1. Knowledge/Skills 需要的知识/技能
   1. Economic
   2. Methematics&Statistics
   3. Accounting
   4. Excel/Calculator
2. Assumption 三大假设
   1. Competitive Markets 竞争市场
   2. Frictions small relative to power of most good ideas 好的想法不会遭遇过多阻力（社会、政府等）
   3. capital can flow (relatively) easily 资本可以相对容易的流动（从资本主义中拯救资本主义）
3. Terminology 专业用语/词汇
   1. PV=Present Value
   2. FV=Future Value
   3. PMT
   4. n=# of Periods
   5. r=Interest Rate(%)
   6. Effective annual rates EAR=(1 + R/K)^K – 1
4. Decision Criteria 决策标准
   1. NPV（Net Present Value）(rate, value1,value2,...) 净现值
      1. r: the next best use of even your own investment, leave alone other people's on a similar project.
      2. Value is always incremental
      3. Out of flexibility
   2. Payback
      1. Payback period 回报周期
   3. IRR(Internal rate of return)
      1. IRR=(FV-PV)/PV=Profit/Investment
      2. Graphic representation
         1. when NPV=0, IRR>r or IRR<r
      3. IRR:Bias Related to r，NPV is different
   4. Cash flows
      1. Background
         1. Sources：Pro forma Income Statements&Balance Sheets
         2. Income Statement：Year's flows
         3. Balance Sheet：A snapshot of assets/stocks 资产负债表
      2. Project/Operation
         1. Revenues
            1. Costs of Goods Sold
            2. Selling，General&Admin. Costs
            3. Depreciation
            4. Operating Profits
            5. Net Operating Profits After Taxes
            6. Capital Expenditure
            7. Increasing in Working Capital
            8. Cash Flows from Operation
            9. Cash Taxes on Operating Profits
      3. Principles
         1. Estimate all cash flows on an incremental basis 在增量的基础上估计所有现金流
         2. Do not forget importance of year 0 and the last year of the chosen timeline for the project 注意第一年和最后一年
            1. Year 0
            2. Capex：（Capital Expenditure）一般是指资金、固定资产的投入
            3. Working Capital=Some cash+inventory+account receivables应收账款-account payables应付账款
            4. Last Year
         3. Accounting issue important
            1. Depreciation（made up、non-cash items）
            2. Capex and Working Capital（balance sheet）
         4. Do not mix financing with operations
         5. Include the effects of inflation/deflation 包括通胀/通缩带来的影响
         6. Do not compare projects with unequal lives 不要将不同时间周期的项目进行比较
   5. Properties
      1. Make sense（benefits exceed costs）
      2. Unit of measurement
      3. Benchmark obvious
      4. Easy to communicate
      5. Easy to compare different ideas/projects
      6. Easy to calculate
5. Bonds & Stocks
   1. Bonds(Debt)
      1. Bonds, like the word suggests, binds the borrower to the lender in a contract
      2. An explicit IOU: A promise to pay money in future in return for the money borrowed
      3. Zero-Coupon Bonds
         1. This bond has only one payment, the face value, at maturity
      4. Discount Bonds
         1. Price of a discount bond: P=(Face Value)/(1+r)^n
         2. Yield to Maturity: The return built-into the pricing of a bond is called yield-to-maturity
      5. Government Coupon Bonds
         1. Yield Curve
            1. The relation between the maturity and the YTM of government bonds
      6. Sources of Risk in Bonds
         1. Interest Rate Risk
            1. The uncertainty concerning bond value/prices due to interest rates fluctuations is known as the interest rate risk of bonds
