Financial Management Cheat Sheet (DRAFT) by lpoole

4 methods - Payback, AAR, IRR and NPV
- Payback period approach.
Payback = outgoings - CFAT (number of periods)
^{No time value of $, no decisions based in economics, ignores CF after payback period, will not choose projects to max. share holder value}

- Accounting rate of return (AAR)
AAR = Average Income / Average invested capital
1. Estimate average income after tax for project
2. Estimate net investment after deprec­iation
3. Calc ARR
4. If ARR > targeted return = accept project
^{Limita­tions of ARR - components reflect tax and accounting figures, not market values and cash flows, time value of $ and no guidance on target AAR}

- NPV technique.
- IRR = rate of return where NPV = 0
i.e IRR of project outlaying $100 returning $106 in 1 year when opp cost of capital is 7% =
0 = -100 + 106/(1 + IRR)
100 = 106 / (1 + IRR) = 6%

What company decided to do with free cash flows;
- reinve­st/­acc­umulate in reserves
-payout in dividends or share repurchase
- also dividend reinve­stment

Miller & Modigliani irrelvance propos­ition. Dividend policy does not effect shareh­older wealth (trade off higher dividends for fall in share price)
- Increase dividend
- Pay no dividend
- Home-made dividend (sell shares)

Dividend smoothing - practice of mainta­ining relatively constant dividend and mainta­ining long term target levels of dividends.

Present Value of an irregular cash flow
PV= CF/(1+r)ⁿ
Future value of an irregular cash flow
FV= CF x (1+r)ⁿ
Present value of Annuities ^{(also use for EAA - replace CF with EAA)}
PV=CF (1-(1+r)^-n)/r)
Future value of annuities
FV=CF(­(1+r)ⁿ-1)/r)
Present Value of perpetuity
PV = CF/r
Present Value of growing perpetuity
PV = d

1

/ r

e

-g
Present Value of growing annuity
PV= C × 1/(r-g) (1-((1­+g)­/(1+r))ⁿ
Determ­ining "­n" whenPV and FV is known
.

Discount rate, Hurdle rate, Opport­unity cost of capital & required rate or return

Financial mathem­atics required consis­tency between numerator and denomi­nator. If cashflow occurs monthly, need a monthly hurdle rate or cashflows annual and rate monthly provided need to convert to annual.

1.5% per quarter to yearly = (1 + r)⁴ = (1.015)⁴ = 6.136% Effective annual.
10.5% PA comp daily to yearly = (1 + 0.105/365) = (1 + y)
(1 + 0.105/3650³⁶⁵ = 11.07%

Continuous compou­nding;

FV = PV e^rt
r = contin­uously compounded rate of return
e = 2.718282
T = compou­nding periods.

β is a measure of how a firm correlates to the market.
The higher the firm's debt, the more variable is its price and hence its β
Always assume given β is levered
If projects or leverage changes then we must adjust β

β = 1 (market)
β < 1 (risk of security is lower than average market)
β > 1 (risk of security is higher than average market risk)
If β is 0 there is no risk (gover­nment bond)

CAPM r

e

= r

f

+ β (r

m

- r

f

) OR r

f

+ (β X ERP)

Suppose RF is 5% and market risk premium is 7%.
Qantas has β of 1.33
According to CAPM what is expected return?

r

f

+ β (e

m

- r

f

) = 0.05 + 1.33 (0.07) = 14.31%
Therefore because qantas β of 1.33 investors will require a risk premium os 9.31% over RF rate.

Unleveling B.
B

u

= B

L

/ (1+ (1-t)((MV Debt)/(MV Equity)))
T is tax rate, B

L

is the observable levered β of equity (also known as project risk of a firm)

To reliever with new D/E ratio B

L

= B

u

(1 + (1-T) x (new D/new E)

WACC
- When should you use - if scale enhancing, when D/E remains unchanged.
E = Market value of equity (current share price x no. shares)
D = Market value of debt
- Yield on similar risky debt (calc like bond)
r

e

= cost of equity (CAPM)
r

d

= Cost of debt (market yield)
- Yield is after tax to reflect the tac shield provided to shareh­olders, not bond holders
WACC = r

A

= (r

d

(1 - T) x (d/v) + (r

e

x E/V))

Modify WAA > need new re > B changes > new WACC

Equal in size, equal in space and it ends.
$500 placed into an account each year earning 5% PA comp annually. How much in 5 years?
FV = 500 ( (1.05)⁵ - 1) / 0.05) = $2763

What is value of asset paying $2.3m each year from 1 to 6 with 10% PA (comp monthly)?
(1 + 0.1/12)¹² = 10.47%
PV = 2.3 ( 1 - (1.1047)^-6) / 0.1047) = $9.88

PV of perpetuity = A / r
i.e BHP paid half yearly divided of $0.58, share market expected to return 10% PA comp 6 monthly, what is value of BHP?
PV = A / r = 0.58 / 0.05 = $11.60
0.05 because 10% divided into 6 months (and dividend paid 6 monthly also).

Annuity starting end of year 1 to 8;
PV = 100 ( 1 - (1.10)^-8 / 0.10) = $533.4

Annuity starting straight away (0 to 7)
PV = 95 ( 1 - (1.10)^-7 / 0.10) +95 = 557.9

Deferred annuity, i.e 1.49 CF @ 10% beginning in year 3.
PV = 1.49 ( ( 1 - ( 1+0.10 )³ / 0.10 ) + (1.10)²
To bring forward to yr 0 we need to discount it at 10% 2 times/­per­iods.

Supply contract. 5 years and require supply of 1000 units at end of each year. Equip cost $20m, annual operating expenses of $7m. Straight line deprec­iation to zero and salvage value of $5m. 40% tax rate and required return is 10% after tax. What price would you bid?

0 = -20 + cash (1-(1.10)^-5 / 0.10) + 3/(1.10)⁵
3 is salvage value of machine (5) less tax
Cash = 4.785.

Rev 12.308
Exp 7
Dep__ 4
PBT 1.308
Tax__
PAT 0.785
Dep__ 4
Cash 4.785

Value of a firm = debt + equity ~ V = D + E
PV of debt;
What is MV of 10% debentures redeemable in 10 years at face value of $1,
when similar securities are yielding 5%?
FV x Coupon ~ 1m * 0.10 = $100
PV

bond

= 100 (1 - (1.05)^-10 / 0.05) + (1m / (1.05)¹⁰)
=$1,38­6,087.
Cost of purchase is $1m and we get back $1.3 so we BUY

PV of equity = share price x no. of shares
PE Ratio (P/E = payout ratio / r

e

-g))
EPS is it a good indicator. Price = EPS x P/E