Finance Final

(Capital Asset Pricing​ Model) ​Breckenridge, Inc., has a beta of 0.85. If the expected market return is 10.5 percent and the​ risk-free rate is 3.5 percent, what is the appropriate expected return of Breckenridge​ (using the​ CAPM)?

3.5 + .85(10.5-3.5) = 9.45%

Max amount of interest that can be deducted from corporate taxable income

30% of Earnings before interest, taxes, depreciation, and amortization (EBITDA)

Six years​ ago, Colt, Inc. sold an issue of 30−​year, $1,000 par value bonds. The coupon rate of​ 5.25% is payable annually. Investors presently require a rate of return of​ 8.375%. What is the current market price​ (intrinsic value) of the​ bonds? Round off to the nearest​ $1.

$681

Fitchminster Armored Car can purchase a new vehicle for​ $200,000 that will provide annual net cash flow over the next five years of​ $40,000, $45,000,​ $50,000, $55,000,​ $60,000. The salvage value of the vehicle will be​ $25,000. Assume that the vehicle is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is​ 9%. (Round your answer to the nearest​ $1.)

$7,390

Warchester Inc. is considering the purchase of a 3−D printer that will require an initial investment of​ $15,000. The printer will produce parts at a net savings of​ $4,000 per year in operating costs. The company will use a discount rate of​ 8.5%. What is the NPV of this equipment to the nearest​ dollar?

$763

unsystematic risk

(diversifiable or company specific risk) that portion of risk that CAN be eliminated thru random diversification Covid-19 recessions inflation credit freeze

systematic risk

(nondiversifiable or market risk) that portion of total risk that CANNOT be eliminated thru random diversification bad management decisions industry strikes lawsuits

ROA Equation

(profit after taxes / sales) x (sales / assets) or profit margin x asset turnover ratio

ROE Equation

(profit after taxes / sales) x (sales / assets) x (assets / equity) or profit margin x turnover x equity multiplier

stock market indexes

-Dow Jones Industrial Average: the average of 30 largest companies -S&P500: average of 500 large companies -NASDAQ: over-the-counter (OTC) market -Russell 2000: rank stocks by size (looks at mid cap stocks)

1st Time Securities sold to public

-IPO or Initial Public Offering (if they need additional funds, they go to the public)

The introduction of a new product at Elia Pharmaceuticals will require a​ $450,000 increase in​ inventory, a​ $730,000 increase in Accounts​ Receivable, and a​ $180,000 increase in Accounts Payable. Introduction of the product will also require a​ $700,000 expenditure for advertising. The increase in net working capital required for the introduction of this product is

450,000+730,000-180,000 1,000,000

You have just purchased a share of preferred stock for​ $50.00. The preferred stock pays an annual dividend of​ $5.50 per share forever. What is the rate of return on your​ investment?

5.50 / 50 = .11 = 11%

Limited Liability Corporation (LLC)

-a cross between a partnership and a corporation 1. retains limited liability for its owners 2. runs and is taxed like a partnership 3. both states and IRS have rules for what qualifies, but the bottom line is mist not look too much like a corporation or it will be taxed as one

Partnership

-all partners have unlimited liability -jointly responsible for liabilities of partnership

If your portfolio consists of​ 20% RJH​ (expected return​ 16% )​ 30% PAV​ (expected return −​2%), and​ 50% MB​ (expected return​ 8%), what is the expected rate of return on the​ portfolio?

6.6%

Variable cost for​ Light.com's fluorescent tubes is​ $12.50, the tubes are sold over the internet to businesses and organizations for​ $20.00 each. Fixed costs are​ $7,500,000. What is the break−even quantity for the fluorescent​ tubes?

7,500,000/20-12.50= 1,000,000

Corporation

-business form existing separate and apart from its owners

interest rate increase bond price decrease

-buy shorter maturities -buy bonds with high/reasonable coupon interest rates

Betty Gilmore plans to sell berry pies at a local​ farmer's market. The permit and space rental will cost her​ $2,000 for the June through August season. The pies will sell for​ $7.00. Ingredients and overhead average​ $4.00 per pie. She also has to pay five percent of her gross sales to the​ markets's organizers. How many pies will she need to sell to cover her fixed​ costs?

