Preview of Lecture 1
Ans 10 CF Annuity Factor Quarter to Annual Discount Rate
10 0.689156 0.215 0.21550625
21.550625
Present Value 21.71334
Discount rate will be as per Cashflows.
New Concepts
Example 8(b)
Perpetuity With Growth
CF1/(d-g) 250
Growth in cahflows will reduce effective Discount Rate
Will growth rate increases bove discount rate?
Mathematically yes and formula change
Logically no
Example 8©
Rate to Quarter
Cashflow Quarterly
0.0241136891 2.411369 Discount Rate Quarterly
322.51585169
CAPM - For determining cost of equity
Coefficient means kisi bhi che
CAPM is not capable of determining value of equity. KSE 100 index is a benchmark
Rf
Risk free rate is the rate of 1 year treasury bill. As treasury bill is from government and is Ab company ka average is sa
considered risk free.
Rm Numerical
Average Market Return - Stock Markets average return
Co. X
1. Be the average of benchmark index.
2. Like for Pakistan stock exchange it is KSE- 100 index. Which it is an average of top 100 companiValue of share?
It is readily available. - KSE 100 Index
Beta equity - Be (Only include systematic risk.) Cost of
Equity
Coefficient of systematic risk
Like when we invest in as shres of a company, we may encountered risks, such as:
1. Company's revenue may jpot exceed.]
2. Companys profit decline
3. Company fire
Categorized in to Systematic and non-systematic.
Nonsystematic - Company Specific
e.g. OGDC
Ghalat policy
senior management fraud
R5ecevable not collect
cost control
Systematic Risk - Macro Risk (Not because of Company)
EXCHANGE RATE - Import expensive
Infltain - Less use of Oil
Political Condition
Well diversified Invwestor will not get non-systematic risk. As if there are company specific risks( Non- systemsati
Coefficient means kisi bhi cheez ko 1 keh dain mutlub benchmark.
KSE 100 index is a benchmark - is equal to Be - 1.
Ab company ka average is sa uper ya neeche ha to uss ka Be dekh ka uss ka risk ka andaza ho ga. Company ka Beta equity 1 sa kum ha to
Numerical
Value of share? = (10(1+.03))/(Ke-g) 56.59341
Ke = Rf+(Rf-Rm)Be
Ke = 21.2 %
Cost of Equity 1. DVM
2. CAPM
Value of Equity DVM
specific risks( Non- systemsatic), they will not affect him as he switched to other alternatives. That's why beta only takes affect of system
ka Beta equity 1 sa kum ha tou risk kum ha average sa.
beta only takes affect of systematic risk.
Chapter 3 Notes
Example
Cost of Debt
BASED ON TYPE OF DEBT 1. Ireedemable Debbt
but, 2. Redeemable Debt
Higher
Value of Debt
Simple
1 Its value is same as its face/ nominal value. - For Bank Loan
Lower
2 Other loans are computed witgh the formula - PV of Debt Cahflows @ comparable yeild.
Formula of other than bank loan debt: --- Bonds, Debentures etc. Check percentage of positive
If
Are of two types.
1. Traded/ Listed Their MV are their price. -- No calculation needed.
Equity In value of equity we read that MV may not be a reflection of Val..
Debt But know in case of debt, with protests they will not fall with th ..
2. Non- Traded
Agur kum interest han tou kum main hi khareedain ga PV kar ka.
Example 97.55629
Cost on Debt
Kd=I(1-T)/P.
Tax ki choot hoti agur interest pay karo tou
isds wajah sa less kar dete hain
Cost of Debt and cost of equity is time sensitive i.e. At time --- as at..
We use tax rates and estinations of that date.
Highher tax rates means lower cost of debt.
Lecture 5
Kd = ?
63 -141.6315 0.064842
59.78898 Kd = 6.484183 %
IRR
Check percentage of positive number with respect to the total number. To chose which percentage to take for negative number.
<10% then use a gap of 5% to choose another percentage.
5% 10%
Curvy Linear IRR Only in Excel and Financial Calculators
Linear IRR We use it , no issue.
for negative number.
All redeemable preference share have working like debt. & classified as debt.
