Tiddlers From Recipe finance_publichttp://finance.dirkjanswagerman.nl/recipes/finance_public/tiddlers2014-03-05T20:27:21Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanSiteInfo2014-03-05T20:27:21Z2014-03-05T20:27:21Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/SiteInfo<pre>
Space finance</pre>
Matthew Carroll's answer to Financial Modeling: Where can web startups learn about financial modeling that accounts for the impo2012-08-14T18:24:20Z2012-08-14T18:24:20Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Matthew Carroll's answer to Financial Modeling: Where can web startups learn about financial modeling that accounts for the impo<pre>
!URL
http://www.quora.com/Financial-Modeling/Where-can-web-startups-learn-about-financial-modeling-that-accounts-for-the-important-metrics-and-costs/answer/Matthew-Carroll
!Description
</pre>
Plugin: jsMath2012-08-02T10:45:42Z2012-08-02T10:45:42Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanmath_public/Plugin: jsMath<pre>
/***
|Name|Plugin: jsMath|
|Created by|BobMcElrath|
|Email|my first name at my last name dot org|
|Location|http://bob.mcelrath.org/tiddlyjsmath.html|
|Version|1.5.1|
|Requires|[[TiddlyWiki|http://www.tiddlywiki.com]] &ge; 2.0.3, [[jsMath|http://www.math.union.edu/~dpvc/jsMath/]] &ge; 3.0|
!Description
LaTeX is the world standard for specifying, typesetting, and communicating mathematics among scientists, engineers, and mathematicians. For more information about LaTeX itself, visit the [[LaTeX Project|http://www.latex-project.org/]]. This plugin typesets math using [[jsMath|http://www.math.union.edu/~dpvc/jsMath/]], which is an implementation of the TeX math rules and typesetting in javascript, for your browser. Notice the small button in the lower right corner which opens its control panel.
!Installation
In addition to this plugin, you must also [[install jsMath|http://www.math.union.edu/~dpvc/jsMath/download/jsMath.html]] on the same server as your TiddlyWiki html file. If you're using TiddlyWiki without a web server, then the jsMath directory must be placed in the same location as the TiddlyWiki html file.
I also recommend modifying your StyleSheet use serif fonts that are slightly larger than normal, so that the math matches surrounding text, and \\small fonts are not unreadable (as in exponents and subscripts).a
{{{
.viewer {
line-height: 125%;
font-family: serif;
font-size: 12pt;
}
}}}
If you had used a previous version of [[Plugin: jsMath]], it is no longer necessary to edit the main tiddlywiki.html file to add the jsMath <script> tag. [[Plugin: jsMath]] now uses ajax to load jsMath.
!History
* 11-Nov-05, version 1.0, Initial release
* 22-Jan-06, version 1.1, updated for ~TW2.0, tested with jsMath 3.1, editing tiddlywiki.html by hand is no longer necessary.
* 24-Jan-06, version 1.2, fixes for Safari, Konqueror
* 27-Jan-06, version 1.3, improved error handling, detect if ajax was already defined (used by ZiddlyWiki)
* 12-Jul-06, version 1.4, fixed problem with not finding image fonts
* 26-Feb-07, version 1.5, fixed problem with Mozilla "unterminated character class".
* 27-Feb-07, version 1.5.1, Runs compatibly with TW 2.1.0+, by Bram Chen
!Examples
|!Source|!Output|h
|{{{The variable $x$ is real.}}}|The variable $x$ is real.|
|{{{The variable \(y\) is complex.}}}|The variable \(y\) is complex.|
|{{{This \[\int_a^b x = \frac{1}{2}(b^2-a^2)\] is an easy integral.}}}|This \[\int_a^b x = \frac{1}{2}(b^2-a^2)\] is an easy integral.|
|{{{This $$\int_a^b \sin x = -(\cos b - \cos a)$$ is another easy integral.}}}|This $$\int_a^b \sin x = -(\cos b - \cos a)$$ is another easy integral.|
|{{{Block formatted equations may also use the 'equation' environment \begin{equation} \int \tan x = -\ln \cos x \end{equation} }}}|Block formatted equations may also use the 'equation' environment \begin{equation} \int \tan x = -\ln \cos x \end{equation}|
|{{{Equation arrays are also supported \begin{eqnarray} a &=& b \\ c &=& d \end{eqnarray} }}}|Equation arrays are also supported \begin{eqnarray} a &=& b \\ c &=& d \end{eqnarray} |
|{{{I spent \$7.38 on lunch.}}}|I spent \$7.38 on lunch.|
|{{{I had to insert a backslash (\\) into my document}}}|I had to insert a backslash (\\) into my document|
!Code
***/
//{{{
// AJAX code adapted from http://timmorgan.org/mini
// This is already loaded by ziddlywiki...
