Finance 401 Cheat Sheet: A Quick Guide to Advanced Concepts

Finance 401 delves deeper into complex financial theories and applications. This cheat sheet provides a concise overview of crucial concepts you’ll encounter in this advanced course.

Valuation and Investment Strategies

Capital Asset Pricing Model (CAPM):

E(Ri) = Rf + βi * (E(Rm) – Rf)

Where:

• E(Ri) = Expected return of investment i
• Rf = Risk-free rate of return
• βi = Beta of investment i (systematic risk)
• E(Rm) = Expected market return

Purpose: Calculates the expected return on an investment based on its risk relative to the market.

Weighted Average Cost of Capital (WACC):

WACC = (E/V) * Ke + (D/V) * Kd * (1 – Tc)

Where:

• E = Market value of equity
• D = Market value of debt
• V = Total market value (E + D)
• Ke = Cost of equity
• Kd = Cost of debt
• Tc = Corporate tax rate

Purpose: Determines the firm’s average cost of financing its assets.

Free Cash Flow (FCF):

FCF = EBIT * (1 – Tc) + Depreciation & Amortization – Capital Expenditures – Change in Net Working Capital

Purpose: Represents the cash flow available to the company and its investors after all operating expenses and investments are paid.

Dividend Discount Model (DDM):

P0 = D1 / (r – g)

Where:

• P0 = Current stock price
• D1 = Expected dividend next year
• r = Required rate of return
• g = Constant dividend growth rate

Purpose: Values a stock based on the present value of its future dividends.

Derivatives and Risk Management

Option Pricing (Black-Scholes Model):

A complex formula used to calculate the theoretical price of European-style options. It considers factors like current stock price, strike price, time to expiration, volatility, and risk-free rate. Understand the core inputs and their impact on option price, but memorizing the entire formula might not be necessary. Focus on interpreting the results.

Hedging Strategies:

• Long Hedge: Buying futures contracts to protect against rising prices.
• Short Hedge: Selling futures contracts to protect against falling prices.

Purpose: Mitigates risk associated with price fluctuations of assets.

Value at Risk (VaR):

A statistical measure that quantifies the potential loss in value of an asset or portfolio over a defined period for a given confidence level.

Purpose: Assesses and manages market risk.

Corporate Finance Advanced Topics

Mergers and Acquisitions (M&A):

Understand the different types of mergers (horizontal, vertical, conglomerate) and the key considerations during valuation, financing, and integration.

Capital Structure Theory:

Explore the Modigliani-Miller theorem (with and without taxes), trade-off theory, and pecking order theory to understand how firms make financing decisions.

Real Options:

Recognize the different types of real options (e.g., option to expand, option to abandon) and how they can impact project valuation using decision tree analysis and other techniques. These are the options embedded in capital budgeting projects.

Key Considerations

• Assumptions: Be aware of the underlying assumptions of each model and their limitations.
• Data Quality: Accurate and reliable data is crucial for obtaining meaningful results.
• Context: Always consider the specific context and circumstances when applying these concepts.

This cheat sheet provides a foundational overview. Consult textbooks and other resources for a more in-depth understanding.