Intro to Corp Finance Cheat Sheet

...

IRR=cost of capital (hurdle rate/discount rate)→NPV is zero

Non standard project: Inflows then outflows, we want an IRR smaller than hurdle rate : IF only cash inflows than there is no IRR…….When NPV is same (both add same value) or very similar for two look at start-up cost and IRR

IRR – ignores scale of your investment, doesn’t incorporate delays…..Payback → measures risk but ignores CF’s after payback and discounting and scale of project…..If project starts with cash inflows then you cannot determine project payback

Low R→Higher NPV High R→Lower NPV

Arithmetic (forecast returns) take average of returns vs geometric (evaluate past performance) amount invested compared to value at end of period amount

Diversification → two assets less than perfectly correlated then risk is strictly smaller than that average

Assets whose future cash flows increase the risk should have higher expected return (decrease→lower)

Required return from an asset: return that rewards us for being patient + return that rewards us for bearing risk

Ri (required return) = Rf (Risk-free Rate) + risk premium for asset (excess return)

Risk premium for asset I = quantity of risk added X price of risk

Re = Rf + beta*MRP→ Re(cost of equity) = Rf (current) +βi *(Rm – Rf(historic))

Market risk premium: required return on the market portfolio, less the risk-free rate; β measures the systematic risk(risk you can’t diversify) of a security or a portfolio in comparison to market as whole (can use weighted average not only for returns but beta too)

-principal: 35m, coupon rate: 5.5% once a year, maturity in one year. If default probability 20% and if default, 50% principal and all interest lost -translates to- .8(1+coupon rate)*principal + .2(50%of principal)

-1yr zero-coupon bond; probability of default 50% and if default 50% of face value lost, discount rate – 9.5%, how big discount? (.5+1)/2*principal=0.75/1.095*principal = .6849315*principal

52.18 weeks 365.25 days

-make sure to include if NPV is positive the project adds value, and define IRR rule and says it’s a good project or bad or IRR doesn’t help in this case, include payback (say if there is criteria or not)

*Always Face value of Bond into FV

-Past performance is not a good predictor of future performance. It is also wrong to focus on volatility of returns. What matters is how much risk the stocks ass to a well-diversified portfolio. Since average returns were similar in past, it may well be betas are quite similar, too. IF we had access to excess returns data, we could answer it.

NIMESH PATEL

...