Lecture 2

Equity and cost of Equity

WACC [Link]*Ke+[Link]*KD/EqMV+DebtMV

equity holder ko kitna return dina

debt holder ko kitna return dina
zayda risk zayda retrun

Concept of Fair vlaue

asset ly
dekhy gy k invest krny k leya mera required rate of return kitna ha
kya cash mil rhi
aur us cash flow ki present value ly gy
esy kahty hian intrinsic vlaue

Dividen Discount model

price of share = pv of dividend
cost of equity represented by KE

dividend for infinte time k leya ha

aur future dividends k estimate laina ha
Pattren of dividend
Constant constantly growing multiple growth stage

KE = cost of equity apply ho ga market value py

ROE yh apply ho ga book value k oper

if company has policy of 100% payout mtlb dividend pay krna

jo kamya wo dy deya
to hmra dividen hamesha constant rhy ga kiyu k compay grow nahi kkry ge
to KE k rate py discount kr dy
R/i

capital employed
Equity+long term debt
or
working capital + Fixed Assets

Lecture 3

Constant growing dividend

jitna retention otny assets increase jitny asset increase otna profit increase jitna profit increase otna dividend increase

Growth rate
agr past k dividend deya howa ha
 g=(Latest dividend/Prefrence dividend)-1
refrence dividend = old dividend
lkn agr sirf old and new dyea ha us ko use krna ha
Dividend 1 120.00
Dividend2 163.26
for four year
120(1+g)^4=163.26

Lecture 6

Business Risk and financial risk

ik sectory sy dusry sector my mov krny sy business risk change ho jata ha

ik company ha lest say pharma company aur wo lesser risky ha
aur company decide krti ha k kuch finance invest krty hian
oil nad gas ha
to ab kya company k shareholder usi same rate py rhy gy nah wo higher rate demand kry gy kiyu k now oil and gas higher risk
to es k leya hm dekhy gy CAPM
let say comapy k pass 100 percent equity ha
lkn ab soch rha ha k ma 80 percnnt equity kr d aur 20 percent debt kr du
to ab es k finacial risk change ho rha ha
to es k leya hmy ny dekhna ha capital strutcre thoery
capital structure ki theory MM theory
Traditional theory
with taxes without taxes
capital asset pricing model CAPM

Traditonal theory of capital structure

Debt/equity0/100 20/100 40/60 60/40
Ke 0.15 0.16 0.17 0.23 share holder kitna return mang rhy
Kd 0.10 0.10 0.12 company jkitn return dy rhi
wacc
hm es sy wacc nikaly gy
ik company ki vlaue sab sy zayda hoti ha jb us k wacc thora hota ha

Mv of co PVIT/Wacc
loan lainy sy cost of equity sy wacc thora sa increase hota ha phr necchy ana shuru ho jata ha

Now loan laina geared mtlb loan laina

PBIT 450,000.00 450,000.00
Interest (60,000.00)
Profit 450,000.00 390,000.00

Ke find 0.15 given 0.16

Kd no loan nahi ha given 0.10
WACC 0.15 0.14
yhh sab cal krna pary ga yh kam ho gya

Equtiy given 3,000,000.00 2,516,129.00

debt 600,000.00
Total MV 3,000,000.00 3,116,129.00
yh increse ho gya
DVD/ke=MV
390/15.5%=MV
2,516,129.03
WACCC PBIT/MV 0.14
450/3116129
Lecture 8

Marginal cost of capital

additional income and aditional return k ratio

When WACC can be used as a discount rate

jb debit equity ratio and finacial risk same ho
tb wacc ko use kr skty
Existing wacc
MV Rate Amount
Equit y 10,000.00 0.02 2,100.00
debt 5,000.00 0.09 450.00
15,000.00 2,550.00
0.17
Evaluation of project
I/o (6,000.00)
inflow pv 9,000.00 1530/17%
3,000.00

Old MV New Finance NPV MV

15,000.00 6,000.00 3,000.00 24,000.00

Conditions for wacc to be used as a discount rate for new projects

1 when no change in business risk
no change in sector
2 no change in debt equity ratio
new fiancne should be raised in such a manner that D/E ratio remains unchanged even after consideraing NPV as

Questionn
Data
Expected annual income 600,000.00 (annual)
finance required 250,000.00 (one time )
Existing WACC
MV Rate Cost
Equity 1,800,000 19% 342,000
Debt 1,200,000 9% 108,000
3,000,000.00 450,000.00
15%
2.00 Evaluate project
i/o (250,000.00)
Pv of finance 400,000.00 60000/15%
NPV 150,000.00
ab agr es 400,000 my be debit equity ratio same rha to hmra beofre and after equal rhy ga
400,000.00
Equity Debt
18/30 12/30
240,000.00 160,000.00
NPV (150,000.00) -
Fiance required 90,000.00 160,000.00
250,000.00
Post and pre project capital structure
Before Finance NPv Post
Equity 1,800,000.00 90,000.00 150,000.00 2,040,000.00 60%
Debt 1,200,000.00 160,000.00 1,360,000.00 40%
3,000,000.00 3,400,000.00

