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1 Financiering Jeroen E. Ligterink jeroenl@fee.uva.nl 2001

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2 Tussenstand? Slechts 36.4% geslaagd voor tussentoets! Dus…… ...AAN HET WERK NU HET NOG KAN !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! Oefen veel! Uitwerkingen van voortgangstoetsen, tussentoetsen etc. op: http://www.fee.uva.nl/materials/ onder financiering propedeuse Mijn sheets op: www.fee.uva.nl/fm onder: course material, first year finance

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3 Vragen en/of problemen met de stof Spreekuur student assistenten dinsdag 13.30-14.30 uur in kamer E. 4.21 Per e-mail aan mij: jeroenl@fee.uva.nl Oefen veel!!!! Alleen dan ben je goed voorbereid!

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4 BMM 8: Topics Covered How Firms Organize Their Investment Process Some “What If” Questions Sensitivity Analysis Break Even Analysis Flexibility in Capital Budgeting Decision Trees Options

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5 Capital Budgeting Process Capital Budgeting Problems Consistent forecasts Conflict of interest Forecast bias Selection criteria (NPV and others)

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6 How To Handle Uncertainty Sensitivity Analysis - Analysis of the effects of changes in sales, costs, etc. on a project. Scenario Analysis - Project analysis given a particular combination of assumptions. Simulation Analysis - Estimation of the probabilities of different possible outcomes. Break Even Analysis - Analysis of the level of sales (or other variable) at which the company breaks even.

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7 Operating Leverage Operating Leverage- The degree to which costs are fixed. Degree of Operating Leverage (DOL) - Percentage change in profits given a 1 percent change in sales.

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8 Operating Leverage Example - A company has sales outcomes that range from $16mil to $19 mil, Depending on the economy. The same conditions can produce profits in the range from $550,000 to $1,112,000. What is the DOL?

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9 Flexibility & Options Decision Trees - Diagram of sequential decisions and possible outcomes. Decision trees help companies determine their Options by showing the various choices and outcomes. The Option to avoid a loss or produce extra profit has value. The ability to create an Option thus has value that can be bought or sold.

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10 Decision Trees NPV=0 Don’t test Test (Invest $200,000) Success Failure Pursue project NPV=$2million Stop project NPV=0

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11 BMM 9: Topics Covered Rates of Return 73 Years of Capital Market History Measuring Risk Risk & Diversification Thinking About Risk

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12 Rates of Return

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13 Rates of Return

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14 Rates of Return

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15 Rates of Return Nominal vs. Real

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16 Market Indexes Dow Jones Industrial Average (The Dow) Value of a portfolio holding one share in each of 30 large industrial firms. Standard & Poor’s Composite Index (The S&P 500) Value of a portfolio holding shares in 500 firms. Holdings are proportional to the number of shares in the issues.

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17 The Value of an Investment of $1 in 1926 Source: Ibbotson Associates Index Year End

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18 Rates of Return 1926-1998 Source: Ibbotson Associates Year Percentage Return

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19 Expected Return

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20 Measuring Risk Variance - Average value of squared deviations from mean. A measure of volatility. Standard Deviation - Average value of squared deviations from mean. A measure of volatility.

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21 Measuring Risk Coin Toss Game-calculating variance and standard deviation

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22 Risk and Diversification Diversification - Strategy designed to reduce risk by spreading the portfolio across many investments. Unique Risk - Risk factors affecting only that firm. Also called “diversifiable risk.” Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.”

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23 Risk and Diversification

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24 Risk and Diversification

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25 Stock Market Volatility 1926-1998 Std Dev

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26 Risk and Diversification

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27 Risk and Diversification

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Introduction to Risk and Return

Introduction to Risk and Return

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