FIN 509 & FIN510 Class Web Page, Summer'22
Weekly SCHEDULE, LINKS, FILES and Questions
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Week |
Coverage, HW, Supplements -
Required |
Equations and
Assignments |
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Weekly Thursday class url on blackboard
collaborate: https://us.bbcollab.com/guest/11cfd26fb4fa44f1ad5d390354662ed0 Weekly
Office Hour on Blackboard collaborate (Sunday 5PM-6PM) https://us.bbcollab.com/guest/23695fc6b73248baa62982746e98a6e9 Class Schedule:
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Week 0 |
Market
Watch Game Use the information and directions
below to join the game. 1.
URL for
your game: 2. Password for this private game: havefun. 3. Click on the 'Join Now' button to get
started. 4. If you are an existing MarketWatch member, login. If you are a new user,
follow the link for a Free account - it's
easy! 5. Follow the instructions and start trading! |
Pre-class assignment: Set up marketwatch.com account and have
fun |
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Week1,2 |
Chapter 5 Time value of money 1 Week 1 in class exercise (word file) Solution The time value of money -
German Nande (youtube)
Concept of FV, PV,
Rate, Nper Calculation of FV, PV,
Rate, Nper Concept of interest
rate, compounding rate, discount rate
Chapter 6 Time Value of Money 2 Concept of PMT, NPV Calculation of FV, PV,
Rate, Nper, PMT, NPV, NFV Concept of EAR, APR Calculation of EAR,
APR First Discussion Board Assignment (post your writing on blackboard under
discussion folder):
(due by 4/3 at 11:59 pm)
Market Watch Game
Let's start trading in the stock market!
Please join a game and report back on your experience. Directions 1.
URL for your game: 2.
Password for this private game: havefun. 3.
Click on the Join Now button to get started. 4.
Register for a new account with your email address or sign in if
you already have an account.
1.
Why did you choose the stock? How much money did you think you would
make? Please explain. 2.
Did you make money or lose money off of your chosen stock? Which
factors contributed to that? 3.
What did you learn from this experience and how will it affect your
choices in real life when choosing stocks? Instructions ·
Responses should be 100 to 250 words in length and should answer
all three prompts ·
Optional: reply to one of your peers with meaningful,
thought-provoking responses ·
Due by 4/3/2022 at 11:59 p.m. ET HOMEWORK of Chapters 5
and 6 (due on week 4, 7/10/2022) 1. The Thailand Co.
is considering the purchase of some new equipment. The quote consists of a
quarterly payment of $4,740 for 10 years at 6.5 percent interest. What is the
purchase price of the equipment? ($138,617.88) 2. The
condominium at the beach that you want to buy costs $249,500. You plan to
make a cash down payment of 20 percent and finance the balance over 10 years
at 6.75 percent. What will be the amount of your monthly mortgage
payment? ($2,291.89) 4. Shannon wants
to have $10,000 in an investment account three years from now. The account
will pay 0.4 percent interest per month. If Shannon saves money every month,
starting one month from now, how much will she have to save each month?
($258.81)
(Hint: Bridget’s is an annuity due, so abs(fv(8%/12, 10*12, 150, 0,
1)) --- type =1; Jordan’s is an ordinary annuity, so abs(fv(8%/12, 10*12,
150, 0) --- type =0, or omitted. There is a mistake in the help video for
this question. Sorry for the mistake.) 14. What is the
future value of weekly payments of $25 for six years at 10 percent? ($10,673.90) 15. At the end of
this month, Bryan will start saving $80 a month for retirement through his
company's retirement plan. His employer will contribute an additional $.25
for every $1.00 that Bryan saves. If he is employed by this firm for 25 more
years and earns an average of 11 percent on his retirement savings, how much
will Bryan have in his retirement account 25 years from
now? ($157,613.33) 16. Sky
Investments offers an annuity due with semi-annual payments for 10 years at 7
percent interest. The annuity costs $90,000 today. What is the amount of each
annuity payment? ($6,118.35) 17. Mr. Jones
just won a lottery prize that will pay him $5,000 a year for thirty years. He
will receive the first payment today. If Mr. Jones can earn 5.5 percent on
his money, what are his winnings worth to him
today? ($76,665.51) 18. You want to
save $75 a month for the next 15 years and hope to earn an average rate of
return of 14 percent. How much more will you have at the end of the 15 years
if you invest your money at the beginning of each month rather than the end
of each month? ($530.06) 19. What is the
effective annual rate of 10.5 percent compounded
semi-annually? (10.78%) 22. What is the
effective annual rate of 12.75 percent compounded daily? (13.60 percent) 23. Your
grandparents loaned you money at 0.5 percent interest per month. The APR on
this loan is _____ percent and the EAR is _____ percent. (6.00; 6.17) FYI only: help for homework Part 1(Qs
1-2) Part 2(Qs
4-8) Part 3(Qs 9-12) Part 4(Qs
13-16) Part 5(Qs
17-20) Part 6(Qs 21-24) (Q13: Bridget’s is an annuity
due, so abs(fv(8%/12, 10*12, 150, 0, 1)) --- type =1; Jordan’s is an ordinary
annuity, so abs(fv(8%/12, 10*12, 150, 0) --- type =0, or omitted. There is a
mistake in the help video for this question. Sorry for the mistake.) Quiz 1- Help Videos |
Calculators Time
Value of Money Calculator © 2002 - 2019 by Mark A. Lane,
Ph.D. Math Formula FV = PV *(1+r)^n PV = FV /
((1+r)^n) N
= ln(FV/PV) / ln(1+r) Rate = (FV/PV)1/n -1 Annuity: N
= ln(FV/C*r+1)/(ln(1+r)) Or N
= ln(1/(1-(PV/C)*r)))/ (ln(1+r))
EAR = (1+APR/m)^m-1 APR = (1+EAR)^(1/m)*m Excel Formulas To get FV, use FV
function. =abs(fv(rate, nper,
pmt, pv)) To get PV, use PV
function = abs(pv(rate, nper,
pmt, fv)) To get r, use rate
function =
rate(nper, pmt, pv, -fv) To get number of years,
use nper function = nper(rate, pmt, pv,
-fv) To get annuity payment, use PMT
function = abs(pmt(rate, nper, pv,
-fv)) To get Effective rate (EAR), use
Effect
function =
effect(nominal_rate, npery) To get annual percentage rate
(APR), use nominal function APR = nominal(effective rate, npery) |
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Week3 |
Chapter 7 Bond
Pricing
Yield Curve http://finra-markets.morningstar.com/BondCenter/Default.jsp Balance Sheet of WalMart https://www.nasdaq.com/market-activity/stocks/wmt/financials
For
discussion: · What is this “long term debt”? · Who is the lender of this “long term debt”? So
this long term debt is called bond in the financial market. Where can you
find the pricing information and other specifications of the bond issued by
WMT? FINRA – Bond market information http://finra-markets.morningstar.com/BondCenter/Default.jsp Go to http://finra-markets.morningstar.com/BondCenter/Default.jsp , the bond market data website of FINRA to find bond
information. For example, find bond sponsored by Wal-mart Or, just go to www.finra.org, è Investor center è market data è bond è corporate bond Corporate
Bond
1.
Understand
what is coupon, coupon rate, yield, yield to maturity, market price, par
value, maturity, annual bond, semi-annual bond, current yield. Refer
to the following bond at http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C104227&symbol=WMT.GP
The above graph shows the cash flows of a five year 5% coupon
bond. How
Bonds Work (video) Investing Basics: Bonds(video) In class exercise: 1.
Find bonds
sponsored by WMT ·
just
go to www.finra.org, è Investor
center è market
data è bond è corporate bond ·
Search
for Walmart bonds For discussion: ·
What
are the ratings of the WMT bonds? How does the rating agency rate a bond? Altman Z Score video
·
Why
some WMT bonds are priced higher than the par value, while others are priced
at a discount? ·
Why
some WMT bonds have higher coupon rates than other bonds? How does WMT
determine the coupon rates? ·
Why
some WMT bonds have higher yields than other bonds? Does a bond’s yield
change daily? ·
Which
of the WMT bonds are the most attractive one to you? Why? http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C610043&symbol=WMT4117477 2. 2.
Understand what is coupon, coupon rate, yield, yield to maturity, market
price, par value, maturity, annual bond, semi-annual bond, current yield. 3. 3.
Understand how to price bond Bond
price = abs(pv(yield, maturity, coupon, 1000)) ------- annual coupon Bond
price = abs(pv(yield/2, maturity*2, coupon/2, 1000)) ------- semi-annual
coupon Also change the yield and observe the
price changes. Summarize the price change pattern and draw a graph to
demonstrate your findings. Again, when yield to maturity of
this semi_annual coupon bond is 4%, how should this WMT bond
sell for? 4. Understand
how to calculate bond returns Yield
to maturity = rate(maturity, coupon, -market price, 1000) ----
annual coupon Yield
to maturity = rate(maturity*2, coupon/2, -market price, 1000)*2
----- semi-annual coupon Bond
Calculator (www.jufinance.com/bond) For example, when the annual coupon bond
is selling for $1,100, what is its return to investors? For example, when the semi-annual
coupon bond is selling for $1,100, what is its return to investors? 5. Current
yield: For the above bond, calculate current yield. Note: current yield = coupon/bond price 6. Zero
coupon bond: coupon=0 and treat it as semi-annual coupon bond. Example:
A ten year zero coupon bond is selling for $400. How much is its yield to
maturity? A ten year zero coupon bond’s yield to
maturity is 10%. How much is its price? 7. Understand
what is bond rating and how to read those ratings. a. Who
are Moody, S&P and Fitch? b. What
is WMT’s rating? c. Is
the rating for WMT the highest? d. Who
earned the highest rating? Supplement:
Municipal Bond
For class
discussion: · Shall you
invest in municipal bonds? · Are municipal
bonds better than investment grade bonds? The
risks investing in a bond · Bond investing: credit Risk (video) · Bond investing: Interest rate risk (video) · Bond investing:
increased risk (video) Market data
website: 1. FINRA http://finra-markets.morningstar.com/BondCenter/Default.jsp (FINRA bond market data) 2. WSJ Market watch on Wall Street Journal has daily yield curve and bond
yield information. http://www.marketwatch.com/tools/pftools/ https://www.youtube.com/watch?v=yph8TRldW6k 3. Bond Online http://www.bondsonline.com/Todays_Market/ Homework ( due on_7/10/2022) 1. Firm AAA’s bonds price =
$850. Coupon rate is 5% and par is $1,000. The bond has six years
to maturity. Calculate for current yield? (5.88%) 2. For a zero coupon bond, use
the following information to calculate its yield to maturity. (14.35%) Years left to maturity = 10 years.
