FM14e PPT Ch06

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Brigham & Ehrhardt
Financial
Management:
Theory and Practice
14e
1

CHAPTER 6
Risk and Return

2

Topics in Chapter






Basic return and risk concepts
Stand-alone risk
Portfolio (market) risk
Risk and return: CAPM/SML
Market equilibrium and market efficiency 3

Determinants of Intrinsic Value:
The Cost of Equity
Net operating profit after taxes



Required investments in operating capital

Free cash flow
=
(FCF)

Value =

FCF1
FCF2
+
(1 + WACC)1 (1 + WACC)2

+
...

FCF∞
+
(1 +
WACC)∞

Weighted average cost of capital
(WACC)
Market interest rates
Market risk aversion

Cost of debt

Firm’s debt/equity mix

Cost of equity

Firm’s business risk
4

What are investment returns? 





Investment returns measure the
financial
…show more content…
But for investments, most analysts normally use historical data rather than discrete forecasts to estimate an investment’s risk unless it is a very special situation.
Most analysts use:






48 to 60 months of monthly data, or
52 weeks of weekly data, or
Shorter period using daily data.

Use annual returns here for sake of simplicity.
20

Formulas for a Sample of T
Historical Returns


Tedious to calculate by hand, easy in Excel. See next slide.

21

Formulas for a Sample of T
Historical Returns


Tedious to calculate by hand, easy in Excel. See next slide.

22

Excel Functions a Sample of T Historical Returns
Suppose

“SampleData” is the cell range with the T historical returns.


=AVERAGE(SampleData)
=STDEV(SampleData)

23

Historical Data for Stock Returns
Year

Market

Blandy

Gourmange

1

30%

26%

47%

2

7

15

−54

3

18

−14

15

4

−22

−15

7

5

−14

2

−28

6

10

−18

40

7

26

42

17

8

−10

30

−23

9

−3

−32

−4

10

38

28

75
24

Average and Standard Deviations for Stand-Alone Investments





Use formulas shown previously (tedious) or use Excel (easy)
What is Blandy’s stand-alone risk?
Note: analysts often use past risk as a predictor of future risk, but past returns are not a good prediction of future returns.

Average return
Standard
deviation

Market
8.0%

Blandy
6.4%

20.1%

25.2%

Gourmange
9.2%
38.6%

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