FINS1613 FORMULAS

Compounding:

interest rate
100
Value t +n=Value t (1+ r)n

Interest= principal
Discounting:

Value t=

Value t +n
n

(1+r )

Annual percentage rate (APR)

APR = Per Period IR x Number of Compounding Periods per Year

APR =r n
Effective annual rate (EAR)
The total amount of interest that will be earned at the end of one year with
compounding.
n

EAR=(1+ r) 1
Converting APR to EAR

EAR=(1+

APR n
) 1
n

Converting EAR to APR

1
n

APR =n [( 1+ EAR ) 1]
Annuities
A stream of cash flows arriving at a regular interval over a specified time period.
Constant annuity:

1
1
Annuity Value t =C (1
)
r
( 1+r )n

The annuity value formula gives the total time-t value of all n cash flows
beginning at t+1
Annuity factor:

PV ( C for n periods at interest rate r )=C

1
1
1
r
( 1+r )n

)
C annuity factor ( n ,r )

1
1
Annuity Factor ( n , r ) = (1
)
r
( 1+r )n
Growing annuity value:

1+ g
1+ r

1( n )
Growing Annuity Value t =C

r g

The growing annuity value formula gives the total time-t value of all n growing cash
flows beginning at t + 1

Perpetuities
A stream of cash flows that occur at regular intervals and makes payments
forever
Constant perpetuity:

Perpetuity Valuet =

C
r

The perpetuity value formula gives the total time-t value of the infinite cash
flows beginning at t + 1
Growing perpetuity:

Growing Perpetuity Value t=

C
rg

The growing perpetuity value formula gives the total time-t value of the
infinite growing cash flows beginning at t + 1
A constant annuity is a growing annuity with no growth:

1+ g
1+r

1+r

( n)
1
1
1
1( n ) with g=0 C
r

1
C

rg
A perpetuity is an annuity that makes an infinite number of payments (provided g < r):

1+ g
1+ r

C
as
1( n ) n
rg

1
C

r g
Scaling of cash flows and valuation
If the time t value of the cash flows is:

Value t ( Ct +Ct +1 +C t+2 + )= X

Then the time t value of M times the cash flows is:

Value t ( M Ct + M C t +1+ M C t +2+ ) =M X

Adding and subtracting cash flows
If the time t value of the cash flows A and B are:

Value t ( A t + A t +1+ A t+2 + )= X

Value t ( B t + Bt +1+ Bt +2 + )=Y
Then the time t value of the combined cash flows is:

Value t ( A t + Bt + A t +1+ Bt +1 + At +2 + Bt +2 )=X + Y

The values X and Y must be at the same reference time and use the same
discount rate.
Delayed & accelerated cash flows
If the time t value of the cash flows

Value t ( Ct +Ct +1 +C t+2 + )= X

Delays by s periods

Value t ( Ct +Ct +1 +C t+2 ++ delayed s periods )=

Delayed cash flows are received later.
They are worth less, so divide
(discount)

Accelerated by u periods

XValue t ( Ct +Ct +1 +C t+2 ++ accelerated u periods )=X (1+r )

(1+r )s
Accelerated cash flows are received
earlier. They are more valuable, so
multiply (compound)

Bond Valuation

Bond=

c
1
FV
1
+
C= per period coupon pa yment
n
r
( 1+ r )
( 1+ r )n
n=number of periods
PV =face value

r= per period yield

Couponrate face value

number of payments per year
Bond value=PV ( coupons )+ PV ( face value )
Bond value=PV ( annuity ) + PV ( single cash flow)
Coupon payment=

Zero coupon bonds

Bond value=

FV
( 1+r )n

r= per period yield

Fisher effect

n=number of periods

PV =face value

1+ Nominal Rate
1+ Inflation Rate
Growth of money

Growth of prices

Growth purchasing power=1+ Real Rate=

Real rate=

Nominal rateInflation rate

=Nominal rateInflation rate
1+ Inflation rate

Total return from equity ownership can be separated into two components:
Dividend yield: a shares expected cash dividend divided by its current price
Capital gain: the amount by which the selling price of an asset exceeds it initial
purchase price.
Capital gain rate: the change in stock price as a percentage of the initial price
Total Return = Dividend yield + Capital gain rate