Price = $250. 3. For a zero coupon
bond, use the following information to calculate its price. ($456.39)
Years left to maturity = 10 years. Yield = 8%. 4. Imagine that an annual
coupon bond’s coupon rate = 5%, 15 years left. Draw price-yield profile.
(hint: Change interest rate, calculate new price and draw the graph). 5. IBM
5 year 2% annual coupon bond is selling for $950. How much
this IBM bond’s YTM? 3.09% 6. IBM 10 year 4% semi-annual coupon
bond is selling for $950. How much is this IBM bond’s YTM? 4.63% 7. IBM 10 year 5% annual coupon
bond offers 8% of return. How much is the price of this
bond? 798.7 8. IBM 5 year 5% semi-annual coupon
bond offers 8% of return. How much is the price of this bond? $878.34 9. IBM 20 year zero coupon bond
offers 8% return. How much is the price of this bond? 208.29 10. Collingwood Homes has a
bond issue outstanding that pays an 8.5 percent coupon and matures in 18.5
years. The bonds have a par value of $1,000 and a market price of $964.20.
Interest is paid semiannually. What is the yield to maturity? (8.90%) 11. Grand Adventure Properties
offers a 9.5 percent coupon bond with annual payments. The yield to maturity
is 11.2 percent and the maturity date is 11 years from today. What is the
market price of this bond if the face value is $1,000? ($895.43) 12. The zero coupon bonds of D&L
Movers have a market price of $319.24, a face value of $1,000, and a yield to
maturity of 9.17 percent. How many years is it until these bonds
mature? (12.73 years) 13. A zero coupon bond with a face
value of $1,000 is issued with an initial price of $212.56. The bond matures
in 25 years. What is yield to maturity? (6.29%) 14. The
bonds issued by Stainless Tubs bear a 6 percent coupon, payable semiannually.
The bonds mature in 11 years and have a $1,000 face value. Currently, the
bonds sell for $989. What is the yield to maturity? (6.14%) Videos
--- homework help (due by 7/7/2022) Part
I Q1-Q2
Q3-Q4 Q5-Q8 Q9-Q14 Quiz
2- Help Video
(Quiz 2 Due by the end
of week 3 Sunday on 7/3/2022) |
Bond Pricing Formula (FYI)
Bond Pricing Excel Formula Summary of
bond pricing excel functions To calculate bond price (annual coupon bond): Price=abs(pv(yield
to maturity, years left to maturity, coupon rate*1000, 1000) To calculate yield to maturity (annual coupon bond):: Yield
to maturity = rate(years left to maturity, coupon rate *1000, -price, 1000) To calculate bond price (semi-annual coupon bond): Price=abs(pv(yield
to maturity/2, years left to maturity*2, coupon rate*1000/2,
1000) To calculate yield to maturity (semi-annual coupon
bond): Yield
to maturity = rate(years left to maturity*2, coupon rate *1000/2,
-price, 1000)*2 To calculate number of years left(annual coupon bond) Number
of years =nper(yield to maturity, coupon rate*1000, -price, 1000) To calculate number of years left(semi-annual coupon bond) Number
of years =nper(yield to maturity/2, coupon rate*1000/2, -price,
1000)/2 To calculate coupon (annual coupon bond) Coupon
= pmt(yield to maturity, number of years left, -price, 1000) Coupon
rate = coupon / 1000 To calculate coupon (semi-annual coupon bond) Coupon
= pmt(yield to maturity/2, number of years left*2, -price, 1000)*2 Coupon
rate = coupon / 1000 Here’s
What You Need to Know About America’s Super-Hot Inflation (FYI) Inflation is a tricky
problem, but it has a few clear causes and consequences, and policymakers are
working to bring it to heel. https://www.nytimes.com/article/inflation-us-prices.html By Jeanna Smialek, June 11,
2022 The government reported on
Friday that consumer prices climbed 8.6
percent over the year through May, the fastest rate of increase in four
decades. Americans are confronting
more expensive food, fuel and housing, and some are grasping for answers
about what is causing the price burst, how long it might last and what can be
done to resolve it. There are few easy answers
or painless solutions when it comes to inflation, which has jumped around the
world as supply shortages collide with hot consumer demand. It is difficult
to predict how long today’s price surge will drag on, and the main tool for fighting it is interest rate increases, which cool
inflation by slowing the economy —
potentially sharply. Here’s a guide to
understanding what’s happening with inflation and how to think about price
gains when navigating this complicated moment in the U.S. and world economy. What’s Driving Inflation It can be helpful to think
of the causes of today’s inflation as falling into three related buckets. Strong demand. Consumers are spending big. Early in the
pandemic, households amassed savings as they were stuck at home, and
government support that continued into 2021 helped them put away even more
money. Now people are taking jobs and winning wage increases. All of those
factors have padded household bank accounts, enabling families to spend on
everything from backyard grills and beach vacations to cars and kitchen
tables. Too few goods. As families have taken pandemic savings
and tried to buy pickup trucks and computer screens, they have run into a
problem: There have been too few goods to go around. Factory shutdowns tied
to the pandemic, global shipping backlogs and reduced production have
snowballed into a parts-and-products shortage. Because demand has outstripped
the supply of goods, companies have been able to charge more without losing
customers. Now, China’s latest lockdowns are exacerbating supply chain snarls. At
the same time, the war in Ukraine
is cutting into the world’s supply of food and fuel, pushing overall
inflation higher and feeding into the cost of other products and services.
Gas prices are averaging around $5 a gallon nationally, up from just over $3
a year ago. Service-sector pressures. More recently, people have been shifting
their spending away from things and back toward experiences as they adjust to
life with the coronavirus — and inflation has been
bubbling up in service industries. Rents are climbing swiftly as Americans
compete for a limited supply of apartments, restaurant bills are heading
higher as food and labor costs rise, and airline tickets and hotel rooms cost
more because people are eager to travel and because fuel and labor are more
expensive. You might be wondering: What
role does corporate greed play in all this? It is true that companies have
been raking in unusually big profits as they raise prices by more than is
needed to cover rising costs. But they are able to do that partly because
demand is so strong — consumers are spending
right through price increases. It is unclear how long that pricing power will
last. Some companies, like Target, have already signaled that they will begin
to reduce prices on some products as they try to clear out inventory and keep
customers coming. Understand Inflation and How
It Impacts You Greedflation: Some experts
say that big corporations are supercharging inflation by jacking up prices.
We take a closer look at the issue. Changing Behaviors: From driving fewer miles to downgrading
vacations, Americans are making changes to their spending because of
inflation. Here’s how five households are coping. How Is Inflation Measured? Economists and policymakers
are closely watching America’s two primary inflation gauges: The Consumer Price Index, which was
released on Friday, and the Personal Consumption Expenditures index. The C.P.I. captures how much consumers pay
for things they buy, and it comes out earlier, making it the nation’s first clear
glimpse at what inflation did the month before. Data from the index is also used to come
up with the P.C.E. figures. The P.C.E. index, which will be released
next on June 30, tracks how much things actually cost. For instance, it counts the price of
health care procedures even when the government and insurance help pay for
them. It tends to be less volatile, and it is the index the Federal Reserve
looks to when it tries to achieve 2 percent inflation on average over time.
As of April, the P.C.E. index was climbing 6.3 percent compared with the
prior year — more than three times the central bank
target. Policymakers are also
particularly attuned to the so-called core inflation measure, which strips
out food and fuel prices. While groceries and gas make up a big part of
household budgets, they also jump around in price in response to changes in
global supply. As a result, they don’t give as clear a read on the underlying
inflationary pressures in the economy — the ones the Fed believes it can do something about. “I’m going to be looking to see a
consistent string of decelerating monthly prints on core inflation before I’m
going to feel more confident that we’re getting to the kind of inflation
trajectory that’s going to get us back to our 2 percent goal,” Lael Brainard, the vice chair of the Fed
and one of its key public messengers, said during a CNBC interview last week. What Can Slow the Rapid
Price Gains? How long prices will
continue to climb rapidly is anyone’s guess: Inflation has
confounded experts repeatedly since the pandemic took hold in 2020. But based
on the drivers behind today’s hot prices, a few outcomes
appear likely. For one, quick inflation seems unlikely to
go away entirely on its own. Wages
are climbing much more rapidly than normal. That means unless companies
suddenly get more efficient, they will probably try to continue to increase
prices to cover their labor costs. What causes inflation? It can be the result of rising consumer
demand. But inflation can also rise and fall based on developments that have
little to do with economic conditions, such as limited oil production and
supply chain problems. Is inflation bad? It depends on the circumstances. Fast
price increases spell trouble, but moderate price gains can lead to higher wages
and job growth. How does inflation affect the poor? Inflation can be especially hard to
shoulder for poor households because they spend a bigger chunk of their
budgets on necessities like food, housing and gas. Can inflation affect the stock market? Rapid inflation typically spells trouble
for stocks. Financial assets in general have historically fared badly during
inflation booms, while tangible assets like houses have held their value
better. As a result, the Fed is
raising interest rates to slow demand and tamp down wage and price growth.
