Foster MBA 2012 Finance Jump Start - Gilbert - Day 3 With Notes and Answers

7/29/2019 Foster MBA 2012 Finance Jump Start - Gilbert - Day 3 With Notes and Answers

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MBA Jump Start

Finance Day 3

Thomas Gilbert

September 21st 2012

Thomas GilbertFinance Day 3 Page 2

Todays Plan Excel is a very important tool for finance (and also for the other courses)

Model building

Pricing

Sensitivity analysis

Today, we will cover

Time value of money in Excel

Simple valuation models in Excel

Wrap-up the course


2/12


On the Jump Start Website

I posted:

Answers to quizzes 1-4

Day 1 and 2 slides with my Tablet notes and answers

Answer to the home mortgage assignment from yesterday

I will post:

Day 3 slides with my Tablet notes and answers

A spreadsheet with todays mini-valuation cases done

Answers to quiz 5

Answers to the recommended textbook problems

If you are missing something, you can always email me

Quick Review Problem Your company has just undertaken a new venture for a cost of $2m (all

spent at t = 0). No cashflows are expected in the first two years, but

starting at t = 3, you are forecasting an annual profit of $100,000 for 8

years. After that, the project will be terminated.

Assuming a discount rate of 12%, was this project a good idea?



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Discount Rates, Again

What does the rtrepresent?

The discount rate used for computing NPV should represent the best

alternative use of your capital

This is sometimes referred to as the hurdle rate or opportunity cost of

capital

In practice, the discount rate often comes from the return on an asset (bond,

traded stock, etc.) with comparable risk

This is called the risk-adjusted discount rate

In the world of riskless payoffs, we can get the rate from U.S. Government

bonds and bills (since they are considered riskless)

1. Finance in ExcelPlease download spreadsheet from course website


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Discounting in Excel

Build an Excel table to calculate the PV at year 0 of each of the following

cashflows and the resulting PV of the stream of cashflows for the given

discount rates

Key points:

Insert formulas using =

Insert the formula in the top row and then drag

Excel can easily handle problems with different discount rates

It can also handle cashflows that are not evenly spaced

Year CF Discount Rate PV(CF)

1 50 0.04 =C4/(1+D4)^B4 48.0769230769231

2 60 0.05 =C5/(1+D5)^B5 54.421768707483

3 100 0.055 =C6/(1+D6)^B6 85.1613664183823

4 80 0.08 =C7/(1+D7)^B7 58.8023882237163

5 150 0.07 =C8/(1+D8)^B8 106.94792692255

PV =SUM(E4:E8) 353.410373349055


NPV Function What if the discount rate is constant for all years (flat term structure), say

6%?

HP-12C can handle that

Use the same table as before and replace all the discount rates with 6%

There is a shortcut: the NPV function

How do we enter a function?

Go to the cell where you want the result

Enter = followed by the name of the function and then (

or Go to Insert, Function, Financial, and find the one you need Enter all the parameters you need and press enter

So we have: = npv(rate , cashflows)


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NPV Function (2)

What is the PV at year 0 of the previous stream of cashflows with a

constant discount rate of 6%?

Trick with the NPV function: It actually calculates the PV of a stream of

cashflows with constant discount rate, where the first cashflow is one

period ahead of where you want the PV

Change the discount rate to 5%. What is the PV?

Change the discount rate to 10%. What is the PV?

Key points:

Put all the primitives at the top of your model, so that you can change

them easily

Use F4 to block the fixed cells before dragging (here, you need to blockthe discount rate)


Project NPV in Excel The previous stream of cashflows actually are the expected cashflows from

a new venture which cost $400 today to set up

What is the NPV of the project and should you invest in it?

Key point:

Since the NPV function assumes that the first cashflow is one year

ahead, you need to add the year 0 cashflow separately

You can change the discount rate and see how the NPV changes

As the discount rate decreases, the NPV increases since the PV of the

future cashflows increases


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Bonds in Excel

What is the price of a 10-year Eurobond with $1,000 face value, 6%

coupons, and a yield-to-maturity of 7.5%?

Lets use both methods:

Full PV table

NPV function

However, there is another shortcut for bonds:

All the HP-12C functions (n, i, PV, PMT, and FV) are in Excel

Functions: nper(), rate(), pv(), pmt(), and fv()

For the price, we want to use pv(), where the primitives are the yield, the

number of years, the coupon payment, and the face value


Bonds in Excel (2) In Excel, it becomes easy to see what happens when you change some

parameters

This is called sensitivity analysis: how does the outcome change when

you change the base parameters?

