FIN 362 Ch 5,6,1

Equation for FV?

FV = PV(1+r)^N

A proxy fight occurs when:

a group solicits voting rights to replace the board of directors.

Single Amount / Lump Sum

a one-time class inflow or outflow

Uneven Cash Flows

a stream of cash flows that varies every period: each cash flow is a single/lump sum amount

A conflict of interest between the stockholders and management of a firm is referred to as the:

agency problem.

Which one of the following actions by a financial manager creates an agency problem?

agreeing to expand the company at the expense of stockholders' value

Annual Percentage Rate (APR) / Nominal Interest Rate

always on an annual basis: lenders are legally required by the government to give an APR when offering loans to borrowers

PV of a growing annuity in perpetuity

an annuity that is increasing (growing) at a constant rate per period forever

Annuity

an equal amount stream of cash flows per period for a DEFINITE number of periods

Perpetuity

an equal stream of cash flow per period for an INDEFINITE number of periods (forever)

The rules by which corporations govern themselves are called:

bylaws.

A stakeholder is any person or entity:

other than a stockholder or creditor who potentially has a financial interest in the firm.

Which one of the following is least apt to help convince managers to work in the best interest of the stockholders?

pay raises based on length of service

Compounding

process of computing FV / process of accumulating interest on an investment over time to earn more interest

A firm's capital structure refers to the firm's:

proportions of financing from current and long-term debt and equity.

The ultimate control of a corporation lies in the hands of the corporate:

stockholders.

Effective Annual Rate (EAR)

the actual interest rate borrowers repair their loans at,because interest compounding is more than once in a year

Interest Only or Non-Amortizable Loans (Straight or Coupon Bonds)

the borrower ONLY PAYS INTEREST each period, and repays the principal (amount borrowed) at the maturity date

Amortized Loans

the borrower pays a fixed amount per period (annuity) which consists of interest charges and a portion of the principal loan

Pure Discount Loans (Zero Coupon Bonds)

the borrower receives a lump sum loan at time zero (PV of a lump sum) and repays a single lump sum amount at a specified future date (FV of a lump sum)

Present Value (PV)

the current value/worth of future cash flows discounted at the appropriate discounting rate

Discounting Rate

the interest rate used to computer PV

Partial Amortization Loans (Balloon or "Bite-The-Bullet" Loans)

the periodic payments of not fully payoff (amortize) the loan; a balloon/lump sum payment is required at the end of the specified term to repay the remaining principal balance of the loan (at which point we say the borrower is biting the bullet)

Discounting

the process of computing the PV

Define Amortization

the process of providing for a loan to be paid off by making regular principal reductions

Future Value (FV)

worth of an investment after one or more periods

Suppose you are committed to owning a $195,000 Ferrari. You believe your mutual fund can achieve an annual rate of return of 8 percent and you want to buy the car in 7 years. How much must you invest today to fund this purchase assuming the price of the car remains constant?

$113,780.63

Island News purchased a piece of property for $1.36 million. The firm paid a down payment of 12 percent in cash and financed the balance. The loan terms require monthly payments for 10 years at an annual percentage rate of 4.75 percent, compounded monthly. What is the amount of each mortgage payment?

$12,548.18

You borrow $230,000 to buy a house. The mortgage rate is 4.5 percent and the loan period is 25 years. Payments are made monthly. If you pay the mortgage according to the loan agreement, how much total interest will you pay?

$153,524

You need some money today and the only friend you have that has any is your miserly friend. He agrees to loan you the money you need, if you make payments of $30 a month for the next six months. In keeping with his reputation, he requires that the first payment be paid today. He also charges you 2 percent interest per month. How much money are you borrowing?

$171.40

Troy will receive $7,500 at the end of Year 2. At the end of the following two years, he will receive $9,000 and $12,500, respectively. What is the future value of these cash flows at the end of Year 5 if the interest rate is 8 percent?

$33,445

You will receive $25,000 in two years when you graduate. When you receive it, you will invest it for 6 more years at 7.5 percent per year. How much money will you have 8 years from now?

$38,582.54

Your car dealer is willing to lease you a new car for $190 a month for 36 months. Payments are due on the first day of each month starting with the day you sign the lease contract. If your cost of money is 6.5 percent, what is the current value of the lease?

$6,232.80

A preferred stock pays an annual dividend of $4.10. What is one share of this stock worth today if the rate of return is 9.68 percent?

$42.36

Southern Tours is considering acquiring Holiday Vacations. Management believes Holiday Vacations can generate cash flows of $187,000, $220,000, and $245,000 over the next three years, respectively. After that time, they feel the business will be worthless. If the desired rate of return is 13.5 percent, what is the maximum Southern Tours should pay today to acquire Holiday Vacations?

$503,098

Your grandmother is gifting you $150 a month for four years while you attend college to earn your bachelor's degree. At a 4.8 percent discount rate, what are these payments worth to you on the day you enter college?

$6,539.14

You have just received notification that you have won the $1.25 million first prize in the Centennial Lottery. However, the prize will be awarded on your 100th birthday, 76 years from now. The appropriate discount rate is 6.8 percent. What is the present value of your winnings?

