FIN300 Exam #2

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Liquidity Premium

The portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity. -bonds that have more frequent trading will generally have lower required returns

Default Risk Premium

The portion of a nominal interest rate or bond yield that represents compensation for the possibility of default. -Bond Ratings

Taxability Premium

The portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status. -Municipal vs. Taxable

Option to wait

The project can be postponed, perhaps in hope of more favorable conditions.

Registered Bond (registered form)

The registrar of a company records who owns each bond, and bond payments are made directly to the owner of record. -protects against money laundering

note

Unsecured debt, usually with a maturity of under 10 years.

Premium Bond

a bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate -Coupon Rate > YTM -Price > Par -Lose Money

Debt Security

a contract that promises to pay a given amount of money to the owner of the security at specific dates in the future -are classified according to the collateral and mortgages used to protect the bondholder.

Debenture

an unsecured debt, usually with a maturity of 10 years or more

Stock Price Sensitivity to Dividend Growth, g

as the growth rate increases, the stock price increases dramatically

Real Rate of Interest =

change in purchasing power

The Fisher Effect

defines the relationship between real rates, nominal rates, and inflation

Price grows at the same rate as _______________

dividends

municipal bonds

free from most taxes and, as a result, have much lower yields than taxable bonds.

Seniority

indicates preference in position over other lenders, and debts are sometimes labeled as senior or junior to indicate seniority. -Bondholders have priority over stockholders in repayment -Senior bonds gets paid before junior bonds. -Jr. bond is subordinate to Sr. Bond.

Collateral security

is a general term that frequently means securities (e.g., bonds and stocks) that are pledged as security for payment of debt. -secured by financial securities -For example, collateral trust bonds often involve a pledge of common stock held by the corporation.

Maturity Premium

longer term bonds will tend to have higher required returns

Decision Criteria Test Payback •Does the payback rule: -Account for the time value of money? -Account for the risk of the cash flows? -Provide an indication about the increase in value? -Permit project ranking? •Should we consider the payback rule for our primary decision rule?

no for all

IF Coupon Rate = YTM

price = par

Founders' Shares

stock owned by the firm's founders that enables them to maintain control over the company without having to own a majority of stock ex. Ford Motor Company, for example, has Class B common stock, which is not publicly traded (it is held by Ford family interests and Page 218trusts). This class has about 40 percent of the voting power, even though it represents less than 10 percent of the total number of shares outstanding.

Capital gains yield

the dividend growth rate, or the rate at which the value of an investment grows = g

Capital Budgeting

the process of planning and managing a firm's long-term investments •Analysis of potential projects •Long-term decisions •Large expenditures •Difficult/impossible to reverse •Determines firm's strategic direction

Reinvestment Risk

uncertainty concerning rates at which cash flows can be reinvested. •Short-term bonds have more reinvestment rate risk than long-term bonds •High coupon rate bonds have more reinvestment rate risk than low coupon rate bonds

Relevant Cash Flows: •"Sunk" Costs •Opportunity Costs •Side Effects/Erosion •Net Working Capital (CA-CL) •Financing Costs •Tax Effects

•"Sunk" Costs ................................N •Opportunity Costs .......................Y •Side Effects/Erosion.....................Y •Net Working Capital.....................Y •Financing Costs.............................N •Tax Effects .....................................Y

Average Accounting Return - Decision Rule

•Accept the project if the AAR is greater than the target rate.

Good Decision Criteria

•All cash flows considered? •TVM considered? •Risk-adjusted? •Ability to rank projects? •Indicates added value to the firm?

The Bond Indenture - "Deed of Trust" -Contract between issuing company and bondholders includes:

•Basic terms of the bonds •Total amount of bonds issued •Secured versus Unsecured •Sinking fund provisions •Call provisions •Details of protective covenants

•Sources of value:

•Be able to articulate why this project creates value

IRR - Disadvantages

•Can produce multiple answers •Cannot rank mutually exclusive projects •Reinvestment assumption flawed

Problems with Scenario Analysis

•Considers only a few possible outcomes •Assumes perfectly correlated inputs -All "bad" values occur together and all "good" values occur together •Focuses on stand-alone risk, although subjective adjustments can be made

Managerial Options

•Contingency planning •Option to expand •Option to abandon •Option to wait •Strategic options

Modified Internal Rate of Return (MIRR)

