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
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