Simple Interest:

Interest paid only on principle

Compound Interest

Interest paid on a changing principle (+interest or –payments)

Annuity

Equal payments at equal intervals for a given period

Perpetuity

Equal payments at equal intervals to perpetuity

Effective Annual Interest Rate

Changing rate with non-annual compounding periods to an annual rate with annual compounding periods

Debt & Valuation

Parties

Acceptor (guarantee)

Drawer (takes funds, issues debt)

Discounter (buys debt @ discount)

Short term debt

Period is less than one year

No explicit interest paid (interest is the difference between FV and purchase price)

Bonds

Pay coupons at regular intervals

Repay an amount at maturity

Market interest rates (“i” or YTM or RRR) fluctuates

When bond price < face value the bond is discount

Equity

Key

P0 = Value of share @ t=0

Dt = Expected dividend payout at time t

D = Value of a constant dividend r = Discount Rate g = growth rate

D1 = D0(1+g)

Equity Valuation (current value of a share) = PV of all future dividends

Constant Dividend Model

Is perpetuity ... therefore from Constant Growth Model

Requires:

Constant rate of change in dividend

Rate smaller than the discount rate

Rights issue

M = Market Price

S = Subscription price

N = Number of shares

Ex Rights Price

X = Ex Rights Price

S = Subscription price

R = Rights issue value

Capital Budgeting

Choosing an investment

Accounting Rate of Return

If ARR ≥ required RR, then accept

Payback Period

Discounted payback

Cash flows are discounted to their present values

Removes the issue of TVM in Payback period

Gives breakeven life

Net Present Value

NPV is PV of all future cash flows discounted at the required rate of return less initial investments

than accept r = required rate of return

CFt = cash flows for time “t”

I0 = Invested amount at “t=0”

NPV = Change in s/h wealth

Internal Rate of Return

Required rr that NPV = 0

Investment relations

Mutually exclusive (one)

Independent (zero, one or two, as per # of choices)

Capital Rationing

Accept all projects w +ve NPV

But! Capital is limited!

Hard

By finance

Soft

By management

Profitability Index

Fischer Effect

R = nominal r = real h = infln.

Capital Budgeting

All net cash flows

1) @ y0

2) @ y1-yn

3) @ yn

After Tax Cash Flow

Tax saving on depn

Change in Accts’ receivable and inventory go in first and last year (where they are instituted and when they are reverted) ... Acct receivable increase as –ve, inventory increase as +ve

Risk

Efficiencies

Strong

All information is reflected in share price

Semi-Strong

All public information is reflected in share price

Weak

Current price reflects own past prices

Trend analysis cannot find mispriced shares

Return (1 period)

R = Return

P = Price (Pt @ t) (Pt-1 @ “beginning”)

D = Cash Flow

Return (multiple periods)

r = rate of return

D = Cash Flow (present value of all future cash flows

Average return

r = rate of return in period n = number of observations

Expected Return

Pa = Probability of a occurring

Ra = Result of A occurring

NB: do “boom” and “bust” separate (i.e. average/weighted average them, and then use form)

Std dev

Old calculator

Mode SD

Clear SCL