7.00x.05=.35 7-.35= 6.65 2000/6.65-4= 755

Allowable deductions from income

-depreciation -interest expenses are deducted before taxes. So when you pay interest you lower taxes (benefit) -dividend payments are made from after tax money (no benefit tax wise)

The Blackburn Group has recently issued 20−​year, unsecured bonds rated BB by​ Moody's. These bonds yield 443 basis points above the U.S. Treasury yield of​ 2.76%. The yield to maturity on these bonds is

7.19%

Preferred stock for the issuer

-dividends can be omitted w/o risk of bankruptcy -disadvantage that dividends are not tax deductible for the issuer

advantages of payback

-easy to understand -emphasizes liquidity

Preferred stock for the investor

-for corporate investors, it has a tax advantage be at a minimum 70% of dividends received are tax free -more valuable to corporate investors than they are to individual investors

Why would a P/E ration go up?

-if you expect future earnings to grow (spend more of today's money) -less risk (willing to spend more) -less inflation (willing to pay more)

disadvantages of payback

-ignores the time value of money -ignores cash flows after the payback period -no way to determine the appropriate cutoff

when you buy a bond you get

-interest -at maturity, you get bond's par value back, regardless of what you paid for it

Long-term debt and fixed income securities for the borrower

-interest rates are locked in over the entire life of the debt -has a tax advantage over common stock in that interest payments are tax deductible, whereas dividend payments are not

(Weighted average cost of​ capital) The target capital structure for QM Industries is 40 percent common​ stock, 10 percent preferred​ stock, and 50 percent debt. If the cost of common equity for the firm is 18.0 ​percent, the cost of preferred stock is 10.0 ​percent, the​ before-tax cost of debt is 8.0 ​percent, and the​ firm's tax rate is 35 ​percent, what is​ QM's weighted average cost of​ capital?

8.0 x (1-.35) = 5.2 .4 x .18 = .072 .1 x .1 = .01 .5 x .052 = .026 -------------- (add) = 10.8%

CAPM (capital asset pricing model) assumes:

-investors are rational -no bankruptcy costs provides us with the theoretically correct required rate of return on asset i

Proprietorship

-largest number -one person owns, holds title and is legally responsible

Common stock for the investor

-long run common stock has outperformed debt-based financial assets -increased expected return = increased risk

Long-term debt and fixed income securities for the investor

-long term debt tends to produce higher returns than short term debt -less risky than common stock -investors can lock in an interest rate and know the future returns

interest rate decrease bond price increase

-longer maturities -low coupon bonds

A lower tax rate means:

-more cash will be available to corporations for reinvesting/paying dividends -US corporations will be more competitive in world markets -cause an increase in the after tax of borrowing money

Common stock for the issuer

-not legally obligated to make payments -no maturity date -increases creditworthiness -has a tax disadvantage

If the before−tax cost of debt is​ 9% and the firm has a​ 34% marginal tax​ rate, the after−tax cost of debt is​ 5.94%.

9x(1-.34) TRUE

Disadvantages of the TVM methods (NPV, PI, IRR)

-only as good as the cash flow forecasts

barriers to entry come from

-patents -quality -service -product differentiation -cost advantage -control of raw materials

(Preferred stock​ valuation) ​Pioneer's preferred stock is selling for ​$33 in the market and pays a ​$3.60 annual dividend. a. If the​ market's required yield is 10 ​percent, what is the value of the stock for that​ investor? b. Should the investor acquire the​ stock?

=Dps/k =3.60/.10 =36 The investor should acquire the stock because it is currently underpriced in the market.

(Preferred stock​ valuation) Calculate the value of a preferred stock that pays a dividend of $6.00 per share when the​ market's required yield on similar shares is 12 percent.

=Dps/k =6/.12 =50

NPV

=PVinflows - PVoutflows =PV future cash flows - Initial Outlay acceptance criteria: accept if NPV >= 0 reject if NPV < 0

real rate of interest

-the difference between the nominal rate of interest and the anticipated rate of inflation -nominal rate AFTER inflation has been taken out Rnominal = Rreal + Rinflation Rreal = Rnominal - Rinflation

Advantages of the TVM methods (NPV, PI, IRR)

-uses time value of money in calculations -maximizes shareholder wealth -uses cash flows

capital budgeting process is designed to answer

-which projects to accept -what the size of your capital budget is

(Preferred stock​ valuation) What is the value of a preferred stock where the dividend rate is 14 percent on a ​$100 par​ value, and the​ market's required yield on similar shares is 12 ​percent?

