is an IRR?
IRR is the r term in the NPV formula, which can be evaluated independently from NPV
it is a yield indicator = an annualised rate that is analogous to common forms of investment
Investment - sum Cn/1+r)^n= 0
irr is the discount rate that get NPV to equal 0
What is the IRR rule?
accept an investment in a project when the IRR>WACC
if Project IRR> Project WACC then Project NPV>0
minimum IRR will be higher for riskier projects, that for safer projects
What is the hurdel rate a sum of?
Hurdle rate = riskless rate + risk premium
What is the issue with having a single hudrle rate for a whole firm?
can lead to errors in capital allocation
How do you calculate the payback period?
total invesment/cash inflow (net profit)