•Controls for some problems with IRR

Treasury notes

•Coupon debt •Original maturity between one and ten years

Treasury bonds

•Coupon debt •Original maturity greater than ten years

Government Bonds -Municipal Securities

•Debt of state and local governments •Varying degrees of default risk, rated similar to corporate debt •Interest received is tax-exempt at the federal level •Interest usually exempt from state tax in issuing state Must consider the fact that there is no tax

Dividend Characteristics

•Dividends are not a liability of the firm until declared by the Board of Directors •Dividends and Taxes

Scenario Analysis

•Examines several possible situations: -Worst case -Base case or most likely case -Best case •Provides a range of possible outcomes Note: "Lower" ≠ Worst "Upper" ≠ Best

Par Value

•Face amount -Face Value •Re-paid at maturity •Assume $1,000 for corporate bonds

Yield Curve

•Graphical representation of the term structure -Normal -Inverted

Payback Period

•How long does it take to recover the initial cost of a project? •Computation -A "break-even" type measure

Reinvestment Rate Assumption

•IRR assumes reinvestment at IRR. •NPV assumes reinvestment at the firm's weighted average cost of capital (opportunity cost of capital). -More realistic -NPV method is best •NPV should be used to choose between mutually exclusive projects.

NPV - Decision Rule

•If NPV is positive, accept the project.

After-Tax Salvage

•If the salvage value is different from the book value of the asset, then there is a tax effect =salvage - T(salvage - book value)

Cash Flows for Stockholders

•If you own a share of stock, you can receive cash in two ways -The company pays dividends -You sell your shares, either to another investor in the market or back to the company •As with bonds, the price of the stock is the present value of these expected cash flows -Dividends → cash income -Selling → capital gains

Relevant Cash Flows

•Include only cash flows that will only occur if the project is accepted •Incremental cash flows

Accrued Interest

•Interest earned since last coupon payment is owed to bond seller at time of sale

MIRR vs. IRR

•MIRR correctly assumes reinvestment at opportunity cost = WACC •MIRR avoids the multiple IRR problem. •Managers like rate of return comparisons, and MIRR is better for this than IRR.

Zero Coupon Bond

•Make no periodic interest payments (coupon rate = 0%) •Entire yield-to-maturity comes from the difference between the purchase price and the par value (capital gains) •Cannot sell for more than par value •Sometimes called zeroes, or deep discount bonds •Treasury Bills and U.S. Savings bonds are good examples of zeroes

Average Accounting Return

•Many different definitions for average accounting return (AAR) •In this book: = Avg Net Income/Average Book Value(cost/2) -Note: Average book value depends on how the asset is depreciated. •Requires a target cutoff rate

Medium Grade

•Moody's A and S&P A - capacity to pay is strong, but more susceptible to changes in circumstances •Moody's Baa and S&P BBB - capacity to pay is adequate, adverse conditions will have more impact on the firm's ability to pay

High Grade

•Moody's Aaa and S&P AAA - capacity to pay is extremely strong •Moody's Aa and S&P AA - capacity to pay is very strong

Low Grade

•Moody's Ba, B, Caa and Ca •S&P BB, B, CCC, CC •Considered speculative with respect to capacity to pay. The "B" ratings are the lowest degree of speculation.

Very Low Grade

•Moody's C and S&P C - income bonds with no interest being paid •Moody's D and S&P D - in default with principal and interest in arrears

Internal Rate of Return

•Most important alternative to NPV •Widely used in practice •Intuitively appealing •Based entirely on the estimated cash flows •Independent of interest rates

NASDAQ

•NASDAQ OMX (merged 2007) •Computer-based quotation system •Multiple market makers •Electronic Communications Networks •Three levels of information -Level 1 - median quotes, registered representatives -Level 2 - view quotes, brokers & dealers -Level 3 - view and update quotes, dealers only •Large portion of technology stocks

Conflicts between NPV and IRR

•NPV directly measures the increase in value to the firm. •Whenever there is a conflict between NPV and another decision rule, always use NPV. •IRR is unreliable in the following situations: -Non-conventional cash flows -Mutually exclusive projects

Evaluating NPV Estimates

•NPV estimates are only estimates •Forecasting risk: •Sources of value:

Disadvantages of Sensitivity and Scenario Analysis

•Neither provides a decision rule. -No indication whether a project's expected return is sufficient to compensate for its risk. •Ignores diversification. -Measures only stand-alone risk, which may not be the most relevant risk in capital budgeting.