Redeemable at MV prevailing on date of redemption:
- Redeemable debts which are redeemed at there FV at the time of redemption. Will be treated as a simple bank loan and the
- Kun ka theorist ya bmanta ka innm pa koe faida nae ho ra. Jitni MV ha utna poa hi mil rae tou ya bhi normal bank loans ki tar
- No need for value determination bcz always traded in market so available.
- No benefit no loss
- Kunka parvalue sa zyada ya kum nae hona dete. Aisay bonds ki value automatically par pa aa jati redemption ka time.
- Market value appproach par.
Floating Interest rates
is based on central bank discount rate / policy rate.
Minimum rate fir dealing bw Banks or with state bank.
Kibor rate is average rate for day. Between financial sectors.
Usually 1 yr KIBOR for no matter how long is
as a simple bank loan and there cost of debt is to be computed as a simple bank loan.
a bhi normal bank loans ki tarah treat honay chaiyain.
ti redemption ka time.
Lecture 8
Ex 10 - Pg 23
Change share price growth in a question to 6%
]]
Lease is not a source of finance in financial management.\
Ex Interest & Cum Interest
In a real world the value of investment grade credit rating bonds is usually and mostly cum-interest.
Normally as per bookish knowledge cum- interest value is usually at the time of interest of Interest payment at near 31-Dec.
Tax deductibility
Ex 12 - In this case no relevance of Tax as tax becomes irrelevant, bcz its FTR Income and tax on revenuie no intervention of ep
Fixed Income Investment
Not in our course.
S13-Q2
3 Alternatives
At date of issuance MV is equal to issue price, bcz debentures are not yet issued.
MV/ Issue price =?
Usually we issue at discount bca uss ki market value hiu kum ho gee uss din.
expected rates are comparable yield.
Tax rate is 30%
est payment at near 31-Dec.
revenuie no intervention of epenses.
Question
If dividend is total in formula, then we will also take total value P., same conventions for numerator and denominator.
Either per bond or total no effect.
Irredeemable bonds considered as equity kunka paisa nae milna wapis , shares ki tarah lambay main chalay ga.
NPV
Any incremental gain from NPV would be a benefit of shareholders.
Debt providers had no benefit, bcz they have fixed interest. They don’t have any benefit from this NPV.
Reducing tip:
1st Yr Dep * (1-D)
D= Dep % 1st Year
Example
Course 1
Real cashflows based on current values. No need fro projection of inflation.\
NPV from real and nominal cashflows are same. Because this two are there own mathematical identicals. No difference.
- which method to use in exam.
Same inflation rate on revenue and cost in above example, so that's why there is no difference
either from nominal or real cashflows. Because both are derived from same formula. But if
there is any difference in Inflation rates of Revenue and costs, then we use General price index
for computing WACC from nominal to real.\
So when rates are different use nominal cashflows with nominal returns to compute NPV.
ator and denominator.
main chalay ga.
identicals. No difference.
W 19 Q3: (Relevant cashflows & working capital impact on NPV)
S 13 - Q4:
Kathkhair Engineering Limited
Skilled Unskilled
Labour Hours 22500 52500
Relevant CYr 1 2,250,000 3,000,000
Yr 2 2250000 3,000,000
Prepaid rent --- Prepaid Expense for Tax
Q with Decision Tree :
Khayyam Limited
Decisions Decisions Scenarios Prob. Expected CF
Y1
1 Y1: 84-87 1 Y1: 84-87 84-87 20% 250
Y2: 84-87 88-91 65%
92-95 15%
2 Y1: 84-87
Y2: 88-91 2 Y1: 88-91 84-87 5% 320
88-91 50%
3 Y1: 84-87 92-95 45%
Y2: 91-95
4 Y1: 88-91
Y2: 84-87
5 Y1: 88-91
Y2: 88-91
+18.99
6 Y1:88-91
Y2: 91-95
+128.49
+128.49
NPV
Y2
280 219.30 249.6922 468.99
330 -450
360 18.99
340 280.70 297.7839 578.49
380 -450
400 128.49
Sensitivity analysis
The outcome of expected NPV is not even our estimat- Problem
It will evaluate on the basis of Inputs like CF's, Discount Rates, Life of project
1. First we will made NPV from the data. - All inputs were used to prepare NPV. - What if is there is a change in t
2. then we will perform sensitivity analysis. /
/
Its NPV will change too.