2040000*0.19 387,600.00
1360000*0.09 122,400.00
510,000.00
Previously (450,000.00)
60,000.00
Additional capital 400,000.00
WACC 15%

Lecture 13
portfolio
24 mint on register

Standard deviation of two portfolio assets

yaha py ik function lgy ga
jis my correlation use ho ga

Lecture 14
Return of two Assets portfolio and its determinants
Expected returns
kitni investment ki jaey k hmy return 16% mil jaey
A B
probability Returns Average probability Returns Average
30% 15% 4.5% 30% 8% 2.4%
40% 18% 7.2% 40% 12% 4.8%
30% 20% 6.0% 30% 24% 7.2%
 17.70% 14.40%
Return on portfolio Rp RA*WA+RB*WB

16%=(17.7%*X)+(14.4%*(1-X)) Wa=x%
Wb=100%-X%
X=48.48%
Rp 16%

Portfolio (A+B)
Retrun of Portfolio
RA*WA+RB*WB
(11%*50%)+(20%*50%)
Rp 15.50%
Risk of Portfolio Function lagna ha Square root wala
17%^2*50%^2+29%^2*50%^2
16.80%
Same for (A+C)

Concept of Co variance
let assume there are two securities
ab hmy pta krna ha k ik oper jaey ge wo nechy jaey he yh oper
to es ko check krny k leya hm co varianc caluate krty hian
es k leyaw hm ny
x-xbar
aur second k ve yhi
 y- ybar
aur un ko probability k sath multiply krna ha aur dekhan ha k net effect k sign positive ha yh negativ ha
aur strenght malom krny k leya hm yn dekhana ha to us ki leya co relation find krna ho ga
co-relation= Covariance/Sd of a and SD of b
yh +1 to -1
jitna 1 k pass otna strong

Lecture 16
Concep t of required retrun

company ny invest keya

beta
A 1.20
b 1.60
company ny 1.80
d 0.90

now invester ny company my invest krna to ab es puri company k kya beta ay ga

ab company k alg sy beta aur required return hona chaeya
aur company en project sy alg alg return demand kry ga

Lecture 17
Investment in mutual funds
Asset management company
stock risky
income funds stable return but risky
cash funds no risk less return
islamic fund
risk and need k according investment
open hand fund
jb ap ko chaeya wo ap ko mil skta ha
close fund
AMC ik certificate diiti ha jb ap ko paisa chaeya hota ap wo stock market my sal
but now its not practicing in pakistan
agent k through AMC my investment
Net asset vlaue of one unit 80RS
agent kahta ha mmujy 1lac k units chaeya 1250 units
but agent kahta ha es my mujy kaya fiada to AMC kahti ha
hm wo unit jis ki vlaue 80 Rs hain us my commision add kr k let say 82.5 k dy gy
1213.5 units
AMC entry
Cash 100,000.00
Units 97,080.00
1213.5*80
comsion to agent 2,920.00 front and load means c
Concept of Back and load
 ap k units ki FV 105 ha lkn ap kabi be 105 py sale nahi kr skt
always little low
jb AMC paisy dy ge to wo kam py sale ho ga aur us k effect baqi sari investment py be ay ga
to AMCV kaya khati ha
unit ki amount 90.00
Bel (0.90)
89.10
ab yh 0.9 baqi sab funds my distribute ho ga

Sharp ratio Expected return-risk free/standard deviation

Lecture 18
Past paper Taizgam ltd
Portfolio Beta
Investment Beta
A 50.00 1.60 Rf 10%
B 40.00 1.20 Rm 20%
C 70.00 1.50
D 40.00 1.80
200.00
ab es portfolio k sall k end my kya vlaue ho ge
aur yh assume kro es k expected return required k barabar ha
A 10%+(20%-10%)*1.6 26%
B same 22%
C same 25%
D same 28%
Value of portfolio at the year end
RS
A 50*(1+26%) 63.00
B 40*(1+22%) 48.80
C 87.50
D 51.20
250.50
Beta
let say RS 50 pharma 1.60
40 in oil 1.20
70 automobile 1.50
40 Service 1.80
ab company apna beta be nikaly ge
en sab k weighted average beta portfolio beta ho ga
Required return yh hr company sy us kbeta k acoording retrun mangy ge

