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FINMAN2 FINALS REVIEWER by Leona Sanchez NOTE: unless specified, assume the ff: (i) interest rates are

quoted on an annua l basis, (ii) cash flows occurs at the end of each period, (iii) annuities are s imple Chapter 5 & 6: Time Value of Money SIMPLE INTEREST: Future Value (FV) FV=PV*(1 + ) where: i=interest rate n= no. of periods End of the year 1 2 3 4 5 Total CF PVIF5%,n PV of CF NOMINAL &EFFECTIVE INTEREST RATES EAR or APY=1 + ( ) -1 1 + ) = ,

Present Value (PV) PV=FV*(1 + )where: (1 + ue (FV) FV=PV*(1 + ) where: i=interest ent Value (PV) PV=CF*(1 + )End of the year ture Value of Annuity (FVA) 1 FVA=PMT*[( )

)= , COUMPOUNDING INTERE rate n= no. of periods m=compounded periods 1 2 3 Total ANNUITIES: ORDINARY ANNUITY Fu (1 + ) ) (1 + 1] where: [(

FOR CONTINOUS COMPOUNDING EAR or APY= - 1 DEPOSITS NEEDED TO ACCUMULATE FUTURE SUM ATION PMT= where: DP=down payment Period 1 2 PVIF(5%,n) PV of CF Loan st I1 I2 I3 P PMTI1 PMTI2 PMTI3 EB Ending bal 1 Ending bal 2 Ending bal 3 CF (PHP) 1

Ending bal 1 3 PMT Ending bal 2 where: BP=Beginning Principal P=Principal EB=End ing Balance PMT= I1=PRT I2=EB1*i I3=EB2*i FVA(PMTI1)=EB1 EB1(PMTI2)=EB2 Present Value of Annuity (PVA) 1 PVA= PMT*[( ) (1 - (1 + )] where: [( )

FINDING INTEREST FOR A SINGLE SUM FVIFi,n = , = FINDIN FOR A SINGLE SUM FVIFi,n = , = FINDING THE NUMBER OF PERIODS FO e=|Optimistic CasePessimistic Case| RISK MEASUREMENT OF STANDARD DEVIATION 1

FVA=PMT*[(

(1 +

1] *(1+i) wh

+ 1

1] =FVIFA

Present Value of Annuity (PVA) 1 1

PVA= PMT*[(

(1 - (1 +

)-

]*(1+i) where: [(

( )-

]=PVIFA where: PP=cost of s

DEFFERED ANNUITY PVA=((PMT*PVIFAi,n)*PVIFi,n) PERPETUITY: PV= tock*dividend rate COMPLEX STREAM: PV=CF*PVIFi,n = =1 ( or = =1 ( ( = ))2 - 1 ( ))2

where:

where: = -

) = = =

where: )/

RISK MEASUREMENT OF COEFFICIENT OF VARIATION

RISKFREE RATE -

) (

))2 (

))2

=k*+IRP(k

k(bar) where: k*=real estate of interest IRP=inflation rate Compounding period Semiann ually Quarterly Bimonthly Monthly Semimonthly Weekly Daily # of times in a yea r (m) 2 4 6 12 24 52 365 Total of ( The higher (ba . r) k_pk_p (bar) ( Pr K Chapter 9: Valuation & Characteristics of Bonds where: 2 CURRENT YIELD (CY) CY= = + K=(( ( ( ))2 ( ))2 , . Portfolio Risk

. where: Annual Interest Payment=Par value*coupon interest rate BASIC VALUATION MO DEL V= 1+ + 1 2 1+ 2 Return is the total gain or loss experienced on an investment over a given time horizon. RETURN ON ASSET ( ) = -1 + -1 + -1 -1 + + 1+ BOND VALUATION GENERAL FORMULA: or = = =1 (1 + + where: (1 + -1 = FOR COUPON BONDS: = , + , = ) - 1 = )

