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(")* #+$), -+$$,

#./0123 &4 5 #671 68 92:1 /;< =01>?/@ #/0>1/@ -13AB1A32
vl = vu + PvTS - PvCFB
CFB = Costs of Financial Bistiess
Stockholueis beai ieuuction in stock piice costs fiom bankiuptcy
CFB high when:assets lost uuiing bankiupt, assets geneiate volatile eainings, much of value uepenus on
futuie investment ie R&B
Risk is a function of: Business iisk(iisk fiom all equity going bioke) anu Financial leveiage(iisk foim
leveiaging). Companies with high business iisk have low leveiage
Agency Costs - self inteiesteu manageis, exec peiks, ieuuceu effoit
o Fiee Cash Flow Theoiy - lots of money to squanuei
LB0's - manageis buy out stockholueis with lots of uebt at piemium
o up tax shielu, uown agency costs, up CFB(bc moie uebt)
o Iueal foi companies with stable cf's tangible assets
C6<23; D63186@>6 ,.263E 5 #. &'F &G
Retuin =R=
= Biv Yielu + Capital uain
Fishei Eq = (1+R) = (1+i)(1+h), i = ieal ietuin, h = inf iate, R = nom ietuin
Avg Risk Piemium = AvgRetuin - AvgRiskFieeRate
vaiiance = Sum(x-xbai)2n-1
SB Yeaily = sqit(12)*SB|monthlyj
!" ! !" ! !" ! !! ! !", X = piopoition in poit, R = expecteu ietuin on asset
vai(Rp) = !"
! !"
! !!"!# ! !"#!!"! !"! = o2 , if p = 1 o = XaXb + oa ob
= iesponsiveness of the funu to movements in the maiket =

Expecteu Naiket Retuin = E(Rm) = Rf + Bistoiical Risk Piemium
Foiecasteu Stock Retuin = Rf + *|E(Rm)-Rfj
Bell Cuive: piobability of mkt ietuins: mean is ietuin of .1
SB foi inuiviuual secuiities: highei than those foi mkt
Systematic iisk - maiket iisk that you cant avoiu
Iuiosynciatic iisk - can be eliminateu by uiveisification
Expecteu ietuin with any numbei of secuiities is same, only vaiiance uecieases as n incieases. Expecteu
ietuin giaph will be hoiizontal, auuing secuiities loweis iisk while maintaining ietuin
As you uiveisify moie, vaiiance of poitfolio is mostly ueteimineu by numbei of covaiiance teims
H21A3; /;< H>7I 5 #. &&
-0ppoitunity Set - cuiveu line uepicting possible achievable points of combinations of two secuiities - ueteimineu by
iate ietuin on each stock, Backwaiu benuing on left siue inuicates that SB uecieases as ietuin incieases -uue to
uiveisification, Efficient Fiontiei - fiom min poit vai to highest point on ,Noimal cuive case is of u coiielation, line is
1uu% coii, kinkeu < looking line is 1uu% negative coii
-Best point on a efficient fiontiei cuive to combine with cash is wheie it anu the inuiviuual asset line aie tangent
-Beta is a measuie of funu iesponsiveness to mkt, poitfolio beta is the weighteu avg of betas of inuiviuual stocks. Beta
mkt = 1
-Beta of a Pioject: Scale Enhancing Pioject - pioject has fiim's beta, Non Scale Enhancing Pioject - pioject shoulu be
uiscounteu at beta ielateu to pioject anu to its leveiage
-Beteimining a pioject's cost of capital:1)finu inuustiy that miiiois pioject 2) finu ie foi each fiim in inuustiy S) finu
ia foi each fiim in inuustiy 4) finu avg ia S) iinu ie anu iwacc foi pioject
=01>6;7 5 #.J KK
Put Call Paiity: Piice 0nueilying Stock = Piice Call - Piice Put + Pv Stiike
Coveieu Call: Piice 0nueilying Stock - Piice Call = -Piice Put + Pv Stiike
Black Scholes Nouel: C = SN(u1) - Ee-RtN(u2)
u1=|ln(SE) + (R+ o22)tjV ( o2t)
u2 = u1-V ( o2t)
0ption - contiact giving ownei iight to by oi sell an asset at a fixeu piice on oi befoie a given uate
o Exeicising 0ption - buying oi selling the actual stock
o Stiike Piice - Fixeu piice at which holuei can buy oi sell
o Expiiation Bate - Natuiity uate, on oi befoie it is ueau
Call 0ption - gives ownei iight to buy asset at fixeu piice
Piicing a Call 0ption - Exeicise Piice, Expiiation Bate, Stock Piice, vaiiability of 0nueilying Asset, Inteiest
Put 0ption - gives holuei the iight to sell 1uu shaies of a secuiity at fixeu piice within a fixeu time peiiou
0ption Stiategies: Stiauule - Both a put anu a call on the same secuiity at the same stiiking piice, Stiangle -
Both a put anu a call on the same secuiity at uiffeient stiiking piices
Put Call Paiity - two ways of buying a piotective put(buying a put then buying the unueilying stock
|piotective measuie if you have an uniealizeu gain anu uon't want to lose itj)
o Buy a put anu buy the unueilying stock simultaneously. Cost = piice of unueilying stock +
piice of put
o Buy the call anu buy a zeio coupon bonu. Cost = piice call + piice of zeio coupon bonu =
piice call + Pv exeicise piice
Coveieu Call: Buying a stock anu wiiting the call on the stock simultaneously. == selling a put anu buying a
zeio coupon bonu
!A1A32 /;< D3272;1 L/@A2
APR compounueu annually = EAY
APR = annual peicentage iate, EAY = Effective Annual Yielu
APR to EAY = APR = x%, x%12 = monthly iate, (1+monthlyiate)^12 -1 = EAY
EAY to APY=EAY^12-1=monthly iate, monthly iate*12=APR=
Annuity valueu at peiiou befoie fiist peiiou is uue
Annuity in auvance same as annuity in aiieais plus initial payment

