Financial Management model for powerpoint presentations

1. Cash Raw materials inventory Receivables Finished goods inventory Financial Management... 100 Slides Powered by www.drawpack.com. All rights reserved.

2. Key Words... Financial Market – Present Value – Perpetuity – Annuity – Compound Interest – Inflation – Bond Yield – Share Value – Free Cash Flow – IRR – Risk Valuation – Markowitz – SML – CAPM – Beta Risk – APT – Portfolio Theory – Economic Profit – CallOption – Straddle – Option Pricing Theory – Leverage Ratio – Liquidity – Du Pont – Private Equity – Volatility – Working Capital – Valuation – Value Drivers – Risk/Return – Diversification – Corporate Finance – Yield – NPV – Cash Transfer – Accounting

3. The financial markets The secondary market The primary market The firm Investors Investors Investors cash cash newly issued securities outstanding securities The Dual Functions of Financial Markets

4. Present Value Value today of a future cash flow. Discount Factor Present value of a $1 future payment. Discount Rate Interest rate used to compute present values of future cash flows. Present Value = PV = 1 DF t ( 1 ) r + ´ PV = discount factor C 1 C = = 1 PV DF C ´ 1 + 1 r 1 Present Value

5. required investment NPV = PV - C + 1 NPV = C 0 + 1 r Net Present Value

6. Perpetuity - Financial concept in which a cash flow is theoretically received forever. cash flow cash flow = = PV of Cash Flow Return present va lue discount rate C C = 1 PV = r r PV Perpetuity

7. Annuity - An asset that pays a fixed sum each year for a specified number of years. é ù 1 1 = ´ - PV of annuity C ê ú ( ) t + r r 1 r ë û Annuity

8. 18 16 10% Simple 14 10% Compound 12 10 FV of $1 8 6 4 2 0 0 3 6 9 12 15 18 21 24 27 30 Number of Years Compound Interest

9. Inflation - Rate at which prices as a whole are increasing. Nominal Interest Rate - Rate at which money invested grows. Real Interest Rate - Rate at which the purchasing power of an investment increases. 1 + nominal in terest rat e + 1 real inter est rate = 1 + inflation rate Inflation

10. 1600 1400 1200 1000 800 Price 600 400 200 0 0 2 4 6 8 10 12 14 Yield 5 Year 9% Bond 1 Year 9% Bond Bond Prices and Yields

11. - P P Div 1 0 Expected R eturn = = + 1 r P P 0 0 Div = = 1 Capitaliza tion Rate P 0 - r g Div = = + 1 r g P 0 Valuing Common Stocks I

12. Return Measurements Div = 1 Dividend Yield P 0 = Return on Equity ROE EPS = ROE Book Equit y Per Share Valuing Common Stocks II

13. If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY. Div EPS = = 1 1 Perpetuity P or 0 r r Assumes all earnings are paid to shareholders. Valuing Common Stocks III

14. PV (free cash flows) PV (horizon value) FCF and PV

15. Cash Investment opportunity (real asset) Investment opportunities (financial assets) Firm Shareholder Invest Alternative: pay dividend to shareholders Shareholders invest for themselves NPV and Cash Transfers

16. 2500 2000 1500 1000 500 NPV (,000s) 0 10 20 30 40 50 60 70 80 90 -500 100 -1000 -1500 Discount rate (%) -2000 Internal Rate of Return

17. 60 40 20 Percentage Return 0 -20 Common Stocks Long T-Bonds -40 T-Bills 30 35 40 45 50 55 60 65 70 75 80 85 90 95 -60 26 Year Rate of Return 1926 - 1997

18. Portfolio standard deviation Unique risk Market risk 0 5 10 15 Number of Securities Measuring Risk

19. The variance of a two stock portfolio is the sum of these four boxes: Stock 1 Stock 2 = x x σ 2 2 1 2 12 Stock 1 x σ 1 1 x x ρ σ σ 1 2 12 1 2 = x x σ 2 2 1 2 12 Stock 2 x σ 2 2 x x ρ σ σ 1 2 12 1 2 Portfolio Risk I

20. = + Expected Portfolio Return (x r ) ( x r ) 1 1 2 2 = 2 2 + 2 2 + σ x σ x 2 ( x x ρ σ σ ) 2 2 1 1 1 2 12 1 2 Portfolio Variance Portfolio Risk II

