CORPORATE FINANCE AND
BEHAVIOR
University Utrecht 2020/2021
Summary all lectures and book
Course code: ECB2FIN
Chapter 8, 13, 17, 18, 20, 21, 28, 30, 27
Grift, A. van der
0
,Author: A. van der Grift
Contents
Chapter 8................................................................................................................................................. 3
Discount rates ................................................................................................................................. 3
9.x After tax WACC .............................................................................................................................. 5
Theories........................................................................................................................................... 6
Chapter 9 - Risk and cost of capital......................................................................................................... 6
Asset beta........................................................................................................................................ 6
Extra ........................................................................................................................................................ 6
Chapter 13............................................................................................................................................... 7
13.1 Investment vs. financing decisions ............................................................................................. 7
13.2 Market efficiency ........................................................................................................................ 8
13.4 Behavioral finance .................................................................................................................... 10
13.5 Five lessons of market efficiency .............................................................................................. 11
Chapter 17 - Debt policy ....................................................................................................................... 11
17.1 The effect of financial leverage in competitive tax-free economy ........................................... 11
17.2 Proposition 1 ............................................................................................................................. 13
17.3 proposition 2 ............................................................................................................................. 13
17.4 Changing capital structure and Beta ......................................................................................... 15
17.5 After tax weighted average cost of capital ............................................................................... 15
Chapter 18............................................................................................................................................. 16
18.1 Corporate taxes......................................................................................................................... 16
18.2 Perpetuity and Annuity ......................................................................................................... 17
18.2 Corporate and personal taxes ................................................................................................... 19
18.3 Costs of financial distress .......................................................................................................... 19
20. Understanding options ................................................................................................................... 22
20.1 Calls, Puts and Shares ............................................................................................................... 22
20.2 A call option .......................................................................................................................... 23
20.3 A put option .......................................................................................................................... 24
20.4 Position diagrams...................................................................................................................... 25
20.5 Pay-off graphs ........................................................................................................................... 26
20.6 Put call parity relationship - Only European options ................................................................ 26
Chapter 21 Valuing options .................................................................................................................. 28
Call put parity methods (CH 20) .................................................................................................... 28
put parity methods ....................................................................................................................... 30
21.1 Option equivalent / replicating portfolio .................................................................................. 31
21.2 Risk - Neutral world................................................................................................................... 32
1
Author: A. van der Grift
,Author: A. van der Grift
21.3 Break even exercise price ......................................................................................................... 33
CH 28 Financial analysis ........................................................................................................................ 34
28.1 Financial ratios .......................................................................................................................... 34
28.2 & 3 Financial statements .......................................................................................................... 35
28.4 Measuring performance ........................................................................................................... 35
28.5 Du point .................................................................................................................................... 37
CH 30- Working capital management ................................................................................................... 37
30.2 Inventories ................................................................................................................................ 38
30.2.2 Cash .................................................................................................................................... 40
30.2.3 Cash continued (not from book) ........................................................................................ 40
Inventories .................................................................................................................................... 43
30.3 Credit management .................................................................................................................. 43
Break even points: ........................................................................................................................ 46
Chapter 27............................................................................................................................................. 46
27.2 Net present value of investment .............................................................................................. 49
2
Author: A. van der Grift
, Author: A. van der Grift
Chapter 8
Risk free rate Interest rate
Rf
Re Expected return on asset
Risk premium Given,
Beta The degree to which your stock moves against the market. This is the
covariance.
How affected by the market you are. Your expected return is based on risk
free return and
• Beta of 0 = Only get the risk free rate
• Beta of 0.5 = Higher return
• Beta of 1 = Market portfolio / market return
You always prefer a lower beta in a portfolio
Market risk premium Rm - Rf
Return on the market - Risk free rate
Market return Risk free rate + risk premium
Diversification Finding shares that are usefull for compensating risks. You are spreading
your investments over numerous assets. You are only left with systematic
risk.
Systematic risk or Non-diversifiable risk. Risk cannot be compensated. The economy goes
(Market risk) bad, for example during the corona crisis. People spend less on everything.
You get compensated for only systematic risk.
Unsystematic risk Diversifiable risk. Something you can get rid of --> diversification. This risk
(Unique risk) is firm specific.
Capital market line Risk defined by standard deviation
Sharpe ratio Risk premium / standard deviation
Standard deviation The larger the standard deviation, the riskier the portfolio
Investors demand higher rates of return from
• highly risky stocks
• Stocks with more nondiversifiable risk.
• Stocks with returns sensitive to fluctuations in stock market (risky)
• Highly exposed to macroeconomic risks.
• Investors do not demand higher rates of return on stock with more variable rates of
return
Discount rates
• False: Distant cash flows are riskier than near-term cash flows. Therefore long-term
projects require higher risk-adjusted discount rates. True: The discount rates should
not be adjusted based on uncertainty in cash flows.
• Adding fudge factors to discount rates undervalues long-lived projects compared with
quick-payoff projects.
A fudge factor applied to a discount rate would compound over time thereby
undervaluing a project.
