Week 2 Chapter 10
Week 2 Chapter 10 Fin 4310
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BUSN 1301 - 006
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This 2 page Class Notes was uploaded by Laura Notetaker on Sunday September 13, 2015. The Class Notes belongs to Fin 4310 at University of Texas at El Paso taught by Dr. Oscar Varela in Summer 2015. Since its upload, it has received 36 views. For similar materials see Managerial Finance in Finance at University of Texas at El Paso.
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Date Created: 09/13/15
Week 2 Chapter 10 There are problems where you are trying to figure out the outcomes of a cash flow There is never the certainty needed to make sure you will gain or lose a specific amount The possible cash flows that come out each year create values such as the net present value NPV the internal rate of return IRR the expected values of the net present value EVNPV and the expected values of the internal rate of return EVIRR The various outcomes that can come out of the cash flows can be determined by a good economy or a bad economy The cash flows or cost of capital determination is allowed to change based on the existence of mean and the standard deviation There might be a good or bad outcome that can be followed by a good or bad outcomes but there might not be a relation between these outcomes The EVNPV is calculated based on the distribution of the NPVs distribution of cash flows the discount rate should be riskfree if the standard deviation of the EVNVP is used in the analysis of risk The risk free rate is used to get the NPVs because the risk is considered through the standard deviations of the EVNVP If a riskadjusted rate then there is no standard deviation because the risk would be counted twice To calculate the EVNPV you need to 1 Calculate the NPV for each of the possible patterns of the cash flow using a riskfree rate 2 The next thing to do is to find the joint probabilities Which is the product of the initial probability and the conditional probabilities for each pattern 3 Then the EVNPV is calculated by the multiplying the probability by each of the NPV and adding all of the values 4 The you find the standard deviation of the EVNPV to calculate the risk A useful thing to do is to calculate the coefficient of variation which is dividing the standard deviation by the EVNPV The lower coefficient of variation the better Another thing to calculate is to know the probability that the NPV would be below zero that is the 2 value To that you need to Z 0 EVNPV STDEVNPV Subtract zero from the EVNPV and divide that by the standard deviation This will result in a probability of the project being below zero The lowest probability that Z is negative the better All of this can be done with a riskadjusted discount rate but there would not be standard deviations 2 values or probabilities that the investment s NPV is below zero Week 2 Chapter 10 To diversify a portfolio with multiple investments that have a negative correlation with the others to benefit the most risk reduction while maintain return If the weight of the projects are shown in dollar values there is no need to use percentage weights but securities are shown as percentages You can compare the NPVs and standard deviation of this portfolio to decide which is beneficial in term of return and risk This can be done with this formulas EVNPV12 EVNPV1 EVNPV2 012 021 022 2 C102 p1212 pm is the correlation coefficient between the values
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