The central bank’s policy response means that the economy
is almost surely headed for a slowdown. Already, higher borrowing costs have
begun to cool off the housing market. The question — and big uncertainty — is just how much Fed action will be
needed to bring inflation under control. If
America gets lucky and supply chain shortages ease, the Fed might be able to
let the economy down gently, slowing the job market enough to temper wage
growth without causing a recession. In that optimistic scenario,
often called a soft landing, companies will be forced to lower their prices
and pare their big profits as supply and demand come into balance and they
compete for customers again. But it is also possible that supply issues will persist, leaving the Fed
with a more difficult task: raising rates more drastically to slow demand
enough to bring price increases under control. “The
path toward a soft landing is a very narrow one — narrow
to the point where we expect a recession as the baseline,” said Matthew Luzzetti,
chief U.S. economist at Deutsche Bank. That’s partly because consumer spending shows little sign of
cracking so far. Households still have about
$2.3 trillion of excess savings to help them weather higher rates and prices,
Mr. Luzzetti’s team has estimated. “There continues to be deep pockets of
pent-up demand,” Anthony G. Capuano, chief executive of
the hotel company Marriott International, said during a June 7 event. “Unlike previous economic cycles and
economic downturns, here you have this added dimension, which was folks were
locked down for 12 to 24 months.” Bringing inflation down is going to take
time, patience - and pain (FYI) PUBLISHED THU, JUN 9
20222:47 PM EDTUPDATED THU, JUN 9 20224:04 PM EDT Jeff Cox https://www.cnbc.com/2022/06/09/bringing-inflation-down-is-going-to-take-time-patience-and-pain.html KEY POINTS ·
To stop 40-year highs in
price increases, the economy will have to slow, supply chains will need to
get fixed and demand will have to come back in line with pre-pandemic norms. ·
Friday’s highly
anticipated CPI inflation report for May is likely to show only modest
relief, if any. ·
A recent paper by former
Treasury secretary and Obama administration advisor Larry Summers suggests
harsh interest rate hikes may be needed. ·
President Joe Biden
himself noted that much of the heavy lifting has to be done by the Fed. Tackling runaway inflation
won’t be easy and it won’t be quick, and it may carry
a steep price tag that is just beginning to be paid. To stop 40-year highs in price increases,
the economy will have to slow. The ability of producers to get their goods to the
marketplace will have to get a lot better, and demand and supply will have to
come back into balance. Most troublingly, until the Ukraine war settles,
these factors will have a limited impact on fixing the economy. Even under the best of
conditions, a trend that has seen gasoline reach nominal new highs near $5 a
gallon, the price of everyday foods like cereal, eggs and hamburger jump by
double-digit percentages over the past year and housing costs rise ever
higher, will ease only incrementally. That means little relief for consumers
anytime soon. “Slow descent” is how Wells Fargo senior economist Sarah House described the
likely downward trajectory of inflation from here. “If you think about inflation, a lot of it is momentum driven.
Price setting is slow moving. Companies don’t just change their prices on a dime.” Indeed, Friday’s highly anticipated inflation report is
likely to show only modest relief, if any. We’re probably, maybe, just past the peak of inflation, says
Pantheon Macroeconomics’ Shepherdson The consumer price index, a
measure that encompasses the cost of a massive basket of goods and services,
is expected to show inflation increasing at an 8.3% pace over the past year,
same as in April, according to Dow Jones estimates. Excluding food and energy
prices, so-called core CPI is expected to show growth of 5.9%, slightly off
the 6.2% pace from the previous month. What’s more, the monthly gains are expected to accelerate — 0.7% for headline inflation versus a gain
of just 0.3% in April. Core is expected to be little changed, up 0.5%, which
would be a one-tenth point month-over-month decline. Peering through the numbers Economists, though, will
look beyond the headline numbers and try to find trends in the CPI
components. Food and energy, for instance, comprise
about 22% of the index,
so any slowdown there will be considered noteworthy. Shelter costs, a vital component, make up 32%. More broadly, services
comprise about 60% of CPI compared to 40% for goods. Most of the current
inflation wave comes from the goods component. “Slowing
the economy would help. Seeing weaker demand growth would take some of the
pressure off,” House said. “It’s not just about a slowdown, though. Compositions effects are
important. Some areas are more important than others. Goods inflation is one
area where we could begin to see spending slow. That’s where a lot of the pressure points are.” The Federal Reserve is
hoping to help that process along by raising short-term interest rates, which
had been anchored near zero as the economy recovered from pandemic-related
restrictions. Markets widely expect the Fed to keep
raising its benchmark borrowing rate to around 2.75%-3% from the current
range of 0.75%-1%. However, the Fed may have
even more work to do than that. A lesson from the 80s A National Bureau of
Economic Research working paper released recently by former Treasury
secretary and Obama administration advisor Larry Summers, along with a team
of other economists, suggests that the
Fed could need to raise rates by considerably more to bring inflation down to
its 2% goal. The paper compared the
current run of inflation to the early 1980s, which was the last time price
increases were of a similar concern. During that time, the Paul Volcker-led Fed took the funds rate up to 19%,
causing a recession that eventually helped send inflation on a downward
spiral that would last almost 40 years, until the current run-up in
prices. Many economists say that kind of
tightening won’t
be necessary because inflation was running at 14.8% back then. But the Summers paper said
CPI was calculated differently then, primarily in the way it accounted for housing
costs. Using the same methodology would bring core CPI to about 9.1% now. “To
return to 2 percent core CPI inflation today will thus require nearly the
same amount of disinflation as achieved under Chairman Volcker,” the Summers team wrote. Biden’s plan President Joe Biden recently
released his plan to help bring down inflation. In a Wall Street Journal
op-ed, Biden said he would take
measures to fix supply chain problems and bring down the budget deficit,
which ran to nearly $2.8 trillion in fiscal 2021 but is on track to be a
fraction of that this year — at just $360 billion
through seven months, due largely to Congress not approving additional
Covid-19 relief money. But those measures are
likely to just nibble at the edges of inflation, and the president himself
noted that much of the heavy lifting
has to be done by the Fed. “They
have the primary role on bringing inflation down,” Treasury Secretary and
former Fed Chair Janet Yellen said at a congressional hearing earlier this
week. “It’s up to them in how they go about doing
it.” But Fed hikes also take time to work
through the system and,
until then, economists will be looking at other factors. Recent announcements from Target and other retailers saying they
will work to bring down excess inventory also could be deflationary. But
with apparel carrying just a 2.5% weighting in the CPI, those kinds of moves
won’t make a big dent in the potentially scary headline numbers. “If
someone tells you recent news that some retailers are discounting clothes
will have any measurably effect on CPI, ignore them,” DataTrek Research
co-founder Nicholas Colas wrote in his daily market note. “Retailers could give clothes away for free
and U.S. inflation would still be over 5 percent.” Ultimately then, taming inflation
will require a slow bleed of the forces that have led up to the current
situation. That means a mix of lower
growth, reduced strain on the labor market and a recipe of other things that
will have to go right before measurable relief is possible. “It’s not going to be easy,” said House, the Wells Fargo economist. “Given
that you have decent consumer spending and business spending, that’s going to
keep the pressure on inflation overall.” |
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Week 4 |
Chapter 8 Stock
Valuation Part
I Dividend payout and Stock Valuation For class
discussion: · Why can we
use dividend to estimate a firm’s intrinsic value? · Are
future dividends predictable? F Dividend History
https://www.nasdaq.com/market-activity/stocks/f/dividend-history ·
EX-DIVIDEND DATE04/25/2022 ·
DIVIDEND YIELD3.53% ·
ANNUAL DIVIDEND$0.4 ·
P/E RATIO3.89
Wal-Mart Dividend History · Refer
to the following table for Wal-mart
(WMT’s dividend history) http://stock.walmart.com/investors/stock-information/dividend-history/default.aspx
WMT Dividend History
https://www.nasdaq.com/market-activity/stocks/wmt/dividend-history ·
EX-DIVIDEND DATE08/11/2022 ·
DIVIDEND YIELD1.83% ·
ANNUAL DIVIDEND$2.24 ·
P/E RATIO26.91
For class discussion: What conclusions can be drawn from
the above information? Can we figure out the stock price
of Wal-Mart based on dividend, with reasonable assumptions? Stock Splits
Wal-Mart
Stores, Inc. was incorporated on Oct. 31, 1969. On Oct. 1, 1970, Walmart
offered 300,000 shares of its common stock to the public at a price of $16.50
per share. Since that time, we have had 11 two-for-one (2:1) stock splits. On
a purchase of 100 shares at $16.50 per share on our first offering, the
number of shares has grown as follows:
Can you estimate the
expected dividend in 2022? And in 2023? And on and on…
Can you write down the math equation
now? WMT stock price = ? WMT
stock price = npv(return, D1, D2, …D∞) WMT
stock price = D1/(1+r) + D2/(1+r)2
+ D3/(1+r)3 + D4/(1+r)4 + … Can you calculate now? It is hard
right because we assume dividend payment goes to infinity. How can we
simplify the calculation? We can assume that dividend grows at
certain rate, just as the table on the right shows. Discount rate is r (based on Beta and
CAPM that we will learn in chapter 13) https://www.nasdaq.com/market-activity/stocks/wmt What
does each item indicate? From
finviz.com https://finviz.com/quote.ashx?t=WMT Part II: Constant Dividend
Growth-Dividend growth model Calculate
stock prices 1) Given next dividends and price Po= Po= Po= Po= ……
Refer to http://www.calculatinginvestor.com/2011/05/18/gordon-growth-model/ · Now let’s apply this Dividend
growth model in problem solving. Constant dividend
growth model calculator (www.jufinance.com/stock) Equations ·
Po=
D1/(r-g) or Po= Do*(1+g)/(r-g) ·
r
= D1/Po+g = Do*(1+g)/Po+g · g= r-D1/Po = r-
Do*(1+g)/Po ·
D1 = Po *(r-g); D0 =
Po*(r-g)/(1+g) · Capital Gain yield = g · Dividend Yield = r – g = D1
/ Po = Do*(1+g) / Po ·
D1=Do*(1+g);
D2= D1*(1+g); D3=D2*(1+g)… Exercise: 1.