Quoted bond prices = "clean" price

•Net of accrued interest -does not include accrued interest

Debt

•Not an ownership interest •No voting rights •Interest is tax-deductible •Creditors have legal recourse if interest or principal payments are missed •Excess debt can lead to financial distress and bankruptcy ex.) Bonds

Equity

•Ownership interest •Common stockholders vote to elect the board of directors and on other issues •Dividends are not tax deductible •Dividends are not a liability of the firm until declared. Stockholders have no legal recourse if dividends are not declared •An all-equity firm cannot go bankrupt ex.) Stocks

Bond Value =

•PV(coupons) + PV(par) •PV(annuity) + PV(lump sum)

IRR - Advantages

•Preferred by executives -Intuitively appealing -Easy to communicate the value of a project •If the IRR is high enough, may not need to estimate a required return •Considers all cash flows •Considers time value of money •Provides indication of risk

Invoice Price = "dirty" or "full" price

•Price actually paid •Includes accrued interest

Bond Markets

•Primarily over-the-counter transactions with dealers connected electronically •Extremely large number of bond issues, but generally low daily volume in single issues •Getting up-to-date prices difficult, particularly on small company or municipal issues •Treasury securities are an exception -Larger than stock market -Don't trade often

Treasury Bills (T-bills)

•Pure discount bonds --> no coupon •Original maturity of one year or less

Sensitivity Analysis

•Shows how changes in an input variable affect NPV or IRR •Each variable is fixed except one - Change one variable to see the effect on NPV or IRR •Answers "what if" questions

Two Reasons NPV Profiles Cross

•Size (scale) differences •Timing differences

Coupon interest rate (coupon):

•Stated interest rate •Usually = YTM at issue •Multiply by par value to get coupon payment -Cash Flows (CF), -PMTs

Yield to maturity (YTM):

•The market required rate of return for bonds of similar risk and maturity •the market required rate of return implied by the current bond price •The discount rate used to value a bond •Return if bond held to maturity •Usually = coupon rate at issue •Quoted as an APR

term structure of interest rates

•The relationship between time to maturity and yields, all else equal -The effect of default risk, different coupons, etc. has been removed.

Government Bonds -Treasury Securities = Federal government debt

•Treasury Bills (T-bills) •Treasury notes •Treasury bonds

Depreciation & Capital Budgeting

•Use the schedule required by the IRS for tax purposes •Depreciation = non-cash expense -Only relevant due to tax effects

Maturity

•Years until bond must be repaid -N -"Matures in", Callable in

AS Interest Rate (YTM) Decreases

•present values Increases •bond prices Increases and vice versa

As Interest Rate (YTM) Increases

•present values decreases •bond prices decreases and vice versa

Mortgage security

•secured by real property, normally land or buildings

Fisher Effect: Exact =

(1+R) = (1+r)(1+h) R = Nominal Rate (Quoted Rate) r = real rate h = expected inflation rate

•Dividends and Taxes

- Dividends are not tax deductible for firm - Taxed as ordinary income for individuals - Dividends received by corporations have a minimum 70% exclusion from taxable income

Developing the Model: -the price of the stock is really just...

- You could continue to push back when you would sell the stock - You would find that the price of the stock is really just the present value of all expected future dividends - Price(PV) of a stock does not change with how long you hold it

•Dividends are not a liability of the firm until declared by the Board of Directors

-A firm cannot go bankrupt for not declaring dividends

Internal Rate of Return Decision Rule

-Accept the project if the IRR is greater than the required return.

Put bond

-Allows the holder to force the issuer to buy the bond back at a stated price. The put feature is therefore the reverse of the call provision and is a relatively new development. -Good for investor if rates increase -Bad for companies if rates increase Issued by companies if rates are to decrease.

Broker market

-Brings buyers and sellers together -Think "Real estate broker"

IRR & Nonconventional Cash Flows

-Cash flows change sign more than once. -Most common: •Initial cost (negative CF) •A stream of positive CFs •Negative cash flow to close project •For example, nuclear power plant or strip mine -More than one IRR . . . -Which one do you use to make your decision? -NPV

Price Risk

-Change in price due to changes in interest rates -Long-term bonds have more price risk than short-term bonds -Low coupon rate bonds have more price risk than high coupon rate bonds

Estimating Dividends Special Cases

-Constant Dividend (zero growth) -Constant Dividend Growth -Supernormal Growth

Option to abandon

-Contraction -Temporary suspension -The option to scale back or even abandon a project is also quite valuable.