if(typeof(window["ajax"]) == "undefined") {
ajax = {
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gets: function(url){var x=ajax.x();x.open('GET',url,false);x.send(null);return x.responseText}
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}
// Load jsMath
jsMath = {
Setup: {inited: 1}, // don't run jsMath.Setup.Body() yet
Autoload: {root: '/static/jsMath/', showFontWarnings: 0} // URL to jsMath directory, change if necessary
};
var jsMathstr;
try {
jsMathstr = ajax.gets("/static/jsMath/jsMath.js");
} catch(e) {
alert("jsMath was not found: you must place the 'jsMath' directory in the same place as this file. "
+"The error was:\n"+e.name+": "+e.message);
throw(e); // abort eval
}
try {
window.eval(jsMathstr);
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alert("jsMath failed to load. The error was:\n"+e.name + ": " + e.message + " on line " + e.lineNumber);
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jsMath.Setup.inited=0; // allow jsMath.Setup.Body() to run again
// Define wikifers for latex
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matched.index-w.matchStart-w.matchLength);
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txt = w.source.substr(w.matchStart, matched.index+matched[0].length-w.matchStart);
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e.appendChild(document.createTextNode(txt));
w.output.appendChild(e);
w.nextMatch = endRegExp.lastIndex;
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config.formatters.push({
name: "displayMath1",
match: "\\\$\\\$",
terminator: "\\\$\\\$\\n?", // 2.0 compatability
termRegExp: "\\\$\\\$\\n?",
element: "div",
className: "math",
handler: config.formatterHelpers.mathFormatHelper
});
config.formatters.push({
name: "inlineMath1",
match: "\\\$",
terminator: "\\\$", // 2.0 compatability
termRegExp: "\\\$",
element: "span",
className: "math",
handler: config.formatterHelpers.mathFormatHelper
});
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backslashformatters.push({
name: "inlineMath2",
match: "\\\\\\\(",
terminator: "\\\\\\\)", // 2.0 compatability
termRegExp: "\\\\\\\)",
element: "span",
className: "math",
handler: config.formatterHelpers.mathFormatHelper
});
backslashformatters.push({
name: "displayMath2",
match: "\\\\\\\[",
terminator: "\\\\\\\]\\n?", // 2.0 compatability
termRegExp: "\\\\\\\]\\n?",
element: "div",
className: "math",
handler: config.formatterHelpers.mathFormatHelper
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backslashformatters.push({
name: "displayMath3",
match: "\\\\begin\\{equation\\}",
terminator: "\\\\end\\{equation\\}\\n?", // 2.0 compatability
termRegExp: "\\\\end\\{equation\\}\\n?",
element: "div",
className: "math",
handler: config.formatterHelpers.mathFormatHelper
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// These can be nested. e.g. \begin{equation} \begin{array}{ccc} \begin{array}{ccc} ...
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name: "displayMath4",
match: "\\\\begin\\{eqnarray\\}",
terminator: "\\\\end\\{eqnarray\\}\\n?", // 2.0 compatability
termRegExp: "\\\\end\\{eqnarray\\}\\n?",
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handler: config.formatterHelpers.mathFormatHelper
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config.formatters=backslashformatters.concat(config.formatters);
window.wikify = function(source,output,highlightRegExp,tiddler)
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if(source && source != "") {
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wikifier.subWikifyUnterm(output);
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wikifier.subWikify(output,null);
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jsMath.Synchronize("jsMath.Font.HideMessage()")
jsMath.ProcessBeforeShowing();
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//}}}</pre>
About2012-08-02T06:53:26Z2012-08-02T06:53:26Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanplugins_public/About<pre>
Welcome to [[Dirk-Jan Swagerman's|http://nl.linkedin.com/in/djswagerman]] [[tiddlyspace|www.tiddlyspace.com]]. I host my own tiddlyspace for notekeeping and bookmarking on different subjects. The site is primairly aimed for my own use, infrequently i may [[blog|http://blog.dirkjanswagerman.nl]] on topics that may interest me. You can explore different subjects in the menu bar on top and in addition the following spaces may be of your interest:
* [[Mbi|http://mbi.dirkjanswagerman.nl]], study notes for my Master of Business Innovation study at ~Tias-Nimbas
* [[Sales|http://sales.dirkjanswagerman.nl]], summary of 3 books on sales, negotiation and influence.