.14 x 100 =14 =Dps/k =14/.12 =116.67

(Weighted average cost of​ capital) The target capital structure for QM Industries is 36 percent common​ stock, 14 percent preferred​ stock, and 50 percent debt. If the cost of common equity for the firm is 18.8 ​percent, the cost of preferred stock is 9.2 ​percent, the​ before-tax cost of debt is 7.4 ​percent, and the​ firm's tax rate is 35 ​percent, what is​ QM's weighted average cost of​ capital?

.36x.188= .06768 .14x.092= .01288 FOR DEBT: 7.4X(1-.35)= 4.81 .50x.0481 = .02405 .06768+.01288+.02405= .10461

nominal interest rate equation

=real risk-free interest rate +inflation premium +default-risk premium +maturity-risk premium +liquidity-risk premium

The Oviedo Thespians are planning to present performances of their Florida Revue on 2 consecutive nights in January. It will cost them​ $5,000 per night for theater​ rental, event insurance and professional musicians. The theater will also take​ 10% of gross ticket sales. How many tickets must they sell at​ $10.00 per ticket to break​ even?

1,112 tickets

securitization process

1. Homebuyer borrow money by taking out mortgages loan 2. Lender sells the mortgage to another firm or finance institution 3. Finance institution pools together a portfolio of mortgages. The purchases of that portfolio is financed through sale of MBS 4. MBS's are sold to investors who can hold them as investments or resell them to others

You are considering a portfolio of three stocks with​ 30% of your money invested in company​ X, 45% of your money invested in company​ Y, and​ 25% of your money invested in company Z. If the betas for each stock are 1.22 for company​ X, 1.46 for company​ Y, and 1.03 for company​ Z, what is the portfolio​ beta?

1.28

(Cost of common​ equity) Salte Corporation is issuing new common stock at a market price of ​$26.12. Dividends last year were ​$1.45 and are expected to grow at an annual rate of 5.1 percent forever. What is​ Salte's cost of common​ equity?

1.45x(1+.051)/26.12+.051= 10.93%

​Welch's Lawn Care products just paid a dividend of​ $1.85. This dividend is expected to grow at a constant rate of​ 3% per​ year, so the next expected dividend is​ $1.90. The stock price is currently​ $12.50. . The​ company's marginal tax rate is​ 35%. Compute the cost of common equity.

1.85x(1+.03)/12.50+.03= 18.2%

basis point

1/100 of 1%

Your portfolio consists of​ $3,000 in ABC​ stock, $4,500 of DEF stock and​ $2,500 of GHI stock. Expected rates of return are ABC​ 5%, DEF​ 12%, and GHI​ 16%. What is the portfolio expected rate of​ return?

10.9%

Limited Partnership

2 types of partners: 1. limited partner - just supplies money, not in the business at all (only liable on the amount invested) 2. general partner - run the business and face unlimited liability for the firm's debts Disadv: -difficult to transfer the ownership of the general partner

A firm has an issue of preferred stock that pays an annual dividend of​ $2.00 per share and currently is selling for​ $18.50 per share.​ Finally, the​ firm's marginal tax rate is​ 34%. This​ firm's cost of financing with new preferred stock is

2.00/18.50= 10.81%

​(Cost of preferred​ stock) The preferred stock of Walter Industries Inc. currently sells for ​$36.84 a share and pays $2.44 in dividends annually. What is the​ firm's cost of capital for the preferred​ stock?

2.44/36.84= 6.62%

The expected dividend is​ $2.50 for a share of stock priced at​ $25. What is the cost of common equity if the long−term growth in dividends is projected to be​ 4%?