/
So we perform sensitivity analysis
1 Sale Sensitivity Sensitivity analysis will predict how much sale will be r
Form: NPV/ PV of post tax relevant CF's.
Sir Example: If we change sale our tax will also get affected.
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Iss sa jo percentage aati uss ka ya mitlub ha ka kitna hum apni sale price
2 VC/ unit
Same formula.
Percentage shows that from this % V.C. will increase to get zero NPV.
Variable of S.P. is more important bcz we oly have a room of 10%. Bohut thora margin ha. Variable cost main 31% ka margin
3 F.C per annum
Same formula
4 Sale Volume
Sale & V.C.
IRR bhi Investment appraisal technique ha, wo tou hum isay bus Kd wghaira nikalana ka lia use kar lete hain.
IRR====> PV of CF's = 0
At investment appraisal, lets say we have
IRR=25% Agur 25 pa NPV zero ha tou iss ka matlab ha ka iss sa neechay 15% tuk
15% wacc So it’s a positive NPV project.
Good It’s a positive NPV project.
- So Investment appraisal main donu metthods ka lia alug practice nae chaiya kun ka CF's nikalna hi asul fankari ha aur wo don
NPV ka lia WACC use kartay hain.
Payback
An investment appraisal technique
Mutlub jo invest kia uss ki wapsi ho gae == - Hum log ya find kartay ka uss ki wapsi kitna arsay amin ho gee.
)
(
Life of project sensitivity
Payback aur project life main jitna furq ha wo hamari life of project ki sensitivity ha.
Exchange rate sensitivity===> will affect selected CF's, only related to imports & exports.
Inflation sensitivity
It will not affect NPV. Technically No sensitivity of inflation.
Nominal Bcz NPV is present value tou iss main koe
Real CF & CF & bhi varrying inflation rate ho future ka 10,
Vs. Have same NPV.
Real Rate Nominal 15, 20% iss ko furq nae para gaa. Kun ka
Rate ya aj ki value ha.
Aur agur lets say hum revenue ko hass kisam ki escalation da dete hain year on year, tou iss ki sensitivity infaltion ki nae balka
Quesiton
IRR ==> Investment appraisal techniquee:
Npv= =-100+(20/d)
Maslay hain IRR main.
- What if is there is a change in these variables when actually been incurred.
ill change too.
tivity analysis
will predict how much sale will be reduced to get zero NPV.
ub ha ka kitna hum apni sale price kum karain ga tou hamara project ki NPV zero ho gee. Aur zero NPV wala project beneficial bhi nae hota
. will increase to get zero NPV.
Variable cost main 31% ka margin ha iss lia bachat ho jae gee.
use kar lete hain.
lab ha ka iss sa neechay 15% tuk koe bhi rate ho uss pa NPV positive hi ho gee
alna hi asul fankari ha aur wo donu main common ha.
y amin ho gee.
value tou iss main koe
n rate ho future ka 10,
nae para gaa. Kun ka
value ha.
ki sensitivity infaltion ki nae balka normal sale price ki sensitivity ha.
project beneficial bhi nae hota.
Lecture 15
Targeted NPV/ IRR
Targeted payback =======> Kisi bhi cheez ko target kia ja sakta ha.
- When there are two variables in NPV/ IRR------- Aik ho tou araam sa d
- Tou wo kisi aur ka sath ka sath taaluq batae ga NPV ka tub hi hum NP
Independent scenarios - Numericals
CEO +20M npv
a equal
b 10% increase
c at end and upfront - Upfront wali CF known ha tou isay CFs ka sath hi lain ga idhar bohut s
d
e Tax CFs to be pushed forward. 1 year
Profitability Index
S14 Q2: S11 Q4: Chapter 5 -8
RR------- Aik ho tou araam sa dhoond lete. Pur do hun tou examiner zyada batae ga aur hum simultaneous equation sa solve karain ga,
atae ga NPV ka tub hi hum NPV nikal saktay.
a sath hi lain ga idhar bohut scenarios hain tou iss lia direct hi 3rd step main lia ha.
equation sa solve karain ga,
BASIC INVESTMENT APPRAISAL
Ch 4 complete Study text Ch 5-8 Plus do past papers mentioned in a notes.
Solve practice Kit
Chapter 5
Curve
Chapter 4
Advanced Investment Appraisal and WACC
Deals with impact of financial risk on WACC or NPV/ Value.