* [[Games|http://games.dirkjanswagerman.nl]], started reading the book [[Gamestorming]]@games but extended with other games i stumbled upon
* [[Software|http://software.dirkjanswagerman.nl]], bookmarks on software
* [[Management|http://management.dirkjanswagerman.nl]], softskills and management bookmarks (for instance around [[DISC|http://disc.dirkjanswagerman.nl]] and [[Situational Leadership|http://situationalleadership.dirkjanswagerman.nl]]
From my time at Philips Healthcare:
* [[FDA Regulation|http://fda.dirkjanswagerman.nl]], my summary of FDA regulation for medical devices.
From my time at FEI:
* [[Microscopy|http://microscopy.dirkjanswagerman.nl]], lectures and bookmarks about microscopy.
* [[Nanotechnology|http://nanotechnology.dirkjanswagerman.nl]], bookmarks on nano tech in general
Please send me an [[email|mailto://dirkjan@dirkjanswagerman.nl]] if you feel i need to remove certain contents from the site due to copyright infringements.
!About this space
<<tiddler [[About this space]]>>
!About ~Dirk-Jan
<<tiddler [[About Dirk Jan]]>>
!How to use
This site is build as a [[tiddlywiki|http://www.tiddlywiki.com]] and hosted using [[tiddlyspace|http://www.tiddlyspace.com]] technololgy. Reading ~TiddlyWikis is easy, but takes some getting used to. Rather than scrolling up and down a long web page or word processing document, you open small chunks of information ("microcontent") written in boxes called "tiddlers." You read what you need from a tiddler, then close it with the close button at the top right hand corner of the tiddler.
When a tiddler is opened up, it appears at the top of the screen or below the tiddler used to link to it. After opening a few tiddlers in succession, you might feel overwhelmed by all the open tiddlers. Not to worry.
* You can close every tiddler but the one you are using by clicking on the close others button.
* If you have multiple tiddlers open, you can use the jump button to quickly go to the open tiddler you desire without having to scroll up and down.
* See here for information on the other buttons at the top right of the tiddler.
To search for a tiddler, you can use the search window at the top right of the screen. All the tiddlers that contain the word that you search for will appear. Use 'search' on (right of the screen) to find information on a topic, for instance:
* Search for M3 to find all notes taken during module '3'. Module numbers can be found at the left
* Search for 'Reading' to see abstract of articles
* Search for 'Session notes' to see notes taken during the training
Click on a module on the left to navigate to a certain module or module session.
!Log In
<<TiddlySpaceLogin>>
!Sign Up
<<TiddlySpaceRegister>>
!Log Out
<<TiddlySpaceLogout>>
</pre>
Do You Know Your Cost of Capital? - Harvard Business Review2012-07-07T17:08:16Z2012-07-07T17:08:16Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Do You Know Your Cost of Capital? - Harvard Business Review<pre>
!URL
http://hbr.org/2012/07/do-you-know-your-cost-of-capital/ar/1
!Description
With trillions of dollars in cash sitting on their balance sheets, corporations have never had so much money. How executives choose to invest that massive amount of capital will drive corporate strategies and determine their companies’ competitiveness for the next decade and beyond. And in the short term, today’s capital budgeting decisions will influence the developed world’s chronic unemployment situation and tepid economic recovery.
To estimate their cost of equity, about 90% of the respondents use the capital asset pricing model [[CAPM|Portfolio Theory and the Capital Asset Pricing Model]], which quantifies the return required by an investment on the basis of the associated risk.
But that is where the consensus ends. Finance professionals differ in opinion on the underlying assumptions for 6 basic metrics:
# The Investment Time Horizon
# The Cost of Debt
# The Risk-Free Rate
# The Equity Market Premium
# The Risk of the Company Stock ([[Beta]])
# The Debt-to-Equity Ratio
# Project Risk Adjustment
!The Investment Time Horizon
The miscalculations begin with the forecast periods. Of the AFP survey respondents, 46% estimate an investment’s cash flows over five years, 40% use either a 10- or a 15-year horizon, and the rest select a different trajectory.
<<image /static/files/Finance/R1207L_A.gif width:300>>
Some differences are to be expected, of course. A pharmaceutical company evaluates an investment in a drug over the expected life of the patent, whereas a software producer uses a much shorter time horizon for its products. In fact, the horizon used within a given company should vary according to the type of project, but we have found that companies tend to use a standard, not a project-specific, time period. In theory, the problem can be mitigated by using the appropriate terminal value: the number ascribed to cash flows beyond the forecast horizon. In practice, the inconsistencies with terminal values are much more egregious than the inconsistencies in investment time horizons, as we will discuss. (See the sidebar [[How to Calculate Terminal Value]])
!The Cost of Debt
Having projected an investment’s expected cash flows, a company’s managers must next estimate a rate at which to discount them. This rate is based on the company’s cost of capital, which is the weighted average of the company’s cost of debt and its cost of equity, the [[WACC]].