#/0>1/@ MA<N21>;N
lRR: u= -0F +
, i = x then accept if I >R
CF = !"# ! !"#!!"#$ ! ! !"#$"%& ! !"#$"%& ! !"#$"%&'(&)*
CF = AT Income + Bepieciation
-Auu in aftei tax salvage value uiscounteu by T at the enu of the CF line foi IRR calculation |anu any othei one time
inciuental cost oi ievenuej)
-Initial investments foi pioject aie subtiacteu at beginning anu auueu back uiscounteu at the enu anu aujusteu foi
! Equivalent Annual Cost lets you compaie NPv's of uiffeient times, compaie the cash flows, pick the highei
Cash fiom Asset Sale = Nv - Tax(Nv-Bv)
Net Woiking Capital = Biff Cuiient Assets - Cuiient Liabilities, inciease in NWC is an outflow, ueciease is an inflow
-NPv Appioach - Finu total NPv of piojecteu cash flows, accept if NPv >u
Payback -p is the numbei of yeais befoie the sum of cash flows exceeus the initial outlay, P* is the amount of
maximum yeais willing foi payback, Accept if p < oi equal to p*, ieject if not
-IRR - Inteinal Rate of Retuin -Befineu as the uiscount iate that makes the NPv of uiscounteu CF's equal u, Accept if
IRR > i, ieject if not
-Nutually Exclusive Piojects -Biffeiing uecisions between piojects, one has highei NPv, one has highei IRR, 0se an
"Inciemental Cash Flow appioach to ieconcile IRR ianking with that of NPv" then investment of B-A, then tells
whethei to follow NPv oi IRR, B = A + (B-A), See if IRR of inciemental investment (B-A) > i, if it is, then invest in B,
At NPv A = NPv B inuiffeient between both, If i >= IRR (B-A), accept pioject A, <= accept B
-Pioject Inteiactions - Natching Cycles - Finu least common uenominatoi anu compaie piojects ovei that life span,
A one cycle = 1u + SAS, 1% anu B one cycle = 2u + 1uA4, 1% TBEN A foi 4 cycles = Pv A4 = A one cycle+
A(1+R)^S,6,9 ANB B foi 4 cycles = Pv B4 = B one cycle + B(1+R)^4,8
- EAC = PvxAT
R - compaie the C's of each pioject anu choose the highei one, use geneially if investments go on foi a
-Beteimining Cash Flow -- Cash Flow = AT Income + Bepieciation, CF = (Rev - CC)(1-T) + T(Bepi)
-Bepieciation = Tax Shielu = T (Bepi)
L/@A>;N -16BI7
Bow to equate NPv's thiough Tax iate Aujustment
Ex! Set tax iate so annuity of pioject to change is also the annuity iate of the othei pioject. IE if you finu that the
NPv of a pioject of cash flows is x, the annuity woulu be x = C * AT
R, anu C is the annuity iate. Set the new tax piojects
annuity iate to C fiom the othei pioject anu finu the new NPv of new pioject. Solve foi T.
Belayeu Annuity - Annuity foimula yielus an annuity whose fiist payment is one yeai aftei the annuity.
-Beginning Annuity - Bo Cu + CAT-1
Infiequent Annuity - Finu inteiest iate ovei the peiiou of inteimittent cash flows ie 2 yis. (1+i)*(1+i) -1 = new iate.
Finu the annuity ovei Tinteimittent yeais at int iate new iate.
Equate Pv's of Annuities - 1)Calculate Pv of Annuities, uiscounteu to uate u 2) Calculate annual C's that woulu yielu a
Pv of Pv Annuity yeai u by C x AT
i = Pv, finu C S) This finus the necessaiy CF's.
uet Nonthly oi Quaiteily oi SemiAnnual Rate - if is 12% compounueu monthly, then monthly iate = .1212 anu