HOLDING PERIOD RETURN (HPR) HPR= where: EV=Ending Value CF=Cash Flow(s) BV=Beg. Val ue HOLDING PERIOD YIELD (HPY) HPY=HPR1 ANNUAL HPY + where: I=Interest (Par value * Coupon rate) M=Par value kb=required return n=yea rs to maturity BOND PRICE (BP) BP= 1+ where: YTM=Yield to Maturity + AHPY= 1 Geometric Mean=[ 1 2 ] Capital Asset Pricing Model (CAPM): - 1 where: n=no. of years of investment Arithmetic Mean= 1

1
EXPECTED OR REQUIRED RETURN ON ASSETS ( = As kb increases, Vb decreases )

BOND VALUATION: INTEREST IS PAID MORE THAN ONCE A YEAR GENRAL FORMULA: ZEROGROWTH MODEL = 1 = =1 + (1 + ) (1 + )

where: kps=required return preferred stock CONSTANTGROWTH (GORDON) MODEL = 1 = 1+ = 1 1 FOR COUPON BONDS: = , + , -

where: g=projected growth rate D1=expected/projected/future Do=current/historica l/past D=par value*interest on dividends PRICE/EARNINGS (P/E) MULTIPLE APPROACH Vcs=Expected EPSfirm x P/E Ratioindustry = # YIELD TO MATURITY (YTM) YTM= 1+ -1 -1 YTM default= 1+ YTM expected=(YTM no default*(1Pd))+(YTM default*Pd) where: Pd=Probability of d efault Approx. YTM= [ + ]*m

where: EPS firm=Estimated earnings per share of firm NIAT=Net income after taxes PD=Preferred dividends EXPECTED RATE OF RETURN kps(bar)= kcs(bar)= +g where: D=di Po=selling price of stock RATE OF GROWTH IN DIVIDENDS g=retention ratio (b) x ra te of return on equity (ROE) formula: 1 1 + YTM= | + [ | -

2 ( )

where: = ; = Steps for Promised YTM Step 1: Compute for Approx. YTM then get the round down and up of the value. Ste p 2: Use round down and up of the value in this = , + , Step 3: Find the difference between the bond values got in step 2. Step 4: Find the absolute difference between the desired value and the bond value associated with the lower rate Step 5: Divide the answer in step 4 and step 3 Step 6: Multi ply the answer in step 5 by the interval width. Step 7: Add the answer in step 6 to the lower rate. where: b=1 1 =dividend payout ratio reflecting the ratio of cash dividends to be 1 paid next pe riod divided by the firm's earnings NOTE: make an investment if expected return > required return Chapter 14: Cost of Capital Steps in determining the cost of capital 1. Calculate the specific costs of capi tal. 2. Determine the break points. 3. Compute for the WACC/WMCC. 4. Prepare an IOS. 5. Decide which projects to accept. DURATION (D) D= 1 (1+ ) 1

MACAULAY DURATION (MD) MD= T 1 2 2 1 + +

COST OF LONGTERM DEBT (kd) Weights (W) 100 ( CF I I P PVIFkb,t See FT PV of CFs PVIF*C F T(PV of CFs) WM ( ) BEFORETAX: kd= + + T(W) Duration (D)

where: I=par value x coupon interest rate M=par value Nd=selling price of bond n =age of bonds AFTERTAX: kj=kd*(1T) where: T=tax rate COST OF PREFERRED STOCK k p= where: Dp=dividend % x selling price of stock Np=selling price of stock cost of i ssuing COST OF COMMON STOCK ks= + GORDON MODEL ks=Rf + [b*(kmRf)] CAPM 1 where: I=AIP(Coupon bond rate*par value) P=Par value or Principal Lower D=less s ensitive to interest risk STOCK VALUATION SINGLE HOLDING PERIOD MODEL 1 1 + = (1 + ) 1 + where: D1=expected dividends P1=projected market price kb=kcs=required return co mmon stock = security value