Consider the valuation of a common stock that
paid $1.00 dividend at the end of the last year and is expected to pay a cash
dividend in the future. Dividends are expected to grow at 10% and the
investors required rate of return is 17%. How much is the price? How much is
the dividend yield? Capital gain yield? 2. The
current market price of stock is $90 and the stock pays dividend of $3 (D1)
with a growth rate of 5%. What is the return of this stock? How much is the
dividend yield? Capital gain yield? Part III: Non-Constant Dividend
Growth Calculate
stock prices 1) Given next dividends and price Po= Po= Po= Po= …… Non-constant
dividend growth model Equations Pn
= Dn+1/(r-g) = Dn*(1+g)/(r-g), since year n,
dividends start to grow at a constant rate. Where
Dn+1= next dividend in year n+1; Do
= just paid dividend in year n; r=stock
return; g= dividend growth rate; Pn=
current market price in year n; Po
= npv(r, D1, D2, …, Dn+Pn) Or,
Po
= D1/(1+r) + D2/(1+r)2 + … + (Dn+Pn)/(1+r)n
Calculator: Non-Constant Dividend Growth Calculator In class exercise for
non-constant dividend growth model 1.
You expect
AAA Corporation to generate the following free cash flows over the next five
years:
Since year 6, you estimate that AAA's free cash flows will
grow at 6% per year. WACC of AAA = 15% · Calculate the enterprise value for DM Corporation. · Assume that AAA has $500 million debt and 14 million shares
outstanding, calculate its stock price. Answer:
2. AAA pays no dividend
currently. However, you expect it pay an annual dividend of $0.56/share 2
years from now with a growth rate of 4% per year thereafter. Its equity cost
= 12%, then its stock price=? Answer:
Do=0 D1=0 D2=0.56 g=4%
after year 2 è
P2 = D3/(r-g), D3=D2*(1+4%) è
P2 = 0.56*(1+4%)/(12%-4%) = 7.28 r=12% Po=? Po =
NPV(12%, D1, D2+P2), D2 = 0.56, P2=7.28. SO Po = NPV(12%, 0,0.56+7.28) =
6.25 (Note: for non-constant
growth model, calculate price when dividends start to grow at the constant rate.
Then use NPV function using dividends in previous years, last dividend plus
price. Or use calculator at https://www.jufinance.com/dcf/
) 3. Required return =12%.
Do = $1.00, and the dividend will grow by 30% per year for the next 4
years. After t = 4, the dividend is
expected to grow at a constant rate of 6.34% per year forever. What is the stock price ($40)? Answer:
Do=1 D1 =
1*(1+30%) = 1.3 D2=
1.3*(1+30%) = 1.69 D3 =
1.69*(1+30%) = 2.197 D4 =
2.197*(1+30%) = 2.8561 D5 =
2.8561*(1+6.34%), g=6.34% P4 =
D5/(r-g) = 2.8561*(1+6.34%) /(12% - 6.34%) Po = NPV(12%, 1.3, 1.69, 2.197,
2.8561+2.8561*(1+6.34%)) /(12% - 6.34%)) = 40 Or use calculator at https://www.jufinance.com/dcf/ Part IV: How to pick stocks?
(FYI) How to pick
stocks – Does it work? PE ratio Stock screening tools ·
Reuters
stock screener to help select stocks http://stockscreener.us.reuters.com/Stock/US/ ·
FINVIZ.com http://finviz.com/screener.ashx use
screener on finviz.com to narrow down your choices of stocks, such as
PE<15, PEG<1, ROE>30% ·
WSJ
stock screen http://online.wsj.com/public/quotes/stock_screener.html ·
Simply
the Web's Best Financial Charts You can
find analyst rating from MSN money For
instance, ANALYSTS RATINGS Zacks average brokerage
recommendation is Moderate Buy
Summary of stock screening rules
from class discussion PEG<1 PE<15 (? FB’s
PE>100?) Growth
rate<20 ROE>10% Analyst ranking:
strong buy only Zacks average
=1 (from Ranking stocks using PEG ratio) current
price>5 How to pick stocks Capital
Asset Pricing Model (CAPM)Explained https://www.youtube.com/watch?v=JApBhv3VLTo Ranking
stocks using PEG ratio https://www.youtube.com/watch?v=bekW_hTehNU HOMEWORK (Due with final) 1. Northern
Gas recently paid a $2.80 annual dividend on its common stock. This dividend increases
at an average rate of 3.8 percent per year. The stock is currently selling
for $26.91 a share. What is the market rate of return? (14.60
percent) 3.
IBM just paid $3.00 dividend per share to
investors. The dividend growth rate is 10%. What is the expected dividend of
the next year? ($3.3) 5.
Investors of
Creamy Custard common stock earns 15% of return. It just paid a
dividend of $6.00 and dividends are expected to grow at a rate of 6%
indefinitely. What is expected price of Creamy Custard's stock? ($70.67) Homework Video of this
week Homework help video
(FYI) Quiz 3- Help Video Part I Part II Part III Part IV
|
P/E Ratio Summary by
industry (FYI) --- Thanks to Dr Damodaran Data Used: Multiple data services Date of Analysis: Data used is as of January 2021 Download as an excel file instead: http://www.stern.nyu.edu/~adamodar/pc/datasets/pedata.xls For global datasets: http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html
Details
about how to derive the model mathematically (FYI) The Gordon growth model is a simple discounted cash flow (DCF)
model which can be used to value a stock, mutual fund, or even the entire
stock market. The model is named after Myron Gordon who first published
the model in 1959. The Gordon model assumes that a financial security
pays a periodic dividend (D) which grows at a constant rate
(g). These growing dividend payments are assumed to continue forever.
The future dividend payments are discounted at the required rate of return
(r) to find the price (P) for the stock or fund. Under these simple assumptions, the price of the
security is given by this equation:
In this equation, I’ve used the “0” subscript
on the price (P) and the “1” subscript on the dividend (D) to
indicate that the price is calculated at time zero and the dividend is the
expected dividend at the end of period one. However, the equation is
commonly written with these subscripts omitted. Obviously, the assumptions built into this
model are overly simplistic for many real-world valuation problems. Many
companies pay no dividends, and, for those that do, we may expect
changing payout ratios or growth rates as the business matures. Despite
these limitations, I believe spending some time experimenting with the
Gordon model can help develop intuition about the relationship between
valuation and return. Deriving the Gordon Growth Model Equation
The Gordon growth model calculates the present value of
the security by summing an infinite series of discounted dividend payments
which follows the pattern shown here:
Multiplying both sides of the previous equation by
(1+g)/(1+r) gives:
We can then subtract the second equation from the first
equation to get:
Rearranging and simplifying:
Finally,
we can simplify further to get the Gordon growth model equation Goldman Sachs calculates a worst-case recession forecast as
investors dump stocks and crypto BY BERNHARD WARNER,
May 16, 2022 4:44 AM EDT https://fortune.com/2022/05/16/goldman-sachs-recession-forecast-spx-stocks-crypto/ As gutting as that
sounds, Goldman Sachs figures things could get worse. Much worse. In a note to
clients, the investment bank's equities team calculated twin full-year
forecasts for the S&P 500. The base case is for the benchmark to close out 2022 at 4,300, a
near-7% premium over Friday's close. This assumes Corporate America will be
able to eke out profits as they adapt to a coming slowdown. The worst case is far bleaker. It involves a full-on recession
slamming the U.S. economy, and that would mean stocks falling a further 10%
to close out 2022 at 3,600. Lloyd Blankfein,
Goldman's former CEO, and current senior chairman, appears to be banking on
the latter scenario. On Sunday, he
told a Face the Nation interviewer that there's a “very, very high risk"
the American economy will slump into a recession. The pessimistic
calculations are adding further volatility to a risk-off market. At 3:30 a.m. ET
Monday, global stocks and U.S. futures were awash in red with Nasdaq futures
down by more than 1% (after climbing 3.8% on Friday). Meanwhile, the
safe-haven dollar was climbing again, adding to its impressive gains against
rival currencies. Baked into
Goldman's downbeat forecast is the belief that economic growth will falter in
the world's most advanced economies. Over the weekend,
in a separate report, Goldman's chief economist Jan Hatzius downgraded 2022
and 2023 U.S. GDP growth. Hatzius's team now sees the U.S. economy growing 2.4% this year
(previously, they'd calculated 2.6% growth) and a lackluster 1.6% next year
(vs. 2.2.% for full-year 2023). The economy is in for a big hit this quarter, Hatzius says, with
COVID and Russia's invasion of Ukraine pushing up prices, snarling supply
chains and sapping consumers' spending power.
