ECN 5600_Chapter06

# ECN 5600_Chapter06 - The numerator of the NPV is the cash...

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The numerator of the NPV is the cash flows--these can be either riskless or risky. The denominator of the NPV is the discount rate. The more risky the numerator, the higher the discount rate. ( 29 ( 29 ( 29 1 2 3 2 3 ... 1 1 1 Cash flow Cash flow Cash flow NPV Cost today discount rate discount rate discount rate = + + + + + +

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BANK CD Savings account interest rate 4.00% CD rate 5.00% Year 0 -10,000.00 1 500.00 2 10,500.00 NPV 188.61 #NAME? CD cash flows A B C 1 2 3 4 5 6 7 8 9 10
Year 0 -1,000 1 1,500 Discount rate 4% NPV 442 #NAME? IRR 50% #NAME? EVELYN WYER LIPSTICK FRANCHISE Franchise cash flows A B C 1 2 3 4 5 6 7 8

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LEASE VERSUS PURCHASE WITH TAXES Asset cost 4,000.00 Annual lease payment 1,500.00 Bank rate 15% After-tax bank rate 9% #NAME? Tax rate 40% Year 0 -4,000.00 -900.00 #NAME? 3,100.00 #NAME? 1 533.33 #NAME? -900.00 -1,433.33 2 533.33 -900.00 -1,433.33 3 533.33 -900.00 -1,433.33 NPV -2,649.98 -3,178.17 #NAME? 18.33% #NAME? What if you borrowed \$3,100 from the bank? Year 0 3,100.00 3,100.00 1 -1,433.33 -1,224.67 #NAME? 2 -1,433.33 -1,224.67 3 -1,433.33 -1,224.67 IRR 18.33% 9.00% #NAME? Purchase cash flows Lease cash flows The differential cash flows: Lease minus purchase Explanation: The lease is like a loan--an inflow of \$3,100.00 in year 0, and an after-tax outflow of \$1,433.33 in year 1, \$1,433.33 in year 2, and \$1,433.33 in year 3. The IRR of these cash flows is 18.33%. Thus the lease is more expensive than borrowing the money from the bank, since the after-tax cost of a bank loan is 9.00%. After-tax money saved by leasing Same amount from bank This is the depreciation tax shield if you buy the computer. A B C D E F G 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
UNITED TRANSPORT--WACC Number of shares 3,000,000 Market price per share 10 E, market value of equity 30,000,000 #NAME? D, market value of debt 10,000,000 20% 8% 40% 16.20% #NAME? r E , cost of equity r D , cost of debt T C , firm's tax rate WACC, weighted average cost of capital: WACC=r E *E/(E+D)+r D *(1-T C )*D/(E+D) A B C 1 2 3 4 5 6 7 8 9 10 11 12

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VALUING XYZ CORP. SHARES 10 Dividend growth rate, g 7% 15% Share value 133.75 #NAME? Current dividend, D 0 Cost of equity, r E The formula used in cell B5 is usually called the Gordon dividend model , in honor of M. J. Gordon,who first stated its application to share valuation (1959). A B C 1 2 3 4 5 6 7
3.00 25.00 Anticipated dividend growth rate, g 8% 20.96% #NAME? USING THE GORDON MODEL TO COMPUTE THE COST OF EQUITY r E Current dividend, Div 0 Current share price, P 0 Gordon model cost of equity, r E A B C 1 2 3 4 5

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3.00 25.00 Anticipated dividend growth rate, g 5% 17.60% #NAME? USING THE GORDON MODEL TO COMPUTE THE COST OF EQUITY r E Current dividend, Div 0 Current share price, P 0 Gordon model cost of equity, r E A B C 1 2 3 4 5
1998 0.2533 1999 0.2667 2000 0.3200 2001 0.3700 2002 0.4000 12.10% #NAME? 0.40

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## This note was uploaded on 02/15/2012 for the course ECON 5600 taught by Professor Will during the Spring '11 term at Utah Valley University.

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ECN 5600_Chapter06 - The numerator of the NPV is the cash...

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