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International Finance And Capital Markets > Time Value and Investment Appraisal AND Debt and Equity > Flashcards

Time Value and Investment Appraisal AND Debt and Equity Flashcards

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1
Q

What is simple interest

A

Interest is earned on principal only

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2
Q

What is compound interest

A

Interest is earned on both principal and interest

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3
Q

What is the time value of money

A

interest earned

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4
Q

The cost of replacing a fleet of company trucks with more energy efficient vehicles is £1 million in 2018. The cost is estimated to rise by 8.5% in 2019. If the interest rate is 4%, what is the cost of a delay in terms of GBP in 2018?

A

2018 £1m
2019 £1m*(1+8.5%)
2018 PV of £1.085m
PV = 1.085m/1.04= £1.0433m

The cost of a delay of one year = £0.0433m

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5
Q

What is the nominal interest rate NIR

A

quoted as an annual rate and interest is compounded more frequently than annually

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6
Q

What is effective interest rate EIR

A

the interest rate that produces the same yield as the nominal interest rate when compounded annually

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7
Q

What is the EIR formula

A

EIR = (1+ NIR/X)^X - 1

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8
Q

When the EIR is used

A

S = P (1+EIR)

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9
Q

What is perpetuity

A

cashflow that will occur at regular intervals forever

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10
Q

What is annuity

A

constant cashflow will occur at regular intervals for a finite number of periods

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11
Q

What is the NPV formula

A

PV(benefits) - PV(costs)

Cashflow/r - Costs

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12
Q

what happens to NPV if the cost of capital goes up while n remains constant

A

NPV drops as R rises

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13
Q

What is the IRR

A

the interest rate that sets the net present value of the cashflows to zero

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14
Q

What is the IRR investment rule

A
  1. Take any investments where the IRR exceeds the cost of capital
  2. Turn down any investment whose IRR is less than the cost of capital
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15
Q

How do you calculate IRR

A

CF/r - Costs = NPV

Calculate what r is when NPV = 0

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16
Q

Whats the difference between NPV rule and IRR rule

A

NPV rule = Accept the project with a positive NPV

IRR rule = Take any investment where the IRR exceeds the cost of capital

17
Q

Which situations are there where the NPV method is preferred over IRR

A
  1. Cashflows of a project are not conventional
  2. There are multiple IRRs or no IRR exists
  3. Mutually exclusive projects are being considered
18
Q

What should you do when the IRR rule conflicts with the NPV rule

A

Take the NPV

19
Q

What is the formula for payback period

A

Initial Investment/ Annual Cashflow

20
Q

What is a pro of the payback period

A

simple and easy to use

21
Q

What is two cons of payback period

A
  1. Ignores the cashflows outside the payback period and does the consider the project as a whole
  2. Ignores the time value of money
22
Q

When the bond price is greater than the face value. What do we say it trades at and when does this occur

A

Above par or at premium

Coupon rate > Yield to maturity

23
Q

When the bond price is equal to the face value. What do we say it trades at and when does this occur

A

At par

Coupon rate = yield to maturity

24
Q

When the bond price is less than face value. What do we say it trades at and when does this occur

A

below par or at a discount

Coupon rate< yield to maturity

25
Q

What is yield to maturity

A

The yield to maturity of a bond is the discount rate that sets the value of the bond equal to the current market price of the bond

26
Q

Suppose a zero-coupon bond has a face value of £100 and a maturity in 2 years with a price of £92.45. Calculate the YTM

A

(100/92.45)^1/2 - 1 = 4%

27
Q

Bond value changes over time as a result of the change in r

A

r is subject to the change of the market interest rates which are affected by economic conditions such as inflation rates

28
Q

bond value changes over time as a result of the change in n

A

n decreases as the bond gets closer to its maturity date

29
Q

What happens to C and FV when a bond is issued

A

nothing they are fixed and do NOT change during the life of the bond

30
Q

What happens to the bond value of a zero coupon bond when the YTM increases

A

as interest rate YTM rises, the bond value falls and vice versa

31
Q

what is the macaulay duration

A

the macaulay duration is the weighted average maturity (measured in years) of the cashflows of a bond

32
Q

What do one year common stock (equity with one year horizon) have in common with a 1 year coupon bond

A
  1. The format of the equation is the same

2. Both equations are the result of the application of the PV formula

33
Q

What do one year common stock (equity with one year horizon) NOT have in common with a 1 year coupon bond

A
  1. Div1 and P1 are expected values (UNCERTAINTY)
    C and FV are both fixed when a bond is issued (CERTAINTY)
  2. Re cost of equity capital represents the return expected by shareholders (HARD TO DETERMINE)
    YTM cost of debt capital represents risk free interest rate (government bonds EASY TO DETERMINE)
34
Q

In Dividend Discount model what is the assumption

A

If a company exists forever its terminal value disappears

35
Q

In DDM if a company exists forever its terminal value disappears, Is this reasonable

A

Yes the assumption is reasonable

  1. Terminal value tends to be negligible as N, the number of years increases
  2. A common practice such as going concern
36
Q

What two challenges does DDM face

A
  1. Re represents the rate of return required by shareholders, which is non observable and therefore impossible to calculate with provision
  2. Dividends are difficult to forecast with accuracy because dividend payout is an internal issue of the company
37
Q

How do we overcome the two challenges face by DDM

A
  1. To estimate Re by CAPM

2. To simplify the forecast by making some assumptions

38
Q

What are 2 assumptions of DDM (intro to dividend growth model)

A
  1. Dividend is a Constant in perpetuity (value of company equity equals dividend divided by the cost of equity capital)
  2. Dividend grow at a constant rate ( cost of equity capital is the sum of dividend yield and dividend growth rate)
39
Q

DC pay an annual dividend of 26p per share. analysts expect dividend to grow 6% per year in perpetuity. What is the value of the share if firm cost of equity capital is 10%

A 
Div0 = 26p
Div1 = 26*1.06=27.56

P0 = 27.56/(0.1-0.06) = 689p

International Finance And Capital Markets (4 decks)

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