Hatzius, it should be noted, did not mention the R-word in his team's report. Across the
Atlantic, the Europe Stoxx 600 opened at 0.6% lower, and stocks in China were
weaker. At 3:30 a.m. ET,
the Shanghai Composite was off 0.3% following a dump of lousy economic data
that confirmed the acute cost of Beijing's most recent COVID restrictions in
the financial capital. Sticking with risk
assets, investors are selling out of crypto once again. Bitcoin tumbled below
$30,000 on Monday, a 5% drop. Ether was also down by roughly the same
percentage. Looking ahead, it's
a packed week for economic data and earnings. Wall Street will be tuning into
tomorrow's retail data numbers to see if the consumer truly is holding back
on spending. Meanwhile, on Tuesday and Wednesday, investors will get the
latest quarterly results from retail giants Home Depot, Lowe's, Walmart and
Target. Stocks Get Crushed With Recession Worries Mounting ·
US mortgage rates post their
biggest increase since 1987 ·
Twitter deal spread widens
after Musk’s staff meeting ByRita Nazareth June 15, 2022 at
6:12 PM EDTUpdated onJune 16, 2022 at 4:44 PM EDT Stocks tumbled around the globe as recession fears resurfaced,
with the Federal Reserve struggling to get on top of inflation that has
proved more persistent and widespread than officials anticipated. The S&P 500 closed at its lowest since December 2020, while
the tech-heavy Nasdaq 100 sank 4%. The deal spread on Elon Musk’s proposed
takeover of Twitter Inc. widened as the billionaire wasn’t directly asked and
didn’t address the issue on whether he’s committed to buying the social-media
firm during a staff meeting. Homebuilders slid as mortgage rates jumped the
most since 1987. In late trading, Adobe Inc. slumped after cutting its sales
forecast. The dollar fell as central
banks in Europe stepped up monetary tightening, promising to narrow the gap
between rates there and in the US. Treasuries rebounded from an earlier
selloff. Bitcoin dropped below $21,000 amid its longest slide in Bloomberg
data going back to 2010. Declaring that it’s essential
to tame inflation, Jerome Powell engineered the biggest rate increase since
1994 Wednesday and held out the distinct possibility of another jumbo hike in
July. While the Fed chief sought to
soften the blow of the 75-basis-point boost, saying he didn’t
expect such moves to be the norm, he tacitly admitted the chance of an
economic downturn. “We’re worrying about growth and where the Fed takes us
ultimately,” said Chris Gaffney, president of world
markets at TIAA Bank. “Yesterday, everybody said, ‘Oh good, the Fed is doing something aggressive, they’re
going to get aggressive, they’ll try to catch up to the inflation curve.’ But now, you’re looking at it and saying, ‘Yeah, but are they chasing something they’re not going to
be able to catch?’” While inflation is “out of control,” the Fed is doing the best it can given its limited tools,
Orlando Bravo, co-founder of private-equity firm Thoma Bravo said. Despite
the stock carnage, valuations still have much further to fall, according to
Jim Chanos, founder of Chanos & Company LP. The S&P 500 now implies an 85% chance of a US recession amid
fears of a policy error by the Fed, according to JPMorgan Chase & Co. The
warning from quant and derivatives strategists is based on the average 26%
decline for the gauge during the past 11 recessions and follows its collapse
into a bear market. One technical indicator of US stocks shows the extent of the
recent slump, while offering a whiff of optimism that it will soon come to an
end. The percentage of S&P 500 members that are trading above
their 50-day moving average sank below 5% this week, the lowest level since
Covid-19 fears battered shares more than two years ago. Both that selloff and
the one that hit markets in late 2018 reversed course shortly after seeing a
similar share of stocks dip below the closely watched technical average. More comments: “Our main takeaway from the Fed is hawkish -- meaning the Fed is
going to accept recession risk to deliver below-trend economic growth,” wrote Dennis DeBusschere, the founder of 22V Research. “Concerns are mounting about whether the Fed is headed towards a
policy mistake,” said Quincy Krosby, chief equity
strategist at LPL Financial. “Despite their assurance, it’s unclear to me whether the Fed has
the tools they say they do to tamp down prices,” said
Jason Brady, chief executive officer at Thornburg Investment Management. Elsewhere, investors dumped
European bonds and the franc rallied after a surprise Swiss rate hike. The
pound rose as the Bank of England raised rates and signaled it’s prepared to
unleash larger moves if needed. Currency options traders are betting the Bank
of Japan will deliver a policy surprise this week. Commodities may deliver breathtaking returns amid tight supplies
and low inventories, according to JPMorgan Chase & Co. Returns could
total 10% by the end of the northern hemisphere summer and 5% by year-end.
Volatility will also stay elevated, the report said. Oil may touch $150 per
barrel in the short-term, while corn could reach $13 a bushel -- a record
price by a long shot. Explainer: U.S. yield curve
inverts again: What is it telling us? By Davide Barbuscia and David Randall, June 13, 2022 https://www.reuters.com/markets/us/us-yield-curve-inverts-again-what-is-it-telling-us-2022-06-13/ NEW YORK, June 13 (Reuters) - A closely watched part of the U.S. Treasury yield curve inverted on
Monday for the first time since April following hotter-than-anticipated
inflation data last week. As the U.S. Federal Reserve
attempts to bring inflation down from 40-year highs, banks have ramped up
projections of interest rate hikes, and some shorter-dated bond yields surged
higher than longer term ones. Here is a quick primer on what a steep, flat or inverted yield
curve means and how it has predicted recession, and what it might be
signaling now. WHAT SHOULD THE CURVE LOOK
LIKE? The U.S. Treasury finances federal government budget obligations
by issuing various forms of debt. The $23 trillion Treasury market includes
bills that mature in one month to one year, two- to 10-year notes, and 20-
and 30-year bonds. The yield curve, which plots
the return on all Treasury securities, typically slopes upward as the payout
increases with the duration. Yields move inversely to prices. A steepening curve typically
signals expectations for stronger economic activity, higher inflation, and
higher interest rates. A flattening curve can mean investors expect near-term
rate hikes and are pessimistic about economic growth. WHAT DOES AN INVERTED CURVE
MEAN? Investors watch parts of the
yield curve as recession indicators, primarily the spread between three-month
Treasury bills and 10-year notes , and the two- to 10-year (2/10) segment. On Monday, the 2/10 part
inverted, meaning two-year Treasuries yielded more than 10-year paper.
Short-term yields, which are sensitive to interest rates, are rising with
rate-hike expectations while higher long-term rates reflect concerns that the
Fed will be unable to control inflation. The inversion signals that a recession could follow. That part of the curve had
inverted in late March for the first time since 2019. It steepened again as traders, having priced in a string of
rate hikes, sharpened their focus on the pace and scope of the Fed's plans to
reduce its balance sheet. The U.S. curve has inverted before each recession since 1955,
with a recession following between six and 24 months, according to a 2018
report by researchers at the Federal Reserve Bank of San Francisco. It
offered a false signal just once in that time. That research focused on a
slightly different part of the curve, between one- 10-year Treasury yields. The yield curve has inverted 28 times since 1900, according to
Anu Gaggar, Global Investment Strategist for Commonwealth Financial Network,
who looked at the 2/10 part of the curve. In 22 of these instances, a
recession has followed. For the last six recessions, a
recession on average began six to 36 months after the curve inverted, she
said. Before March, the last time the 2/10 part of the yield curve inverted
was in 2019. The following year, the United States entered a recession, which
was caused by the global pandemic. WHY IS THE YIELD CURVE
INVERTING NOW? Yields of short-term U.S.
government debt have been rising quickly this year, reflecting expectations
for a series of rate hikes by the Fed. Longer-dated government bond yields
have moved at a slower pace amid concerns policy tightening may hurt the
economy. As a result, the shape of the
Treasury yield curve has been generally flattening and in some cases
inverting. The curve steepened in April and May but last week's
higher-than-anticipated inflation data shifted investors' focus once again on
the short-end of the curve. Two-year yields rose to a 15-year high of around
3.25% on Monday. Other parts of the curve also inverted, including the spread
between five- and 30-year U.S. Treasuries , and between three- and 10-year
paper . WHAT DOES THIS MEAN FOR THE
REAL WORLD? While rate increases can be a weapon against inflation, they can
also slow economic growth by raising borrowing costs for everything from
mortgages to car loans. The yield curve also affects
consumers and business. When short-term rates
increase, U.S. banks tend to raise benchmark rates for a wide range of
consumer and commercial loans, including small business loans and credit
cards, making borrowing more costly for consumers. Mortgage rates also rise. When the yield curve steepens,
banks can borrow at lower rates and lend at higher rates. When the curve is
flatter their margins are squeezed, which may deter lending. |
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Chapter 9 Capital
Budgeting
1. NPV Excel syntax Syntax NPV(rate,value1,value2, ...) Rate is the rate of discount over
the length of one period. Value1, value2,
... are 1 to 29
arguments representing the payments and income. · Value1, value2, ... must be equally spaced in
time and occur at the end of each period. NPV uses the
order of value1, value2, ... to interpret the order of cash flows.
Be sure to enter your payment and income values in the correct sequence. 2. IRR Excel syntax Syntax IRR(values, guess) Values is an array or a reference to cells
that contain numbers for which you want to calculate the internal rate of
return. Guess is a number that you guess is
close to the result of IRR.
