FM Flashcards
(26 cards)
Formula for the present value of a perpetuity cash flow
Formula for the present value of a growing perpetuity
How to evaluate replacement decisions?
- NPV per economic cycle
- Annuity factor
- NPV/Annuity factor for average cost per year
7 value drivers for shareholder value analysis
Increase
Growth of sales
Operating margins
Life of projects
Decrease
Taxes
Investment in working capital
Capex
Cost of capital
4 real options for strategic value
- follow on options - benefits after project
- abandonment options - can abandon project at less cost
- timing options - can choose when to begin project
- growth options - project can be started small and scaled
- flexibility options - project can be changed to suit developing objectives
Explain the two types of portfolio risk
- Unsystematic/specific risk - risks due to specific products/companies, can be diversified away
- Systematic - market level risk factors, cannot be diversified away
4 considerations with overseas investment
- market attractiveness
- competitive advantage
- political risk
- cultural risk
TERP formula
Formula for value of a right
TERP - exercise price
Human behaviours that affect market efficiency
- Conservatism - resistant to changing their mind
- Availability - place more importance on prominent facts in their mind
- Representativeness - assume history will repeat itself
- Miscalculation of probabilities - overestimate forecasts and unusual events, underestimate common events
3 levels of market efficiency
- Strong - all relevant info factored into market, even secret
- Semi-strong - all public info factored into market when published
- Weak - previous share price info factored into the market
Cost of preference share capital formula (Kp)
Kp = current div / ex-div price
Cost of debt formulae (Kd)
Spreadsheet function for the price of a debenture
= PV
Spreedsheet function for the historic growth rate of equity
= POWER(recent value/oldest value, 1/numper) - 1
Spreadsheet function for the yield of redeemable / convertible debt
= RATE
For convertible debt: Calculate value of shares vs redemption
Formula for the earnings retention growth rate of equity
ARR = earnings/opening shareholders funds
Reten. rate = retained profit for the year / earnings
Traditional theory of gearing at low, higher, and very high levels
Low - equity holders see risk as unchanged, cheaper debt incorporated makes WACC fall
Higher - equity holders see increased volatility, increased equity risk makes WACC rise
Very High - bankruptcy risk worries debt and equity holders, WACC rises even further
M&M’s no-tax theory of gearing at low, higher, and very high levels
- WACC remains constant at all levels of gearing
- investors are rational so all increases in gearing offset by increase in Ke
M&M’s with-tax theory of gearing at low, higher, and very high levels
- WACC falls as gearing increases as debt provides tax benefits
- Optimal capital structure is 99.9% gearing
What to do if the gearing changes as a result of a new project?
Use adjusted present value
1. find base case NPV by discounting using ungeared cost of equity
2. Add the PV of tax shield brought by using debt by discounting at pre-tax cost of debt
3 theories about dividend policy
1. Traditional - bird in the hard
2. M&M - perfect info, DIY dividend
3. Practical - signalling, clientele effect
How to get the market value of equity using enterprise value?
EV = EBITDA * EBITDA multiple
minus mv of debt
minus mv of pref shares
plus cash / short-term investments
Formula for calculating the number of interest rate futures needed