            2. Price risk
            3. Coupon reinvestment risk
         2. Corporate Bonds and Default Risk
            1. Corporate bonds almost always pay coupons
            2. Like government bonds, they are subject to interest rate risk
            3. But they are also subject to default risk
            4. Most "bonds" are contracts/loans issued by a bank
      7. Market Data on Bonds
   2. Stocks(Equity)
      1. Another form of financing
         1. Different from a bond
            1. Not an IOU
            2. Bond gats paid first
            3. How are you paid back?
            4. Dividend
            5. Selling price
      2. Pricing a stock
         1. P0=Today's price; P1=Expected price next year; DIV1=Expected dividend at the end of the year
         2. P0=(DIV1+P1)/(1+r)
      3. Dividend&Growth Stocks
         1. Dividend Stocks
            1. Suppose dividends expected to remain approximately constant, P0=C/R=DIV/R
         2. Growth Stocks
            1. Suppose dividends are expected to grow at a rate of g per year, P0=C1/(r-g)=DIV1/(r-g)
      4. Engine of Growth(Assume Perpetuities)
         1. Capital/Share=ICPS(Invested Capital Per Share)
         2. ROI(Return on Investment)投资回报率>0
         3. EPS(Earnings Per Share)=CFPS(Cash Flow Per Share)=ICPS*ROI
         4. CFPS
            1. DIV
            2. 1-b=DIV/EPS
            3. RE(Retained Earn)
            4. b=RE/EPS
            5. g=b*ROI
      5. Valuation
         1. P0=EPS/r+PVGO(Present Value of Growth Opportunities)
      6. Good or Bad Growth
         1. Emphasis on growth, but it is a flow
         2. IRR(ROI)<r, Bad; IRR>r, Good
6. Risk & Return
   1. Why?
      1. Valuing an Idea/Project
         1. Two basic ingredient to conduct a valuation
            1. Cash Flows: Who do they "belong" to?
            2. Cost of Capital, r: Who do this "belong" to?
      2. Different ideas/projects have different risks
      3. Most people are risk-averse, and hence the returns on ideas should be different depending on their risks
      4. We therefore need to understand and measure:
         1. Risk
         2. The relation between risk and return of different ideas/projects/firms
   2. Valuation & Risk Estimation
      1. How to find Return on asset?
         1. Financial Market
   3. Risk
      1. Measuring the risk of a "comparable"
      2. Determining the return that would compensate investors for that risk
      3. Treasure Bill is Riskless
      4. Fundamental Sources of Risk
         1. Economy-wide/Macro宏观/Systematic
         2. Specific/Idiosyncratic/Unique
      5. Statistics
         1. Mean & Variance
         2. Covariance & Correlation
         3. Regression
   4. Risk & Return
      1. Why?
         1. Valuing an Idea/Project
            1. Two basic ingredient to conduct a valuation
            2. Cash Flows: Who do they "belong" to?
            3. Cost of Capital, r: Who do this "belong" to?
         2. Different ideas/projects have different risks
         3. Most people are risk-averse, and hence the returns on ideas should be different depending on their risks
         4. We therefore need to understand and measure:
            1. Risk
            2. The relation between risk and return of different ideas/projects/firms
      2. Valuation & Risk Estimation
         1. How to find Return on asset?
            1. Financial Market
      3. Risk
         1. Measuring the risk of a "comparable"
         2. Determining the return that would compensate investors for that risk
      4. Diversification
         1. 2 Assets
            1. Formalize the risk of two asset portfolio
         2. 2 Assets Intuition
         3. Bottom Line
            1. Variance of an asset determine risk faced by you only if you hold one (or very few) assets: you face both systematic and specific risks of that/those asset(s)
            2. Variance of any asset is unimportant when held in a large (assets>30) diversified portfolio
            3. Specific risks are diversified (cancel each other); Only relations among the assets matter
            4. An asset's contribution to a portfolio's risk is determined by its relations with all other assets in the portfolio
            5. All relations are due to common/systematic/market affects!
      5. Measure of Risk: Beta
         1. Risk of an idea/project/asset has to measure its relations with other assets
         2. Using a large diversified market portfolio(like S&P 500 or Russell 2000) we can capture (almost) all relations
         3. σ_im is the covariance between the return on security i and the return on the market
         4. σ_m^2 is the variance of the rate of the return of the market (say, S&P 500 or Russell 2000) portfolio
      6. CAPM: Capital, Asset, Pricing, Model
         1. r_i is the expected rate of return on the equity of project/idea/firm i
         2. r_m is the expected rate of return on the "market" portfolio
         3. (r_m-r_f) is the average market risk premium
7. Valuation
   1. Cost of Capital: WACC
      1. All Equity World
         1. If a firm/project is all-equity-financed, the cost of capital (or the return on assets) is the return on equity
         2. The return on equity is obtained by using the beta of equity in CAPM for a comparable
         3. All published batas are betas of equity.
      2. Equity and Debt
         1. A firm/project/idea could be financed by equity and debt, and hybrids.
         2. Equity and debt capture most important aspects of financing for valuation.
         3. Leverage means that the firm uses debt in its "capital structure".
      3. In a world with competitive markets and no frictions, financing (or the mix of equity and debt) has no effect on the value of an idea/project/firm
         1. Value is created by your idea (real asset) and its ability to generate cash flows
         2. The cost of capital, or the return on asset, is determined by the inherent(market) risk(beta) of the business (real asset). not by how it is financed.
      4. WACC 加权平均资本成本
         1. Under perfect capital markets, E(Ra) is just the weighted average of the equity and debt cost of capital, or the weighted average cost of capital(WACC):
         2. where E(R_d) is the required rate of return on debt and R_e^L is the required rate of return on the levered equity of the firm.
