FINC 341 Final Revised

NPV, IRR, MIRR

Will always agree as to whether a project with normal cash flows is profitable or not

MIRR

Should be used to evaluate mutually exclusive project with similar sizes

NPV

Should be used to evaluate mutually exclusive projects with different sizes

IRR

Can have multiple of these, but only one MIRR

NPV vs IRR

When these two rankings conflict you follow NPV because it’s adding wealth at the cost of capital not because of unequal lives

High debt ratio

Discouraged from having a high fixed costs if it wants to keep its degree of total leverage down

Riskiness of EPS increases

As a firm begins to put debt in its capital structure, the firms eps will increase, but this will happen as well

Minimizes WACC

When the capital structure maximizes the company’s stock price, it will also do this

Low operating leverage

Stems from having low fixed costs

Positive NPV

A project with normal cash flows that has an IRR that exceeds the cost of capital has to have this

Whether normal or nonnormal

projects NPV will approach the value of the project's last cash flow at t=n as the cost of capital approaches zero

MIRR assumption

Interim cash flows are reinvested at the cost of capital

IRR and MIRR

Both require at least one positive and one negative cash flow

Cannabalization

Occurs when the introduction of a new product steals sales of a different product within the same firm and those stolen sales shouldn’t be included in the new product’s sales number for running an NPV for the new product

Signaling Theory

Says that a firm with very favorable prospects would avoid selling stock, and instead raise required capital by using new debt

Obtaining debt capital

Firms often use less debt than their optimal debt level to ensure that they can do this later if necessary

DOL > 1

If a firm has fixed operating costs than at a given sales level this will be true

Why is kps not adjusted for taxes

Dividends are not tax deductible

Measurement problems

Difficult to get good input data for CAPM variables

Costs of capital for projects of differing risk

Difficult to measure a project’s risk

Capital structure weights

Difficult to establish the target capital structure

PP

Expected number of years required to recover a projects cost

PP assumption

CFs will trickle out to you

DPP

Expected number of years required to recover a projects cost when all CFs are expressed in today’s dollars

NPV

Is the profit of the project expressed in time 0 today’s dollars

NPV weaknesses

NPV can’t be used directly when projects have different lengths of life

NPV reinvestment rate assumption

CFs reinvested at k

IRR

The discount rate which forces the PV of a project’s inflows to equal the PV of its outflows

IRR meaning

Return of the project expressed completely in a percentage of return, leaving none of the return to be expressed as NPV = $0

MIRR weaknesses

ME projects diff sizes cant trust MIRR

Incremental cash flow

The change in the firm’s total cash flow that occurs as a direct result of accepting the project

Sunk cost

An outlay not affected by the decision under consideration

Opportunity cost

Cash flow give up by taking on the project

Externalities

Effects of a project on other parts of the firm

MACRS

Used for tax purposes; makes it more appropriate for capital budgeting decisions than straight line since taxing affects cash flow which doesn’t subtract sv to determine db

Straight line depreciation

Used for stockholder reporting

Sensitivity analysis

technique that examines how changes in input variables affect a model’s output, usually by varying one input at a time while holding others constant

Scenario analysis

technique that evaluates how a project, business, or portfolio would perform under several distinct, internally consistent “what if” future states by changing multiple key assumptions at the same time and observing the resulting outcomes

Monte Carlo simulation

computational technique that models uncertainty by repeatedly sampling random values from specified probability distributions for key inputs, running the model many times, and using the resulting distribution of outputs to estimate the probabilities of different outcomes

Optimal capital structure

Must strike that balance between risk and return which maximizes the firm’s stock price and minimizes the firm's wacc

High FC

Contribute to high business risk and high operating leverage

Low fc

Labor intensive

DOL massive

If a firm is operating just above BE, this will be true

Art Cashin

longtime New York Stock Exchange floor trader and the director of floor operations for UBS, famous as a veteran market commentator.

Bob Pisani

CNBC journalist who has reported from the floor of the New York Stock Exchange for decades as a senior markets correspondent

CR

Designates coupon payments

Sinking fund provision

Facilitates orderly retirement of the bonds

Putable bonds

Allows investors to sell bond back to company

Income bond

Pays interest only if the interest is earned

Indexed bond

Interest paid rises automatically when inflation increases

Institutional investors

Restricted to investment grade securities

Changes in ratings

When a company gets downgraded price of bonds goes down

Junk bonds

Market collapsed in early 1990s but rebounded later and is here to stay

Michael Milken

Promoted junk bonds in the late 1970s who went to prison for insider trading

King of Junk Bonds

Michael Milken other name

Ted turner

Used junk bonds to finance the development of CNN and Turner broadcasting

Insolvency

When the company can’t pay their debts on time and creditors can declare bankruptcy

Positive beta

Same direction as market

Poison pill provision

Allows stockholders to buy takeover firm’s shares at reduced price

Zero growth

Perpetuity

Constant growth rule

Time period right before the constant growth rate will have the same CGY

Abbey joseph cohen

All computer related stocks 40xEPS = P0

Foreign bonds decrease

When that country goes into war

Zero coupon bonds

Desirable since they give capital gains that aren’t taxed at as high of a rate as interest income would be on a regular bond

Floating coupon bonds

Maintain value equal to par

Market value of shares of stock

Doesn’t increase if the investor plans to keep it longer

Interest rate price sensitivity

Generally decreases as years remaining to maturity decreases

Constant growth rate = CGY

Assumed that if dividends increase by a certain percentage, that the stock price will increase by about the same percentage

2008 financial crisis

Big banks that caused this were overvalued just before the debt crisis because the rating companies were inaccurately rating them

Risk averse investors

Equilibrium price of stock should decrease

Fed cuts interest rates

equilibrium price of stocks increase

Founders’ shares

Enable control over the company by the founders without having to own a majority of the stock

Proxy vote

If a stockholder can’t vote in person, participation in the annual meeting still possible through this

Preemptive right

Gives the stockholder the right to buy additional new shares

Coefficient of variation

Main focus of a well diversified stock

Christine LaGarde

Current president of the European Central Bank

Discount rates increase w/o limit

Present value of future cash inflow approaches zero

Mario Draghi

Italian economist and central banker who used to lead the European Central Bank, is widely credited with helping save the euro during the European debt crisis

Different prices

Three bonds that have 15 years left to maturity can have this even if they each have the same credit risk

Investor in high tax brackets

Zero coupon bonds are more attractive to them

treasury bond

Less default risk than a corporate bond because it is backed by the federal government

Zero coupon bond’s tax

Less than on regular bonds

Zero coupon bonds issued at

Discount below par