Estimating the cost of debt should be a no-brainer.But people have different ways of applying a tax rate which can have major implications for the calculated cost of capital. The median effective tax rate for companies on the S&P 500 is 22%, a full 13 percentage points below most companies’ marginal tax rate, typically near 35%. (See the [[The Consequences of Misidentifying the Cost of Capital]])
<<image /static/files/Finance/R1207L_B.gif width:300>>
!The Risk-Free Rate
Errors really begin to multiply as you calculate the [[Cost of Equity]]. Most managers start with the return that an equity investor would demand on a [[risk-free|Risk free rate of return]] investment. What is the best proxy for such an investment? Most investors, managers, and analysts use U.S. Treasury rates as the benchmark. But that’s apparently all they agree on.
* 46% of our survey participants use the 10-year rate,
* 12% go for the five-year rate,
* 11% prefer the 30-year bond
* 16% use the three-month rate.
<<image /static/files/Finance/R1207L_C.gif>>
The variation is dramatic. When this article was drafted, the 90-day Treasury note yielded 0.05%, the 10-year note yielded 2.25%, and the 30-year yield was more than 100 basis points higher than the 10-year rate.
In other words, two companies in similar businesses might well estimate very different costs of equity purely because they don’t choose the same U.S. Treasury rates, not because of any essential difference in their businesses.
!The Equity Market Premium
The next component in a company’s [[weighted-average cost of capital|WACC]] is the risk premium for equity market exposure, over and above the risk-free return. In theory, the market-risk premium should be the same at any given moment for all investors. That’s because it’s an estimate of how much extra return, over the risk-free rate, investors expect will justify putting money in the stock market as a whole.
The estimates, however, are varied.
* About half the companies in the AFP survey use a risk premium between 5% and 6%
* Some use one lower than 3%,
* Others go with a premium greater than 7%
<<image /static/files/Finance/R1207L_D.gif>>
A huge range of more than 4 percentage points. We have found that companies tend to use a standard, not a project-specific, time period. In theory, the problem can be mitigated by using the appropriate terminal value: the number ascribed to cash flows beyond the forecast horizon. In practice, the inconsistencies with terminal values are much more egregious than the inconsistencies in investment time horizons, as we will discuss. (See [[How to calculate terminal value]])
!The Risk of the Company Stock
The final step in calculating a company’s cost of equity is to quantify the [[Beta]], a number that reflects the volatility of the firm’s stock relative to the market. A [[Beta]] greater than 1.0 reflects a company with greater-than-average volatility; a [[Beta]] less than 1.0 corresponds to below-average volatility. Most financial executives understand the concept of [[Beta]], but they can’t agree on the time period over which it should be measured:
* 41% look at it over a five-year period
* 29% at one year
* 15% go for three years
* 13% for two.
<<image /static/files/Finance/R1207L_E.gif>>
Reflecting on the impact of the market meltdown in late 2008 and the corresponding spike in volatility, you see that the measurement period significantly influences the [[Beta]] calculation and, thereby, the final estimate of the cost of equity. For the typical S&P 500 company, these approaches to calculating [[Beta]] show a variance of 0.25, implying that the cost of capital could be misestimated by about 1.5%, on average, owing to [[Beta]] alone. For sectors, such as financials, that were most affected by the 2008 meltdown, the discrepancies in [[Beta]] are much larger and often approach 1.0, implying [[Beta]]-induced errors in the cost of capital that could be as high as 6%.
!The Debt-to-Equity Ratio
The next step is to estimate the relative proportions of debt and equity that are appropriate to finance a project. Managers are pretty evenly divided among four different ratios:
* Current book debt to equity (30% of respondents);
* Targeted book debt to equity (28%)
* Current market debt to equity (23%)
* Current book debt to current market equity (19%).
<<image /static/files/Finance/R1207L_F.gif>>
Because book values of equity are far removed from their market values, 10-fold differences between debt-to-equity ratios calculated from book and market values are actually typical.
!Project Risk Adjustment
Finally, after determining the [[weighted-average cost of capital|WACC], which apparently no two companies do the same way, corporate executives need to adjust it to account for the specific risk profile of a given investment or acquisition opportunity.
* Nearly 70% do
** half of those correctly look at companies with a business risk that is comparable to the project or acquisition target.
* Many companies don’t undertake any such analysis
** instead they simply add a percentage point or more to the rate. An arbitrary adjustment of this kind leaves these companies open to the peril of overinvesting in risky projects (if the adjustment is not high enough) or of passing up good projects (if the adjustment is too high).
* 37% of companies surveyed by the AFP made no adjustment at all: They used their company’s own cost of capital to quantify the potential returns on an acquisition or a project with a risk profile different from that of their core business.
