Samenvatting
Finance 2: extensive summary final exam
- Instelling
- Universiteit Van Amsterdam (UvA)
extensive summary finance 2 for final exam, uva year 2
[Meer zien]Voorbeeld 4 van de 38 pagina's
Voorbeeld 4 van de 38 pagina's
In winkelwagengesponsord bericht van onze partner
Voorbeeld van de inhoud
Finance 2 week 1 + tutorial 1 (also study the book, not gonna discuss all the slides)Lecture 1
• One of key things in finance is valuation, how to value/evaluate investment?
• In this repetition we will see how to value stocks/shares, like Philips. Don’t look at stock values on daily basis because they go up and down like crazy.
• Once we do valuation, its not that one way is better than the other way, there are ways that are wrong, but ways we are going to do valuation here basically
all right if apply them in right way, if you know what you’re doing, if don’t know hat doing you might apply in wrong way and that is not valuation.
• If you buy stock of Philips, what do you get out of it? Dividends in future. Dividends discount model looks at future dividends, and if you discount them to
today, you have the value. You buy Philips and thing you get are dividends in future, if would say yeah only keep 4 years and then sell to someone else, why
would I look at these dividends 10 years from now? I am planning to sell it after 4, answer: you sell it to somebody who is willing to pay for it, because that
person will look at dividends at 10 years from now. Even if sell after 4 years will still depends on dividends after 10 years, will affect price at which you can
sell it. We know that if things run to infinite, things become easy. That’s why we have many examples of dividends that grow at rate g to infinity.
• You get div1 at time 1, you get div 1+g at time 2, and at div(1+g)^2 at time 3. Can take these things together so value is equal to dividend/discount rate-
growth rate. looks like formula but can derive it, can understand it. Because discount rate is something bad if goes up, because if r goes up, value P goes
down. the growth rate Is something positive because means higher dividends, if growth rate goes up value goes up. Can rewrite it to equity cost of capital,
interesting because tells discount rate is equal to dividend yield + growth rate. think about it: if you buy share of Philips, whay type of return are you getting,
get return because of dividends that are being paid and because share price may go up. Share price going up, this value gain, is equal to the growth rate. so
you make 2 types of profit: profit based on dividend, and profit based on value fo the share going up and actually that profit percentage wise is g. why does
this hold? Equal to discount rate? why is discount rate equal to what you’re getting? Because if you buy Philips, there are 2 things you get: dividends return
and this value gain. Why is that equal? Discount rate equal to dividend return + increase in share price? Because you are investing in Philips (buying share
Philips) and return you’re making is precisely the discount rate. which normally is not the case if have business and going to make investment, you want to
make return which is more than discount rate because discount rate is what we call REQUIRED rate of return, min. you want to have before wiling even
consider it, so in business and make investment won’t have return that is higher than discount rate, but now buying share of Philips and return I make is
precisely the discount rate, that’s what formula says. Why does this hold? Market is competitive (everybody can buy this share of Philips). Return is going to
be exactly equal to discount rate because that’s when you’re just willing to buy it. Now see difference with investment in corporation, a corporation making
investment ha special knowledge, knows something, sees opportunity and has some type of monopoly. Somebody else does not have this idea. Market
would be competitive, that’s difference between real investments like corporation and financial investments in financial market. Only way to do better in
financial market is to have insider knowledge. That’s prohibited.
• Can apply this to examples.
It has to be 309 tomorrow otherwise don’t make capital gain of 3%. As yourself the question at which price can you sell the stock at time 1? What is the first
dividend? Its not 15, the first dividend is going to be 15*(1+t), 15.45, so what is the value of P1 the stock price of time 1 is going to be 15.45, which is first
dividend you are going to get, if buy stock tomorrow, which is dividend at time 2/r-g. 15.45/0.5 is going to be 309. Required return of 8%market competitive,
price stock of tomorrow and today is right, making 3% capital gain and 5% dividend yield. This Is easy its forever
• This is not forever. Now have to look at discounting at time 1,2,3 etc. take them 1 by 1. If N=8, what do you tell this corporation, consultants have no idea
but they make a appealing story of it. Consulting is about business of plausibility, making pictures, don’t worry about causality. Make sure this goes up
because then that goes up. Consultancy is about plausibility and not causality. Consultants hired to make people enthusiastic motivated thinking 1 line, mind
focused. If whole organization running in that direction, it might be good. The best strategy is not the best on paper, but the one that everybody believes in,
so plausibility story is to channel energy of corporation in one direction can be sometimes good/bad.