where: D1=expected dividend Po=market price of cs g=growth rate Rf=riskfree rat e COST OF RETAINED EARNINGS kr=ks COST OF NEW ISSUES OF COMMON STOCK kn= + eeds Po=market price F=quotation cost BREAK POINT It is a level of total new fin ancing at which the cost of one of the financing component rises. BPj= 1 1 DISCOUNT PAYBACK PERIOD (DPP) DPP= A discounted +| ast negative CFC occurred c=last FCF NET PRESENT VALUE (NPV) NPV= =1 1+ Cumulative PV of FCFs Accept: NPV 0 Year FCFs PVIFi,n *then Total of PV of FCFs less Initial Investmen t to get NPV If Annual FCFs are constant: Annual FCFs Multiply: PVIFAi,n Total P V of FCFs Less: Initial Investment NPV PROFITABILITY INDEX (PI) =1 PI= 1+ PV of FCFs XX XX XX XX XX where: AFj=amount of financing Wj=weight WEIGHTED AVERAGE COST OF CAPITAL (WACC) ka=(wj*kj) + (wp*kp) + (ws*k r or n) where: w=weight WEIGHTED MARGINAL COST OF CAPITAL (WMCC) Range of total new financing 0 to 600K >600K 1M >1M to Source Cap ital LTD PS CS LTD PS CS LTD PS CS of Weight 0.4 0.1 0.5 0.4 0.1 0.5 0.4 0.1 0.5 Cost (%) 5.53 10.61 13 5.63 10.61 13.99 8.40 12 13.99 Weighted Cost (%) 2.252 1 .061 6.5 2.252 1.061 6.995 3.360 1.200 6.995 Accept: PI 1 *Use total PV of FCFs in NPV then divide it by the initial outlay INTERNAL RATE OF RETURN (IRR) MIXED STREAM: =1 IRR= 1+ = to zero MODIFIED INTERNAL RATE OF RETURN (MIRR) Chapter 11: Capital Budgeting STEPS IN THE CAPITAL BUDGETING PROCESS Step 1: Proposal generation Step 2: Revie w & analysis Step 3: Decision making Step 4: Implementation Step 5: Followup = =0 Or 1 + = 1 + 1 + | Accept: DPP

MIRR=PV outflows= 1+ Accept: MIRR required return Year FCFs FVIFi,n FV of FCFs * FV of FCFs divided by Initial Investment to get FVIF i,n; [FVIFi,n=(1 + ) ] to get e xact MIRR Chapter 12: Cash flows & other topics in capital budgeting INITIAL OUT LAY Cost (purchase price) of the asset Add: Incidental Expenses Installed Cost o f the Asset (ICA) or Depreciable Cost of the Asset Less: Proceeds from the sale of old asset Add/Less: Taxes on sale of old asset Subtotal Add/Less: Net Working Capital (NWC) Initial Outlay XX XX XX XX XX XX XX XX AVERAGE OR ACCOUNTING RATE OF RETURN (ARR) ARR= 2 Accept: ARR minimum acceptable ARR PAYBACK PERIOD (PP) PP=A+| /

PP annuity= Accept: PP maximum acceptable PP Year FCFs A=year when last =last negative CFC occurred c=the FCF after getting the last negative CFC

Cumulative FCFs

INCIDENTAL COTS Shipping Cost Handling Cost Insurance while in Transit Cost of T rial Rally/Run Taxes & Customs Duties Installation Costs Incidental Costs TAXES ON SALE OF OLD ASSET Selling PriceBook Value Multiply: Tax Rate Taxes on Sale of Old Asset BOOK VALUE ICA Less: Accumulated Depreciation Book Value FREE CASH FLO WS (FCF) Project's OCFs Less: NWC Less: Capital Spending FCF OCF PRO FORMA APPROACH EBIT Less: Taxes XX XX XX XX XX XX XX CE APPROACH ( = )

CE NPV CE NPV= Year t - Initial Outlay FCFs

=1 1+krf

XX XX XX Riskless FCFs PVIFi,n PV of Riskless FCFs *Then Total PV of Riskless FCFs less Initial Investment to get CE NPV Riskadjus ted Discount Rates (RADR) XX XX XX RADR NPV= where:

; RI=risk index XX XX XX XX Year FCFs PVIFi,n PV of FC

*Then Total PV of FCFs less initial investment to get RADR NPV Chapter 15: Plann ing the Firm's Financing Mix CURRENT PRICE OF A FIRM'S COMMON STOCK