Factors Effecting Required Return

-Default risk premium -Taxability premium -Liquidity premium -Maturity premium -Anything else that affects the risk of the cash flows to the bondholders will affect the required returns.

Sensitivity Analysis: Weaknesses

-Does not reflect diversification. -Says nothing about the likelihood of change in a variable. -Ignores relationships among variables.

Advantages of AAR

-Easy to calculate -Needed information usually available

Advantages of Payback

-Easy to understand -Adjusts for uncertainty of later cash flows -Biased towards liquidity

Payback Period -Computation

-Estimate the cash flows. -Subtract the future cash flows from the initial cost until initial investment is recovered. -A "break-even" type measure

Option to expand

-Expansion of existing product line -New products -New geographic markets

Constant Dividend (Zero Growth)

-Firm will pay a constant dividend forever -Like preferred stock -Price is computed using the perpetuity formula -Dividends expected at regular intervals forever = perpetuity -Po=D/R

Classes of Stock

-Founders' shares -Class A and Class B shares

Bond Ratings - Investment Quality

-High Grade -Medium Grade -Lower Risk and, Lower Interest

Internal Rate of Return Definition -IRR=

-IRR = discount rate that makes the NPV = 0

Disadvantages of Payback

-Ignores the time value of money -Requires an arbitrary cutoff point -Ignores cash flows beyond the cutoff date -Biased against long-term projects, such as research and development, and new projects

Bond Ratings - Speculative

-Low Grade -Very Low Grade -Higher Risk, Higher Interest -Sunk bonds, High-yield Bonds

Dealer market

-Maintains an inventory -Ready to buy or sell at any time -Think "Used car dealer"

Good Decision Criteria?: NPV Method

-Meets all desirable criteria •Considers all CFs •Considers TVM •Adjusts for risk •Can rank mutually exclusive projects -Directly related to increase in VF -Dominant method; always prevails

New York Stock Exchange (NYSE)

-Merged with Euronext in 2007 -NYSE Euronext merged with the American Stock Exchange in 2008 •Members (Historically) -Buy a trading license (own a seat) -Designated market makers, DMMs (formerly known as "specialists") -Floor brokers -Supplemental liquidity providers (SLPs)

NPV vs IRR exceptions

-Non-conventional cash flows: •Cash flow sign changes more than once -Mutually exclusive projects: •Initial investments are substantially different. •Timing of cash flows is substantially different. •Will not reliably rank projects

Disadvantages of AAR

-Not a true rate of return -Time value of money ignored -Uses an arbitrary benchmark cutoff rate -Based on accounting net income and book values, not cash flows and market values

•NPV > 0 means:

-Project is expected to add value to the firm -Will increase the wealth of the owners

Timing differences

-Project with faster payback provides more CF in early years for reinvestment -If discount rate is high, early CF especially good

•Pro Forma Financial Statements

-Projects future operations

Sensitivity Analysis: Strengths

-Provides indication of stand-alone risk. -Identifies dangerous variables. -Gives some breakeven information.

•Forecasting risk:

-Sensitivity of NPV to changes in cash flow estimates -The more sensitive, the greater the forecasting risk

Other Rights

-Share proportionally in declared dividends -Share proportionally in remaining assets during liquidation -Preemptive right

Size (scale) differences

-Smaller project frees up funds sooner for investment -The higher the opportunity cost, the more valuable these funds, so high discount rate favors small projects

•Voting Rights

-Stockholders elect directors -Cumulative voting vs. Straight voting -Proxy voting

IRR: Mutually Exclusive Projects

-The acceptance of one project precludes accepting the other.

IRR: Independent Projects

-The cash flows of one project are unaffected by the acceptance of the other.

Features of Common Stock

-Voting Rights -Classes of Stock -Other Rights

Good Decision Criteria - IRR •All cash flows considered? •TVM considered? •Risk-adjusted? •Ability to rank projects? •Indicates added value to the firm?

