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Full Literature summary Finance for Real Esate
- Instelling
- Rijksuniversiteit Groningen (RuG)
This summary contains all obligatory literature for the course Finance for Real Estate (Book + articles)
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Voorbeeld 4 van de 85 pagina's
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Voorbeeld van de inhoud
Literature Summary – finance for real estateWeek Topic Literature
Week 1 Introduction and time value of money Ch. 1,3 & 4
Week 2 Interest rates and valuing bonds and options Ch. 5,6 & 21
Week 3 Valuing shares Ch. 2,7 & 10
Week 4 Capital budgeting Ch. 8 & 9 + Bokhari et
al (2016) + Hutchison
et al (2017)
Week 5 Risk & return 10. 4,5/11 & 12
Week 6 Cost of capital and sources of finance 13,m 14 & 15
Week 7 Capital structure 16 & 17
Week 8 Guest lecture + recap
Week 1 – Introduction to the time value of money
Chapter 01 – introduction
Four main types of firms
1. Sole proprietorships → small businesses (72% of all businesses, 3% revenue)
a. Easy to set up, limitation: no separation between owner and firm, owner is
responsible for debt payment, difficult to transfer ownership
2. Partnerships → business run by more than one owner (law firms, medical practices)
a. All partners liable for firms debt, partnership ends with death of one partner,
possible to avoid liquidation by a buyout deceased partner
3. Limited liability companies (LLC) → limited partnership without general partner
4. Corporations (most important, 85% of all revenue) → rechtspersoon, company is legally
separated from its owners. Corporation is solely responsible for its own obligations.
a. Corporation is legally formed, therefore costly
b. No limit to the number of owners (aandeelhouders)
c. Corporations can raise unlimited amount of capital by selling shares
Double taxation = profits from the corporation are taxed, but also the remaining profits are taxed as
income (dividend payout). The OECD offers relief in double taxation by not taxing dividend income
(also in the Netherlands)
- S Corporations = US structure where certain companies are exempted for double taxing
(taxing happens directly via shareholders ownership share)
- C Corporations = corporations who can’t apply for S Corporation regulations, immediately
become C Corporations, which are subjected to corporate taxes
Stock market = organized market on which the shares of many public corporations are traded. These
markets provide liquidity for a company’s shares.
Primary market = when a corporation issues new shares or stocks and sells them to investors
Secondary market = where shares of a corporation are traded between investors without the
interference of the corporation.
Liquidity = extent to which the market for an asset is liquid, meaning that assets can be easily turned
into cash because they can be sold immediately at competitive market prices.
,Financial institutions = entities that provide financial services, such as taking deposits, managing
investments, brokering financial transactions or making loans. (much attention was drawn to these
institutions during the financial crisis in 2008).
- Banks and credit unions, insurance companies, mutual funds (peoples savings), pension
funds (retirement savings), hedge funds (wealthy investors), venture capital funds (wealthy
investors), private equity funds (wealthy investors buying entire companies with a little
private and a lot of borrowed money)
The financial cycle – people invest and save their money (1). That money (loans and stocks) flows to
companies who invest with that money to enhance the corporation’s financial growth, generating
profits and wages, and money flows back to savers and investors.
Chapter 03 – Time value of money: An introduction
Cost benefit analysis
The first step in financial decision making is to identify the costs and benefit of a decision. Any
decision in which the value of the benefits exceeds the costs will increase the value of the firm.
Competitive market = A market in which a good can be bought and sold at the same price.
Whenever a good trades in a competitive market, the price determines the value of the good.
The valuation principle = the value of a commodity or an asset to the firm or its investors is
determined by its competitive market price. The benefits and costs of a decision should be evaluated
using those market prices. When the value of the benefits exceeds the value of the costs, the
decision will increase the market value of the firm (positive NPV)
The valuation principle relies on using a competitive market to value cost or benefit. We
cannot have two different competitive market prices for the same good. The Law of one price, states
that in competitive markets, the same good or securities must have the same price. Securities that
produce the same cash flows must have the same price. The valuation of financial asset involves the
following three steps:
1. Estimate the expected cashflows
2. Determine the appropriate interest rate, used to discount the cash flows
3. Calculate the present value of expected cash flows (NPV) = CF/(1+r)^n
Time Value of money and interest rates
Most financial decisions have costs and benefits that occur at different point in time. For example
your company has an investment opportunity with the following cash flows
- Cost: $100.000 today
, - Benefit: $105.000 in one year.