1. Traditional theory :
- Saucer shape
- WACC minimum, NPV max., Co. Value max.
Debt iss lia kum hota ha kun ka Rsik bhi kum hta ha aur tax benefit bhi milta ha.
Post tax interest expense --- Kabhi kabhi aisa bhi ho sakta ha ka hum isay post tax nahi kar
saktay kun ka hamara interest itna barh jaata ha ka hum ya expect nae kar saktay ka aglay 6 saal
main hum ya loss recover akr sakain ga tou direct post tax expense ane nikalain ga
2. Modigiliani and Millers theory:
Cost of debt hamesha cost of equity sa kum hota ha. Pur hum ya dekhte hain ka jitna cost of
equity barhta ha pur kunka cost of bedt kum ha tou ya assume kartay hain ka cost of equity bhi
utnay sa kum ho jae ga.
Jis ki wajah sa WACC constant rehta ha.
It is not true in practice.
Wih Tax
With increase in gearing WACC will get reduced. Because the tax benfit on Kd increases when
the gearing increases. Pur Ke tou wese hi barha gee jese without tax main barhti tou iss wajah
sa ya curve neechay aye gaa.
With tax Value is highest and WACC is lowest at maximum gearing.--------Practically not correct.
Tax Benefit on debt
Iss main change ki wajah sa jo value ka increase ha uss ka faida equity walun ko jae ga.
CF remain the sane.
Lecture 18
What is the impact of financial risk on NPV/WACC/VALUE?
1. Abhi tuk total capital constant hi rehta tha equity sa bedt ya debt sa equity repay karatay thay.
Case 2. Change in a capital structure-----new project
Example with new project
Agur geared sa mazeed gearing main jaa rae tou pehlay sub ungear karain ga aur phur sa
WACC formula use karnay ka bajae direct nikal lo tou zyada sae ha jaldi ho jae ga .
M&M PRACTICAL USE
New Project NPVg ----------> Discount Rate'----- WACCg
Finance say that for
- Normal running projects-------- Existing WACC of Co.
- Special projects ----------use project WACC.
- Normal Running + significant project ---------Company revised WACC after incl. this project.
Akhri wala bohut kum use hota ha . And it is impossibke to apply unless M& M theory applies.
M &M theory of Capital Structure
With tax Without tax
WACC is going to be decreased - Ke geared company ki utni hi zyada ho gee Ke U
due to tax shield. company sa jitna WACC gira sasta debt ki wajah sa .
Keg=Keu+Dg/Eg(Keu-Kdg)
Shortcomings of M7M theory:
1. Practically Ke & Kd will immediately rise significantly at high gearing.
2. Agency Cost (Mngt. Agent of shareholder tou masla ho jaata ha shartun ki wajah sa debt providers ki tou agency cost
3. Bankruptcy Cost (Koe durr ka aata nae ha tou business affect ho jaat ha).
4. Tax Exhaustion
Vg=Vu-DT-PV of agency cost-PV of bankruptcy cost
Pur practically ya theory ya sub aspects ignore karti ha. Jis wajah sa ya effective nahi ha.
Risks
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Business Financial
Hamada equation
Be=Ba ------If entity is 100% equity financed
No business risk.]
- Hamada eq na sirf financuial risk ko cover kia ha
- ya business risk ko cover nae karta
- ya M&M ko use kar ka bana ha tou iss sa jo Ke ka answer aata woe aksar hamara M&M sa bhi aata ha.
Pureplay Method
Hmaada ko istemakl kar ka iss na ya banaya ha.\
- He gave the method to capture financial risk.
t providers ki tou agency cost barh jaati.)
&M sa bhi aata ha.
Lecture 19
Pureplay :
- In previous lecture we do all things to get revised WACC using pureplay method.
- This WACC is being used to get NPV of new project.
Jis business main ab ja rae uss ka Be alug ho ga. - Gearing zyada ya kum hona sa Be kum ya zy
Example Paint business
Steps:
1. Jis business main jaa rae pehle uss ka uss industry ka Ba nikaltay hain . -- By using avg. Be and Gearing.
2. Phir uss ki madad sa apni Be equity nikaltay hain uss business ka lia, by putting over own gearing in it.
3. Then we will use that Be in CAPM to calculate revised Ke for new project.
4. Than this cost of equity is used to calculate WACC for calculating NPV of the new project.
Till now we read half formula. Now we are going to learn the complete formula.