-Yes -Yes -Yes -Sometimes -No

Secondar Market

-existing shares traded among investors

Nominal rate of interest =

-quoted rate of interest -change in purchasing power and inflation -includes our desired real rate of return plus an adjustment for expected inflation

Timeline: at time 0

-subtract NWC -subtract NCS (NWC)

Constant Growth Model Conditions

1) Dividend expected to grow at g forever 2) Stock price expected to grow at g forever 3) Expected dividend yield is constant 4) Expected capital gains yield is constant and equal to g 5) Expected total return, R, must be > g 6) Expected total return (R): = expected dividend yield (DY) + expected growth rate (g) = dividend yield + g

•Straight-line depreciation D =

= (Initial cost - salvage) / number of years Straight Line --> Salvage Value

The Tax Shield Approach to OCF OCF =

= (Sales - costs)(1 - T) + Deprec*TC -Dep. is cost/number of years. •Particularly useful when the major incremental cash flows are the purchase of equipment and the associated depreciation tax shield -i.e., choosing between two different machines

Depreciation tax shield =

= DT -D = depreciation expense -T = marginal tax rate

Rationale for the NPV Method NPV =

= PV inflows - Cost •net gain in shareholder wealth -is a direct measure of how well this project will meet the goal of increasing shareholder wealth.

Net Salvage Cash Flow (After tax Salvage) =

= SP - (SP-BV)(T) Where: SP = Selling Price BV = Book Value T = Corporate tax rate

Book Value =

= initial cost - accumulated depreciation

primary market

= new-issue market

Unsecured bond

A bond backed only by the reputation of the issuer; also called a debenture bond. -no collateral, more risky, higher interest rate

Bearer Bond (bearer form)

A bond issued without record of the owner's name; payment is made to whomever holds the bond.

Discount Bond

A bond that sells below its par value; occurs whenever the going rate of interest is above the coupon rate - Coupon Rate < YTM - Price < Par -Make money

Sunk Cost

A cost that has already been incurred and cannot be recouped and therefore should not be considered in an investment decision. -Irrelevant

inverted yield curve

A downward-sloping yield curve indicates that short-term interest rates are generally higher than long-term interest rates. =downward-sloping: Long-term interest rates < short-term interest rates

Bond

A financial security that represents a promise to repay a fixed amount of funds •Debt contract •Interest-only loan -Debt, allows states/gov't to borrow money

Proxy Voting

A grant of authority by a shareholder allowing another individual to vote his or her shares.

protective covenant

A part of the indenture limiting certain actions that might be taken during the term of the loan, usually to protect the lender's interest. ex. Can't prioritize shareholder's over bond holders.

Straight Voting

A procedure in which a shareholder may cast all votes for each member of the board of directors. -Vote for each director one at a time. -Bad for minority shareholders

Cumulative Voting

A procedure in which a shareholder may cast all votes for one member of the board of directors. Every director is vote at once. -Better for minority shareholders

Payback Period -Decision Rule

Accept if the payback period is less than some preset limit.

Timeline: at last time

Add: NWC, After Tax Salvage, OCF

Call Provisions (confirm with shimmin) -Callable bond

Agreement giving the issuer the option to repurchase a bond at a specific price prior to maturity. -Deferred call -Call premium -Company will call the bond when Yield-to-Call is less than YTM. -Bad for investor if interest rates decrease -Good for company if rates decrease -Are riskier bonds, higher interest rate.

sinking fund provisions

An account managed by the bond trustee/owner for early bond redemption. -The company makes annual payments to the trustee, who then uses the funds to retire a portion of the debt. -Company makes incremental deposits to avoid having to pay entire amount at end. -Debt shrinks overtime -Provision to set $ aside -less risky --> lower interest rate

Normal Yield Curve

An upward-sloping yield curve indicates that long-term interest rates are generally higher than short-term interest rates. =upward-sloping: Long-term interest rates > short-term interest rates

Relationship Between Bond Price (PV) and Yield to Maturity (I/Y)

As YTM Increases, then Bond Price decreases

Stock Price Sensitivity to Required Return, R

As the Required Return increases, Price decreases.

Best investment strategy if YTM is going to increase in future

Bad time to buy bonds -Short-term bonds -High coupon rates -Bond value/price will decrease

Price at time t = Pt =

Benchmark PE ratio X Earnings per share (t) Benchmark price-sales ratio X Sales per share (t) •The price-sales ratio can be especially useful when earnings are negative.

deferred call provision

Bond call provision prohibiting the company from redeeming the bond prior to a certain date.

call protected bond

Bond during period in which it cannot be redeemed by the issuer.

Which bonds will have the higher coupon, all else equal? •A bond with a sinking fund versus one without

Bond without sinking fund: company has to come up with substantial cash at maturity to retire debt, and this is riskier than systematic retirement of debt through time.

secured bonds

Bonds that have specific assets of the issuer pledged as collateral. - Ensures that if bond is not paid back then investor will get something in return.