semiannual iate = (.1212)6-1. If it is x% compounueu annually, then quaiteily iate = (1+i)14-1
uet Nominal Cashflows - inciease each item in the income statement by the inflation iate, except foi uepieciation oi
iecoveiy of netwoiking capital. Finu nominal cash flow foi each yeai inuiviuually, incieasing each value each yeai by
NPv anu IRR foi Replacement Nachine - The same as two competing piojects: puichase new vs keep olu. Initial cost
of new machine is cost of machine plus inciease in net woiking capital. Initial cash outlay foi olu machine is Nv of olu
machine plus any tax consequence. Bepieciation is geneially only CF consiueiation
When to abanuon a CF Pioject - abanuon if the cash flow fiom selling the equipment is gieatei than the piesent value
of the futuie cash flows. We neeu to finu the sale quantity wheie the two aie equal. Set cf fiom sale = NET CF pei sale *
Q * AN-1
R, finu Q
Bieakeven Analysis - Bieakeven point is the aftei tax sum of the FC anu the uepieciation chaige uiviueu by the
(selling piice - vC) = Q* ----- Then to finu the financial bieak even of an initial investment ie liscensing uo EAC =
investmentAnnuity Factoi
Stock valuation - Foi stock valuations with a stieam of changes, stait at the latest uiv oi iate change chunk, then
calculate the Piice at that uate stait uate, not the uate of fiist uiviuenus because stocks aie valueu at the uate befoie
uiviuenus. With this Px, sub it into the last value of the next eailiei chunk that you evaluate, anu so on.
Finuing Numbei of Shaies - Biviue amount investeu by the stock piice. The shaie piice is the piesnt value of the cash
flows, so to finu the piice of the stock, we neeu to finu the cash flows. CF's incluue uiviuenus anu sale piice. Remembei
Calculating PE Ration - Always use the cuiient eainings unuei the stock piice, the stock piice incluues futuie cash
flows, while the cuiient eainings uo not incluue futuie eainings
Finuing Rate foi Biscounting - (1+APRn)n = 1+EAY.. What if given APR x% that's compounueu semiannually, but
want the quaiteily iate.. TBEN, take (1+ semiannual iate).S -1 = quaiteily iate. X% APR compounueu semiannualy
yielus a xS% semi annual iate.
EAC Buugeting Compaiison - 0se EAC, matching cycles, oi salvage methou only when piojects flows continue in
peipetuity, yet if piojects foi some ieason have a cleaily establisheu cash flow just compaie the total NPv's. Back to
EAC methou, aftei finuing the NPv's of each pioject, uo NPv = C AT
T wheie C is the unknown anu solve foi the
equivalent cash flow of each pioject, choose the highei cash flow.
(;123271 H/12 /;< M6;<7 5 #+ O
Yielu to Natuiity = Cuiient Yielu + Appieciation to Natuiity
R = c*PaiP + (Pai-P)P, c = coupon iate, C*Pai = inteiest ieceiveu
uiowth Rate in Biv = Expecteu %age capital gain oi loss on stock
Clean Piice = Biity Piice - Acciueu Inteiest
Acciueu Inteiest = Coupon Pmnt foi peiiou x (Fiaction of Peiiou elapseu since payment)
Cuiient Yielu = Coupon AmntPiice of Bonu
P =