2.50x(1+.04)/25=.04= 14%

Compute the payback period for a project with the following cash​ flows, if the​ company's discount rate is​ 12%. Initial outlay​ = $450 Cash​ flows: Year 1​ = $325 Year 2​ = $65 Year 3​ = $100

2.6 years

​(Determining relevant cash flows​) ​Captain's Cereal is considering introducing a variation of its current breakfast​cereal, Crunch Stuff. This new cereal will be similar to the​old, with the exception that it will contain​sugar-coated marshmallows shaped in the form of stars. The new cereal will be called Crunch Stuff​n' Stars. It is estimated that the sales for the new cereal will be ​$24 ​million; however, 25 percent of those sales will draw from former Crunch Stuff customers who have switched to Crunch Stuff​n' Stars and who would not have switched if the new product had not been introduced. What is the relevant sales level to consider when deciding whether or not to introduce Crunch Stuff​n' Stars?

24,000,000x.25=6,000,000 24,000,000-6,000,000= 18,000,000

(Annuity payments) Ford Motor​ Company's current incentives include 4.9 percent APR financing for 60 months or $1,000 cash back on a Mustang. ​ Let's assume Suzie Student wants to buy the premium Mustang​ convertible, which costs $25,000​, and she has no down payment other than the cash back from Ford. If she chooses the $1,000 cash​ back, Suzie can borrow from the VTech Credit Union at 6.9 percent APR for 60 months​ (Suzie's credit​ isn't as good as Prof.​ Finance). What will Suzie​ Student's monthly payment be under each​ option? Which option should she​ choose?

If Suzie chooses 4.9 percent APR financing for 60 months to buy the premium Mustang​ convertible, which costs $25,000=PMT(53.119570)​, what will her monthly payment​ be? N 60 I (4.9/12) = .4083 PV -25000 PMT ? FV 0 PMT = 470.64 If Suzie chooses $1,000 cash back to buy the premium Mustang convertible and borrows $24,000 from the VTech Credit Union at 6.9 percent APR for 60 months, how much will her monthly payment​ be? N 60 I (6.9/12) = .575 PV -24000 PMT ? FV 0 PMT = 474.10

​(Net present value​ calculation) Carson Trucking is considering whether to expand its regional service center in​ Mohab, UT. The expansion requires the expenditure of $10,000,000 on new service equipment and would generate annual net cash inflows from reduced costs of operations equal to $2,500,000 per year for each of the next 8 years. In year 8 the firm will also get back a cash flow equal to the salvage value of the​ equipment, which is valued at $1 million. ​ Thus, in year 8 the investment cash inflow totals ​$3,500,000. Calculate the​ project's NPV using a discount rate of 9 percent.

If the discount rate is 9 percent, then the​ project's NPV is: CF -10,000,000 C01 2,500,000 FO1 *7* CO2 3,500,000 NPV I=9 CPT =4,338,914

(Determining the outstanding balance of a​ loan) Five years ago you took out a $300,000​, 25​-year mortgage with an annual interest rate of 7 percent and monthly payments of ​$2,120.34. What is the outstanding balance on your current loan if you just make the 60th ​payment?

If you just make the 60th payment, the outstanding balance on your current loan is N (25-5 = 20 x 12) = 240 I (7/12) = .5833 PV ? PMT -2120.34 FV 0 PV = 273486.77

If interest expense lowers​ taxes, why does the WACC not decrease indefinitely with the addition of more​ debt?

Increasing debt too much can result in a greater likelihood of firm failure​ (financial distress).

​(Calculating changes in net operating working​ capital) Tetious Dimensions is introducing a new product and has an expected change in net operating income of ​$780,000. Tetious Dimensions has a 33 percent marginal tax rate. This project will also produce ​$190,000 of depreciation per year. In​ addition, this project will cause the following changes in year​ 1:

Calculate change in AR, Inventory, and AP 45,000+84,000-50,000= 79,000 780,000- (780,000(.33)= 257,400)+ 190,000- 79,000= 633,600 increase in AR add increase in inventory add increase in AP subtract

Financial intermediaries​ include:

Insurance companies, Finance companies, Investment companies, Investment banks, Commercial banks

In a large corporation the primary responsibility for overseeing the​ firm's finance-related activities falls to​ the:

Chief Financial Officer (CFO)

Differences b/t common and preferred stock: Governance

Common shareholders elect the board Preferred shareholders have no vote

Which of the following sequences is arranged in the correct​ order, from highest long−term returns to​ lowest?

