This teaching note is a continuation of the previous teaching note on risk-neutral valuation. In Section One, we estimate the value of levered equity in a levered company in an M amp; M world with risk-free debt and without taxes. The structure of the presentation will facilitate the subsequent...

Risk-neutral valuation is simple, elegant and central in option pricing theory. However, in teaching risk-neutral valuation, it is not easy to explain the concept of 'risk-neutral' probabilities. Beginners who are new to risk-neutral valuation always have lingering doubts about the validity of...

The conventional wisdom about psi, the appropriate discount rate for the tax shield, is as follows. If the tax shield is risk-free, that is, the revenue is sufficient to ensure that the interest deduction will be used with full certainty in the relevant period, then the appropriate discount rate...

In the recent writings on valuation, there is no consensus about the correct formulas for calculating the relevant cost of capital in an M amp; M world. The proliferation of alpha number of methods and omega number of theories for the calculation of the cost of capital is puzzling because in the...

In the arena of valuation, the fanciful claims about the dethronement of the champion (a.k.a. NPV) by the concept of economic value added (EVA) have been greatly exaggerated, and it would be premature and unwise to abandon our reliable and trusted NPV. EVA is simply an interesting algebraic...

Recently, the residual income (RI) model has become very popular in valuation because it purports to measure quot;value addedquot; by explicitly taking into account the cost for capital in the income statement. Some proponents of the residual income approach have even suggested that the RI model...

In the financial appraisal of a project, the cashflow statements are constructed from two points of view: the Total Investment (TI) Point of View and the Equity Point of View. One of the most important issues is the estimation of the correct financial discount rates for the two points of view....

There are two ways to define the present value of the tax shield (PVTS). First, the (present) value of the tax shield VTS is simply the tax shield, discounted by y, which is the appropriate discount rate for the tax shield. Second, the (present) value of the tax shield VTS is the difference in...

There are two ways to view the inter-temporal risk profile of a finite stream of cash flows that is represented by a binomial process. We can examine the risk profile of the cash flow process or the value process that is derived from the cash flow process. First, with respect to a given year n,...

If the forecast period is short, then the specification of the assumption for the calculation of the terminal may be an important element of the valuation exercise. To be specific, with respect to the reference year 0, the (present) value of the terminal value may be more than fifty percent of...