Less: Depreciation OCF ADD BACK APPROACH Net Income Add: Depreciation OCF DEFINI TIONAL APPROACH Revenue Less: Cash expenses Less: Taxes OCF DEPRECIATION TAX SHI ELD APPROACH Revenue Cash expenses Multiply: 1Tax rate Subtotal Add: Depreciat ion * Tax rate OCF TERMINAL CASH FLOW (TFC) Aftertax salvage value of the proje ct Less: Cash outlays associated with the Project's Termination Less: Recapture of nonexpense outlays that occurred at the project's initiation TCF EQUIVALENT ANNU AL ANNUITY (EAA or ANPV) EAA= , Chapter 13: Capital Budgeting and Risk Analysis 3 MEASURES OF A PROJECT'S RISK 1. Project standing alone risk 2. Project's contribut iontofirm risk 3. Systematic risk METHODS OF INCORPORATIONG RISK INTO CAPITAL BUDGETING 1. Certainty Equivalent (CE) Approach 2. Riskadjusted Discount Rates (RADRs) 3. Simulation 4. Scenario Analysis 5. Sensitivity What if? Analysis 6. Pro

PLAN B EBIT UEPS APPROACH: 1 -

where: I=(under LTD bonds) # bonds issued*interest rate # of CSO=(under Common E quity) # of shares Plan A EBIT Less: interest NIBT Less: Taxes (%*NIBT) NIAT Less: PD NIAT Available for Common Stock holders Divide: # of CSO EPS *Project with h igher EPS should be chosen. MARKETPRICE Plan A EPS Multiply: P/E Ratio Market Pric e *Project with lower EPS but same with another project's market price less risky. Plan B Plan B

MAXMIZING SHAREHOLDER VALUE APPROACH Po= = Debt Ratio of % EBIT Less: interest Taxes (%*NIBT) NIAT Less: PD NIAT Available for Common Stock holders Divide: # o f CSO EPS Divide: Required Return Market Price *Investors are not comfortable wi th a debt ratio higher that 30% RECESSIONARY CASH FLOWS CBr=Co+NCFrFC where: NC Fr= (Cs +OR) Pa+RM++En CBr=Cash balance at the end of the recession Co=Cash balan ce at the beginning of the recession NCFn=Net of total cash receipts and other n ondiscretionary expenditures FC=Fixed financial charges associated with a speci fic capital structure Cs=Collection from sales OR=Other cash receipts Pa=Payroll RM=Raw Matl's En=Nondiscretionary expenditures *Do not issue bonds when the CBr is negative Chapter 16: Dividend Policy and Internal Financing DIVIDEND PAYOUT R ATIO (DPR) DPR= RESIDUAL DIVIDEND THEORY Earni for dividends Investment amount needed Multiply (1Debt %) Equity Investments CA SH DIVIDENDS REnew=RE (# of CSO*Dividend per share) STOCK DIVIDENDS CSnew= # of CSO*(1+%of SD)*Par PCEPnew=PCEP+[# of CSO* % of SD)*(MPSPar)] REnew=RE [(# of CSO *Dividend per share)*MPS] TOTAL STOCKHOLDER'S EQUITY Preferred Stock Common Stock Paidin Capital in Excess of Par Retained Earnings Total Stockholder's Equity EPS of the firm EPS= # WARREN'S CURRENT OWNERSHIP % of PSO=# # WARREN'S OWNERSHIP AFTER STOCK DIVIDEND % of PSOnew=# S) 2 new shares for 1 old share # of CSOnew= # PARnew= (1+% # (1+%

) NEW MARKET )

REVERSE STOCK SPLITS (RSS) 1 new share for 2 #

STOCK REPURCHASE (BUYBACK) 3 METHODS FOR STOCK REPURCHASE buy in the open marke t make a tender offer purchase on a negotiated basis Repurchase Price=MPS(afte r the exdividend rate) + Dividend per share # of shares to repurchase= *round d own # of CSOnew=# of CSO # od shares repurchased EPSnew=