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27 Cards in this Set
- Front
- Back
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Net Present Value (NPV)
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The present value of expected cash inflows associated with the project less the present value of the project's expected cash outflows, discounted at the appropriate cost of capital
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Example of NPV on calc:
Initial cost of 5mm Positive cash flows at: EOY1: 1.6mm EOY2: 2.4mm EOY3: 2.8mm |
CF(2nd) CLR WRK
5(+/-) ENTER Down Arrow 1.6 Enter (C01=1.6) DA DA 2.4 ENTER (C02=2.4) DA DA 2.8 ENTER (C03=2.8) NPV 12 ENTER (I=12) DA CPT |
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IRR
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Rate of return that equates the PVof an investment's expected benefits(inflows) with the PV of its costs(outflows). Also the discount rate for which the NPV of an investment is 0
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Calculating IRR with calculator
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CF(2nd) CLR WRK
5(+/-) ENTER Down Arrow 1.6 Enter (C01=1.6) DA DA 2.4 ENTER (C02=2.4) DA DA 2.8 ENTER (C03=2.8) NPV 12 ENTER (I=12) IRR CPT |
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NPV Formula
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CF/(1+r)^t
CF=Respective cash flow N(t)=estimated life of investment r=discount rate |
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IRR Formula
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CF0+(CF1/1+IRR)+(CF2/(1+IRR)^2)...(CFN/(1+IRR)^N)
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NPV Rule
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1. Accept projects with positive NPV --they will increase shareholder wealth
2. Reject projects with negative NPV 3. When 2 projects are mutually exclusive choose higher NPV |
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IRR decision Rule
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1. Accept projects with and IRR that is greater than the firm's required rate of return
2. Reject projects with an IRR that is less than than required IRR |
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When NPV rule and IRR rule conflict...what do you do?
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Always choose greatest NPV because shareholder wealth maximization is the ultimate goal of the firm
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Holding Period Return
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Percentage change in the value of an investment over the period it is held
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Total Return
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Total value of the return of investment during the holding period INCLUDING dividends, interest payments, or interim cash flows
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HPR Formula
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Ending value + Cash flow received /Beginning Value - 1
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Money Weighted ROR
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Internal ROR on a portfolio taking into account all inflows and outflows
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Example of Money Weighted ROR: 1 share of stock bought for 100 at t=0, buys 1 share at t=1. Sells 2 shares at t=2 for 260. Both years a div. was paid for $2. Calculate Money Weighted ROR
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CF 2nd CLR WRK
100 ENTER DA 118 ENTER DA 264(+/-) ENTER IRR CPT |
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Time Weighted ROR
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Measures compound growth. It is the rate at which $1 compounds over a specified performance horizon
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Calculating Time Weighted ROR
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Step 1: Value portfolio immediately preceding significant additions or withdrawals. Form corresponding sub periods
Step 2: Compute Holding Period Return (HPR) for each period Step 3: Compute (1+HPR1)*(1+HPR2)...-1 to get ANNUAL TIME WEIGHTED ROR |
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Bank Discount Yield (BDY)
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How T-Bills are quoted based on a bank discount basis which is based on the face value
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Formula for BDY
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rBD=(D/F)*(360/t)
rBD=annualized yield on a bank discount basis F=Face value(par value) of the bill t=number of days until maturity 360=bank convention of a year |
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Calculate BDY:
Tbill priced at 98,500 Face Value of 100K 120 days until maturity |
1500/100000*3=4.5%
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PITFALLS of BDY
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1. Bank Discount Yield annualizes using simple interest and ignores effects of compounding
2. BDY is based on face value of bond, not purchase price 3. BDY is based on 360 day year, not 365 |
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Holding Period Yield(
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Total Return an investor earns between the purchase date and teh sale or maturity date
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Formula for HPY
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Price Received for investment at Maturity + Interest Payment / Initial Price of Investment
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Example of HPY:
Tbill priced at 98500 with face value of 100,000 and 120 days until maturity |
1500/98500=1.5228%
D=0 because Tbills are a pure discount instrument |
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Effective Annual Yield
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An annualized value based on a 365-day year that account for compound interest.
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Equation for Effective Annual Yield (EAY): Compute EAY using 120-day HPY of 1.5228%
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EAY=(1.015228)^365/120-1=4.7042
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Money Market Yield (or CD Equivalent Yield)
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Equal to the annualized holding period, assuming a 360-day year. Using the money market yield makes the quoted yield on a Tbill comparable to yield quotes for interest bearing money market instruments that pay on a 360 day basis
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Formula for Money Market Yield rMM
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= HPY * (360/t)
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