• Keep in mind: with dividend stuff we were valuing a stock. You have stock of Philips and say how much is share what’s the value, depends on dividends I get
in future. You can also say let’s compute directly the value of business, let’s forget about one share, whole business. Now be careful: if value whole business,
that’s we do with free cash flow stuff:
,• Think about balance sheet looks, balance sheet corporation, have business (activity) and you have the equity (shares) and debt (debt)
• now can say what is value of this business? Value of this business is the value of this A (activity) that business if financed by shares, equity and by debt. Once
use discounted free cash flow model you are valuing the business meaning the debt and equity together. To get to the value of shares and equity, you have
to subtract the value of the debt, because you are valuing A. in all these textbooks, want you to make it confusing, say if these business not just have activity
A but also money lying around w/o purpose so they have cash, redundant cash, C is redundant cash, not needed for business. Put somewhere in bank
account. Has no purpose, then what do you say, make sure you get rid of the cash when do this valuation, want to value A, the business, don’t want to value
the cash. To get rid of cash, just use the cash to retire debt. Subtract is from debt. What is real debt you have? Real debt is if use C to repay debtholders and
get rid of C there.
• This is what we’ll do, value A because free cash flow come out of busines, out of A, and cash we have got rid of on paper to not get confused by cash because
this cash not generating free cash flow, just invested at stupid market rate, so we get rid of it by retiring some debt. Now gonna value A. what’s the story:
what are the cash flows that come out of this business? Careful because what do we know, we have accounting data, what are they? Useful in own way, cant
do much with it. These cash flows In accounting sense, want to tell them to which year they really belong. Got lot of cash today, for finance people is fine if
we got it today, accounting people will say its because of sales we did last year, so cash today belongs to last year. In accounting want to allocate all amounts
to given year. Forget about taxes for now, so we have earnings before interest and taxes (EBIT), comes close to operational cash flow. Because we looking at
value asset and not subtracting interest payments, because interest payments go to debt holders, its about operational cash flow, who’s getting is not what
we’re after. So EBIT comes close, but ebit is relatively low because have subtracted depreciation, so have to add depreciation back, otherwise need to use
EBITDA. Add depreciation back because was subtracted, depreciation we don’t pay its just for accounting. BUT its still not free cash flow because we made
the investments today so have to subtract capital expenditures investments, and made investments in working capital if need extra inventory/cash in order
to run business, that’s also investment,
• So what is free cash flow? Its EBIT + depreciation – investment – investment in net work capital. What then is value of business? All these free cash flows
discounted to today. At time 1,2,3 and discount them to today. That’s the way of valuing this business, then have value of A then still don’t have value of
equity yet, so subtract this net debt (D-C) to get to value of equity.
• We have BS, on left side assets, (with redundant cash can repay debt, so real debt is D-C, cash not doing anything because redundant), Equity on right side,
debt on right side. Point is: if assets are 100, and debt is 40, equity is 60, then accounting people happy because equal. What they don’t like is that balance
sheet that finance people talk about are about real values, market values. Market value of shares (equity)60, market value of debt 40, and market value of
assets is 100. Market value of 100 is what we did in the discounted cash flow. We computed free cash flow and computed value of assets, which in this stuff
• The 100, is the Vo in the equation. Because the equation is all the free cash flows discounting back to time today, 0. What have we discounted? Everything
that comes out of assets, all these FCF we just count today, so what computed? market Value the assets: Vo. So A=Vo. o refers to time 0.
• What should the discount rate be? Rwacc, free cash flow we get at time 2 has to be discounted twice to time 0. So we have the discount (otherwise
comparing apples to oranges). But at what discount rate? where does it come from? Keep in mind we are computing value of the assets. Whatever risk there
is in assets, risk has to be born by the equity holders and debt holders. Whatever risk there is on left hand side BS, assets can go up down, who’s carrying
that risk? Debtholders and equity holders, because right handside total is equal to left handside, so if lefthandside goes up, righthandside goes up vice versa.