International​ equities, U.S. government​ bonds, treasury bills

(Common stock valuation​) Header​ Motor, Inc., paid a ​$3.50 dividend last year. At a constant growth rate of 5 ​percent, what is the value of the common stock if the investors require a 20 percent rate of​ return?

D1 = Do (1 + g) =3.50(1.05) Vcs = D1/(k-g) =3.50(1.05)/(.2-.05) =24.50

valuation of common stock

D1/(k-g)

​(Cost of preferred​ stock) The preferred stock of Walter Industries Inc. currently sells for ​$36.00 a share and pays $2.50 in dividends annually. What is the​ firm's cost of capital for the preferred​ stock?

Dps/Po 2.50/36 = 6.94%

EBITDA equation

EBIT + Depreciation + Amortization

house money effect

Investors take more risks with money they've made in the market than they do with "hard earned" money Las Vegas

Jayden spends a lot of time studying charts of stocks past​ performance, but his investment return are only average. This outcome supports

ALL: the weak-form efficient market hypothesis; the strong-form efficient market hypothesis; the semi-strong form efficient market hypothesis

(Bond valuation) A bond that matures in 10 years has a $1,000 par value. The annual coupon interest rate is 9 percent and the​ market's required yield to maturity on a​ comparable-risk bond is 15 percent. What would be the value of this bond if it paid interest​ annually? What would be the value of this bond if it paid interest​ semiannually?

ANNUALLY: N 10 I 15 PV ? = 698.87 PMT (1000x.09) = 90 FV 1000 SEMIANNUALLY: N (10x2) =20 I (15/2) =7.5 PV ? = 694.17 PMT (1000x.09)/2 = 45 FV 1000

(Yield to​ maturity) ​Fitzgerald's 20​-year bonds pay 9 percent interest annually on a $1,000 par value. If the bonds sell at $945​, what is the​ bond's yield to​ maturity? What would be the yield to maturity if the bonds paid interest​ semiannually? Explain the difference.

ANNUALLY: N 20 I ? = 9.63 PV -945 PMT (1000x.09) = 90 FV 1000 SEMIANNUALLY: N (20x2) =40 I ? *x2* = 4.81 *x2* = 9.625 PV -945 PMT (1000x.09)/2 = 45 FV 1000 Other things being​ equal, the YTM is higher for an annual bond than a semiannual bond if the bond is selling at a discount.

Partnership Advantages and Disadvantages

Adv: -easy to form Disadv: -unlimited legal responsibility

Corporation Advantages and Disadvantages

Adv: -limited legal responsibility -transfer of ownership is inexpensive and doesn't impact operations -ease in raising capital Disadv: -time and money to incorporate -double taxation of dividends --corporation earnings are taxed --individual level: dividends taxed at the personal rate

Proprietorship Advantages and Disadvantages

Adv: -easy to form Disadv: -unlimited legal responsibility

The calculation of differential cash flows over a​ project's life should include which of the​ following?

All of the above (Investment in net working capital, Additional revenues attributable to the project, Labor and material savings)

Each of the following is true of Mutual Funds EXCEPT

An index fund is the fund with the highest expenses payable by investors.

Which of the following is considered to be a deficiency of the​ IRR?

It could produce more than one rate of return.

A call option on a stock is a financial instrument defined by which of the following​ statements?

It gives the investor holding it the​ right, but not the​ obligation, to buy the stock at the specified price at the stated date in the future.

Which of the following reasons causes investors to require a lower rate of return on the​ firm's bonds than on its​ stock?

Bondholders bear less risk than common stockholders bear.

ABC Service can purchase a new assembler for​ $15,052 that will provide an annual net cash flow of​ $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of return is​ 12%. (Round your answer to the nearest​ $1.)

CF -15,052 CO1 6000 FO1 5 NPV I=12 CPT =6577

You have been asked to analyze a capital investment proposal. The​ project's cost is​ $2,775,000. Cash inflows are projected to be​ $925,000 in Year​ 1; $1,000,000 in Year​ 2; $1,000,000 in Year​ 3; $1,000,000 in Year​ 4; and​ $1,225,000 in Year 5. Assume that your firm discounts capital projects at​ 15.5%. What is the​ project's NPV?

