Access over 20 million homework & study documents

finance_modelling

Content type
User Generated
Type
Study Guide
Rating
Showing Page:
1/95
Corporate Finance
Rainier Kraakman
Class Outline
Spring 2001

Sign up to view the full document!

lock_open Sign Up
Showing Page:
2/95
Part I: Fundamental Concepts in Valuation
§1. Discounting and Net Present Value
§1.1 Present Value, Future Value, and Net Present Value
Key: r = rate of return available for similar investment on the capital market (market rate of interest)
C
x
= expected cash flow at period x (when x = 0, C
x
is the initial cash outlay)
Present Value (PV): PV = C
1
/(1+r).
Future Value (FV): FV(x) = x(1+r).
Net Present Value (NPV): NPV = C
0
+ C
1
/(1+r).
Project Rate of Return (y): y = (C
0
+C
1
)/-C
0
.
Two criteria for measuring the value of a project: The value of a project can be measured by
either NPV or y. NPV is the better measure because it gives you an answer in absolute dollars.
[Example: Project 1 gives a $100 payoff for an initial investment of $10. Project 2 gives
you a $2000 payoff for an initial investment of $2000. Project 2 is more valuable in
dollars because you earn more of them, even Project 1 has a higher y.]
Rule for Corporate Investing: A corporation should invest in projects with the highest NPVs
(never < 0), regardless of individual shareholders’ wealth and tastes, because shareholders can
borrow against their stakes in the corporation if they need cash immediately.
§1.2 Extending Net Present Value to Multiple Periods
Key: r
x
= market rate of return x-period investments
C
x
= expected cash flow at period x
NPV For Multiple-Period Cash Flow: For a project that pays off in cash flows over n periods,
NPV = C
0
+ C
1
/(1+r
1
) + C
2
/(1+r
2
)
2
+ C
3
/(1+r
3
)
3
+ . . . + C
n
/(1+r
n
)
n
= C
t
/(1+r
t
)
t
, where t = 0, 1, 2, 3, . . ., n
Annuities and Perpetuities: An annuity is an asset that pays a fixed sum (C) each year for a
specified number of years. A perpetuity is an asset that pays a fixed sum (C) each year to
perpetuity.
Annuities: The formula used to compute the present value of an n-year annuity:
PV(annuity)
1, n
= C/r[1-1/(1+r)
n
]
Growing Annuities: For an n-year annuity that grows at rate g,
PV(growing annuity)
1, n
= [C
1
/(r-g)][1-(1+g)
n
/(1+r)
n
].
Perpetuities: The formula to compute the present value of a perpetuity:
PV(perpetuity)
1,
= C/r
Growing Perpetuities: For a perpetuity whose cash flows grow at rate g,
PV(growing perpetuity)
1,
= C
1
/(r-g)
[***note: A perpetuity can grow at rate g if and only if g < r. Otherwise, PV
would be infinite, which is impossible in the real world because of the rule
against money-machines.]

Sign up to view the full document!

lock_open Sign Up
Showing Page:
3/95

Sign up to view the full document!

lock_open Sign Up
End of Preview - Want to read all 95 pages?
Access Now
Unformatted Attachment Preview
 Corporate Finance Rainier Kraakman Class Outline Spring 2001 Part I: Fundamental Concepts in Valuation §1. Discounting and Net Present Value §1.1 Present Value, Future Value, and Net Present Value Key: r = rate of return available for similar investment on the capital market (market rate of interest) Cx = expected cash flow at period x (when x = 0, Cx is the initial cash outlay) Present Value (PV): PV = C1/(1+r). Future Value (FV): FV(x) = x(1+r). Net Present Value (NPV): NPV = C0 + C1/(1+r). Project Rate of Return (y): y = (C0+C1)/-C0. Two criteria for measuring the value of a project: The value of a project can be measured by either NPV or y. NPV is the better measure because it gives you an answer in absolute dollars. [Example: Project 1 gives a $100 payoff for an initial investment of $10. Project 2 gives you a $2000 payoff for an initial investment of $2000. Project 2 is more valuable in dollars because you earn more of them, even Project 1 has a higher y.] Rule for Corporate Investing: A corporation should invest in projects with the highest NPVs (never < 0), regardless of individual shareholders’ wealth and tastes, because shareholders can borrow against their stakes in the corporation if they need cash immediately. §1.2 Extending Net Present Value to Multiple Periods Key: rx = market rate of return x-period investments Cx = expected cash flow at period x NPV For Multiple-Period Cash Flow: For a project that pays off in ca ...
Purchase document to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Anonymous
Great content here. Definitely a returning customer.

Studypool
4.7
Trustpilot
4.5
Sitejabber
4.4