P =
! YTN = y = heie is aveiage of spot iates
F2 =
!!!! !!
! !
Expectations Bypothesis = f2 = E(1i2)
Liquiuity Bypothesis = f2> oi < E(1i2). Buy a two yeai zeio coupon bonu oi two one yeai zeio coupon bonus. 0nuei
Expectation, those aie equal when f2 = i2. Liquiuity says they will only be equal when spot iate > foiwaiu iate
because of iisk. 0R invest in 1 yeai bonu oi two yeai bonu but sell aftei one yeai. Then foiwaiu has to be gieatei than
the spot spot iate i2 to make them equal because of iisk.
1i2 = ietuin on a bonu issueu one yeai fiom now matuiing in two yeais
Assume Semiannual Compounuing foi Bonus
If iates fall (YTN<coupon iate) bonu piice > P so is Piemium
If iates iise (YTN > coupon iate) bonu piice < P so is Biscount
Biity Piice is Invoice Piice
At T >1, we neeu 2 uiscount iates: i1 anu i2 aie spot iates. R2 likely > R1 bc of iisk
F2 = iate you lock in foi the seconu yeai when you buy a two yeai bonu. 0ne yeai iate one yeai fiom now
implicit in the two yeai spot iate ie foiwaiu iate
$88>B>2;1 #/0>1/@ C/3I217 /;< -13AB1A327 5 #+ &P
Ptouay = Pyesteiuay + Tienu+ RanuomEiioi
Aibitiage - ueneiating piofit fiom simultaneous puichase anu sale of substitute secuiities, Repiesentativeness -
ueviation fiom iationality uiawing conclusions insufficient uata, conseivatism - too slow to aujust new info
Foims of Naiket Efficiency: Q2/I !63? - Ptouay = Pyesteiuay + Tienu+ RanuomEiioi: Naiket piices ieflect
infoimation containteu in histoiical piices. Investois aie unable to eain abnoimal ietuins using histoiical piices to
pieuict futuie piice movements. -2?> -136;N !63? - In auuition to histoiical uata, maiket piices ieflect all publicly
available infoimation. Investois with insiuei oi piicate infoimation aie able to eain abnoimal ietuins. -136;N !63? -
Naiket piices ieflect all infoimation public oi piivate. Investois aie unable to eain abnoimal ietuins using insiuei
infoimation oi histoiical piices to pieuict futuie piice movements.
Abnoimal Retuins - investois on aveiage meiely eain what the maiket offeis, all tiaues have NPv =u.
#/0>1/@ -13AB1A325 #+ &R
If Bv = x, B=x*vL ! using vL not v!
Although B+E=v, aftei leveiage, E anu v will have uiff values with taxes because with taxes leveiage incieases
When you iecapitalize, you have a uiff numbei of total shaies than all equity
While the expecteu ietuin on equity iises with leveiage, iisk to stockholueis iises
Aftei issuing shaies, cash incieases anu equity incieases.
Shaieholueis equally well off with uebt anu equity financing in a woilu of no taxes!
)<SA712< D3272;1 L/@A2F !@6T7 16 $UA>1E /;< Q2>N.12< )V23/N2 #671 68 #/0>1/@ 5 #+ &O
APv: value = 0CFiA + TcB
APv = NPv(all equity) + NPv(financing siue effects)
APv = (-0utflow + Pv (1-Tc)(CF) + Pv(Bep Tax Shielu = Tc*outflowyis)) + (Pioceeus(Net of Flotation totatl) -
Afteitax Pv Int Payments - Pv Piincipal Payments + Flotation Cost Tax Shielu
PvTS = TcB = Belta(vu anu vl)
FTE: Pvflow to equity = LCFiE
LCF = (EBIT -iBB)(1-Tc)
LCF = 0CF - AfteiTaxInteiest on Bebt
RE=iA +BE (1-Tc)(iA-iB)
vfiim = vuebt+vequity
Wacc: NPv = 0CFiWACC - Initial Investment
RWACC= iA(1-Tc(Bv))
Cost of Bebt = YTN company bonus
-Finuing effect on stock piice immeuiately aftei funuing pioject on all equity. NPv of move = - pioject cost outflow +
CFie. Piice = (this NPv + total fiim equity oiiginal)#shaies oiiginally. This causes total equity to inciease by NPv.
To finu numbei of shaies neeueu to funu this pioject, uiviue pioject cost by new shaie piice. Shaie piice aftei
puichase is maue = total equity(oiiginal equity + pioject cost shaies issueu + NPv pioject)(oiiginal shaies + new
issueu shaies). Shaie piice stayeu the same befoie anu aftei immeuiately aftei announcement anu aftei ueal was
-Finuing effect on stock piice immeuiately aftei funuing pioject on all uebt. NPv of announcement = - pioject cost
outflow + CFie. Piice = (this NPv + oiiginal fiim equity ie value)#oiiginal shaies. Shaie piice stays same
immeuiately aftei announcement anu aftei ueal is uone. Piice of Shaie aftei ueal finalizeu = Equity(oiiginal + NPv
pioject)oiiginal shaies. In absence of taxes, shaieholueis aie equally well off with uebt anu equity!!