      5. The expected rate of return on equity of a levered firm increase in proportion to the debt-equity ratio(D/E), expressed in market values:
   2. Leverage & Risk
      1. Risk of Equity increases with debt
         1. β_a is Business Risk; D/E_L (β_a-β_d) is Financial Risk
         2. If D=0 (i.e., firm has no leverage), β_a=β_d
         3. If D/E is positive (i.e. firm is levered), then β_a>>β_b due to financial risk.
      2. Business Risk and Financial Risk
         1. Business risk is the risk of the firm's assets; the riskiness inherent in their operations. It is also the risk of the equity of an all equity firm.
         2. Financial risk is the additional risk placed on equity as a result of the firm's decision to use senior fixed-income securities--i.e., debt
         3. Payment to equity holders = (project cash flows) - (amount owed on fixed borrowing)
      3. Leverage and Cost of Capital
   3. Leverage & WACC
      1. Cost of Capital
         1. To evaluate investment projects, we must find the beta (and return) of the assets, i.e., the risk and return of the assets generating the cash flows
         2. Since the beta of assets are not observable, we take the beta of equity and remove the effects of the financial leverage of the firm (or unlever) to get an estimate of beta asset.
   4. The Real World
      1. Two reasons why capital structure might affect firm value in the real world:
         1. Capital structure policy may result in the realization of tax benefits due to the interest tax shields provided by debt at the corporate level
         2. The capital structure policy adopted by a company's management may lead to costs incurred due to the presence of debt, especially if the firm is in financial distress.
      2. Corporate Taxes and the WACC
         1. The weighted average cost of capital(WACC) of a firm with corporate taxes becomes:
         2. Note that WACC is an after-tax measure. It takes specific account of the tax subsidy to debt financing.
      3. Why don't firms have 100% debt?
         1. The tax-deductibility of interest on debt implies that firms should have 100% leverage, but the evidence shows that firms do not borrow 100% or even close to 100%.
         2. Two potential reasons:
            1. Personal taxes may favor equity
            2. Bankruptcy-related costs
   5. Example
      1. Online,Inc. is a video gaming company with no debt. Recently, their stock has been added to NASDAQ and it has an (equity) beta of 1.50. Online,Inc. is considering investing in the software in the software business. The business project will require an initial investment of $5*10^7. If undertaken, the video gaming business will represent 25% of Online,Inc.'s assets. There is a 50% chance the project will generate an annual payoff of $7*10^6 forever, a 40% chance of an annual payoff of $5*10^6 forever, and a 10% chance of that the project will fail and generate no cash flows. Companies solely in the software business have an equity beta of 1.40. These firms have a debt/equity ratio of 0.25, on average, and have riskless debt. Online,Inc. is forecasting that the average market risk premium is about 5% and the risk-free rate on a long-term bond is 4.5%.
         1. β_e(v)=1.50
         2. I0=5*10^7, 25%
         3. Cash flow: 50%, 7*10^6; 40%, 5*10^6; 10%, 0
         4. β_e(soft)=1.40, βd=0
         5. D/E=0.25
         6. Rm-Rf=5%; Rf=4.5%
      2. Question 1: What is Online Inc.'s cost of capital before undertaking the project?
         1. D=0, Ra=Re=WACC
         2. β_e(v)=1.50=β_a(v)
         3. R_a(v)=R_e(v)=Rf+β_e(v)*(Rm-Rf)=4.5%+5%*1.5=12%
      3. Question 2: What is the IRR of the new project?
         1. I0=5*10^7
         2. E(C)=50%*7*10^6+40%*5*10^6=5.5*10^6
         3. IRR=C/I0=5.5/50=11%
         4. PV=5.5/0.11=50; NPV=0
      4. Question 3: Should Online,Inc. take the new project?
         1. IRR(soft)(<>=)Ra(soft)(Cost of Capital)
         2. IRR=11%, R_a(v)=12%≠R_a(soft)
         3. Do not know
      5. Question 4: What is the cost of capital (hurdle rate门槛收益率) of the project?
         1. β_a=β_a(soft)
         2. 1.40=β_a(soft)+0.25(β_a(soft)-0)
         3. β_a(soft)=1.12
         4. R_a(soft)=Rf+β_a(soft)*(Rm-Rf)=10.1%
      6. Question 5: Should Online,Inc. accept the new project?
         1. R_a(v)=12%, IRR_new(soft)=11%, R_a(soft)=10.1%
         2. IRR_new(soft）>R_a(soft), YES
      7. Question 6: If Online,Inc., has 1 million shares, what will happen to its stock price?
         1. NPV=-I0+PV(C1,C2...)=-I0+C/[Ra(soft)]=-50M+5.5M/10.1%=5*10^6
         2. Share price=5M/1M=5,↑
      8. Question 7: What is Online,Inc.'s new cost of capital? Is this good or bad new?
         1. Ra(new)=12%*0.25+10.1%*0.75=10.5%
         2. βa(new)=1.50*0.25+1.12*0.75=1.215