•Cash Flow From Assets:

CFFA = OCF - NCS -ΔNWC NCS = Net capital spending

Which bonds will have the higher coupon, all else equal? •A callable bond versus a non-callable bond

Callable - bondholders bear the risk of the bond being called early, usually when rates are lower. They don't receive all of the expected coupons, and they have to reinvest at lower rates

Convertible Bonds

Can be swapped for a fixed number of shares of stock anytime before maturity at the holder's option. -Are relatively common, but the number has been decreasing in recent years. -Lower risk, Lower interest rate -Exist for young companies who can't raise money/financing

Class A and Class B shares

Class B shares are more affordable than Class A

Relevant Cash Flows: -Incremental Cash Flow for a Project=

Corporate cash flow with the project minus Corporate cash flow without the project

Dividend yield =

D1/P0

Solve for R =

D1/P0 + g

Which bonds will have the higher coupon, all else equal? •Secured debt versus a debenture

Debenture: secured debt is less risky because the income from the security is used to pay it off first

Supernormal growth(nonconstant)

Dividend growth is not consistent initially, but settles down to constant growth eventually

Features of Preferred Stock

Dividends -Must be paid before dividends can be paid to common stockholders -Not a liability of the firm -Can be deferred indefinitely -Most preferred dividends are cumulative -Missed preferred dividends have to be paid before common dividends can be paid Preferred stock generally does not carry voting rights

Do =

Dividends just paid

Dt=

Do(1+g)^t

Share proportionally in declared dividends

Everyone gets same dividend.

D1 to Dt =

Expected Dividends

Constant Dividend Growth

Firm will increase the dividend by a constant percent every period

Valuation Using Multiples

For stocks that don't pay dividends (or have erratic dividend growth rates), we can value them using the price-earnings (PE) ratio and/or the price-sales ratio:

Best investment strategy if YTM is going to decrease in future

Good time to buy bonds -Long-term bonds -Low Coupon rates -Bond value/price will increase

If you think interest rates (YTM) will decrease in the future...

Good time to buy bonds now.

Net Present Value

How much value is created from undertaking an investment? Step 1: Estimate the expected future cash flows. Step 2: Estimate the required return for projects of this risk level. Step 3: Find the present value of the cash flows and subtract the initial investment to arrive at the Net Present Value. Sum ofthe PVs of all cash flows

Taxable bonds

Investors demand the extra yield on these as compensation for the unfavorable tax treatment. This extra compensation is the taxability premium.

NPV vs. IRR

NPV and IRR will generally give the same decision -

Accrued Interest =

Next Coupon * (days since last coupon payment / days in current coupon period)

Good Decision Criteria? - Average Accounting Return •All cash flows considered? •TVM considered? •Risk-adjusted? •Ability to rank projects? •Indicates added value to the firm?

No for all -Worst Decision tool

•Operating Cash Flow:

OCF = EBIT + Depr - Taxes OCF = NI + Depr if no interest expense

Timeline: Dividends are

OCF using per year depreciation w/o salvage

Strategic options

Options for future, related business products or strategies.

Stock Value =

PV of dividends Po=sum(Dt/(1+R)^t

Dividend Growth Model -"Gordon Growth Model"

Po = D1/(R-g)

NPV = 0 means:

Project's inflows are "exactly sufficient to repay the invested capital and provide the required rate of return

The Fisher Effect: Approximation =

R=r+h

Share proportionally in remaining assets during liquidation

Remaining assets are shared equally, but often no assets are available after bankruptcy because debt gets repaid first

Preemptive right

Right of first refusal to buy new stock issue to maintain proportional ownership if desired -shareholders sometimes have the right to share proportionally in any new stock sold

Stocks -N = -CF = -I/Y= -PV = -FV =

Stocks -N = Periods -CF = Dividend (D) -I/Y=Required Return(Capitalization Rate)(R) -PV = Price -FV = Sale Price (Future Price)

Which bonds will have the higher coupon, all else equal? •Subordinated debenture versus senior debt

Subordinated debenture: will be paid after the senior debt

Contingency planning

Taking into account the managerial options implicit in a project.

call premium

The amount by which the call price exceeds the par value of the bond. -Call price > bond's stated/par value.

Erosion/side effects

The cash flows of a new project that come at the expense of a firm's existing projects. -Relevant

Opportunity Cost

The most valuable alternative that is given up if a particular investment is undertaken. -Relevant


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