In perfect capital markets, financing transactions have an NPV of zero- the interest and principal
repayment have exactly a present value of the amount of the bonds.
The interest tax deductibility makes this a positive NPV transaction for the f
Debt cost of capital will always be lower than equity cost of capital.
We can deduct interest expense from Debt Cost of Capital.
Debt Cost of Capital (RD): lower than RE and tax deductible
We find RE using CAPM model.
WHEN FINDING RD USING CALC
When raising funds from outside investors, a firm must choose what type of security to issue and
what capital structure to have.
Capital Structure: the collection of securities a firm issues to raise capital from investors
(usually debt, prefer
Beta: the sensitivity of an investment to fluctuations in the market portfolio (measure of risk)
Beta = 2.0, stock is twice the return of the market.
Compare the historical return to the market historical return to determine stock
Use excess re
CHAPTER 11 CONTINUED
Individual stocks: no correlation on map of risk and return.
Portfolios have DIVERSIFIED risk so it becomes more stable, less sensitive, higher correlation.
As long as two stocks are perfectly not correlated, investing in both will de
THIS CLASS MATERIAL WILL NOT BE ON MIDTERM. ONLY ON THE FINAL!
Small Stocks* highest growth
For Annual Returns:
Realized Return = Dividend Yield + Capital Gain Yield
Div1 + P1 - P0
Discounted FCF Model
Must forecast all inputs to FCF
Uncertainty surrounds each assumption
Sensitivity analysis is important, translates the uncertainty into a range of values for the
Present value of
1. Dividend Payments
2. Total Payouts
Discounted Free Cash Flow Model:
focuses on the cash flows to all of the firms investors, both debt and equity holders.
Enterprise Value = Market Value of Equity + Debt Cash
Equity Market Capitalization/Market Value of Equity = Stock price * Sh
Net working capital of 126,000 that you expect to grow at a rate of 7% per year forever. You are
considering slowing growth to 4% per year. If your discount rate is 12% how would these
changes impact the value of your firm?
(126,000 * 1.07)/(.05
CHAPTER 19: MANAGING WORKING CAPITAL
What if you could decrease increase in NWC by 10%,
increase FCF by 10% of NWC, THEN divide by (r-
*Inventory Days: Inventory/Average Daily COGS
*Accounts Receivable Days: Accounts Receiva
Makes investment decisions (weigh costs/benefits, maximize wealth to shareholders)
Makes financing decisions
Manages cash flow from operating activities
Net Present Value *most important test for making decision* trumps all