Fundamentals of Corporate Finance Third edition Chapter 9 Introduction to Brealey Myers Marcus Risk, Return, and the ndamentals of Corporate Finan Opportunity Cost of Capital Brealey Myers Marcus slides by Matthew Will IrwinMcGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 1 Irwin/McGraw-Hill Chapter 9 Fundamentals of Corporate Finance Third Edition Introduction to Risk, Return, and the Opportunity Cost of Capital Brealey Myers Marcus slides by Matthew Will Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc.,2001
9-2 Topics Covered RAtes of return 373 Years of Capital Market Histor → Measuring risk RIsk diversification THinking about risk Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 2 Irwin/McGraw-Hill Topics Covered Rates of Return 73 Years of Capital Market History Measuring Risk Risk & Diversification Thinking About Risk
9-3 Rates of return Percentage Return Capital gain Dividend Initial Share Price Percentage return 28+125 74 395or39.5 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 3 Irwin/McGraw-Hill Rates of Return = .395 or 39.5% Percentage Return = 7 4 2 8+1.25 Percentage Return = Capital Gain + Dividend Initial Share Price
9-4 Rates of return Dividend yield Dividend Initial share Price Capital Gain Yield Capital gain Initial share Price Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 4 Irwin/McGraw-Hill Rates of Return Dividend Yield = Dividend Initial Share Price Capital Gain Yield = Capital Gain Initial Share Price
9-5 Rates of return Dividend Yield 1.25 74 =.017or01.7% 28 Capital gain Yield 74 378or37.8 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 5 Irwin/McGraw-Hill Rates of Return .017 or 01.7% 74 1.25 Dividend Yield = = .378 or 37.8% 74 28 Capital Gain Yield = =
9-6 Rates of return Nominal ys. real 1+ real ror 1 nominal ror 1 inflation rate 1+ real ror=1+395=1.373 real ror=37.3%o Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 6 Irwin/McGraw-Hill Rates of Return Nominal vs. Real 1+ real ror = 1 + nominal ro r 1 + inflation rate real ror 37.3% 1+ real ror = 1.373 1+.016 1+.395 = =
9=7 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 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 7 Irwin/McGraw-Hill 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
9-8 The Value of an Investment of Sl in 1926 1000 10 Common Stocks Long T-bonds T-Bills 0.1 Source: Ibbotson associates Y ear上n Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 8 Irwin/McGraw-Hill The Value of an Investment of $1 in 1926 Source: Ibbotson Associates 0.1 10 1000 1930 1940 1950 1960 1970 1980 1990 1998 Common Stocks Long T-Bonds T-Bills Index Year End
9-9 Rates of return 1926-1998 0 Common stocks 40 g T-Bc T-Bills 263035404550556065707580859095 Source: Ibbotson associates Year Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 9 Irwin/McGraw-Hill Rates of Return 1926-1998 Source: Ibbotson Associates -60 -40 -20 0 20 40 60 26 30 35 40 45 50 55 60 65 70 75 80 85 90 95 Common Stocks Long T-Bonds T-Bills Year Percentage Return
9-10 Expected Return Expected market interest rate on normal risk return Treasury bills pI retum (1981)23.3% 14 9.3 (19991419 4.8 9.3 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 9- 10 Irwin/McGraw-Hill Expected Return (1999) 14.1% = 4.8 + 9.3 (1981) 23.3% = 14 + 9.3 premium normal risk + Treasury bills interest rate on = return Expected market