Or, PI =
NPV / CFo +1 Profitable
index (PI) =1 + NPV / absolute value of CFo 3. MIRR( values, finance_rate, reinvest_rate ) Where
the function arguments are as follows:
Modified Rate of Return:
Definition & Example (video)
https://study.com/academy/lesson/modified-rate-of-return-definition-example.html NPV, IRR, Payback Period calculator I NPV, IRR, Payback Period calculator II
Excel Template - NPV, IRR, MIRR, PI, Payback,
Discounted payback NPV
Profile in Excel Demonstration (Video, FYI) In class exercise Part I: Single project 1.
How much is MIRR? IRR? Payback period?
Discounted payback period? NPV? WACC: 11.00% Year 0 1 2 3 Cash
flows -$800 $350 $350 $350 Answer: 1)
NPV: NPV = -800 + 350/(1+11%) +
350/(1+11%)2 + 350/(1+11%)3 = 55.30 Or in excel: = npv(11%, 350, 350, 350)-800 = 55.30 2)
IRR:
So NPV = 0 = -800 +
350/(1+IRR) + 350/(1+IRR)2 + 350/(1+IRR)3 , use Solver,
can get IRR = 14.93% Or in excel:
3)
PI: profitable index
SO, PI= (350/(1+11%) + 350/(1+11%)2 + 350/(1+11%)3
) / 800 = 1.069 Or PI = NPV/800 + 1 = 55.30/800 + 1 = 1.069 4)
Payback period:
A portion of the third year = (800-350-350)/350 = 100/350 =
0.2857 So it takes 2 + 0.2857 = 2.2857 years to pay off the debt of
$800. 5)
Discounted payback period:
Note: All the cash flows in the above equation should be the
present values.
A portion of the third year = (800-318.18-289.26)/262.96 =
0.72 So it takes 2 + 0.72 = 2.72 years to pay off the debt of $800.
Or use the calculator at https://www.jufinance.com/capital/ Part
II: Multi-Projects 1.
Projects S and L, whose cash flows are
shown below. These projects are
mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best
selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the
project with the higher IRR rather than the one with the higher NPV, how
much, if any, value will be forgone, i.e., what's the chosen NPV versus the
maximum possible NPV? Note that (1) “true value” is measured by NPV,
and (2) under some conditions the choice of IRR vs. NPV will have no effect
on the value gained or lost. WACC: 7.50% Year 0 1 2 3 4 CFS -$1,100 $550 $600 $100 $100 CFL -$2,700 $650 $725 $800 $1,400 Answer:
If the required rate of return is 10%. Which
project shall you choose? 1) How
much is the cross over rate? (answer: 11.8%) 2) How
is your decision if the required rate of return is 13%? (answer: NPV of
B>NPV of A) · Rule for mutually exclusive projects: (answer:
Choose B) · What about the two projects are independent?
(answer: Choose both) Solution:
Part III More on IRR – (non-conventional cash flow) Suppose an investment will
cost $90,000 initially and will generate the following cash flows: – Year 1: 132,000 – Year 2: 100,000 – Year 3: -150,000 The required return is 15%.
Should we accept or reject the project? 1) How does the
NPV profile look like? (Answer: Inverted NPV profile) 2) IRR1= 10.11% --
answer 3) IRR2= 42.66% --
answer Solution:
HOMEWORK(Due with final) Year Cash flows 1 $8,000 2 4,000 3 3,000 4 5,000 5 10,000 1) How
much is the payback period (approach one)? ----
4 years 2) If
the firm has a 10% required rate of return. How much is NPV (approach
2)?-- $2456.74 3) If
the firm has a 10% required rate of return. How much is IRR (approach
3)? ---- 14.55% 4) If
the firm has a 10% required rate of return. How much is PI (approach
4)? ---- 1.12 Question 2: Project with an initial cash outlay of $60,000 with
following free cash flows for 5 years. Year FCF Initial
outlay –60,000 1 25,000 2 24,000 3 13,000 4 12,000 5 11,000 The firm has a 15% required rate of return. Calculate payback period, NPV, IRR and PI.
Analyze your results. Question 3: Mutually Exclusive
Projects 1) Consider
the following cash flows for one-year Project A and B, with required rates of
return of 10%. You have limited capital and can invest in one but one
project. Which one? § Initial
Outlay: A = -$200; B = -$1,500 § Inflow: A
= $300; B = $1,900 2) Example:
Consider two projects, A and B, with initial outlay of $1,000, cost of
capital of 10%, and following cash flows in years 1, 2, and 3: A:
$100 $200 $2,000 B:
$650 $650 $650 Which
project should you choose if they are mutually exclusive? Independent?
Crossover rate? (mutually
exclusive: A’s NPV=758.83 > B’s NPV = 616.45, so choose A; Independent,
choose all positive NPV, so choose both; Crossover
rate = 21.01%. The calculator does not work. Use IRR in Excel) Quiz 4- chapter 9 –
(no video prepared; Could use the calculator) Homework help videos (chapter 9) |
Simple
Rules’ for Running a Business
From the 20-page cellphone contract to the five-pound employee handbook,
even the simple things seem to be getting more complicated. Companies have been complicating things for themselves, too—analyzing hundreds of factors when making decisions, or
consulting reams of data to resolve every budget dilemma. But those requirements
might be wasting time and muddling priorities. So argues Donald Sull,
a lecturer at the Sloan School of Management at the Massachusetts Institute
of Technology who has also worked for McKinsey & Co. and Clayton, Dubilier & Rice LLC. In the book Simple
Rules: How to Thrive in a Complex World, out this week from Houghton
Mifflin Harcourt HMHC -1.36%,
he and Kathleen Eisenhardt of Stanford University claim that
straightforward guidelines lead to better results than complex formulas. Mr. Sull recently spoke with At Work about
what companies can do to simplify, and why five basic rules can beat a
50-item checklist. Edited excerpts: WSJ: Where, in the business
context, might “simple rules” help more than a complicated
approach? Donald Sull: Well, a common decision that people face in organizations is
capital allocation. In many organizations, there will be thick procedure
books or algorithms–one company I worked with had an
algorithm that had almost 100 variables for every project. These are very
cumbersome approaches to making decisions and can waste time. Basically, any
decision about how to focus resources—either people
or money or attention—can benefit from simple rules. WSJ: Can you give an example of
how that simplification works in a company? Sull: There’s
a German company called Weima GmBH that makes shredders. At one point,
they were getting about 10,000 requests and could only fill about a thousand
because of technical capabilities, so they had this massive problem of
sorting out which of these proposals to pursue. They had a very detailed checklist with 40 or 50 items. People
had to gather data and if there were gray areas the proposal would go to
management. But because the data was hard to obtain and there were so many
different pieces, people didn’t always fill out the checklists completely. Then
management had to discuss a lot of these proposals personally because there
was incomplete data. So top management is spending a disproportionate amount
of time discussing this low-level stuff. Then Weima came up with guidelines that the
frontline sales force and engineers could use to quickly decide whether a
request fell in the “yes,” “no” or “maybe” category. They did it with five
rules only, stuff like “Weima had to
collect at least 70% of the price before the unit leaves the factory.” After that, only the “maybes” were sent to management. This
dramatically decreased the amount of time management spend evaluating these
projects–that time was decreased by almost a factor
of 10. Or, take Frontier Dental Laboratories in Canada. They were
working with a sales force of two covering the entire North American market.
Limiting their sales guidelines to a few factors that made someone likely to
be receptive to Frontier—stuff like “dentists
who have their own practice” and “dentists
with a website”—helped focus their efforts and
increase sales 42% in a declining market. WSJ: Weima used five factors—is
that the optimal number? And how do you choose which rules to follow? Sull: You should have four to six
rules. Any more than that, you’ll spend too much time trying to follow
everything perfectly. The entire reason simple rules help is because they
force you to prioritize the goals that matter. They’re
easy to remember, they don’t confuse or stress you,
they save time. They should be tailored to your specific goals, so you choose
the rules based on what exactly you’re trying to
achieve. And you should of course talk to others. Get information from
different sources, and ask them for the top things that worked for them. But
focus on whether what will work for you and your circumstances. WSJ: Is there a business leader
you can point to who has embraced the “simple rules” guideline? Donald Sull: Let’s look at when Alex Behring took
over America
Latina Logistica SARUMO3.BR +1.59%,
the Brazilian railway and logistics company. With a budget of $15 million,
how do you choose among $200 million of investment requests, all of which are
valid? The textbook business-school answer to this is that you run the
NPV (net present value) test on each project and rank-order them by NPV. Alex
Behring knows this. He was at the top of the class at Harvard Business School. But instead Similarly, the global-health arm of the Gates Foundation gets
many, many funding requests. But since they know that their goal is to have
the most impact worldwide, they focus on projects in developing countries
because that’s where the money will stretch farther. |
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Week 5 - Chapter 14 Cost of Capital
For class discussion: · What is WACC? · Why is it important? · WACC increases, good or bad to stock holders? · How to apply WACC to figure out firm value?
