These are my notes for FM213 Lent Term.
Grade: 1st
Topics:
1. Capital Budgeting and NPV Rule
2. Real Options
3. Payout Policy
4. Debt Policy
5. Optimal Leverage for a Firm
6. Types of Debt
7. Initial Public Offerings
8. Mergers, Corporate Governance and Control
=
Account Receivables +
Inventory
-
CL Salvage
I0U money owed by used by company to
'
manufacture and sell
Book value of an asset after all depreciation has been
customers to me
company products .
TAR → Towedto him →cash ↑ inventory → %ehd→↓fCf fully expense d.
must pay tax on diff .
between sale price and
A measure of to resold at market price
a
company 's ability pay Equipment can be
-
-
boon value
off its short term liabilities with short -
salvage of =
selling proceeds
-
tax rate ✗
capital gain .
assets ✓
term Ca
selling proceeds Book value
= -
.
cumulative
↑ NWC →
more cash tied up → trfcf original investment -
depreciation
' '
Book value captures me
remaining acquisition cost
Incremental cash flows Project depends on all ADDITIONAL cash flows
Include Exclude
Incidental Effects (e. g. introduction of new product decreasing sunk costs
-
-
sales of
existing products .
Networking capital changes
-
opportunity cost ( best alternative use )
-
,Alternatives to NPV
Book Rate of Return IBRR) Accept it BRR > r
Average income divided book value over Reflects lax and not cash flow
by average ✗
accounting figures ,
the project 's life . ✗
Ignores time value of money and risk
BOOK Income
BRR =
BOOK Assets
Payback Period Accept it project pays back within desired timeframe .
Number of years before the cumulative additional ✗
Ignores TVM
cashflows equal the initial outlay .
✗
Ignores cash flows after payback period .
Internal Rate of Return IIRR ) Accept it IRR >
opportunity cost of capital
The discount rate that makes NPV = 0
Problems :
Lending Borrowing
✗
us .
streams of cash Hours
1- preferred
It two are
exactly opposite to
0/
-
to B
each other, have the same IRR
they .
✗
Multiple Rates of Return
-
certain cash flows ( usually negative future cash flows ) can generate NP40 at multiple discount rates .
↑
cashflow with IRR at 3.5%
and 19.54%
✗ NO Internal Rate of Return
-
It is possible to have no IRR and NPV > 0
Usually because project is too good bad
-
or
✗ scale of the Projects
-
IRR
ignores scale of the projects
IRR Chooses f- despite a offering
→
a
higher absolute NPV Of cash flows .
Applications of NPV
Profitability Index Inflation Equivalent Annual cost CEAC)
NPV
PI =
Affects me discount rate The cost per period with the same
investment
I + nominal r
1 + real r = PV as the actual cost of the project .
I + inflation
Choose highest weighted avg.pl
investment Unused PV of costs
WAPI =
§ P/ i ✗
cash available
+ 0 ✗
cash avail .
£ At =
Annuity factor
, 2. Real Options
Real option The
right but not the obligation to
modify the project in the culture .
make money '
? /
Why are real options valuable future is uncertain →
volatility → ↑ value of
flexibility avoid loss .
Decision Trees Build
Diagram of sequential decisions and possible outcomes .
serneiey
0.8
~
Build
"' Build
Cleveland
Types of Real Options •
Build
1. Option to Abandon
abandon to avoid losses
Project no
longer profitable → .
Temporary Abandonment Permanent Abandonment
e. g. Abandon it prices are too low ,
CFCO e.
g. Abandon it NPVA of continuation cashflow
→ cash flows on decision tree
-
< 0 become 0 < value of abandoning ✗
'
Backwards
calculate NPV with new Cfs find where NPVA abandonment ✗
→ →
.
at <
Induction
/
→
Remove subsequent decision three branches for these
scenarios and replace him × .
2. Optionto Expand
investment more provable man expected →
invest more
/
PV of not option date
e. g. Invest more it PV of investment at option date >
investing at backwards
induction .
→
replace decision tree branches
following decision with me higher NPV choice
→
calculate NPV of project with new Cfs .
3. Option to wait
NPV > 0 now , but it implemented in me lutnve ,
NPV will be even
higher .
profit it exercised now value of
waiting ^
option
Option value =
Intrinsic Value + Time Premium price
intrinsic
option value
value
↑ time premium
>
0
stock price
Timing
Even projects with NPV > 0
may be more valuable if deterred .
later
Net future value as of date
Current value =
Peter it RHS > LH5 .
)t
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller lsenotes. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $26.63. You're not tied to anything after your purchase.