10%+(20%-10%)
Requiird return 25.25%

200(1+25.25%) 250.50
 Portfolio beta

opening balance Closing balances

Valuation of security at the year end

Investment RS 80.00
Rf 10.50%
Rm 22%
Beta 1.99

Ke 10.5%+(22%-10.5%)*1.99
Ke 33.38%

Dividend yield Dividend as the percentage oof opening market value

Dividend 8%
Growth rate in market rate 33.38%-8% 25.38%
kiyu k 8% to ap dividend k tor py ly gy
800*(1+25.38%) 100.30

Capital gain 20.30 100.3-80

dvd 6.40 80*8%
Gain 26.70

Alternative method for calculating beta

Security Market
Expected return 16% 14.50%
SD 3% 4%
corelation
0.75
Beta 3%*0.75/4%

Lecture 20
Gearing and ungearing o beta

steps
1.00 sector choose
2.00 reference company
3.00 identity relevant beta
4.00 ungear ta k us my sirf business risk rhy jaaaey
5.00 phr re gear
6.00 than rsik adjusted wacc

Investment
different sector
fuel and oil
 pharma
coal
automobile
New company in pharma sector
after exploring parhma sector
ma ny ik ase compan choose ki jis my us company ny agy different sector my inv
I see company C
capital structure
debt 40.00
equity 60.00
ab yh ungeared nahi ha geared ha
ke 21% keg ha kiyu k yh geared ha
General market
Rm 16%
Rf 7%
ab ma kasy pta krna k pahrma kitna risky ha
to ma beta nikalu ga
keg Rf+(Rm-Rf)*beta
Beta 1.56
ab yh company k beta ha aur company my finanical risk be rakha gya ha
ab yh beta equity ha kiyu k yh alreaady financial risk ha
ab hm es beta ko ungear krty hian
beta asset =beta equity *E/E+D
beta assset 0.93
ab yh beta pharma k risk ko represent kr rha ha

ab ma chaht hhu k ma apni company my debt aur equity 50 50 rakhu

to ab yh beta mery kam k nahi ha kiyu k wo 40 aur 60 ki ratio my tha
ab ma esy regear kru ga
lkn phly ma 0.933 kiyu leya wo es leya ta k ma es my sy financial risk nikal k sirf
Step 2
Regear
Beta asset =Beta equity*E/E+D
ab ma equity aur debt 50 50 rkahna ha
0.93 Be*50/50+50
pharma my ghusny k risk
yaha py ma beta equity 1.5656 es leya nahi rkaha kiyu k ma apna debt equity 5
beta equity 1.87
ab ma keg of my company laina
keg Rf+(rm-Rg)*Beta equity
23.80%
step
Wacc
50*23.803%+50*7%/50+50
15.40%
risk adjsuted WACC
 agr kd exams my nahi deya ho ga to hm kf ko he kd many g y

company C k wacc aur mera Wacc same hona chaeya

15.40%
it proves that k agr sector same ha to WACC same ho ga
lkn agr dono k WACC equals ha to hm ny itna lam
kiyu k es my tax a jae y ga aur Kd and wacc equa

Introduction of Taxes in theory of CAPM and MM theory

taxes
Beta asset=beta equity*E/E+D(1-t)

Comapy A
and im reading company B
mera sector pahrma ha aur ma change kr k cement my ja rha hu ]

Co.A Co.B
Sector pharma cenment
Tax rate 25% 30%
keg 19% 24%
D/E 50/50 45/55
Rf 7%
Rm 16%
Target investment
D/E 70/30
ab ma es sector k cash flow ko kis rate sy discount kru ?

ab es my mera apna sector kisi kam ki nahi kiyu k ma to sector he change kr rha hu ab ma jaha jau ga waha k rates use kr u g
Step 1
Beta equity
24%=7%+(16%-7%)*Beta equity
Beta equity 1.8889
Step 2
ungeared us sector my sy financial risk hata dy
Beta asset 1.889*55/50+45(1-30%)
beta asset 1.20
Step 2
Re gear
1.201=beta equity *30/30+70*0.7 same tax rate for ungear and regear my
betaeqity 3.16
Step 4
Finad keg for the new company
7%+(16%-7%)*3.16
keg 35.44%
Step 5
WACC risk adjsuted
 WACC 30*35.44%+70*7%*0.7/30+70
WACC 140.063%