!Conclusion
Disparities in assumptions profoundly influence how efficiently capital is deployed in the US economy. </pre>
How to Calculate Terminal Value2012-07-07T17:00:06Z2012-07-07T17:00:06Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/How to Calculate Terminal Value<pre>
For an investment with a defined time horizon, such as a new-product launch, managers project annual cash flows for the life of the project, discounted at the cost of capital. However, capital investments without defined time horizons, such as corporate acquisitions, may generate returns indefinitely.
When cash flows cannot be projected in perpetuity, managers typically estimate a terminal value: the value of all cash flows beyond the period for which predictions are feasible. A terminal value can be quantified in several ways; the most common (used by 46% of respondents to the Association for Financial Professionals survey) is with a perpetuity formula. Here’s how it works:
First, estimate the cash flow that you can reasonably expect—stripping out extraordinary items such as one-off purchases or sales of fixed assets—in the final year for which forecasts are possible. Assume a growth rate for those cash flows in subsequent years. Then simply divide the final-year cash flow by the weighted-average cost of capital minus the assumed growth rate, as follows:
$\Large \text{TERMINAL VALUE} = \frac{\text{NORMALIZED FINAL YEAR CASH FLOW}}{\text{WACC}+\text{GROWTH RATE}}$
It’s critical to use a growth rate that you can expect will increase forever—typically 1% to 4%, roughly the long-term growth rate of the overall economy. A higher rate would be likely to cause the terminal value to overwhelm the valuation for the whole project. For example, over 50 years a $10 million cash flow growing at 10% becomes a $1 billion annual cash flow. In some cases, particularly industries in sustained secular decline, a zero or negative rate may be appropriate.
HBR.ORG: To see how terminal-value growth assumptions affect a project’s overall value, try inputting different rates in the online tool at hbr.org/cost-of-capital.</pre>
CAPM2012-07-07T16:03:02Z2012-07-07T16:03:02Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/CAPM<pre>
* Simultaneity: The discount rate depends on the standard deviation (risk) of the project. But value of the project depends on the discount rate again.
* Solution: Certainty equivalent version ([[Certainty Equivalent Cash Flow]]) of CAPM
* CAPM may not be the right model to value expected returns (ongoing academic debate)
* CAPM is not inconsistent with real options valuations as the CAPM can be used to value the underlying
* Required rate of return for a new venture:
$\LARGE r_{proj}$ = $\LARGE R_F + \beta_{proj}(r_M - r_F) + \text{Effort} + \text{Illiquidity}$</pre>
IRR2012-04-28T11:57:19Z2012-04-28T11:57:19Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/IRR<pre>
The Internal Rate of Return (IRR) is the discount rate that delivers a [[Net Present Value (NPV)]] of zero for a series of future cash flows. It is an [[Discounted Cash Flow]] approach to valuation and investing. [[IRR]] and [[NPV]] are widely used to decide which investments should be undertaken, and which investments not to make. The IRR can be calculated by trial and error using the following expression:
$\Large NPV = C_0 + $ + $\LARGE \frac{C_1}{1 + IRR} + \frac{C_2}{(1 + IRR)^2} + \frac{C_3}{(1 + IRR)^3} + \frac{C_T}{(1 + IRR)^T} = 0$
If the IRR is bigger than the cost of capital ([[WACC]]) then an investment decision can be accepted.
Be aware of the difference of a [[Project IRR]] and an [[Equity IRR]]. The project IRRs consider the project cash flows before considering funding, with initial negatives equal to construction costs, and later positives from the net operating cash flows, and gives a measure of the general ''strength of the project''.
The equity or investor IRRs are calculated on the relevant cash flow to investors, with payments from investors (pure equity paid in, drawings on sub debt etc) as initial negatives, and payments to investors (dividends, payments to sub debt etc. as appropriate) as positives.
''When presenting IRR in a business plan make sure that the difference between investor IRR and project IRR is clearly articulated''
The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally, the higher a project's internal rate of return is, the more desirable it is to undertake. Thus, IRR can be used to rank potential projects. Assuming all factors are equal, the project with the highest IRR probably would be considered the best and would be undertaken first. IRR sometimes is referred to as the economic rate of return (ERR). The IRR has the following pitfalls:
1) ''Lending or borrowing''
No all cash flow streams have NPV's that decline as the discount rate increases. In the following example based on IRR both projects are equally attractive:
|Project|\[C_0\]|\[C_1\]|IRR|NPV at 10%|h
|A|-1000|+1500|+50%|+364|
|B|1000|-1500|+50%|-364|
2) ''Multiple rates of return''
In certain cases the formula for IRR can result in two solutions.