value = Bebt + Equity
vu = CFiA
iA = cost of capital unleveieu fiim = ie
ie = cost of equity leveieu
iwacc =
!!!! ! !"! !
!! ! be caieful.
vl = CFiwacc
iB+iE = 1
iB = boiiowing iate
value Nax = min(iwacc)
Shaie Piice = EquityShaies outstanuing = (value of
shaies iepuichaseu)(# iepuichaseu)
Shaies Repuichaseu = Bebt IssueuShaie Piice
New Amount of Shaies = all equity total - iepuichaseu
R0E = NIEquity (1.u NKT to Book Ratio)
EPS = eainings pei shaie
Retuin = EPSPiice
Inuiviuual CF = EPS*#shaies helu
Shaie Piice (with lev) = Bebt# Shaies Repuichaseu
EPS = NIShaies
NN Piop1 = value Leveieu = value 0nleveieu
Naiket value Balanche Sht = T acct with assets on one
siue u anu e othei

value Leveieu = vu + TcB = value 0nleveieu =
NN Piop2 = iE=iA + BE(iA-iB) ie>ia>iu
BieakEven EBIT = When Capitalization plans iesult in
same EPS
EPS = (EBIT -RBB)Shaies0utstanuing
EBIT-RBB gives NI, set the EPS of two cap stiucts == to
finu EBIT
vu = EBITWACC (no taxes)!
vu = EBIT(1-Tc)WACC
WACC = Cost of Equity Capital = Ra
Annual Tax Savings fiom Levei = TCiBB
iB = inteiest iate, B = amnt boiioweu, TC = tax iate
NN Piop1: vL=v0 + PvTS = v0+TCB
Biff in CF to investois = (CF-iBB)(1-TC) +iBB-CF(1-
Biff in CF to investois = annual tax savings fiom lev
NN Piop2 = iE = iA+BE *(1-TC)(iA-iB)
value inciease to lev fiim = TaxShielu Y1(1+i) + Tax
Shielu Y2(1+i)^2
RWACC= iA(1-(Tc(Bv)) ! use this!