One option (if beta is given, refer to chapter 13)
Another option (if dividend is given):
WACC Formula
WACC calculator (annual
coupon bond) (www.jufinance.com/wacc)
WACC calculator (semi-annual coupon bond) (www.jufinance.com/wacc_1)
WACC Calculator help
videos FYI
Summary of Equations
Discount rate to figure out the value of projects is called WACC (weighted average cost of capital)
WACC = weight of debt * cost of debt + weight of equity *( cost of equity)
Wd= total debt / Total capital = total borrowed / total capital We= total equity/ Total capital Cost of debt = rate(nper, coupon,
-(price – flotation costs), 1000)*(1-tax rate) Cost of Equity = D1/(Po – Flotation Cost) + g D1: Next period dividend; Po: Current stock price; g: dividend growth rate Note: flotation costs = flotation percentage * price
Or if beta is given, use CAPM model (refer to chapter 13) Cost of equity = risk free
rate + beta *(market return – risk free rate) Cost of equity = risk free rate +
beta * market risk premium
In Class Exercise: A firm borrows money from bond market. The price they paid is $950 for the bond with 5% coupon rate and 10 years to mature. Flotation cost is $40. For the new stocks, the expected dividend is $2 with a growth rate of 10% and price of $40. The flotation cost is $4. The company raises capital in equal proportions i.e. 50% debt and 50% equity (such as total $1m raised and half million is from debt market and the other half million is from stock market). Tax rate 34%. What is WACC (weighted average cost of capital, cost of capital)? (Answer: 9.84%) 1) Why does the firm raise capital from the financial market? Is there of any costs of doing so? What do you think? 2) What is cost of debt? (Kd = rate(nper, coupon, -(price – flotation costs $)), 1000)*(1-tax rate)) 3) Cost of equity? (Ke = (D1/(Price – flotation costs $)) +g, or Ke = Rrf + Beta*MRP)) Why no tax adjustment like cost of debt? 4) WACC=Cost of capital = Percentage of Debt * cost of debt + percentage of stock * cost of stock = Wd*Kd + We* Ke Meaning: For a dollar raised in the capital market from debt holders and stockholders, the cost is WACC (or WACC * 1$ = several cents, and of course, the lower the better but many companies do not have good credits)
Solution: Cost
of debt = rate(10, 50, -(950-40), 1000)*(1-34%) Cost
of/equity = 2/(40-4)+10% WACC
= 0.5*cost of debt + 0.5*cost of equity
https://www.jufinance.com/wacc/ No
homework for chapter 14
Homework
help videos (chapter 9) Quiz 4- chapter 9 – (no video prepared) |
(both annual and
semi-annual) WACC calculator (annual coupon bond) WACC calculator (semi-annual coupon
bond) (www.jufinance.com/wacc_1) Wal-Mart
Inc (NYSE:WMT) WACC %: 5.22%
As of 7/14/2022 As of today (2022-7-14), Walmart's
weighted average cost of capital is 5.22%. Walmart's ROIC % is 10.70% (calculated using TTM income
statement data). Walmart generates higher returns on investment than it costs
the company to raise the capital needed for that investment. It is earning
excess returns. A firm that expects to continue generating positive excess
returns on new investments in the future will see its value increase as
growth increases.https://www.gurufocus.com/term/wacc/WMT/WACC/Walmart%2BInc
Amazon.com
Inc (NAS:AMZN) WACC %:8.75% As of 7/14/2022 As of today (2022-7-14), Amazon.com's weighted average cost of capital is 8.75%. Amazon.com's ROIC % is 7.41% (calculated using TTM income statement data). Amazon.com generates higher returns on investment than it costs the company to raise the capital needed for that investment. It is earning excess returns. A firm that expects to continue generating positive excess returns on new investments in the future will see its value increase as growth increases. https://www.gurufocus.com/term/wacc/AMZN/WACC-Percentage/Amazon.com%20Inc
Apple
Inc (NAS:AAPL) WACC %:10.06%
As of 7/14/2022 As of today (2022-7-14), Apple's
weighted average cost of capital is 10.06%. Apple's ROIC % is 35.02% (calculated
using TTM income statement data). Apple generates higher returns on investment
than it costs the company to raise the capital needed for that investment. It
is earning excess returns. A firm that expects to continue generating
positive excess returns on new investments in the future will see its value
increase as growth increases..https://www.gurufocus.com/term/wacc/AAPL/WACC/Apple%2Binc
Tesla WACC %: 19.93% As of 7/14/2022
As of today (2022-7-14), Tesla's weighted average cost of capital is 19.93%. Tesla's ROIC % is 22.74% (calculated using TTM income statement data). Tesla earns returns that do not match up to its cost of capital. It will destroy value as it grows. https://www.gurufocus.com/term/wacc/NAS:TSLA/WACC-/Tesla
Cost of Capital by
Sector (US) Date of Analysis: Data used is as of January 2022 Download as an excel file instead: https://www.stern.nyu.edu/~adamodar/pc/datasets/wacc.xls For global datasets: https://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html
http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/wacc.htm |
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Chapter 13 Risk and Return Equations (FYI): 1. Expected return and
standard deviation Given a probability distribution of
returns, the expected return can be calculated using the following equation:
where
https://www.zenwealth.com/businessfinanceonline/RR/ExpectedReturn.html Given an asset's expected return, its
variance can be calculated using the following equation:
where
The standard deviation is
calculated as the positive square root of the variance.
https://www.zenwealth.com/businessfinanceonline/RR/MeasuresOfRisk.html Exercise: Stock A has the following returns for various states of the
economy: State of the Economy Probability Stock
A's Return Recession 10% -30% Below
Average 20% -2% Average 40% 10% Above
Average 20% 18% Boom 10% 40% Stock A's expected return is?
Standard deviation? Solution: Expected return = 10%*(-30%))
+ 20%*(-2%) + 40% *10% + 20%*18% + 10%*40% = 8.2% Standard deviation = sqrt(10%*(-30%-8.2%)2 + 20%*(-2%-8.2%)2
+40%*(10%-8.2%)2 + 20%*(18%-8.2%)2 +10%*(40%-8.2%)2)
= 16.98% Or, https://www.jufinance.com/return/
W1 and W2 are the percentage of each stock in the
portfolio.
Exercise: Stocks A and B have the following returns for various states of
the economy: State of the
Economy Probability Stock
A's Return Recession 10% -30% -10% Below
Average 20% -2% 2% Average 40% 10% 1% Above
Average 20% 18% 2% Boom 10% 40% -5% Solution: (or use calculator
at https://www.jufinance.com/return/) Stock 1: Expected return = 10%*(-30%))
+ 20%*(-2%) + 40% *10% + 20%*18% + 10%*40% = 8.2% Standard deviation = sqrt(10%*(-30%-8.2%)2 + 20%*(-2%-8.2%)2
+40%*(10%-8.2%)2 + 20%*(18%-8.2%)2 +10%*(40%-8.2%)2)
= 16.98% Stock 2: Expected return = 10%*(10%)) +
20%*(2%) + 40% *1% + 20%*2% + 10%*(-5)% = 1.7% Standard deviation = sqrt(10%*(10%-1.7%)2 + 20%*(2%-1.7%)2
+40%*(1%-1.7%)2 + 20%*(2%-1.7%)2 +10%*((-5)%-1.7%)2)
= 3.41% Covariance: Covariance = 10%*(-30%-8.2%)*(10%-1.7%)+20%*(-2%-8.2%)*(2%-1.7%)+40%*(10%-8.2%)*(1%-1.7%)+20%*(18%-8.2%)*(2%-1.7%)+10%*(40%-8.2%)*((-5%)-1.7%)
= -0.54% Correlation: Correlation = -0.54%/(16.98%* 3.41%) = -0.93
]3..
Historical returns Holding period return (HPR) =
(Selling price – Purchasing price + dividend)/ Purchasing price 4. CAPM (Capital Asset
Pricing Model) model · What is Beta? Where to find Beta?
Beta
is a measurement of a stock's price fluctuations, which is often called
volatility, and is used by investors to gauge how quickly a stock's price
will rise or fall. Because beta is calculated from past returns, it's not
considered as reliable a tool to forecast rises in stock prices, and it is
more commonly used by options traders. Beta compares the changes in a
company's stock returns against the returns of the market as a whole. Online
brokerages give investors extensive data on a stock's beta value, and some
free financial news websites also show current beta measurements. · What
Is the Capital Asset Pricing Model?
The Capital Asset Pricing Model (CAPM)
describes the relationship between systematic risk and expected
return for assets, particularly stocks. CAPM is widely used throughout
finance for pricing risky securities and generating expected
returns for assets given the risk of those assets and cost of capital. Ri = Rf + βi *( Rm -
Rf) ------ CAPM model Ri =
Expected return of investment Rf = Risk-free
rate βi = Beta of the investment Rm = Expected
return of market (Rm - Rf) = Market risk premium Investors expect to be compensated for risk and the time
value of money. The risk-free rate in the CAPM formula accounts for
the time value of money. The other components of the CAPM formula account for
the investor taking on additional risk. The beta of a potential investment is a
measure of how much risk the investment will add to a portfolio that looks
like the market. If a stock is riskier than the market, it will have a beta
greater than one. If a stock has a beta of less than one, the formula assumes
it will reduce the risk of a portfolio. A stock’s beta is then multiplied by
the market risk premium, which is the return expected from the market
above the risk-free rate. The risk-free rate is then added to the product of
the stock’s beta and the market risk premium. The
result should give an investor the required return or discount
rate they can use to find the value of an asset. The goal of the CAPM formula is to evaluate whether a stock is
fairly valued when its risk and the time value of money are compared to its expected
return. For example, imagine an investor is
contemplating a stock worth $100 per share today that pays a 3% annual
dividend. The stock has a beta compared to the market of 1.3, which means it
is riskier than a market portfolio. Also, assume that the risk-free rate is
3% and this investor expects the market to rise in value by 8% per year. The expected return of the stock based on the CAPM formula is
9.5%. The expected return of the CAPM formula is used to discount
the expected dividends and capital appreciation of the stock over the
expected holding period. If the discounted value of those future cash flows
is equal to $100 then the CAPM formula indicates the stock is fairly valued
relative to risk. (https://www.investopedia.com/terms/c/capm.asp) · SML – Security Market Line
In class
exercise Steps: 1. From finance.yahoo.com, collect stock prices
of the above firms, in the past five years Steps: · Goto finance.yahoo.com,
search for the company · Click
on “Historical prices” in the left column on the top and choose monthly stock
prices. · Change
the starting date and ending date to “Sept 30th, 2016” and “Sept 30th, 2021”,
respectively. · Download
it to Excel · Delete
all inputs, except “adj close”
– this is the closing price adjusted for dividend. · Merge
the three sets of data just downloaded Pick three stocks. Has to be the leading firm
in three different industries. · For
example: chose Apple, Dell, and Boeing. 3. Evaluate the performance of each stock: · Calculate
the monthly stock returns. · Calculate
the average return · Calculate
standard deviation as a proxy for risk · Calculate
correlation among the three stocks. · Calculate
beta. But you need to download S&P500 index values in the past five years from
finance.yahoo.com. · Calculate stock returns based on CAPM. · Draw SML ·
Stock
Price In Class exercise all included (Beta, CAPM, excel file here) · Stock Price Normal Distribution
(FYI) (
https://homepage.divms.uiowa.edu/~mbognar/applets/normal.html) HOMEWORK (Due with final) 1. AAA
firm’s stock has a 0.25 possibility to make 30.00% return, a 0.50 chance to
make 12% return, and a 0.25 possibility to make -18% return. Calculate
expected rate of return (Answer: 9%) 2. If
investors anticipate a 7.0% risk-free rate, the market risk premium = 5.0%,
beta = 1, Find the return. (answer:12%) 3. AAA
firm has a portfolio with a value of $200,000 with the following four stocks.