1 + P1
1
P0

P P0
1 ( dividend yield ) + 1
(captial gain yield )
P0
P0
r E=

A one-year investor
Value of the stock today: P0
Expects to receive a dividend of Div1 in one year and sell the stock for P1

P0=
An n-year investor
Value of the stock today: P0

Div 1 + P1
1+r E

Expects to receive a dividend of Div1 each year through to time n. At time n, will
receive a final dividend and sell the stock for P n

1+r E

1+r E

Di v 1 2
P 0=
+
1+r E
An infinite horizon investor

1+r E

1+r E

1
2
P 0=
+
1+r E
Constant dividend growth model

P 0=

1
r

P 0=

1
r Eg
r E=

1
+g
P0

Retention rate: The fraction of earnings that a firm retains for new investment.
Return on new investment: Measures the ability of a firm to turn investment into
earnings. It is the ratio of new earnings to new investment

dividend payout rate+ retention rate=1

Estimating dividend growth

t =

Earningst
Dividends pai d t

Shares outstanding t
Earnings t

EPS t Divident payout ratet

Assume the dividend payout rate is constant, then

t +1 t
t
EPS t +1 Dividend pa yout rateEPS t Dividend payout rate

EPS t Dividend payout rate

Dividend growth ( g )=

EPSt +1 EPS t
EPSt

An estimate for earnings growth is an estimate for dividend growth

Assuming dividends are paid from earnings, estimating dividend growth requires
estimating earnings growth.
Use accounting measures to:
- Determine the amount of earnings retained for new investments
- Determine the return on this new investment

g=

EPS t +1EPS t
EPS t

New earningst +1
New Investment t New Earnings t +1

EPS t
EPS t
New Investment t
Retention Ratio Return on New Investment

Assuming the dividend payout rate is constant, the dividend growth rate can be
expressed as follows:

Divident growth=retentionrate RONI

( 1dividend payout rate ) RONI

RONI: return on new investment

Growth in dividends:

Growthdividends=

t +1 t
t

EPS ( 1payout ) RONI payout

EPS Payout

( 1 payout ) RONI

retention RONI
Total payout
The total amount paid by the firm to shareholders through dividends and share
repurchases. Total payout is expressed as a dollar amount for the firm and NOT
normalised by the number of shares outstanding.

Total payout=Dividends+Share repurchases

As share repurchases changes the number of equity shares outstanding, total
payout per share would not be a meaningful measure.

Total Payout Model

The dividend discount model can be easily adapted to allow for share repurchases:
Estimate total payouts (dividends + share repurchases) to equity. Do not
normalise by the number of shares.
Use total payouts as cash flows to equity in valuation model.
Discount payouts at the cost of equity to the market value of equity.
Divide market value by current number of shares outstanding to find current
share price.

P 0=

PV (Future total dividendsrepurchases)

Shares outstanding

Equivalent annual annuities

The constant annual cash flow that has the same present value as the actual
cash flows of a project

Equivalent annual annuity cash flow=

present value
1
1
(1
)
r
( 1+r )n

Profitability index
The net present value of a project per unit of resource consumed

Profitability index=

NPV
resource consumed

Capital budgeting

Assets=Liabilitites+ Shareholder s ' equity

Incremental Earnings=Inc remental EBIT x (1tax rate)
Net working capital = working capital assets working capital liabilities
Net working capital = accounts receivable + inventories accounts payable
The indirect method

IncrementalCF=incremental earnings+depreciationCapEX + after tax salvagechangenet working capital

FCF=Incremental EBIT ( 1tax rate ) + depreciationiCapE Xchange NWC
( RevenuesCosts Depreciation) ( 1Taxrate )+ depreciationCapEX change NWC
( RevenusCosts ) ( 1Tax rate )CapEX ChangeNWC + DepreciationTax
Depreciationtax shield=Depreciation Tax rate
After tax earnings= ( revenuescostsdepreciation ) ( 1tax rate )
After tax salvage=salvage price ( sale price )taxrate capital gain(sale pricebook price)