NPV and Other Criteria
Which metric indicates that a project is expected to create value for its owners?
Positive Net Present Value
What are "incremental CFs"
The difference between a firm's future CFs with a project and those without a project
Total value of a corporation (number of shares x share price)
Market Capitalization
A firm with publicly traded stock makes its quarterly earnings announcement and it is less than forecast. What's the formula for total return?
Total Return = Expected return + unexpected return
The cost of capital primarily depends on ___?
The use of funds and NOT the source of funds
The discount rate that results in a zero net present value for the project.
IRR (Internal rate of return)
If a projects internal rate of return equals the required return, What is the NPV?
$0
What is the "stand-alone" principle?
the evaluation of a project must be based on the projects' incremental CF
Formula for Total Dollar Return (TDR)
TDR = Dividend Income + Capital Gain (or Loss)
What are the two basic types of risk?
systematic and unsystematic
Dividend Growth Model formula
P0 = D1 / (Re - g)
What is the IRR? A project has these CFs: (Year, CF) 0) −$ 13,800; 1) 6,700; 2) 8,000; 3) 3,900; 4) 3,500
25.51%
What decreases as the required rate of return increases.
The NPV
A cost that has already been incurred and cannot be recouped
sunk cost
The excess return required on a risky asset over that required from a risk-free asset
Risk premium
What type of risk is reduced by portfolio diversification?
Unsystematic risk is reduced by diversification
Name one benefit and one challenge with the Dividend Growth Model
Benefit => simplicity
Challenge => only works for firms that pay dividends
The residual value of a firm
Shareholders Equity
Define "Average Accounting Return"
Avg Net Income / Avg Book Value
Financial Statements projecting future years' operations
Pro forma financial statements
Given a normal distribution what percentage of asset returns fall within 1 standard deviation?
68%
The amount of systematic risk present in a particular risky asset relative to the average risky asset
Beta coefficient
What's the formula for the cost of preferred stock?
Rp = D/P0
The Option to Sell a stock at a current price is a
Put Option
A project has a RRoR of 8.7%, and these CFs:[Year/CF] [0, −$34,070], [1, 12,810], [2, 14,740], [3, 20,220], [4, 11,480]. What is the project's NPV?
$14,155.72
CFs from a new project that come at the expense of existing projects
Erosion
The average compound return earned per year over a multiyear period
Geometric average return
A top equity analyst estimates that XYZ corp stock will return 70% if the economy booms but lose 20% in a recession. Economists estimate an 80% recession probability. What is the expected return?
80% x -20% = -16%
20% x 70% = 14%
E(R) = -16% + 14% = -2%
What is the formula for the WACC?
WACC = [(E/V)*Re] + [(D/V) * Rd * (1-Tc)]
where E = Mkt value of firm's equity;
D = Mkt value of firm's debt;
V = Mkt value of E & D; Tc = corp tax rate
The tax rate that determines the amount of tax that will be due on the next dollar of taxable income earned is called
Marginal Tax Rate