corp_Ch10_09

corp_Ch10_09 - Covenant for Course Participants Who I You I...

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IRPGEN424 Corporate Finance Alex Kane 1 Covenant for Course Participants Who I You I You I I You I You I I You Will do what Will end each session ON TIME Will make every effort to show up ON TIME Will present and post clear notes and use clear examples Will ask about any item that isn’t made clear to you Will respond to any question, none will be disrespected Will show up to class 10 minutes early for short questions Will e-mail for meeting whenever a relevant problem arises Will respond and setup a meeting within 2 business days Will not rest until you can solve all end-of-chapter problems Will restrict the exams to similar problems Will assume your intentions are always honorable Will do the same and, as I, allow for cultural differences in interpretation of behavior
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IRPGEN424 Corporate Finance Alex Kane 2 CLASS NOTES WEEK I READING ASSIGNMENT BMA Ch.10 Capital budgeting and risk
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IRPGEN424 Corporate Finance Alex Kane 3 Business organizations and objective individual business partnership / private corporation public corporation nonprofit / NGO Government entity In all cases, the aim is to undertake projects/business as defined in the charter to “enrich” (explain) owners/stakeholders We will deal with public corporations, but the analogies to other orgs should be clear
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IRPGEN424 Corporate Finance Alex Kane 4 The expected return equation The objective of a corporation is to enrich shareholders by taking risk (why?) How does the corp account for risk? It assumes shareholders are rational, that is, hold diversified portfolios (why?) For such shareholders, only systematic risk matters Thus, the required (expected) return is given by an expected return equation of the type: (1) E(r) = α + r F + beta[E(r M )–r F )]
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IRPGEN424 Corporate Finance Alex Kane 5 The rate-of-return equation and risk Eq.(1), or a variation on it, represents our understanding of capital markets It is the expectation from the return equation: • (2) r = α + r F + beta[r M –r F ] + e e stands for non-systematic return. The e-s get diversified away in a well-diversified portfolio Beta represent cyclicality + operating leverage = systematic risk of the corp 2200 α stands for return when the overall market excess return ( r M –r F ) is zero. Hence, α represents a desired extra return. We expect that in equilibrium α values will be bid down to zero (why?)
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IRPGEN424 Corporate Finance Alex Kane 6 Conventional wisdom (stylized facts) The hierarchy of our beliefs about the market is: rates of return are linear in a benchmark portfolio (why?) we take a position on what this benchmark (M) is, e.g., the beta measures systematic risk relative to the benchmark (what does this mean in practice?) we expect that α =0 in eqs(1,2) for all fairly priced assets -- this is the CAPM when applied to practical work with our
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corp_Ch10_09 - Covenant for Course Participants Who I You I...

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