So risk on left comes from left the assets, who gets risk? Equity holders and debtholders. Risk on left is distributed over equity holders and debtholders.
Whatever happens to left handside happens to rightside. Left handside causes risk, because business doing good or poorly so left handside causes risk right
hand side (not other way around). What do we know? Debtholders get paid first, if they are paid equity holders get something, means debtholders carry
disproportionally less risk, and equityholders have to wait and carry disproportionally more risk.
• So risk coming from the left is distributed more to equityholders than to debt holders. Now we know what happens to discount rate, means whatever ends
up with equityholders, so when valuing stock of Philips, discount rate of equityholders is going to be higher than discount rate of debt holders because
equityholders have more risk, whatever they get in future, (in changing dividend growth rate slide: Po is value of stock and discounting dividends at Re, what
is Re, it’s the discount rate of equityholders. Because equityholders have more risk, so we discount them at discount rate of equity holders, and Re is going to
be higher than discount rate of debt holders, and also higher than discount rate we would have used for the assets, because equity holders get more risk,
debtholders less, means discount rate of equityholders exceeds average, that’s what wacc is (discount rate of a), and that exceeds discount rate of debt
holders because they have less risk. Now explained why for assets, which are the average we use the average discount rate wacc, for equityholders have
more risk we use Re, and for debtholders less risk we use Rd. discount rate is what investors in debt or equity demand in market, given the risk they are
exposed to. Means: all these discount rates if people don’t like that risk will exceeds the risk-free rate, risk free rate means no risk. that’s what you have as
discount rate. if don’t like risk, discount rate is going to be higher, higher discount rate is what you require to get on average. So on average better off with
risk. So on average require with equity Re, with debt Rd (low), and Re on average you get it if stock priced at right level. Why ask for higher compensation to
be better off? Its because you don’t like risk (=risk aversion). You want to be compensated for the fact that you run that risk/may lose money. Now question
is: how does that risk translate in higher discount rate? how much higher is this Re compared to Rd? if risky, Rd will exceeds rf (risk free rate how do we get
that? Keep in mind: they carry more risk. Somebody has to carry risk, not hat equity is expensive because you get something they carry the risk. Party that
carries risk has to be compensated.
• If say debt is cheaper then equity, lets get rid of some equity and take more debt because its cheaper, can already conclude that that’s idiotic. Because risk is
caused by assets, and risk has to be born by somebody, that somebody wants to have compensation for the risk, if going to replace equity by debt so less
equity more debt, as debtholder will not like it. Because that equity was like almost safety guard (buffer). Equity can carry losses before debtholder loses
money. Risk comes from the assets it didn’t disappear. All this playing around righthandside BS by changing proportion E and D. risk comes from left side and
needs to be compensated for, by equity or debt holders/ or both. Risk is not changing. If change right handside the risk of left side changing, and that’s key
lesson of finance: the assets determine the risk, financial contracts distribute the risk (who’s getting it). Can play around with distribution but doesn’t change
risk itself.
• If A is high, run risk, is average, wacc. Buying equity and debt is same as buying assets. Risk of equity and debt is risk of assets. Wacc is average of equity and
debt.
,• How does risk translate in higher required rate of return? Re is higher than Rd, and potentially higher than rf if debt is risky, where does that difference come
from? And that’s when Nobel prizes come in because if risk that matters in economy should have a price, what meant: all risk is not equal, why is all risk not
equal? Making 2 investments and both risky. But actually by making them we don’t have any risk, as long as make both don’t have any risk. (if both riskless,
then no risk), but if 2 risky things, and I put money in 2 diff things, by putting money in 2 diff things have no risk whatsoever. NEEDS TO BE: perfectly
negatively correlated. So how would you explain this to grandmother: example: put 50 dollars in green energy company and 50 dollars in fossil oil company,
and regardless of whether greens/fossils are going to win, one of 2 investments is going to do great and one badly. If green wins green investment great and
fossil guys win then fossil investment great and green going to be bad. So on average it cancels out. One other example: think about defense industry, big
order by US gov. for fighter jets. Assume 2 fighter jets producers in world. Either fighter jets company A will get the order or fighter jet B will get the order.