3) ''Mutually exclusive''
In case where multiple options exists a higher NPV is better than a higher IRR.
|Project|\[C_0\]|\[C_1\]|IRR|NPV at 10%|h
|D|-10000|+20000|+100%|+8182|
|E|-20000|+35000|+75%|-+11818|
In the case of project 'D' you have a 100% rate of return, in the case of project 'E' you are \$11818,- richer (~3M more than project 'D')
4) ''The cost of capital for near term cash flows may be different than the cost of capital for future cash flows''
If we look again at the formula for NPV:
$\Large NPV = C_0 + \frac{C_1}{1 + r_1} + \frac{C_2}{(1 + r_2)^2} + \frac{C_3}{(1 + r_3)^3} + ...$
The IRR rule says to accept a project if the IRR is greater than the cost of capital (represented by $r_1$, $r_2$ etc). But what to do if you have different values for $r$? If you assume the $r$ will not change and it increases than you may have been too optimistic in accepting the project.
See also this [[excel sheet|/static/files/MBI/Module%209/Exercize%20Arosa%20Brixen%20Chamonix.xlsx]] example for comparison:
And the picture on the board during the [[M9-Accounting]] block:
<html>
<img src="/static/files/MBI/Module%209/DSC08466a.JPG" width=500>
</html>
</pre>
Equity IRR2012-04-28T11:05:07Z2012-04-28T11:05:07Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Equity IRR<pre>
The equity or investor IRRs are calculated on the relevant cash flow to investors, with payments from investors (pure equity paid in, drawings on sub debt etc) as initial negatives, and payments to investors (dividends, payments to sub debt etc. as appropriate) as positives.
See also: [[IRR]]</pre>
Project IRR2012-04-28T11:45:03Z2012-04-28T11:45:03Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Project IRR<pre>
The project [[IRR]]s consider the project cash flows before considering funding, with initial negatives equal to construction costs, and later positives from the net operating cash flows, and gives a measure of the general ''strength of the project''.
See also: [[IRR]]</pre>
Net Present Value2012-01-19T15:52:30Z2012-01-19T15:52:30Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Net Present Value<pre>
<<tiddler [[NPV]]>></pre>
PV2012-01-19T15:51:22Z2012-01-19T15:51:22Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/PV<pre>
In [[Principles of Corporate Finance]] the concept of //present value// is defined as the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. An intuitive understanding of present value is to see it as a mechanism to translate a future value to today: //If i get \$100000 5 years from now and correct for inflation and interest, what would the actually value be today//
To calculate present value, just discount future [[Cash Flow]] by an appropriate rate //r//. Usually this rate //r// is called the discount rate, the hurdle rate or [[Opportunity Cost]] of capital: For a single period the formula can be written as:
$\Large \text{Present Value (PV)}$ = $\LARGE \frac {C_1}{1+r}$
$\large C_1$ denotes the expected pay off at date 1 (for instance one year in the future).
${1+r}$ denotes the [[Discount Factor]]
For multiple varying cash flows in several years the formula changes:
$\Large {PV} = \sum{\frac{C_t}{(1+r_t)^t}}$
See also [[Net Present Value]]</pre>
NPV2012-01-19T15:50:43Z2012-01-19T15:50:43Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/NPV<pre>
In [[Principles of Corporate Finance]] the concept of //net present value// or //NPV// is defined as a project's net contribution to wealth ([[Present Value]]) minus initial investments. [[NPV]] is a measure of the difference between how much an asset is worth and what it costs. When it is worth more than it costs, the project has a positive NPV and the cooperation goes ahead and invests. A very simple to understand interpretation of the NPV is that it is your net profit at the end of the investment period corrected for inflation.
Put in another way; the NPV = PV(expected benefit cash flows) //minus// PV (capital expenditure). The decision is to invest if the NPV > 0.
Net present value is calculated as present value plus any immediate cash flow:
$\Large \text{Net Present Value (NPV)} = C_0 + \frac{C_1}{1+r}$
If $\large C_0$ is negative the immediate cash flow is an investment or [[Cash Outflow]]. For example, if a dentist wishes to purchase a new dental practice, he may calculate the net present value over a number of years to see if he will recover his investment in a reasonable period of time. If the ask price for the dental practice is \$500,000, this is the present cash outflow used in the calculation. If the discounted cash inflow over, say, two years, is greater than or equal to \$500,000, then the investment will likely be profitable. For multiple varying discount factors and multiple years the formula becomes:
$\Large NPV = C_0 + \sum{\frac{C_t}{(1+r_t)^t}}$
There are three points to make about NPV:
1) A dollar today is worth more than a dollar tomorrow
2) The NPV depends on the forecasted cash flows from a project and takes the [[Opportunity Cost]]s into account
3) Because the present values are translated to 'dollars today' NPV's can be added up:
$\Large NPV (A+B) = NPV(A) + NPV(B)$
See also:
* [[Present Value]]
* [[IRR]]
* this [[excel sheet|/static/files/MBI/Module%209/Exercize%20Arosa%20Brixen%20Chamonix.xlsx]] example for comparison:
</pre>
Real Options2012-01-16T12:42:49Z2012-01-16T12:42:49Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Real Options<pre>
Real options valuation is the term usually used for mathematical evaluation techniques inspired by the modeling of options on the financial markets. Several types of real options exists. Real options are considered to be closer to modeling financial reality by some when certain conditions apply. Most notably, whenever flexibility in decision making is possible, real options represent the financial reality more accurate than [[NPV]]. The most important difference with NPV is that a pure NPV calculation is not capable of modelling in the decision points that are present in reality. Practical examples of using real options include:
* Model the decision to expand production in at a later date.
