ECONOMICS 448, Review 4
16.12 The general expression for the value of a leveraged firm in a world in
which Ts=0 is
VL= VU+[1-(1-TC)(1-TS)/(1-TB)]B-C(B)
where:
VU = Value of an unlevered firm
TC = Effi
Risk and Return
Holding Period Return
Three month ago, Peter Lynch purchased 100
shares of Iomega Corp. at $50 per share. Last
month, he received dividends of $0.25 per
share from Iomega. These shares
Lecture 17
Lecture
Capital Budgeting
for Levered Firm
Three approaches
1. Adjusted Present Value (APV) approach
2. Flow to Equity (FTE) approach
3. Weighted Average Cost of Capital
(WACC) approach
Adj
Lecture 16
Lecture
Limits to the Use of Debt
Personal Taxation of Corporate Income
While the corporate tax favors debt, the personal tax favors equity.
Dividends, like interest, are taxed as ordinary
Lecture 15
Lecture
Capital Structure
Basic Concepts
Focus on common stock and straight debt as representative
financial instruments. We ignore default for now.
The market value of the firm is V = B +
Lecture 14
Lecture
Long-Term Financing
Stocks (equity) and Bonds (debt)
Debt and equity are broad categories of firm liabilities.
Key distinguishing features of debt and equity are :
- Whether asset y
Lecture 13
Lecture
Efficient Capital Markets
Basic idea and implications for financing decisions
In efficient capital markets, asset prices prevent investors making
excess profits, relative to the ris
Lecture 12
Lecture
NPV Analysis Accounting for Risk
More risk requires a higher expected return
Corporate investments satisfy a risk-return separation theorem.
The expected return on a project has to
Lecture 11
Lecture
The Arbitrage Pricing Theory (APT)
Basic Idea
APT aims to explain correlation between returns.
Whereas CAPM focuses on market risk, the APT argues that
each source of systematic ris
Lecture 10
Lecture
The Capital Asset Pricing Model
Preliminaries
Expectation, variance, standard error (deviation), covariance, and
correlation of returns may be based on
(i) fundamental analysis
(ii)
Lecture 9
Lecture
Capital Market Theory : An Overview
Returns on Stock
Two components to the return on most stocks are dividend
and capital gain/loss (reinvested if not realized).
Let D t +1 be the di
Introduction Lecture Notes
Economics and Corporate Finance
Some relevant economic concepts
Consumers are the drivers of a market economy:
* Business maxim: The customer always comes first.
* Efficien
Lecture Notes 1
What is Corporate Finance?
Corporate finance is concerned with:
* the capital budgeting decisions of a corporation the types and
proportions of real investments it chooses;
* the capi
Lecture Notes 11
The Arbitrage Pricing Theory
The basic idea
The APT aims to explain correlations between returns by developing a model of where those correlations come from.
This is most useful whe
Lecture Notes 10
The Capital Asset Pricing Model
Expected return, variance and standard deviation
The expected return on a security may be based:
i. on the historical returns earned in the past, or
i
Lecture Notes 9
Introduction to Risk
Returns on stock
There are two components to the return on most stocks:
i. most, but not all, stocks pay a cash dividend; and
ii. a capital gain or loss which, if
Lecture Notes 8
Risk Analysis, Real Options and Capital Budgeting
Sensitivity analysis
Sensitivity uses a range of values for annual revenues, costs, etc.
to examine how changes in underlying assumpt
Lecture Notes 7
Net Present Value and Capital Budgeting
Recipe for financial decision makers within a firm
i. Identify the size and timing of all relevant cash flows.
ii. Evaluate cash flow riskiness
Lecture Notes 6
Alternative Investment Rules
Key features of net present value
A firm operating in the interests of its shareholders should accept investment projects if and only if they have positiv
Lecture Notes 5
Valuing Bonds and Stocks
Valuing bonds
A bond is a contract showing that a borrower owes:
i. a specified sum
ii. that will be repaid on a number of specified dates
iii. along with a s
Lecture Notes 4
Net Present Value
Recipe for financial decision makers
i. Identify the size and timing of all relevant cash flows.
ii. Identify the riskiness of the cash flows in order to determine
th
Lecture Notes 3
Intertemporal Resource Allocation
The source of investment funds
Most consumers prefer to spread their consumption over time
and investment by firms provides a major way they can do s
Lecture Notes 2
Accounting statements and cash flows
The Balance Sheet
A balance sheet provides a snapshot of the firms accounting
value at a particular date.
Current liabilities
Current assets
Net
W
Lecture 8
Lecture
Strategy and Analysis in using NPV
NPV analysis
Applying NPV analysis requires judgements about revenues,
expenses, depreciation tax shields, true economic lives of
plant and equipme
Lecture 7
Lecture
NPV and Capital Budgeting
Cash flows calculations
NPV analysis is based on cash flows not accounting earnings.
Capital investments are treated as current expenses in cash
flow analys
Lecture 6
Lecture
Alternative Investment Rules
The NPV Rule, a review
A firm operating in the interests of its shareholders should
accept investment projects if and only if they have
positive NPV
Thre
Lecture Notes 4
Net Present Value
The single period case
Recall from the previous set of notes that, when the interest rate per period is r, the net present
value of an investment that has a negative
Lecture Notes 3
Intertemporal Resource Allocation
The demand and supply of investment funds
As we noted in the first set of lecture notes, investment is critical to providing consumers with
the maxim