Only uncertainty that we have is whether A gets it or B gets it. The one who gets it will get sky-high share price, and other very low. If put money half in one
half in other, you always win and always lose. So either one is high or other low, because this one got order, or this one got order and other one low. As long
as have 50% of money in both, you have no risk whatsoever. What does this mean? This type of risk you don’t care about, just by combining 2 defense
companies, you don’t run that risk. So don’t need to be compensated! Risk that you can get rid of by putting things together, diversifying, you do not need
compensation for.
• Risk that you cannot get rid of, somebody needs to have that risk. If I don’t want to have that risk, which is fine, I have to convince you to take it. What does
it mean? I have to pay you to take that risk, paying means I have to make sure you get higher return, so I can only sell this share in whatever risky thing that I
cannot get rid of by diversifying I can only sell this share to you and you need to be compensated for that risk and you are going to give me very little for it in
order to make higher return. Can get it cheap, by getting it cheap you make higher return afterwards, that was because have to take this risk from me. Risk
that I can only get rid of by giving it to someone else needs to be compensated. That’s what this book called: market risk, systemic risk, non ideocratic risk, all
same. and that’s where all theories based on, CAPM, beta (=measure of market risk, measure of risk that cannot get rid of without giving it to someone else).
• How does that look? Jump to slide 18.
• This is slide 18. Required rate of return on a particular investment is the risk free rate + beta of that particular stock/activity/investment, beta is measure of
risk that can only get rid of by giving by someone else (market/systemic risk) x market risk premium (=what you get on market as a whole extra compared to
risk free Rm-Rf, market as a whole(all stocks/bonds) goes up and down and somebody needs to have that risk, that’s why market return Rm is higher than
risk-free rate Rf, because its risky). If stock has beta of 1, just look at formula. Substitute beta is 1, what left with on lefthandside if beta 1? Only thing what
remains on righthandside is Rm, because Rf + 1x(Rm-Rf), Rf drops out so if beta is 1, of particular stock, then required rate of return on this particular stock
we look at (Philips), if Philips has beta equal to 1, then required rate of return is the required return of market (because rf drops out). If beta 1, stock has
same market risk as whole market, what is required rate of return on stock? Its what was on whole market Rm, if stock beta more than 1, its more risky in
terms of market risk and market, and will see that required rate of return is going to be higher than Rm, if beta is greater than 1, if beta less than 1, required
rate of return is going to be less than required rate of return on market. What’s nice about this: every stock has particular beta, moves with market in
particular way. Every activity has a beta. And you can see what required rate of return has to be, need to know risk-free rate and have to make assessment
about market risk premium (diff between Rm and Rf), its linear, if one activity has beta of 2, other has beta of 1, and these are two activities a company has
and lets assume equal amount of both, then beta of company between 2 and 1, so is 1.5.
• key thing: the only risk you care about is the risk that you cannot get rid of yourself. Only risk you care about is risk you have to give to someone else, given
that give to someone else, has to be price for that risk. So diversification allows you to get rid of lot of risk, don’t need to be compensated for that, but
whatever is left (beta risk/systemic risk/market risk), that needs to have a price, that’s whole thinking behind CAPM. If project A requires investment of 100
and has expected cash flow of 115 at time t=1, put in 100 today and tomorrow get 115 expected so there is risk, on average 115. So expected return of 15%,
but is it good investment? Depends on discount rate, what is the required return? How do we like this risk? What do we know about this investment, beta is
2 so high and lot of undesirable risk, market risk premium (5-2) is 3%, we have beta of 2 so we have twice this market risk, so need to account 2 times this
extra 3^ which is 6%. + risk free rate which is 2, = 8%. Discount rate with rf rate of 2 and given this risk is discount rate of 8%. Discount rate of 8%, this is good
investment, because compute net present value – 100, +115/1.08 >0 so its good investment. This is investment made by firm that has special knowledge,
, this is impossible in stock market. If buy stock of Philips everybody can buy it, no reason why expected return would be higher than required rate of return,
because then everybody would have been buying it and then price would go up, so price is wrong. 1 more thing: this CAPM for stocks (freely traded), we
know 1 thing: we can talk about it as expected return because thing that are freely traded everybody can do it, expected return will be equal to required rate
of return. Meaning: if required rate of return on Philips is 12%, then price of Philips stock should be such that expected return on market is also 12%,
because if it would be 13, people would say jee required is 12, if I buy Philips I make on average 13, we all going to buy it. Price is wrong. So expected return
on something that’s freely traded (all access to) is equal to required rate of return. So in the stock market, this thing you can also interpret as the expected
rate of return is risk free + beta x (Rm). However for investments in firm, buying machine, having unique idear, making this pen, you’re only one that can
make it, can sell for price that is 2 million, while cost are 2 euros, of course expected return much higher than required rate of return. This can only be
interpreted as what discount rate should be, what required rate of return should be. So required rate of return is the discount rate, and the expected return
is something else but within financial market investments that everybody can do, it happens to be equal to required rate of return.