* Model the decision to abandon after a first phase of development.
* Model phases to seperare technology and market risk.
There are different ways to calculate real options. The most common ways are:
* [[Black-Scholes Option Pricing]]
* [[Binomial Trees Option Pricing]]
|Option Type|Features|Option type used|h
|Defer|IThe defer options enables postponing decisions until more information is available.|[[Call options]]|
|Stage|The investment is realized in several stages. After each stage, continuation or shutdown of the project can be considered. Returns are generally expected after the last stage|[[Call options]] on [[Call options]]|
|Explore|Investments start with a prototype / pilot version. If successful, real investments in project can begin. Unlike stage options, prototypes and pilots can generate payoffs|[[Call options]] on [[Call options]]|
|Expand|Option to increase future investments.|[[Call options]]|
|Contract|Opposite of expansion option. Cash Flow contraction can be modeled. Usually used to decrease variable costs.|[[Put options]]|
|Abandon / Switch|Option to model an exit from a project. Salvage values can be included to represent sell-off payoff from past investments.|[[Put options]]|
|Outsource|Models the decrease of cost due to sub-contracting. Often it possible to cancel the outsourcing contract with the payment of a penalty fee.|
|Strategic Growth|IT investment results in possibilities to implement future investment opportunities otherwise not available. The underlying of the future investment can differ in underlying and volatility. Used to model infrastructure investments without own payoff|[[Call options]]|
|Compound|Option, which affects the value of other following options and vice-versa.|[[Call options]] on [[Call options]]|
[[Aswath Damodaran|/static/files/MBI/Module%2013/optval.pdf]] mentions three important questions with respect to the relevance of real options:
* [[When is there a real option embedded in a decision or an asset?]]
* [[When does that real option have significant economic value?]]
* Can that value be estimated using an option pricing model?
See also:
* http://en.wikipedia.org/wiki/Real_options_analysis
* http://www.ifi.uzh.ch/pax/uploads/pdf/publication/686/Bachelorarbeit.pdf
</pre>
Replicating Portfolio2012-01-14T21:03:36Z2012-01-14T21:03:36Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Replicating Portfolio<pre>
In [[Principles of Corporate Finance]] a replicating portfolio is defined as the combination of:
* Borrowing money
* Buying a ratio of stock
Such that you replicate exactly the payoff from one call option. The number of shares need to replicate one call is called the ''option delta'' or ''hedge ratio''.