Calculate the beta of this portfolio ( answer: 0.988) Stock value β A $
50,000.00 0.9500 B 50,000.00 0.8000 C 50,000.00 1.0000 D 50,000.00 1.2000 Total $200,000.00 4. A
portfolio with a value of $40,000,000 has a beta = 1. Risk free rate = 4.25%,
market risk premium = 6.00%. An additional $60,000,000 will be included in
the portfolio. After that, the expected return should be 13%. Find the
average beta of the new stocks to achieve the goal ( answer:
1.76) 5. Stock A
has the following returns for various states of the economy: State of the
Economy Probability Stock
A's Return Recession 10% -30% Below
Average 20% -2% Average 40% 10% Above
Average 20% 18% Boom 10% 40% Stock A's
expected return is? Standard deviation? (answer:
expected return = 8.2%, variance=0.02884, standard deviation=16.98%,
visit https://www.jufinance.com/return/) 6. Collectibles
Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The
return on the market portfolio is 15% and the risk free rate is 4%. What is
the risk premium on the market? 7. An
investor currently holds the following portfolio: Amount Invested 8,000 shares of
Stock A $16,000 Beta = 1.3 15,000 shares of
Stock B $48,000 Beta = 1.8 25,000 shares of
Stock C $96,000 Beta = 2.2 The beta
for the portfolio is? 8. Deleted 9. Assume that
you have $165,000 invested in a stock that is returning 11.50%, $85,000
invested in a stock that is returning 22.75%, and $235,000 invested in a
stock that is returning 10.25%. What is the expected return of your portfolio? 10. If you hold
a portfolio made up of the following stocks: Investment
Value Beta Stock
A $8,000 1.5 Stock
B $10,000 1.0 Stock
C $2,000 .5 What is the
beta of the portfolio? 11. You
own a portfolio consisting of the stocks below. Stock Percentage
of
portfolio Beta 1. 20% 1 2. 30% 0.5 3. 50% 1.6 The risk free
rate is 3% and market return is 10%. a. Calculate
the portfolio beta. b. Calculate
the expected return of your portfolio. 12. An
investor currently holds the following portfolio: Amount Invested 8,000 shares of
Stock A $10,000 Beta = 1.5 15,000 shares of
Stock B $20,000 Beta = 0.8 25,000 shares of
Stock C $20,000 Beta = 1.2 Calculate the
beta for the portfolio. Homework Help videos Q1 Q5 Q2 Q3 Q4 Q6 Q7 Q9 TO THE END Quiz 5
prep video Part
I (has three questions from chapter 8) Part
II |
How much does Amazon worth?” --- FYI only: Amazon.com Inc. (AMZN) https://www.stock-analysis-on.net/NASDAQ/Company/Amazoncom-Inc/DCF/Present-Value-of-FCFF
Present
Value of Free Cash Flow to the Firm (FCFF)
In
discounted cash flow (DCF) valuation techniques the value of the stock is estimated
based upon present value of some measure of cash flow. Free cash flow to the
firm (FCFF) is generally described as cash flows after direct costs and
before any payments to capital suppliers.
Intrinsic Stock Value (Valuation Summary)
Amazon.com
Inc., free cash flow to the firm (FCFF) forecast
1 Weighted Average Cost of Capital (WACC)
Amazon.com
Inc., cost of capital
1 USD $ in millions Equity (fair value) = No. shares of
common stock outstanding × Current share price Debt (fair value). See Details » 2 Required rate of return on equity
is estimated by using CAPM. See Details » Required rate of return on
debt. See Details » Required rate of return on debt
is after tax. Estimated (average) effective
income tax rate WACC
= 16.17% FCFF Growth Rate (g)
FCFF growth rate
(g) implied by PRAT model
Amazon.com
Inc., PRAT model
2017
Calculations 2 Interest expense, after tax =
Interest expense × (1 – EITR) 3 EBIT(1 – EITR) = Net income
(loss) + Interest expense, after tax 4 RR = [EBIT(1 – EITR) – Interest
expense (after tax) and dividends] ÷ EBIT(1 – EITR) 5 ROIC = 100 × EBIT(1 – EITR) ÷
Total capital 6 g = RR × ROIC FCFF growth rate
(g) forecast
Amazon.com
Inc., H-model
where: Calculations g2 = g1 + (g5 – g1) × (2 – 1) ÷ (5 – 1) g3 = g1 + (g5 – g1) × (3 – 1) ÷ (5 – 1) g4 = g1 + (g5 – g1) × (4 – 1) ÷ (5 – 1) |
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Weeks 7 & 8 |
Final
Exam (will be posted on blackboard) Final prep video (on youtube) |
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Weeks 7 & 8 |
Thank you! Thank you! |
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Chapters 2, 3 - Financial Statements (not required)
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Cash Flow Statement Answer |
calculation for changes |
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|
Cash at the beginning of the
year |
2060 |
||
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Cash
from operation |
|||
|
net income |
3843 |
||
|
plus depreciation |
1760 |
||
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-/+ AR |
-807 |
807 |
|
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-/+ Inventory |
-3132 |
3132 |
|
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+/- AP |
1134 |
1134 |
|
|
net
change in cash from operation |
2798 |
||
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Cash
from investment |
|||
|
-/+ (NFA+depreciation) |
-1680 |
1680 |
|
|
net
change in cash from investment |
-1680 |
||
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Cash
from finaning |
|||
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+/- long term debt |
1700 |
1700 |
|
|
+/- common stock |
2500 |
2500 |
|
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- dividend |
-6375 |
6375 |
|
|
net
change in cash from financing |
-2175 |
||
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Total
net change of cash |
-1057 |
||
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Cash
at the end of the year |
1003 |
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************ What is Free Cash Flow **************
What is free cash flow (video)
What is free cash
flow (FCF)? Why is it important?
•
FCF is the amount of cash available from operations for
distribution to all investors (including stockholders and debtholders) after
making the necessary investments to support operations.
•
A company’s value depends on the amount of FCF it can generate.
What are the five
uses of FCF?
1. Pay interest on debt.
2. Pay back principal on debt.
3. Pay dividends.
4. Buy back stock.
5. Buy nonoperating assets (e.g.,
marketable securities, investments in other companies, etc.)
What
are operating current assets?
•
Operating current assets are the CA
needed to support operations.
•
Op CA include: cash, inventory,
receivables.
•
Op CA exclude: short-term investments,
because these are not a part of operations.
What
are operating current liabilities?
•
Operating current liabilities are the
CL resulting as a normal part of operations.
•
Op CL include: accounts payable and
accruals.
•
Op CL exclude: notes payable, because
this is a source of financing, not a part of operations.
Capital expenditure = increases in NFA +
depreciation
Or, capital expenditure = increases in GFA
Note: All companies, foreign and
domestic, are required to file registration statements, periodic reports, and
other forms electronically through EDGAR. https://www.sec.gov/edgar/searchedgar/companysearch.html
In class exercise
1. Firm AAA has EBIT (operating income) of $3 million, depreciation of $1 million. Firm AAA’s expenditures on fixed assets = $1 million. Its net operating working capital = $0.6 million. Calculate for free cash flow. Imagine that the tax rate =40%.
a. $1.2
b. $1.3
c. $1.4
d. $1.5
FCF = EBIT(1 – T) + Deprec. – (Capex + NOWC)
answer:
EBIT $3
Tax rate 40%
Depreciation $1
Capex + NOWC $1.60
So, FCF = $1.2
2. The following information should be used for the following problems:
2014 2015
Sales $ 740 $ 785
COGS 430 460
Interest 33 35
Dividends 16 17
Depreciation 250 210
Cash 70 75
Accounts receivables 563 502
Current liabilities 390 405
Inventory 662 640
Long term debt 340 410
Net fixed assets 1,680 1,413
Common stock 700 235
Tax rate 35% 35%
• What is the net income for 2015? ($52)
Ratio Analysis template
https://www.jufinance.com/ratio
Finviz.com/screener
for ratio analysis (https://finviz.com/screener.ashx)
Financial ratio analysis (VIDEO)