3
Author: A. van der Grift
BEHAVIOR
University Utrecht 2020/2021
Summary all lectures and book
Course code: ECB2FIN
Chapter 8, 13, 17, 18, 20, 21, 28, 30, 27
Grift, A. van der
0
,Author: A. van der Grift
Contents
Chapter 8................................................................................................................................................. 3
Discount rates ................................................................................................................................. 3
9.x After tax WACC .............................................................................................................................. 5
Theories........................................................................................................................................... 6
Chapter 9 - Risk and cost of capital......................................................................................................... 6
Asset beta........................................................................................................................................ 6
Extra ........................................................................................................................................................ 6
Chapter 13............................................................................................................................................... 7
13.1 Investment vs. financing decisions ............................................................................................. 7
13.2 Market efficiency ........................................................................................................................ 8
13.4 Behavioral finance .................................................................................................................... 10
13.5 Five lessons of market efficiency .............................................................................................. 11
Chapter 17 - Debt policy ....................................................................................................................... 11
17.1 The effect of financial leverage in competitive tax-free economy ........................................... 11
17.2 Proposition 1 ............................................................................................................................. 13
17.3 proposition 2 ............................................................................................................................. 13
17.4 Changing capital structure and Beta ......................................................................................... 15
17.5 After tax weighted average cost of capital ............................................................................... 15
Chapter 18............................................................................................................................................. 16
18.1 Corporate taxes......................................................................................................................... 16
18.2 Perpetuity and Annuity ......................................................................................................... 17
18.2 Corporate and personal taxes ................................................................................................... 19
18.3 Costs of financial distress .......................................................................................................... 19
20. Understanding options ................................................................................................................... 22
20.1 Calls, Puts and Shares ............................................................................................................... 22
20.2 A call option .......................................................................................................................... 23
20.3 A put option .......................................................................................................................... 24
20.4 Position diagrams...................................................................................................................... 25
20.5 Pay-off graphs ........................................................................................................................... 26
20.6 Put call parity relationship - Only European options ................................................................ 26
Chapter 21 Valuing options .................................................................................................................. 28
Call put parity methods (CH 20) .................................................................................................... 28
put parity methods ....................................................................................................................... 30
21.1 Option equivalent / replicating portfolio .................................................................................. 31
21.2 Risk - Neutral world................................................................................................................... 32
1
Author: A. van der Grift
,Author: A. van der Grift
21.3 Break even exercise price ......................................................................................................... 33
CH 28 Financial analysis ........................................................................................................................ 34
28.1 Financial ratios .......................................................................................................................... 34
28.2 & 3 Financial statements .......................................................................................................... 35
28.4 Measuring performance ........................................................................................................... 35
28.5 Du point .................................................................................................................................... 37
CH 30- Working capital management ................................................................................................... 37
30.2 Inventories ................................................................................................................................ 38
30.2.2 Cash .................................................................................................................................... 40
30.2.3 Cash continued (not from book) ........................................................................................ 40
Inventories .................................................................................................................................... 43
30.3 Credit management .................................................................................................................. 43
Break even points: ........................................................................................................................ 46
Chapter 27............................................................................................................................................. 46
27.2 Net present value of investment .............................................................................................. 49
2
Author: A. van der Grift
, Author: A. van der Grift
Chapter 8
Risk free rate Interest rate
Rf
Re Expected return on asset
Risk premium Given,
Beta The degree to which your stock moves against the market. This is the
covariance.
How affected by the market you are. Your expected return is based on risk
free return and
• Beta of 0 = Only get the risk free rate
• Beta of 0.5 = Higher return
• Beta of 1 = Market portfolio / market return
You always prefer a lower beta in a portfolio
Market risk premium Rm - Rf
Return on the market - Risk free rate
Market return Risk free rate + risk premium
Diversification Finding shares that are usefull for compensating risks. You are spreading
your investments over numerous assets. You are only left with systematic
risk.
Systematic risk or Non-diversifiable risk. Risk cannot be compensated. The economy goes
(Market risk) bad, for example during the corona crisis. People spend less on everything.
You get compensated for only systematic risk.
Unsystematic risk Diversifiable risk. Something you can get rid of --> diversification. This risk
(Unique risk) is firm specific.
Capital market line Risk defined by standard deviation
Sharpe ratio Risk premium / standard deviation
Standard deviation The larger the standard deviation, the riskier the portfolio
Investors demand higher rates of return from
• highly risky stocks
• Stocks with more nondiversifiable risk.
• Stocks with returns sensitive to fluctuations in stock market (risky)
• Highly exposed to macroeconomic risks.
• Investors do not demand higher rates of return on stock with more variable rates of
return
Discount rates
• False: Distant cash flows are riskier than near-term cash flows. Therefore long-term
projects require higher risk-adjusted discount rates. True: The discount rates should
not be adjusted based on uncertainty in cash flows.
• Adding fudge factors to discount rates undervalues long-lived projects compared with
quick-payoff projects.
A fudge factor applied to a discount rate would compound over time thereby
undervaluing a project.
3
Author: A. van der Grift