• Final observation: do we, stock in Philips above 30 euros in break, is it possible that we’re going to make, if we make investment in Philips today, is it possible
that tomorrow we have made 60% return? So we invest today and tomorrow we sell it and have made/realized return of 60%. Is this possible? Yes. Because
you can be lucky. No theory about what outcome will be of risk, what does risk mean? Risk means it can be high/it can be low. So outcome we have not
theory about, about distribution we have theories, where expected return should be equal to required rate of return, which was 12% on Philips, so expected
return on share of Philips should be 12. Based on beta of Philips etc., required and expected return should be 12, when we buy it, there might suddenly be
good news. Maybe get new CEO who’s great and they didn’t expect that or maybe do invention that nobody expected so return when we sell tomorrow can
be 5000%. It can be really lucky, keep it in mind. No theory saying anything about realizations, expected return normally diff from required rate of return,
however with something freely traded expected return has to be equal to required rate of return. So there are some essential things.
• Taking one element out of question: there is something that’s called law of one price (=in a world where we care about expected returns and risk, things that
have save return distribution, so same expected return and risk, should have the same price). If both are freely available if both can get our hands on, if I’m
the only one who can buy something and that something has same risk characteristic as Philips but I’m the only one who can buy the thing that is like the
share of Philips, then that’s no longer competitive can no longer get our hands on something that is very similar to a share of Philips, so cannot get our hands
on it, price can be diff, law of one price depends on arbitrage (=two things are same, if one has higher price people will buy cheap thing that goes up and sell
expensive up till price is equal). That’s what law of one price is, arbitrage, can only do arbitrage if can buy and sell. So both have to be available.
Voordelen van het kopen van samenvattingen bij Stuvia op een rij:
Verzekerd van kwaliteit door reviews
Stuvia-klanten hebben meer dan 700.000 samenvattingen beoordeeld. Zo weet je zeker dat je de beste documenten koopt!
Snel en makkelijk kopen
Je betaalt supersnel en eenmalig met iDeal, creditcard of Stuvia-tegoed voor de samenvatting. Zonder lidmaatschap.
Focus op de essentie
Samenvattingen worden geschreven voor en door anderen. Daarom zijn de samenvattingen altijd betrouwbaar en actueel. Zo kom je snel tot de kern!
Veelgestelde vragen
Wat krijg ik als ik dit document koop?
Je krijgt een PDF, die direct beschikbaar is na je aankoop. Het gekochte document is altijd, overal en oneindig toegankelijk via je profiel.
Tevredenheidsgarantie: hoe werkt dat?
Onze tevredenheidsgarantie zorgt ervoor dat je altijd een studiedocument vindt dat goed bij je past. Je vult een formulier in en onze klantenservice regelt de rest.
Van wie koop ik deze samenvatting?
Stuvia is een marktplaats, je koop dit document dus niet van ons, maar van verkoper kdamsterdam. Stuvia faciliteert de betaling aan de verkoper.
Zit ik meteen vast aan een abonnement?
Nee, je koopt alleen deze samenvatting voor €6,99. Je zit daarna nergens aan vast.
Is Stuvia te vertrouwen?
4,6 sterren op Google & Trustpilot (+1000 reviews)
Afgelopen 30 dagen zijn er 62555 samenvattingen verkocht
Opgericht in 2010, al 14 jaar dé plek om samenvattingen te kopen