Summary
Summary Formulas
- Institution
- The University Of York (UOY)
This sheet provides all the formulas you need for this module.
[Show more]
Seller
Follow
Content preview
Corporate Finance Formulas:Principal-Agent Relationship:
• Agent’s utility: u ( w )−a (risk averse)
• Principal’s payoff: x−w (risk neutral)
Optimal Contract:
• Maximize the Principal’s expected payoff:
PH(xS-wS) +(1- PH)(xF-wF)
s.t.:
• Incentive compatibility constraint (IC) (the manager should be
compensated so as to prefer to exert high effort)
PHu(wS)+(1-PH)u(wF)- aH≧ PLu(wS)+(1-PL)u(wF) – aL
• Individual rationality constraints (IR) (the contract should be
attractive to the manager)
PHu(wS)+(1-PH)u(wF)-aH ≧U
where U is the Agent’s reservation utility (opportunity cost)
Solution:
a H ( 1−P L )−a L ( 1−PH )
u ( w S ) =U +
P H −P L
a L P H −a H P L
u ( w F )=U +
P H −P L
1-year investor:
• For a one-year investor, the potential cash flows include:
, • Dividend
• Sale of stock
Discount rate = cost of equity (rE)
Equity investors’ expected rate of return
We will take it as given, but one could use the Capital Asset Pricing
Model (CAPM) to estimate this rate.
• PV of the potential cash flows:
¿1 + P 1
P0=
1+r E
• If the current stock price < this amount → investors would rush
in and buy it → increasing the stock’s price
• If the current stock price > this amount → investors who
already hold this stock would sell it → lowering the stock’s price
¿1 + P 1 ¿1 P1−P0
• r E=
P0
−1= +
P0 P0
¿1
P0
= Dividend yield
P 1−P0
P0
= Capital Gain rate
• The expected total return of the stock should equal the
expected return of other investments available in the market
with the equivalent risk
A multi-year investor:
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller emcevoyp2001. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £9.49. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
62890 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now