Fall 2014
Corporate Finance
Prof. Jules van Binsbergen and Prof. Michael Roberts
Cost of Capital at Ameritrade
Read and prepare:
Cost of Capital at Ameritrade
Big picture question:
What cost of capital should Ameritrade use in evaluating its expansion?
Qu
Ameritrade!
David Cao
Jane Xuejing Li
Mike Xu
Dongye Zhang
KNOWLEDGE FOR ACTION
Background!
Ameritrade was a deep-discount brokerage rm that planned to invest
heavily in technology and advertising to increase customer base and brand
awarenes
FNCE 611: Corporate Finance
Professors Jules van Binsbergen and Michael Roberts
Midterm
Name:
Solutions
Section:
Instructor:
Question
Maximum
1
20
2
20
3
20
4
20
5
20
Total
Student Score
100
Instructions:
Please read each question carefully
Round all nu
FNCE 611: Corporate Finance
Professors Jules van Binsbergen and Michael Roberts
Midterm
Name:
Section:
Instructor:
Question
Maximum
1
20
2
20
3
20
4
20
5
20
Total
Student Score
100
Instructions:
Please read each question carefully
Round all numbers to t
Finance 611: Corporate Finance
Real Options
Capital Budgeting
How do we make investment decisions?
Compare costs and benefits: accept if benefits > costs
o We have developed a set of tools to value the cash-flows of projects:
NPV, FCF, CAPM, WACC, APV
o
Finance 611: Corporate Finance
Financial Options
Option Combinations: Portfolio Insurance
100
75
Payoff
Stock
+ Put
Call
+ TBills
50
25
0
0
25
50
75
100
-25
Stock Price
PROF. JULES H. VAN BINSBERGEN & PROF. MICHAEL R. ROBERTS
2
Put-Call Parity
We have s
Finance 611: Corporate Finance
Risk Management
Derivatives: What are they?
A derivative security is a security whose cash flows are derived
from the market prices of other securities or assets.
o
o
Derivatives give no ownership or control rights.
A deriv
Finance 611: Corporate Finance
Capital Structure
The Capital Structure Question
So far we tried to answer the following
The next question:
question:
Which projects should the firm invest in
to maximize value?
How should the firm raise the capital
nece
Finance 611: Corporate Finance
Capital Asset Pricing Model
Action
We are going to slow down.
Last two cases dropped from the schedule (Twitter IPO & Open Table
Acquisition).
Less time spent on cases. Presenters/discussants each get 10 minutes.
We will
Finance 611: Corporate Finance
Risk and the Cost of Capital
Measuring Returns
Recall the definition of the total return:
R1
Div1 P1 P0
P0
P0
Stock returns are highly variable over time: General Motors
Year
2000
2001
2002
2003
2004
2005
2006
2007
2008
S
Solutions to Problem Set 1
Corporate Finance, Sections 001 and 002
1. (i) EAIR = .08
(ii) EAIR = (1 + 0.08/365)365 1 = .08328
(iii) EAIR = e.08 1 = .08329
Continuous compounding implies the highest EAIR, annual compounding the lowest.
In general, the grea
Solutions to Problem Set 2
Corporate Finance, Sections 001 and 002
1. (a) The yield on the bond (assuming annual compounding) is:
r = (1000/800)1/5 1 = .04564
(b) With a yield of 4.564%, the present value (that is, the price) of a three year
zero-coupon b
Solutions to Problem Set 3
Corporate Finance, Sections 001 and 002
1. (a) Because the yield to maturity on similar securities is 8%, you will pay a premium
for a 10% coupon bond such that the yield to maturity for both securities are
equal. Since interest
Solutions to Problem Set 4
Corporate Finance, Sections 001 and 002
1. (a) The stock price can be estimated using the dividend growth model as follows:
P0 =
EPS1 (1 b)
r b ROE
where b equals the plowback ratio and r equals the required rate of return. Thus
Solutions to Problem Set 5
Corporate Finance, Sections 001 and 002
1. (a) The plowback ratio is equal to 1 (Div 1 /EPS1 ). We can calculate this number
from the dividend yield Div1 /P0 and the price-earnings ratio P0 /EPS1 .
b=1
Div1 P0
Div1
=1
= 1 .0163(
Solutions to Problem Set 6
Corporate Finance, Sections 001 and 002
1. Because the proceeds from Year 1 are reinvested in Year 2 etc., the proper summary
measure for returns is the geometric average of the annual returns. Thus, the geometric
average return
Solutions to Problem Set 7
Corporate Finance, Sections 001 and 002
1. (a)
i. The investor should choose security 2 because security 2 has a higher expected
return than security 1 (R2 = .16 while R1 = .10).
ii. The investor should choose security 1 because
Solutions to Problem Set 8
Corporate Finance, Sections 001 and 002
1. (a) The risk premium is given by
RM Rf = .12 .06 = .06
(b) The equilibrium expected return of a risky asset is given by:
Ri = R f + i ( RM R f )
The expected return for the securities g
Solutions to Problem Set 9
Corporate Finance, Sections 001 and 002
1. (a) Recall that the asset beta, A is the beta of the underlying assets of the rm.
Since the rm is a portfolio of debt and equity,
A =
D
E
D + E
V
V
(1)
where V is the total value of the
Solutions to Problem Set 10
Corporate Finance, Sections 001 and 002
1. (a) The position that produces prots if IBM increases while limiting losses if IBM
declines comes from buying a call. Buying an at the money (E = $150 ) call
for $15 produces:
Stock pr