What happens to the price when you raise the yield?

What happens to the price when you decrease the yield?

Hence the answer to the classic investment banking interview question:

What happens to bond prices when interest rates rise?

They fall!!!


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Yield-to-Maturity in Excel

Lets price the following bond:

What is the yield-to-maturity of the bond?

Use the function rate()

Year Cashflow Discount Rate1 $50 3%

2 $50 4%

3 $50 5.5%

4 $50 8%

5 $1,050 7%


Break No quiz

Just a 10-minute break today


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2. Mini-Valuation Cases


Model-Building in Excel The power of Excel for valuation is that if you have built your spreadsheet

in a fully-linked way, you can easily see the impact of a change in the

primitives

Therefore, here are some things you should always do

Put all your primitives (assumptions) at the top

Build your spreadsheet so that all the formulas flow from these

primitives (no manual entries of numbers half-way through)

Valuation Cases: For each of the next two problems, you will work on your

own or in groups (2-4 people) for 15 minutes and then one of you will

present his/her results to the rest of the class


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P-pod Investment

Mr. Gonzales owns an import/export business. He is investigating whether to

import a new gadget from Asia a P-pod, which can be used to watch family

photos while driving. Mr. Gonzales estimates the market size for the gadget to be 10,000 units the first

three years and then 50,000 for three years. After this, the gadget will be obsolete.

Mr. Gonzales thinks he can price the gadget at $100 the first two years, at $75 the

following two years and at $40 the final two years. There is a cost of $10 associated

with selling a gadget (shipping), and Mr. Gonzales pays $25 per gadget to the

manufacturer. Mr. Gonzales expects these per-gadget costs to be the same every

year. Moreover, Mr. Gonzales will need to rent a warehouse at a cost of $50,000

per year. Finally, if Mr. Gonzales goes ahead, he must pay the Japanese

manufacturer a one-time license fee of $3 million, to obtain the proprietary rights to

sell the gadget in the US for six years.

Mr. Gonzales is not sure how future cash flows should be discounted (they are

uncertain), but he thinks using a discount rate of somewhere between r = 8% and

r = 15% makes sense.

Should Mr. Gonzales go ahead with this project?


Introduction to Company Valuation The price of one Google share on July 19, 2006 was $398, which implied a

company market value of $120.5B (= price per share * number of shares).

Google reported annual earnings of $1.5B for 2005.

a) Assume that Googles earnings will be constant in perpetuity. Which

discount rate would motivate Googles current market value?


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Introduction to Company Valuation (2)

b) From a), clearly Google is expected to expand. Assume that Googles

earnings will be constant for 3 years, then jump to a new, higher, rate

and thereon be constant in perpetuity. Assume the correct discount rate is12%. How much would Googles earning have to jump to motivate its

current market value?

3. Wrap-Up


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Expectations

I am attaching a final quiz (Quiz #5), which you should be able to solve on

your own at the end of this workshop

If you are having trouble, please get help before the start of the quarter

Remember that the topics covered in this workshop will be assumed known

at the start of your core finance class

You will have to hand in a bond valuation case on the second day of

class

I advise you to look back through these notes and problems the week

before the start of the quarter, in order to refresh your memory


What We Covered Time value of money

Present values, discounting

Future values, compounding

Net present values

Annuities and perpetuities

Bonds

Bond pricing

Yield-to-maturity

EAR vs. APR

Mortgages

Model-building in Excel


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Whats To Come

In the core finance class, you will learn to value much more complex

projects

A firm is a group of projects

A key role of managers is to choose the best projects: NPV > 0

You will learn how to rank projects

What makes one project better than another?

What techniques do we use to account for the risk of projects?

What criteria should managers use to rank projects?

What criteria do investors want managers to use?

Your knowledge of accounting will become important since financial

information is always summarized in accounting statements


Conclusion Thank you for a very fun week

Hopefully, you have learned a lot about finance

And you are excited about learning more this quarter

Do not hesitate to contact me if you have any question

See you next week!!!

Always Remember Gordon Gekko :

Money never sleeps pal.

This is your wake-up call.

Go to work.

Foster MBA 2012 Finance Jump Start - Gilbert - Day 3 With Notes and Answers

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