Corporate Securities and
Corporate Securities as Options
Currently an all equity firm
Market Capitalization = $100M = $40 per share 2.5M shares
Volatility of AMC stock =
Option Pricing and Corporate
It is never optimal to exercise early an American
call option on a stock which pays no dividends.
Use put-call parity to explain why.
Binomial Model: Main idea
Binomial option pricing model
Introduction to Options
Exchange Offe r
Type of Transaction
The Interest Tax Shield
Debt gives the firm an interest tax shield which reduces taxes
Tax reduction = Corporate Tax Rate Interest Payments
This tax shield:
Reduces the taxes paid by the firm
Increases the net-of tax cash
Clarkson Lumber (cont.)
Clarkson Lumber Co
Why does the firm have to borrow?
Uses of funds
Net Fixed Assets
Sources of funds
Class 2: Takeaways
Earnings (net income) are not equal to free cash flows
The value of investments (firms) is determined by discounted FCFs
Changes in value drivers matter for investors
CAPM and Project Discount
There is a unique optimal portfolio
On the line tangent to the efficient frontier of the two stocks
This portfolio is optimal, independent of your risk preference
Optimal Portfolio Choice
Multiples or valuation using comparables
How much are you willing to pay for firm X?
A little inaccuracy sometimes saves tons of explanation
Popular form of valuation: simplest!
RV: residual o
IRR Review, Loans, and
Internal Rate of Return (IRR)
The IRR is the discount rate at which the NPV is equal to zero.
A measure of the projects return on investment
Calculate by using:
Trial and error
IRR function in Excel
Free Cash Flows
Class 1: Takeaways
Finance is about decision making
Include all relevant costs and benefits
Consider the opportunity cost of taking the decision: best alternative use
Net present value rule captures the essence of go
Equity and Firm Valuation
Suppose we have the following (different) Zero-Coupon (STRIPS)
What would you pay for the following fixed income security?