FIN303 CHAPTER 4 STUDY GUIDE
FIN303 CHAPTER 4 STUDY GUIDE FIN303
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Giulia Dias Roncoletta
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This 5 page Study Guide was uploaded by Giulia Dias Roncoletta on Thursday February 11, 2016. The Study Guide belongs to FIN303 at University of Miami taught by Douglas R. Emery in Winter 2016. Since its upload, it has received 87 views. For similar materials see Corporate Finance Management in Finance at University of Miami.
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Date Created: 02/11/16
FIN303 NOTES CHAPTER 4 4.1 RATES OF RETURN AND NET PRESENT VALUE Returns: Rate of Return = CF + (End. Value Beg. Value) Beginning Value Realized Returns: rate of return actually earned on an investment during a given time period. an outcome, not a prediction observed from actual investment you can only react to it Expected Return: rate of return you expect to earn if you make the investment the return you expect to get from an investment helps you make investing decision Required Return: rate of return that exactly reflects the riskiness of the expected future cash flow return market requires on invest. of identical risk the market compares prices and risk of all other investments the fair return for an investment Net Present Value NPV: NPV = PV of future CFs Cost Positive: a positive NPV increases wealth because it means the asset invested on is worth more than it costs. Earn more than the appropriate return. Negative: a negative NPV decreases wealth because it means the asset costs more than it’s worth. Zero: an NPV of 0 earns the required return and it’s “fair” NPV is measured on a benchmark of “normal” market return it provides framework for decision making on investments measures the value created or lost by financial decisions maximize shareholder’s wealth = strive for positive NPV “fair price” a price that does not favor the buyer or the seller Principle of Capital Market Efficiency all securities are fairly priced. makes the NPV 0 does not mean zero return, but required return. Principle of Risk Return Trade off more risk = more return. * If markets were perfect required and expected return would be the same, because all securities would be fairly priced and have an NPV of 0. * Realized rarely equals Expected return, but you can measure risk, if there’s a great difference between the rates of return the higher the risk, risk is low when difference is slight. 4.2 VALUING SINGLE CASH FLOWS Future Values: n FV =n V(1+r) = PV(FVF ) r,n Future Value: value at the end of a given time period. Compound Interest: method of interest computation wherein interest is earned on both the original investment and on the reinvested interest. Simple Interest: method of interest computation wherein interest in earned on only the original investment. use of simple interest has largely disappeared Future Value Factor is the (1+r) part of the FV equation, is the value $1 is going to grow to at a rate of r for n periods. negative sign in FV is due to the fact that the formula sums up to 0. Present Values: PV= V [ 1 n = FV (PVF ) n r,n (1+r)n Present Value: an amount invested today at r per period that would provide a given future value at time n. the larger the r the smaller the present value more time until cashflow, smaller the present value (for positive r ) Solving for a Return: 1/n r = [FV n ] 1 [PV] 4.3 VALUING ANNUITIES Future Value of an Annuity: FVA =Pn [(1+r) 1] r Annuity: series of qual, periodic cash flows, which occur regularly. majority of annuities have endofperiod payments Ordinary Annuities: annuities whose payments occur at the end of each period Deferred Annuities: annuities whose first payment is different than one period in the future Annuity Due: annuities whose payments are made at the beginning of the period each subsequent payment earns interest for one less period than the previous one the last payment does not earn any interest because it occurs at the end of annuity Present Value of an Annuity: n PVA =Pn [(1+r) 1] r (1+r) n Present Value of an Annuity: If you borrow money and are paying back these are your present value payments: PMT=PV [ n r (1 n (1+r) 1 If you save money, the accumulated amount is the future value, therefore these are your receivables PMT= FVA n [(1+r) 1] Amortizing a Loan: Loan Amortization Schedule: shows how a loan is paid overtime, aka the relationship between its payments, principal, and interest rate. Create a Schedule: (1) star with amount borrowed (2) add first period’s interest (3) subtract the first periods payment (4) results in remaining balance = starting amount for 2nd period (5) repeat until remaining balance is 0 at last period. Valuing Deferred Annuities: Deferred annuities start at a time other than right away, therefore they start at t=1 not t=0 PV of an annuity can be calculated by first calculating the annuity’s future value, then calculating the present value of thats lumpsum future value. (1) find future value using N= when payments are received, plug in payments (2) use FV () to find real PV, use N=whole period, and pmt=0 Perpetuities: PVA = PMT perpetuity r Perpetuity: is an annuity that goes on forever. accurate approximations of long term annuities. Valuing an Annuity Due: has a higher present value than ordinary annuities higher future value because each pay has an additional period to compound value an annuity due, but multiplying the value of a comparable ordinary annuity and multiply it by (1+r) 4.4 MULTIPLE EXPECTED FUTURE CASH FLOW NPV equals the sum of the present value of all cash flows. Or use “rollback” and discount the r back one period starting from last cashflow Use FV and PV formulas to find the exact payment at any time period. 4.5 COMPOUNDING FREQUENCY Annual Percentage Rate (APR) APR = (m)(r) APR is the periodic rate times the number of periods in a year a nominal rate “in name only” Compound Frequency: how often an interest is compounded monthly, weekly, daily, annually period rare is an effective rate (r ) m Annual Percentage Yield (APY) (1) APY = [ 1+ APR ] 1 m (2) APY = Annual Interest / Principal APY is the effective (true) annual rate of return. rate you actually earn in one year if APR is compounded annually, it equals APY Continuous Compounding: APR APY = e 1 When the m (frequency) becomes too large (minutes, seconds) compounding becomes essentially continuos Just use a very large value for m like 100,000 and you’ll get the same number as a continuous compounding APY 4.6 PARTIAL TIME PERIODS read the book cuz its just examples and i cant really take note on it, it’s very straight forward 4.7 EVALUATING “SPECIALFINANCING” OFFERS Special Financing Offers: used as part of sales promotion, consumers purchases it as a package. It’s a promotional gimmick firm is lowering the effective price to encourage sales. how much does the interest savings lowers the price? (1) market interest rate for such loans, market interest provides a measure of opportunity cost of the special financing use market rate to compute the real price of the product if PV is smaller than cash price, special financing is a better deal
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