$8,423.54

What are the Four primary types of loans?

1. Pure Discount Loans (Zero Coupon Bonds) 2. Interest Only or Non-Amortizable Loans (Straight or Coupon Bonds) 3. Amortized Loans 4. Partial Amortization Loans (Balloon or "Bite-The-Bullet" Loans)

Your insurance agent is trying to sell you an annuity that costs $50,000 today. By buying this annuity, your agent promises that you will receive payments of $250 a month for the next 20 years. What is the rate of return on this investment?

1.88 percent

You are paying an effective annual rate of 15.33 percent on your credit card. The interest is compounded monthly. What is the annual percentage rate on this account?

14.35 percent

You are considering an annuity that costs $160,000 today. The annuity pays $17,500 a year at an annual interest rate of 7.5 percent. What is the length of the annuity time period?

16 years

Your credit card company charges you 1.65 percent interest per month. What is the annual percentage rate on your account?

19.80 percent

At 6 percent interest, how long would it take to quadruple your money?

23.79 years

You expect to receive $5,000 at graduation in 2 years. You plan on investing this money at 9 percent until you have $75,000. How many years from today will it be until this occurs?

33.42 years

You just paid $750,000 for an annuity that will pay you and your heirs $36,000 a year forever. What rate of return are you earning on this policy?

4.80 percent

Assume the average vehicle selling price in the United States last year was $35,996. The average price 4 years earlier was $29,208. What was the annual increase in the selling price over this time period?

5.36 percent

You're trying to save to buy a new $72,000 sports car You have $38,000 today that can be invested at your bank. The bank pays 1.26 percent annual interest on its accounts. How many years will it be before you have enough to buy the car assuming the price of the car remains constant?

51.04 years

Which one of the following statements concerning a sole proprietorship is correct?

A sole proprietorship is difficult to form. The business profits are taxed twice at the federal level. The business profits are taxed separately from the personal income of the owner. (The owner may be forced to sell his/her personal assets to pay company debts). A sole proprietorship has an unlimited life.

Computer EAR when given APR

APR = [(1 + EAR)^(1/#of compounding per period) -1] x #of compounding per period

The interest rate that is most commonly quoted by a lender is referred to as which one of the following?

Annual percentage rate.

Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true?

Barb will earn more interest the second year than Andy.

Examples of perpetuity?

Consol (A British bond) and Preferred Stock Dividends

Which form of business structure faces the greatest agency problems?

Corporation

Which one of the following statements concerning a sole proprietorship is correct?

Correct The life of the firm is limited to the life span of the owner.

A business created as a distinct legal entity is called a:

Correct corporation.

One intent of the Sarbanes Oxley Act of 2002 is to:

Correct protect investors from corporate abuses.

If interest is paid once a year:

EAR = APR

Computer APR when given EAR

EAR = [1+(interest rate A.K.A. APR / #of compounding per period)^#of compounding per period -1

An ordinary annuity is best defined by which one of the following?

Equal payments paid at the end of regular intervals over a stated time period.

A business formed by two or more individuals who each have unlimited personal liability for all of the firm's debts is called a:

General partnership.

Your grandmother has promised to give you $10,000 when you graduate from college. She is expecting you to graduate three years from now. What happens to the present value of this gift if you speed up your graduation by one year and graduate two years from now?

Increases.

Equation for PV?

PV = FV / [(1+r)^N]

Equation for PV of a growing annuity in perpetuity?

PV(annu.perp) = (Expected Annuity at the end of Period 1) / (Discounting Rate - Growth Rate per period forever)

Equation for the perpetuity PV?

PV(perp) = Expected Annuity / Discounting Rate

Samantha opened a savings account this morning. Her money will earn 3.5 percent interest, compounded annually. After four years, her savings account will be worth $5,000. Assume she will not make any withdrawals. Given this, which one of the following statements is true?

Samantha could have deposited less money today and still had $5,000 in four years if she could have earned a higher rate of interest.

The process of planning and managing a firm's long-term assets is called:

capital budgeting.

Always use EAR when...

comparing two or more investment options or sources of loans with different compounding frequencies

Which one of the following is a capital budgeting decision?

determining how much debt should be borrowed from a particular lender (Deciding whether or not a new production facility should be built). deciding when to repay a long-term debt determining how much inventory to keep on hand deciding how much credit to grant to a particular customer

One disadvantage of the corporate form of business ownership is the:

double taxation of profits.

Which one of the following best describes the primary advantage of being a limited partner rather than a general partner?

entitlement to a larger portion of the partnership's income ability to manage the day-to-day affairs of the business no potential financial loss greater management responsibility (Liability for firm debts is limited to the capital invested).

Annuity Due

equal cash flow coming in at the BEGINNING of each period

Ordinary/ Deferred Annuity

equal cash flow coming in at the END of each period

Simple Interest

interest only on the original principal amount invested (the investor withdraws interest earned after every period)

In a limited partnership each limited partner's:

liability is limited to the amount he or she invested into the partnership.

A business entity operated and taxed like a partnership, but with limited liability for the owners, is called a:

limited liability company.