Are cost and benefit directly comparable? No. Calculating the project’s net value as $5000 is
incorrect because it ignores the timing of the costs and benefits.
In general: a dollar receives today is worth more than a dollar received in one year. The difference in
value between money today and money in the future = time value of money.
Just like silver and gold, money today and money in the future are not the same. We compare them
just like we did with silver and gold – using competitive market prices. But in the case of money:
What is the price? It is the interest rate, the price for exchanging money today for money in a year.
Value of $100.000 investment in one year with an interest rate of 10%. (The earlier mentioned
example had the following costs ($100.000) benefits ($105.000) in one year.
Think of this amount as the opportunity cost of spending $100.000 today: The firm gives up the
110.000 it would have had in one year if it had left the money in the bank. Alternatively, by
borrowing the $100.000 from the bank, this firm would owe $110.000 in one year.
We have used the market price, interest rate, to put both costs and benefits in terms of dollars in
one year. So, now we can use the valuation principle to compare them and compute the investments
net value by subtracting the cost of investment from the benefit in one year.
$105.000 - $110.000 = -$5.000 in one year.
➔ in other words, the firm could earn $5.000 more in one year by putting the $100.000 in the
bank rather than making this investment. Because the net value is negative, we should reject
the investment.
We can use the interest rate factor to convert to dollars today. Consider the benefit of $105.000 in
one year. What is the equivalent amount in terms of dollars today? How much would we need to
have in the bank today so we end up with $105.000 in the bank in one year → We find this by
dividing $105.000 by the interest rate factor:
➔ 105000/1.10 = $95,454.55
This is also the amount the bank would lend to us today if we promised to repay $105,000 in one
year. Thus, it is the competitive market price at which we can “buy” or “sell” today an amount of
$105,000 in one year.
Now we are ready to compute the net value of the investment today (as opposed to its net value in
one year) by suybstracting the cost from benefit: $95,454.55 - $100,000 = -$4545.45 today.
, ➔ Taking the investment would make the firm $4,545.45 poorer today because it gave up
$100,000 for something worth only $95,454.55.
If we convert from dollars today to dollars in one year:
(-4545.45 today) x (1.10 in one year/1 today) = $5000 in one year.
When we express the value in terms of dollars today, we call it Present Value (PV) of the investment.
If we express it in terms of dollars in the future, we call it future value (FV).
In preceding calculation, we can interpret 0,90909 as the price today of $1 in one year. Money in the
future is worth less today, so its price reflects a discount. Because it provides the discount at which
we can purchase money in the future, the amount 1(1+r) is called the one year discount factor. The
interest rate is also referred to as the discount rate for an investment.
Valuing cash flows in different points in time
Rule 1: comparing and combining values
Our first rule that it is only possible to compare or combine values at the same point in time. A dollar
today and a dollar in one year are not equivalent. You need to convert the cash flows into the same
units by moving the to the same point in time.
Rule 2: Compounding
Suppose you have $1000 today, and we wish to determine the equivalent amount in one year’s time
with an interest rate of 10%. We saw in the last section that we can use that rate as an exchange
rate, meaning the rate at which we exchange money today for money in one year, to move the cash
flow forward in time.
FV = $1000 today * (1.10 in one year) = $1100 in one year
In general, if the market interest rate for the year is r, then we multiply by the interest rate factor,
(1+r) to move the cash flow from the beginning to the end of the year. We multiply by (1+r) because
at the end of the year you will have (1 x your original investment) plus interest in the amount of (r x
your original investment).
Compounding = the process of moving forward along the timeline to determine a cash flow’s value in
the future.
The second rule is that is that to calculate a cash flow’s future value, you must compound it.
➔ Compound interest = The effect of earning interest on both the original principal plus the
accumulated interest (interest on interest).
How does the future value change in three years?
In general: to compute a cash flows C’s value n periods into the future, we must compound it by the
n it by the n intervening interest rate factors. If the interest rate r is constant this calculation yields:
Rule 3: Discounting
The third rule describes how to put a value today on a cash flow that comes in the future. Suppose
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