Market Value Measures

Market Price = $88 per share = PPS

Shares outstanding = 33 million
Earnings per Share = EPS = 363 / 33 = $11
PE ratio = PPS / EPS
$88 / $11 = 8 times

Price/Sales ratio = PPS/Sales per share

$88 / ($2,311 / 33) = 1.26 times

Market-to-book ratio = PPS / Book value per share

Book value per share = Total Equity/shares outstanding
= $2,591 / 33 = $78.52
Market-to-Book = $88 / 78.52 = 1.12 times

Weighted Average Cost Of

capital (WACC)

WACC
WACC = E/ V( cost of equity) +D/V (cost of debt)
(1- tax)
WACC = E / V (Ce) + D/ V (Cd) (1-t)
WACC= = E / V (Re) + D/ V (Rd) (1-t)

Example
A firm needs to raise EGP 1000000 to finance
a new project. The firm will maintain its
capital structure by raising EGP 700000as a
bonds. What is WACC if the YTM is 10% and
the required return on equity is 12%. Tax rate
is 20%.
WACC= E /V (Re) + D/ V (Rd) (1-t)
WACC= 300000/1000000 (0.12) + 700000 /1000000
(0.1) (1- 0.2)
WACC= (0.3) (0.12) + (0.7)(0.1) (0.8)
WACC= 0.092 = 9.2%

How we will use WACC?

Because it a cost, we will reject any
project if its return is less or equal to
that cost.
Project application.

Dollar & Percent Returns

Total dollar return = the return on an
investment measured in dollars
$ Return = Dividends + Capital Gains
Capital Gains = Price received Price paid

Total percent return = the return on

an investment measured as a
percentage of the original investment.
% Return = $ Return/$ Invested

What is Risk?

Risk, in traditional terms, is viewed as a negative.

Websters dictionary, for instance, defines risk as
exposing to Danger and Hazard. The Chinese
symbols for risk, reproduced below, give a much
better description of risk
The first symbol is the symbol for danger, while the
second is the symbol for opportunity, making risk a
mix of danger and opportunity.

The Importance of Diversification: Risk Types

The risk (variance) on any individual investment can be broken down

into two sources. Some of the risk is specific to the firm, and is called
firm-specific, whereas the rest of the risk is market wide and affects all
investments.
The risk faced by a firm can be fall into the following categories
(1) Project-specific; an individual project may have higher or lower
cash flows than expected.
(2) Competitive Risk, which is that the earnings and cash flows on a
project can be affected by the actions of competitors.
(3) Industry-specific Risk, which covers factors that primarily impact
the earnings and cash flows of a specific industry.
(4) International Risk, arising from having some cash flows in
currencies other than the one in which the earnings are measured
and stock is priced
(5) Market risk, which reflects the effect on earnings and cash flows
of macro economic factors that essentially affect all companies

The Capital Asset Pricing Model

Uses variance as a measure of risk
Specifies that a portion of variance can be
diversified away, and that is only the nondiversifiable portion that is rewarded.
Measures the non-diversifiable risk with beta,
which is standardized around one.
Expected Return = Riskfree rate + Beta * Risk
Premium
E(R) = Rrf + ( Market Risk Premium)
E(R) = Rrf + (RM- Rrf )

Return Variability Review

Variance = VAR(R) or 2
Common measure of return dispersion
Also call variability
Standard deviation = SD(R) or
Square root of the variance
Sometimes called volatility
Same "units" as the average

Return Variability:
The Statistical Tools for Historical
Returns
Return variance: (T" =number of
returns)
T
2
VAR(R) 2

R
i1

T 1

StandardSD(R)
Deviation:
VAR(R)

Inputs required to use the CAPM

E(R) = Rrf + ( Market Risk Premium)
E(R) = Rrf + (RM- Rrf )
(a)the current risk-free rate
(b) the expected market risk premium (the premium
expected for investing in risky assets over the
riskless asset)
(c) the beta of the asset being analyzed.

Risk Free Rate

Governmental rate Modified ??
Why we need to modify it?
How we will modify it?

Risk Premium
Survey
Historical

Reaction of stock price to new information in

efficient and inefficient markets

Forms of Market Efficiency

Strong-form Efficient Market:
Information = Public or private
Inside information is of little use

Semistrong-form Efficient Market:

Information = publicly available information
Fundamental analysis is of little use

Weak-form Efficient Market:

Information = past prices and volume data
Technical analysis is of little use