Lecture 21

Brief revision of beta

Beta
Beta Asset business risk
Beta Equity business risk and financial risk
Beta Debt beta debt is generally zero cash flow constant hota tha aur sta
its only for exams view lkn actually
Case A
company k passs equity ha
aur us ny project A my invest keya howa ha
ab company es project sy kitna demand kry ge
aur shareholder company sy kitna return mangy gy
Case B
company k pass equity or debt dono hian
aur invest proejct A my he keya hwoa ha
ab company kitna return mang rhi ha uar
investor commpany sy kya mang rha ha
Case C
company k pass ik source of finacne ha
aur invest 2 projects my keya hwoa ha A and B
aur ab investor comapyn su ktina mang rha ha
aur company hr project sy kitna kitna mang rhi ha
Case D
two sources
aur 2 projects my ivnest keyta ha

Case A
Equity 100,000.00
project A 100,000.00 invested
project A
ab es sector k beta asset 1.6 ha
ab company k be beta 1.6 ho ga
Rm14%
Rf 8%
ab kitna return hona chaeya ese project sy company k pass
ke 8%+(14%-8%)*1.6
17.60%
company es project sy kya mang rhi ha 17.6
ab investor kitna mangy ga17.6

Case B
 equity 100,000.00
project A 60,000.00
Project B 40,000.00

A B
Beta 1.80 1.20
Rm 14%
Rf 8%
company ny project A sy alg aur B sy alg return laina
aur investro ny direct ik he return mangna

project A
1.8*(14%-8%)+8%
rate 18.80%
Project B
1.2*(14%-8%)+8%
15.20%
now investor k point of view sy
now investor ik portfolio ki trha company ko dekh rha ha jis my 60k A my aur 40k B my
to investor ik weighted average Beta calculate kry ga
Weighted Beta 1.8*60/10+1.2*40/10
1.56
yh ik wiehgted average beta ha company k

Now rate
1.56*(14%-8%)+8%
17.36%
Case C
Equity 120,000.00
debt 40,000.00
investment project A 160,000.00
beta asset 1.60
Rm 14%
Rf 8%
ab compny k ik he required rate ho ga
aur wo WACC ho ga
aur wo debt or equity ko kd and ke dy ga
ab company kya krey ge
Step 1
Gear up beta
es ko pta ha mery pass debt sy be a rha ha
aur yh beta asset ko beta equity banaey ge aur alg alg kd aur ke k hisab sy distribute kry ge
beta asset 1.60
1.60 B equity *120/120+40
beta equity 2.13
Step 2 find keg
8%+(14%-8%)*2.1333
 keg 20.80% equity wlay yh
Step 3 Risk adjuested wacc
120*20.8%+40*8%/120+40
17.60% company yh

Case D
Equity 70.00
Debt 30.00
investment Beta Equity investment debt invest
A 60.00 1.80 35.00 25.00 60.00
B 40.00 1.20 35.00 5.00 40.00

Rm 14%
Rf 8%

ab debt holder aur shareholder ny company A my invest keya uar company ny A nad B my ivnest keya

project A Return
Step 1 gear up beta
beta asset 1.80
1.8=beta equity*35/35+25
beta equity 3.09
Step 2 find keg
3.09*(14%-8%)+8%
26.51%
Step 3 risk adjsuted WACC
35*26.51%+25*8%/35+25
Wacc 18.80%

company ny 18.8% laina

share holder ny 26.515%
debt hodler ny 8%
project B
Step 1 gear up beta
beta asset 1.20
1.2=beta equity*35/35+5
beta equity 1.37
Step 2 find keg
1.37*(14%-8%)+8%
16.22% 35 equity investment
Step 3 risk adjsuted WACC
35*16.22%+5*8%/35+5
Wacc 15.20%

company 15.20%
shareholder
for investor
 step 1 Portfolio Beta weighted average beta
1.8*70+1.2*30/100
1.56 beta asset
ab es beta sy ma beta equity nikalu ga
step 2 find beta equity
1.56=beta equ*70/70+30 dono ki quity
2.23 ab yh 2.23 dono projects k weighted average fin
step 3 find ke
2.23*(14%-8%)+8%
21.37% 35 equity investment
ab agr en dono ke k average ly lu to same abat ha aur wo ho

Lecture 22
Iron ltd
discounting hamesha required rate sy hoti ha

Lecture 23

Reconstruction of portfolio
AZAD textile ltd

Lecture 24
 mtlb multiple busines na ho

k ma apna debt equity 5 0 50 rkahna ha aur us k 40 60 tha

quals ha to hm ny itna lamba kam kiyu keya
ga aur Kd and wacc equal nahi ho ga

a waha k rates use kr u ga

us my apni debt equity k finacial risk add kr dy

my aur 40k B my

aur wasy be company k pass 2 risk hain financial risk and business risk business rsik to always aur finacnai risk debt ki wjha sy
debt holder 8%
ts k weighted average financial risk ko be represent kr rha ha aur busines risk ko be

21.37%
ys aur finacnai risk debt ki wjha sy aya