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WHAT TO COME

WHAT TO COME. The results of Test 1 will be posted on the class Website sometime next week. Tomorrow, Dr. Glenn Hubbard’s Talk 1:15 PM at Rm107 Next Week – Chapter 11 (Solver Function). Note 1. Fama-French Model: its test

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WHAT TO COME

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  1. WHAT TO COME • The results of Test 1 will be posted on the class Website sometime next week. • Tomorrow, Dr. Glenn Hubbard’s Talk 1:15 PM at Rm107 • Next Week – Chapter 11 (Solver Function)

  2. Note 1 • Fama-French Model: its test • Regress Excess return on any asset (stock, e.g.) against three factors and check if the intercept estimate is close to zero. • Ri – Rf = a + b1(Rm-Rf) + b2(SMB) + b3(HML) • Refer to the examples on the web to familiarize yourself in obtaining the actual data. Data: Russell; Federal Reserve Bank; Yahoo links.

  3. Chapter 11 Capital Budgeting(Practice on Exh. 11-3, 11-4, 11-6, and 11-9 thru 11-11 with NPV and IRR techniques; Solver function) Traditional approaches vs. New approach – options, Monte-carlo simulation (Chapter 12)

  4. Capital Budgeting • Simply put, it is to compare benefits and costs of projects • Benefit = PV (present Value) = Future Cash Flow discounted at a Discount rate

  5. NPV vs. IRR 1. Accept (Reject) the project if NPV > (<) 0. • Accept if IRR exceeds the required rate of return for a Project. • Potential problem: Multiple IRRs occur when there is more than one sign change in the cash flow. Do not use IRR in this case.

  6. Topics: 1.Identify the relevant cash flows 2.Excel functions in calculating the after-tax cash flows 3.Various techniques (NPV and IRR ); Do not consider other methods. 4.Scenario analysis in Excel 5.Excel’s “Solver” function (MBA’s favorite)

  7. Examples: • Mergers and acquisitions (e.g., Target firm valuation) • Corporate restructuring • Mortgage refinancing • Stock or Firm valuation (e.g., CoCa-Cola, Yahoo-Microsoft) • Lease or Buy analysis

  8. Estimating the Cash Flows The cash flows must be: 1.Incremental – The cash flows must be in addition tothose that the firm already has. 2.After-tax

  9. But disregard cash flows which are: • Sunk costs • Financing costs (interest payments) * To be considered in WACC

  10. IO (Initial Outlay) Price of project + shipping + installation + training – (salvage – additional tax) + increase in net working capital (WC) Coca-Cola example – Owner’s equity = NI + Dep –Cap Exp. + adj. in WC Adjusting cash flow based on the change in WC. + Asset => - Cash flow + Liability => + Cash flow

  11. After-Tax Cash Flow = (Revenue + Savings – Expenses) * (1 – tax rate) + (Change in depreciation * tax rate)

  12. The Terminal Cash Flow: normally, occurs in the final time period of the project TCF = (Recovery of NWC – Shut-down expenses)+ Salvage – Salvage taxes

  13. Depreciation Methods: Depreciation in Straight Line method Depreciable Base - Salvage Value = ---------------------------------------------------- Useful Life Excel functions : Straight-line (SLN), double-declining balance (DDB), fixed-declining balance (DB), sum of the years’ digits (SYD), and variably-declining balance (VDB).

  14. Alternative Valuation Methods Accounting for flexible decisions under uncertainties. • Real Option (Merck’s example) • Monte-Carlo Simulation (Chapter 12)

  15. Scenario Manager and Solver Function • Supreme Shoe Example (Exh. 11-1 thru 11-6, except 11-2 and 11-5) • NPV, IRR functions • Scenario Manager • Constrained Optimization (Exh. 11-9 thru 11-11; Capital Budget with some constraints) • “Include” variables • Array Sum • Solver Function

  16. Structure of the Solver • Max or Min Target (Objective) • Changing or choosing choice variables (Cells) • Subject to constraints.

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