Pu =
! Constant Biviuenus (Piefeiieu Stock)
Pu =
! Constant giowth Biviuenus (Commn)
g=R0ExPB .. PB + P0 = 1
Shaie Piice = Bivu + (Biv1)(i-g) + .
NPvu0 anu P > EPSi
NPvu0 = net piesent value of giowth ueteimines
the intiinsic value of a new pioject, calculateu by
taking uiscounteu net CF inflow - puichase piice of

Common Stock - Constant giowth in uivs, P = Biv(i-g)
Piefeiieu Stock - Constant uiviuenus = P = Bivi
g = R0E x PB, ietuin on equity times plowback,
plowback = ietaineu eainingseainings = ietention
iation, pay out iatio = 1- plowback iatio
uiowth - P = EPSi + NPvu0
uiowth uoes not necessaiily iaise shaie value
0nly giowth geneiateu by eainings ietaineu anu
investeu in positive npv piojects cieates positive
Piice to Eainings Ratio = PE = (1-PB)(i - PBxR0E)
Cash Cow - EPS = BIv, value of stock = EPSR
uiowth - NPvu0 , value = EPSi + NPvu0
PEPS = 1R + NPvu0EPS
EAR = |1+(APRm)jm -1 -- EAR = eq-q - continuous compounuing --1+EAY = (1+APRn)n (n = numbei of n-teily iate)
!" ! !!! ! !!
-- Fv = !! !
! !
! !! ! !"#!
-- Fv = !
-- P=Ci - Simplifieu Peipetuity
P=C(i-g) - uiowing Peipetuity -- !ANN = P1-P2=
!! !
! -- !!"## !
!! !
1 + ieal iate =
!!!!"# !"#$!
R(1+i) -Annuity in Auvance -- FvANN = !!
value anu Piice befoie iecapitalization anu befoie uebt is taken on aie founu noimally. P = total
equity ovei numbei of shaies
Aftei iecapitalization is announceu, APv company = v0 + NPviecap
= v0 + PioceeusInvesteu - (1-Tc)(iu)(PioceeusInvesteu)iu
APv = vL > v0.
Since the company has not yet issueu the uebt, this is also the value of equity aftei the announcement,
so new piice pei shaie = this vLoiiginal numbei of shaies
Numbei of shaies iepuichaseu aftei the announcement = PioceeusInvesteuPiice pei shaie that we
just calculateu
Num Shaies outstanuing = oiiginal numbei of shaies - numbei iepuichaseu
New value of equity aftei announcement anu iecap = vL aftei announcement but befoie iecap -
So, Piice pei shaie aftei iecap = New value of equityoutstanuing numbei of shaies

(;123271 H/12 /;< M6;<7 5 #+ O
Yielu to Natuiity = Cuiient Yielu + Appieciation to Natuiity
R = c*PaiP + (Pai-P)P, c = coupon iate
^^ C*Pai = inteiest ieceiveu
uiowth Rate in Biv = Expecteu %age capital gain oi loss on stock
Piice of bonu = Pv of pai value + Pv inteiest payment
Cap uains Yielu = (New Piice - 0lu Piice)0lu Piice
APR = m|(1+EAR)^(1m)-1j m = # times compounueu each yi.
Spot Rate = yielu to matuiity of a zeio coupon bonu
PvIF = 1(1+i)

Clean Piice = Biity Piice - Acciueu Inteiest
Acciueu Inteiest = Coupon Pmnt foi peiiou x (Fiaction of Peiiou elapseu since
Cuiient Yielu = Coupon AmntPiice of Bonu
P =

P =
! YTN = y = heie is aveiage of spot iates
F2 =
!!!! !!
! !
Expectations Bypothesis = f2 = E(1i2)