## The Discount Factor on Tax Obligations and Tax Shelters

We know the future tax-related cash flows. How do you discount them Let's work a simple example with risky payoffs. The tax payment is as risky as the firm, and thus warrants a higher cost of capital. For our 1-year, non-growing firm, the tax shelter is safer than the firm, and thus warrants a lower cost of capital. Alas, you can often use the firm's cost of capital also on the tax shelter. Why Worry more about the correct discount factor on big amounts. On Page 480,1 stated that it is common...

## Some Other Corporate Tax Avoidance Schemes

Wall Street and Main Street employ armies of tax experts to help their clients avoid taxes, but this is really an arms race between the IRS (Congress) and investors. Investors keep looking for new tax avoidance schemes and the IRS tries to close these new loopholes. There are a large number of both past (now closed) and current tax avoidance schemes. Some of the more noteworthy remaining tax reduction schemes are as follows Sometimes, high-tax firms may be able to purchase low-tax firms, and...

## End of Chapter Problems

Q 6.42 What is the difference between a perfect market and a competitive market Q6.43 What are the perfect market assumptions Q 6.44 What is the difference between a perfect market and an efficient market Q6.45 Your borrowing rate is 15 year. Your lending rate is 10 year. The project costs 5,000 and returns a rate of return of 12 . Should you take the project a if you have 2,000 to invest b if you have 3,000 to invest c if you have 4,000 to invest If you have 3,000 to invest, should you take...

## Reverse Engineering Accounting into Finance

Discounting the Net If you did not know about the details of this machine but saw only the financials, could you heuue o'ect NPV compute the correct firm value by discounting the net income Discounting net income with a t e true project . cost of capital of 12 would yield which is definitely not the correct answer of 73.16. Neither would it be correct to discount the net income with a cost of capital of 10 , Cash flows can be How can you reverse-engineer the correct cash flows for the NPV...

## How Bad Are Mistakes Averaging PE Ratios and the 1X Problem

A P E ratio in which E Unfortunately, averaging P E ratios is not only formally wrong, it can also create huge problems is smaN is bad, bad, by itself. The main problem is that ratios are not sensible if their denominator can be zero or negative. This is the case for the P E ratio. Earnings can be temporarily zero or negative. This can totally mess up any P E ratio analysis. The function 1 E is both discontinuous and very steep when earnings are close to zero. We shall call this the 1 X...

## Application Stock Valuation with A Gordon Growth Model

Perpetuities are With their fixed interest and growth rates and eternal payment requirements, perpetuities are a roximationerfeijt rarely exactly correct. But they can be very helpful for quick back-of-the-envelope estimates. apopfteximveanuseful For example, consider a stable business with profits of 1 million next year. Because it is stable, upper bound. its profits are likely to grow at the inflation rate of, say, 2 per annum. This means it will earn 1,020,000 in two years, 1,040,400 in...

## Important The Yield to Maturity is the quantity YTM which given a complete set of bond cash flows solves the NPV

0 CF0 ITyTM 17 TTYTMP ''' 425 An example of solving In this case, you want to solve the YTM equation. ffmnnnn 5,000 10,000 120,000 0 - 100'000 1 1 YTM 2 1 YTM 3 426 In general, you solve this equation by trial and error. Start with two values, say 5 and 10 . nnnnnn 5,000 10,000 120,000 - 100'000 1 5 U W O W M 17,493 100 000 . 5,000 , 10,000 . 120,000 2 968 - 100, 000 1 10 1 10 2 1 10 3 2, 968 To reach zero, you need to slide above 10 . Try 11 and 12 , - 100,000 1 11 1 11 2 1 11 3 M 363 100 000...

## Returns Net Returns and Rates of Return

The most basic financial concept is that of a return. The payoff or dollar return of an invest- Defining return, net ment is simply the amount of cash CF for cash flow it returns. The net payoff or net return is the difference between the return and the initial investment, which is positive if the project is profitable and negative if it is unprofitable. The rate of return is the net return expressed as a percentage of the initial investment. Yield is a synonym for rate of return. For example,...

## The Annuity Formula

An Annuity pays the The second type of cash flow stream that lends itself to a quick formula is an annuity, which is a stream of cash flows for a given number of periods. Unlike a perpetuity, payments stop after T periods. For example, if the interest rate is 10 per period, what is the value of an annuity that pays 5 per period for 3 periods Let us first do this the slow way. You can hand-compute the net present value to be PV0 1 10 ur1W Ot1W m 12.4343 3 20 What is the shortcut to compute the...

## The Goal of Finance Relative Valuation

Finance is such an important part of modern life that almost everyone can benefit from understanding it better. What you may find surprising is that the financial problems facing PepsiCo or Microsoft are not really different from those facing an average investor, small business owner, entrepreneur, or family. On the most basic level, these problems are about how to allocate money. The choices are many money can be borrowed or saved money can be invested into projects, undertaken with partners...