WACC is time sensitive --- ya badalta rahay ga wakt ka sath. ------- Sath main Be bhi badlay ga.
- WACC calculate kartay hua hum na aik simplictic assumption li hui ha ----- Kun ka MM main equity at
the end change ho jaati due tax shield benefit and NPVu. Iss main shamil ho gee.
- Ya iss lia ho rha kun ka NPV calculate karnay ka lia humain ya equity chaiya/, aur ya equity revise
karnay ka lia hamain NPV chaiya tou ya circular reference bun jata ha.
Company / Group WACC\
- Group main tou dono cheezzain hain food bhi Aur paint bhi, tou iss ka wacc alug tareeqay
sa niklay ga . Both Ve and Vd.\
WACC = Weighted average of betas.
1. Group Ba is computed by weighted average of group.
2. Gear Ba, as done earlier.
3. Ke of group.
(Rm and Rf are same for both industries.)---Rm is for 100 index
market and Rf is for govt. which is common for both businesses of
group.
4. Compute WACC.
- Abhi tuk hamain pureplay ka adha formula samajh aa gya ha.
Pureplay Complete formula
Ba= Be.(E/(E+D(1-T))+Bd.(D(1-T)/E+D(1-T))
Bd is for risk faced by debt providers.
Good company have zero beta debt.
Check: Pre tax Kd is significantly higher than Rf. ---------> Then it must have Bd.
Otherwise assume Bd as zero.
Simple way to calculate Bd is CAPM. However there is specific formula for it too.
Cashflow Lost Vs. Opportunity Cost
1. Shop Rent (Empty) - Opportunioty Cost (Virtual)
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Options Grocery or HARDWARE
- NPV main opportunity costs nae li jaati. Kin ka jo original CF's hoti unhain discount karna
hota. WACC pa. ----- And WACC is the opportunity cost of capital providers.
- iss lia NPV ki CF's main opportunity cost ka impact nahi lete kun ka wo double accounting
ho jae gee,
- opportunity cost is second next best alternative.
2. Shop Rent (Running Hardware Business) - Cashflow lost (Real)
Hardware bund kar ka Grocery shuru karnay ka decision.
- Then we take net cashflows. ---------> Cash lost
-- In NPV we use relevant costs of material and labour,----- those are not
opportunity costs. Uss main hamara paas wo cheezain pari hoti thein.
- Agur udhar naya stock lena hota tha tou uss ki opportunity cost nae lete thay
=== Jitna lene pa kharcha ho ga, utna hi lete the.
- Relevant cost ka mutlub ya hota ka koe cheez hamara paas ha aur iss ko use
karnay ka bajae agur bech dain tou kya mil sakta.
- Pur opportunity cost jo hoti ha wo iss wajah sa aati ka aik cheez abhi le nae ha
aur agur iss cheez ki jagah kuch aur khareedain tou uss pa kitna kharcha aye ga.
W 17 - Q1
Bcz its easy. So, generally used.
Total CF of NPV is called free CF. However banks and financial institutions use
gearing by BV. Whether they want to set -- 1)
Perpetuity----- Grow after 5 year Loan Int. rate. 2) Credit rating 3) Covenant
Return CF lose. Means rent on 50% property lose. ||
100 basis points --- means 1% reduce. -------> ??? Gearing by BV or MV? -- Not mentioned.
10 basis points ------ 0.1% less cost of debt. ||
Alll theories:
a. WACC
b. M&M Gearing by MV.
c. Pureplay
MV is difficult
-6.75%+2%=8.75% Vs. 6.5%
-Beta debt be asumed to be zero. (insignificant)
- M&M sa hum equity ki revised value bhi nikal saktay. Pur jub tuk examiner na kahay nae nikalain gay.
Sawal karnay ka ya tarika rakhna ha ka jo cheez chaiya usay pehlay likhna ha aur phir
sath sath missing niklana ha like in W-2.
- Ba shows business risk.
um hona sa Be kum ya zyada hota ha.
APV is alternative of NPV, for projects which have following attributes;
1. Heavy debt financing
2. Issue Costs on equity or debt
3. Subsidized