21. The shaded boxes contain variance terms; the remainder contain covariance terms. 1 2 3 To calculate portfolio variance add up the boxes 4 STOCK 5 6 N 1 2 3 4 5 6 N STOCK Portfolio Risk III

22. Expected s stock im = return B i s 2 beta m +10% Expected - 10% + 10% market return -10% Beta and Unique Risk

23. Price changes vs. Normal distribution 600 500 400 # of Days (frequency) 300 200 100 0 -10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% Daily % Change Markowitz Portfolio Theory

24. Return Expected Return (%) B A Risk Standard deviation Efficient Frontier I

25. Expected Return (%) T Lending Borrowing rf S Standard deviation Efficient Frontier II

26. Return Low Risk High Return High Risk High Return Low Risk Low Return High Risk Low Return Risk Efficient Frontier III

27. Return . Market Return = rm Efficient Portfolio Risk FreeReturn = rf Risk Security Market Line I

28. Return . Market Return = rm Efficient Portfolio Risk Free Return = rf BETA 1.0 Security Market Line II

29. Return SML rf BETA 1.0 SML Equation = rf + B ( rm - rf ) Security Market Line III

30. Expected return Security market line Market portfolio rate Rm = 13.5% Rf = 5% Treasury bill rate Beta 1 0 R = rf + B ( rm - rf ) Capital Asset Pricing Model (CAPM)

31. Avg Risk Premium 1966-91 30 20 10 0 SML Investors Market Portfolio Portfolio Beta 1.0 Beta vs. Average Risk Premium

32. Stocks (and other risky assets) Stocks (and other risky assets) Wealth is uncertain Standard CAPM Consumption CAPM Market risk makes wealth uncertain. Wealth Consumption is uncertain Wealth = market portfolio Consumption Consumption Betas vs. Market Betas

33. Alternative to CAPM Expected Risk Premium = r - rf = Bfactor1(rfactor1 - rf) + Bf2(rf2 - rf) + … Return = a + bfactor1(rfactor1) + bf2(rf2) + … Arbitrage Pricing Theory

34. Specific company return (%) Market return (%) Portfolio Risk

35. Expected Returns and Betas prior to refinancing Expected return (%) 20 Requity= 15 Rassets= 12.2 Rdebt= 8 0 0 0.2 0.8 1.2 Bdebt Bassets Bequity Capital Structure & COC

36. = EVA Residual Income = Income earned - Income required = ´ [ ] Income earned - Cost of Capital Investment Risidual Income & EVA Residual Income or EVA = Net Dollar return after deducting the cost of capital.

37. Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital. = EP Economic Profit = - ´ ( ROI r ) Capital Invested Economic Profit

38. ECONOMICACCOUNTING Cash flow + Cash flow + change in PV = change in book value = Cash flow - Cash flow - economic depreciation accounting depreciation Economic income Accounting income PV at start of year BV at start of year INCOME RETURN Accounting Measurement

39. r rE rA rD D E Risk free debt Risky debt M&M Proposition

40. r r rE rE WACC rE =WACC rD rD D V D V r rE WACC rD D V WACC (traditional and M&M view)

41. Maximum value of firm Costs of financial distress PV of interest tax shields Value of levered firm Value of unlevered firm Optimal amount of debt Debt Financial Distress

42. Call option value given a $85 exercise price. Call option value $20 85 105 Share Price Call Option (long)

43. Put option value given a $85 exercise price. Put option value $5 80 85 Share Price Put Option (long)

44. Call option payoff (to seller) given a $85 exercise price. Call option $ payoff 85 Share Price Call Option (short)

45. Put option payoff (to seller) given a $85 exercise price. Put option $ payoff 85 Share Price Put Option (short)

46. Long stock and long put Long Stock Protective Put Position Value Long Put Share Price Protective Put

47. Long call and long put - Strategy for profiting from high volatility Straddle Position Value Share Price Straddle

48. Ps S v2 2 ln + ( r + ) t (d1) = v t N(d1)= 32 34 36 38 40 Black-Scholes Option Pricing Model

49. Expanding the binomial model to allow more possible price changes 1 step 2 steps 4 steps (2 outcomes) (3 outcomes) (5 outcomes) etc. etc. Binomial vs. Black Scholes

50. Value of Straight bond bond 100 Bond Callable at 100 75 50 25 Value of straight bond 25 50 75 100 125 150 Straight Bond vs. Callable Bond