Take the example of a stock with has a current stock price of \$80,- with a maximum downside potential of 25% drop and an upside of 33% increase. This means that the stock can move between
* \$60,-
* \$106,67,-
A call option for \$80,- in this case would be moving between:
* \$0,- (in the case there the stock price was below \$80,-)
* Between \$0,- and \$26,67 if the stock price was moving between and \$106,67,-
* \$26,67 (in the case the stock price was exactly \$106,67,-)
How should we value such a call option? There are two methods of calculation:
!Calculate option delta
The option delta can be calculate as follows:
$\Large \text{Option delta}$ = $\Large \frac{\text{Spread of option prices}}{\text{Spread of share prices}}$=$\LARGE \frac{26.67 - 0}{106.67 - 60}$=$\LARGE \frac{26.67}{46.67}$=$\LARGE \frac{4}{7}$
$\LARGE \frac{80 - ((4/7) \cdot 80)}{1.025}$= $\Large 33.45$
A more intuitive way of calculating the amount of money that needs to be borrowed is to simply subtract
The value of the call is then:
$\Large \text{Value of call}$ = $\Large \text{Value of (4/7) shares}$ - $\Large \text{33.45 bank loan}$ =
= $\Large 80 \cdot (4/7) - 33.45$ = $\Large 12.26$
!Risk Neutral Valuation
<<tiddler [[Risk-Neutral Valuation]]>></pre>
Risk-Neutral Valuation2012-01-14T20:50:10Z2012-01-14T20:50:10Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Risk-Neutral Valuation<pre>
In [[Principles of Corporate Finance]] the risk neutral valuation is calculated by assuming that investors are indifferent to risk and expect return on stock to be equal to the risk-free rate of interest. Furthermore it assumed that stock have a certain downside potential $\Large d$ and and and upside potential $\Large u$. There is a certain chance $\Large p$ that the stock will go up with percentage $\Large u$ and a chance of $\Large 1-p$ that the stock will go down with percentage $\Large d$. This gives:
$\Large \text {Expected Return}$ = $\Large p \cdot u + (1-p) \cdot d = r$
This gives the general probability of rise of the stock:
$\Large p$ = $\LARGE \frac{(1 + r) -d}{u - d}$
Valuing a call this way gives ($\Large k$ is the exercise price):
$\Large \text{Expected value of a call}$ = $\LARGE \frac{p \cdot max(Su-k,0) + (1 - p) \cdot max(Sd-k,0)}{1 + r}$
Using the same example as in [[Replicating Portfolio]] we get:
$\Large p$ = $\LARGE \frac{(0.025) - (-0.25)}{0.33 - (- 0.25)}$ = $\Large .471$
$\Large \text{Expected value of a call}$ = $\LARGE \frac{0.471 \cdot max(106.67 - 80,0) + (1 - 0.471) \cdot max(60-80,0)}{1 + r}$ = $\Large 12.26$
</pre>
Pay-off Diagram2012-01-14T19:17:15Z2012-01-14T19:17:15Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Pay-off Diagram<pre>
A ''//pay-off diagram//'' below represents the effective pay-off of a long put position of an option at the time of the expiry date. It looks at the option from the point of view of buyer.
* The //''X-axis''// in a pay-off diagram represents a range of possible share prices.
* The //''Y-axis''// in a pay-off diagram represents the profit or loss that can be realized at the time of expiration.
* The strike price represent the upfront agreed price for the option.
<<image /static/files/MBI/Module%2013/payoffdiagram.png width:600>>
This image reflects all option types in one diagram:
<<image /static/files/MBI/Module%2013/callsandputs.png width:600>>
!Buying a call
Buying a call buys you the right to buy a stock at expiration for the exercise price. It costs you immediate money. You win than money back if the stock price at exercize is higher than the strike price. If it is lower, you lost the money you invested in the call.
!Writing a call
By writing a call you promise to your buyer you will sell the stock at expiration for the exercise price. Writing a call gets you immediate money. You cannot loose money by writing a call but if the stock price is much higher than the exercise price at expiration, it will feel like it...
!Buying a put
If you buy a put you buy the right but not the obligation to sell stock at the agreed exercise price.
!Writing a put
By writing a put you promise to buy stock at the exercise price. Writing a put gets you immediate money. But you risk loosing that money and much more (up to the full amount of the stock price) if the stock price turns out to be lower than the strike price. You can risk that you need to
<<tiddler [[Financial Options]]>></pre>
M12-S1 - Reading - Principles of Corporate Finance - Chapter 212012-01-14T18:53:04Z2012-01-14T18:53:04Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/M12-S1 - Reading - Principles of Corporate Finance - Chapter 21<pre>
<<tiddler [[Option basics]]>></pre>
Principles of Corporate Finance2012-01-14T18:52:04Z2012-01-14T18:52:04Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Principles of Corporate Finance<pre>
<<formTiddler [[NewBookTemplate]]>>
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[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 1]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 2]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 3]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 6]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 7]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 8]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 9]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 21]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 30]]
[[M12-S1 - Reading - Principles of Corporate Finance - Chapter 31]]<data>{"ReadingCompleted":true,"Author":"Richard Brealey","Title":"Principles of Corporate Finance"}</data></pre>
Fundamental relation between call and put2012-01-14T18:51:37Z2012-01-14T18:51:37Zdirkjanhttp://finance.dirkjanswagerman.nl/profiles/dirkjanfinance_public/Fundamental relation between call and put<pre>
In the picture below you can see a fundamental relation between a call and a put:
<<image /static/files/MBI/Module%2013/fundamentaloptionrelation.png width:800>>
{{{
Buying share + Buying a put = Depositing the prevent value of the exercise price in the bank + Buying a call
}}}
In human language this means that:
* Buying a call and saving the money of the exercise price
Is the same as
* Buying a put and buying the share
Other forms of this relationship are:
{{{
Value of the put = Value of the call + Present value of exercise price - share price
}}}
Buying a put is identical to:
* Buy a call
* Invest present value of exercise price in safe asset
* Sell share</pre>