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Margin Calls and Stop Outs are part of the Risk Management strategies or way of Trade12 and was implemented to limit further losses and to decrease the risk of a negative account balance.
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WEEK 13
MAKING CAPITAL INVESTMENT DECISIONS
RELEVANT CASH FLOWS
• The cash flows that should be included
in a capital budgeting analysis are
those that will only occur (or not occur)
if the project is accepted
• These cash flows are called incremental
cash flows
• The stand-alone principle allows us to
analyze each project in isolation from
the firm simply by focusing on
incremental cash flows
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• You should always ask yourself “Will this cash
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▪ If the answer is “yes,” it should be included in the
analysis because it is incremental
▪ If the answer is “no,” it should not be included in the
analysis because it will occur anyway
▪ If the answer is “part of it,” then we should include
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• Sunk costs – costs that have accrued in the past
• Opportunity costs – costs of lost options
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▪ Negative side effects – costs to other projects
• Changes in net working capital
• Financing costs
• Taxes
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Okay, let me work through these step-by-step:
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12,500 shares of common stock x $30 per share market price = $375,000 conversion value
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- Rate of return considers the purchase price, sale price, and any payments to calculate return over a period of time for investments sold before maturity.
- Real interest rates adjust nominal rates for inflation to show returns in terms of purchasing power rather than dollar amounts. The Fisher equation defines the relationship between real and nominal rates.
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1) Derivatives such as financial futures contracts, options, swaps, caps, floors and collars are used to manage interest rate risk.
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WEEK 13MAKING CAPITAL INVESTMENT DECISIONSRELEVANT.docx
WEEK 13
MAKING CAPITAL INVESTMENT DECISIONS
RELEVANT CASH FLOWS
• The cash flows that should be included
in a capital budgeting analysis are
those that will only occur (or not occur)
if the project is accepted
• These cash flows are called incremental
cash flows
• The stand-alone principle allows us to
analyze each project in isolation from
the firm simply by focusing on
incremental cash flows
ASKING THE RIGHT QUESTION
• You should always ask yourself “Will this cash
flow occur ONLY if we accept the project?”
▪ If the answer is “yes,” it should be included in the
analysis because it is incremental
▪ If the answer is “no,” it should not be included in the
analysis because it will occur anyway
▪ If the answer is “part of it,” then we should include
the part that occurs because of the project
COMMON TYPES OF CASH FLOWS
• Sunk costs – costs that have accrued in the past
• Opportunity costs – costs of lost options
• Side effects
▪ Positive side effects – benefits to other projects
▪ Negative side effects – costs to other projects
• Changes in net working capital
• Financing costs
• Taxes
PRO FORMA STATEMENTS AND
CASH FLOW
• Capital budgeting relies heavily on pro forma
accounting statements, particularly income
statements
• Computing cash flows – refresher
▪ Operating Cash Flow (OCF) =
EBIT + depreciation – taxes
▪ OCF = Net income + depreciation
(when there is no interest expense)
▪ Cash Flow From Assets (CFFA) =
OCF – net capital spending (NCS) – changes in
NWC
PRO FORMA INCOME
STATEMENT
Sales (50,000 units at $4.00/unit) $200,000
Variable Costs ($2.50/unit) 125,000
Gross profit $ 75,000
Fixed costs 12,000
Depreciation ($90,000 / 3) 30,000
EBIT $ 33,000
Taxes (34%) 11,220
Net Income $ 21,780
PROJECTED CAPITAL
REQUIREMENTS
Year
0 1 2 3
NWC $20,000 $20,000 $20,000 $20,000
NFA 90,000 60,000 30,000 0
Total $110,000 $80,000 $50,000 $20,000
PROJECTED TOTAL CASH
FLOWS
Year
0 1 2 3
OCF $51,780 $51,780 $51,780
Change
in NWC
-$20,000 20,000
NCS -$90,000
CFFA -$110,00 $51,780 $51,780 $71,780
MORE ON NWC
• Why do we have to consider changes in NWC
separately?
▪ GAAP requires that sales be recorded on the income
statement when made, not when cash is received
▪ GAAP also requires that we record cost of goods
sold when the corresponding sales are made,
whether we have actually paid our suppliers yet
▪ Finally, we have to buy inventory to support sales,
although we haven’t collected cash yet
DEPRECIATION
• The depreciation expense used for capital
budgeting should be the depreciation
schedule required by the IRS for tax
purposes
• Depreciation itself is a non-cash expense;
consequently, it is only relevant because it
affects taxes
• Depreciation tax shield = D × T
▪ D = depreciation expense
▪ T = marginal tax rate
COMPUTING DEPRECIATION
• Straight-line depreciation
▪ D = (Initial cost – salvage) / number of years
▪ Very few assets are depr ...
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Get Margin and leverage in forex trading with trade12
- 1. • Using only a portion of the proceeds for an investment • Borrow remaining component • Margin arrangements differ for stocks and futures Margin Trading Example with Trade12
- 2. • Greatest margin – Currently 30% – Set by the securities commissions • Minimum margin – Minimum level the equity margin can be (called “maintenance” in USA) • Margin call – Call for more equity funds Stock Margin Trading
- 3. X Corp $70 50% Initial Margin 30% Minimum Margin 1000 Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Equity $35,000 Margin Trading - Initial Conditions
- 4. Margin Trading - Minimum Margin Stock price falls to $60 per share New Position Stock $60,000 Borrowed $35,000 Equity $25,000 Margin% = $25,000/$60,000 = 41.67%
- 5. Margin Trading - Margin Call • How far can the stock price fall before a margin call? Therefore, P = $50 Note: 1,000xP – Amount Borrowed = Equity %30 P000,1 000,35$P000,1 = × −×
- 6. Leveraging effect of margin purchases • You buy 200 shares of XYZ at $100, expecting a 30% appreciation of the stock in one year: – Initial margin: 50% – Financed by a 9% loan for one year – Expected net return: 51% • A 30% drop in the price, though, brings a negative rate of return of -69%.
- 7. Short Sales • Purpose: to profit from a decline in the price of a stock or security Mechanics • Borrow stock through a dealer • Sell it and deposit proceeds and margin in an account • Close out the position: buy the stock and return it to the owner
- 8. Short Sale - Initial Conditions Z Corp 100 Shares 50% Initial Margin 30% Minimum Margin $100 Initial Price Sale Proceeds $10,000 Margin & Equity $ 5,000 Stock Owed $10,000
- 9. Short Sale - Minimum Margin Stock Price Rises to $110 Sale Proceeds $10,000 Initial Margin $ 5,000 Stock Owed $11,000 Net Equity $ 4,000 Margin % (4,000/11,000) = 36%
- 10. Short Sale - Margin Call • How much can the stock price rise before a margin call? So, P = $115.38 Note: $15,000 = Initial margin + sale proceeds $15,000 $100 30% 100 P P − =