-CAPM: how risk affects return

-Expected Return (on investment): mean value of its probability distribution of returns; greater the probability return will be below expected, greater the stand-alone risk -Risk Averse: he/she must be compensated for holding risky assets -Asset has 2 risk types: Diversifiable risk can be eliminated by diversification; market risk cannot be eliminated -Market risk measured by standard deviation of returns on portfolio consisting of all stocks -Relevant Risk: individual asset’s risk contribution to diversified portfolio -Beta: measures how stock’s returns move relative to market (avg. = 1.0) -Ri = Rrf + (RMp)Bi, Market Risk Premium (RMp) = Market return – Risk free

Chapter 4

-Bond: long term promissory note

-Zero Coupon Bond: issued at discount, no payment

-Call provision: issuing corp can redeem bonds prior to maturity at call premium; typically happens if interest rates fall below coupon rate

-Value of bond: present value of annuity + present value of lump sum -Nominal interest rate (Rd) = r* + IP + DRP + LP + MRP

r* = real risk free, IP = inflation premiums, DRP = default risk, LP = liquidity, MRP = maturity risk

-Yield Curve: graph of relationship between yields on securities and securities’ maturities -Normal curve upward sloping, however, curve can slope downward if inflation rate is expected o decline. Curve can be humped meaning interest rates on medium-term maturities are higher than rates on both short and long term maturities -Expectations Theory: yields on long-term bonds reflect expected future interest rates

Chapter 9

-Forecast financial requirements with FFS (forecasted financial statements) method or AFN (additional funds needed) method; for changing conditions FFS is more reliable -Determine AFN by estimating amount of new assets necessary to support forecasted level of sales, then subtract spontaneous funds generated from operations -The higher a firms sales growth rate the higher the payout ratio, and the greater its need for additional financing -Linear regression and excess capacity adjustments used to forecast asset requirements when assets not expected to grow at same rate as sales

Chapter 10

-Component cost of debt = after-tax cost of new debt. Found by multiplying interest rate paid on new debt by 1-T -Component cost of preferred stock calculated as preferred dividend divided by net price: Rps = Dps / P(1-F) -Cost of common equity/stock, Rs = rate of return required by frm’s stockholders

-Can be estimated with CAPM or dividend yield plus growth rate -Best proxy for risk-free rate is yield on long term T-bonds, 10 yr maturity -Dividend approach: Rs = D/P + g

-Use historical growth rates of earnings or g = (1-payout)(return on equity) -Firm has target capital structure, defined as mix of debt, preferred stock, and common equity that minimizes WACC -Project Stand-alone Risk: risk the project would have if it were the firm’s only asset -Corporate or within-firm risk reflects effect of project on firm’s risk, measured by project’s effect on firm’s earnings variability -Market or Beta risk reflects effects of project on stockholders’ risk, measured by project’s effect on firm’s beta coefficient -Risk-adjusted cost of capital is cost of capital appropriate for given project, given its risk. Greater the risk, higher the cost of capital

Chapter 11

-Corporate assets: include operating, financial, and non-operating -Operating Assets: assets in place and growth options

-Non-operating assets include financial assets such as investments in marketable securities and non-controlling interests in stock of other companies -Value of operations is present value of all future free cash flows when discounted at WACC -Horizon Value: value of operations at end of explicit forecast period (terminal value), equal to present value of all free cash flows beyond forecast period, discounted at WACC -Corporate valuation model: value of company = value of...