CF -2,775,000 CO1 925,000 FO1 1 CO2 1,000,000 CO3 1,000,000 CO4 1,000,000 CO5 1,225,000 NPV I=15.5 CPT =582,380

Central Mass Ambulance Service can purchase a new ambulance for​ $200,000 that will provide an annual net cash flow of​ $50,000 per year for five years. Calculate the NPV of the ambulance if the required rate of return is​ 9%. (Round your answer to the nearest​ $1.)

CF -200,000 CO1 50,000 FO1 5 NPV I=9 CPT =(5,517)

​(IRR calculation) Jella Cosmetics is considering a project that costs ​$800,000 and is expected to last for 10 years and produce future cash flows of ​$175,000 per year. If the appropriate discount rate for this project is 19 ​percent, what is the​ project's IRR?

CF -800,000 CO1 175,000 FO1 10 IRR CPT =17.52%

With respect to the capital budgeting practices of large U. S. corporations

IRR and NPV have been gaining in popularity.

​(Annuity payments) Calvin Johnson has a $5,000 debt balance on his Visa card that charges 12.9 percent APR compounded monthly. In​ 2009, Calvin's minimum monthly payment is 3 percent of his debt​ balance, which is $150. How many months​ (round up) will it take Calvin Johnson to pay off his credit card if he pays the current minimum payment of $150 at the end of each​ month? In​ 2010, as the result of a federal​ mandate, the minimum monthly payment on credit cards rose to 4 percent. If Calvin made monthly payments of $200 at the end of each​ month, how long would it take to pay off his credit​ card?

If Calvin made monthly payments of $150 at the end of each​ month, how long would it take to pay off his credit​ card? N ? I (12.9/12) = 1.075 PV 5000 PMT -150 FV 0 N = 41.49 months

​(Calculating project cash flows and​ NPV) ​Garcia's Truckin', Inc. is considering the purchase of a new production machine for ​$150,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $55,000 per year. To operate this machine​ properly, workers would have to go through a brief training session that would cost $5,500 after tax. In​ addition, it would cost ​$4,500 after tax to install this machine correctly. ​ Also, because this machine is extremely​ efficient, its purchase would necessitate an increase in inventory of ​$21,000. This machine has an expected life of 10 ​years, after which it will have no salvage value. ​ Finally, to purchase the new​ machine, it appears that the firm would have to borrow ​$90,000 at 8 percent interest from its local​ bank, resulting in additional interest payments of $7,200 per year. Assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a 38 percent tax​ rate, and a required rate of return of 14 percent. a. What is the initial outlay associated with this​ project? b. What are the annual​ after-tax cash flows associated with this project for years 1 through 9​? c. What is the terminal cash flow in year 10 ​(that is, the annual​ after-tax cash flow in year 10 plus any additional cash flows associated with termination of the​ project)? d. Should this machine be​ purchased?

a. Capital Expenditures +Installation Charges +Training +Increase In Net Operating Working Capital =Initial Cash Outlay 150,000+4,500+5,500+21,000= 181,000 b. net operating profit-taxes+depreciation =operating cash flow 55,000-(55,000x.38)=(150,000+5,500+4,500/10)= 50,100 c. free cash flow+ increase in inventory 50,100+21,000= 71,100

​(Break-even analysis) The Marvel Mfg. Company is considering whether or not to construct a new robotic production facility. The cost of this new facility is ​$600,000 and it is expected to have a​ six-year life with annual depreciation expense of ​$100,000 and no salvage value. Annual sales from the new facility are expected to be 2,000 units with a price of ​$1,000 per unit. Variable production costs are ​$600 per​ unit, and fixed cash expenses are $80,000 per year. a. the accounting break-even units of production is b. will the plant make a profit based on its current expected level of operations c. will the plant contribute cash flow to the firm at the expected level of operations

a. fixed cash exp + depreciation exp = 180,000 180,000/(1000-600) = 450 units b. 85,000/(100-600) = 200 units From part a​, we can observe that for making an accounting profit we have to sell only 450 units, but our expected units of sale is 2,000​, so we would make an accounting profit. c. From part a​, we can observe that the cash​ break-even units of production is 200 units, but the firm expects to sell 2,000 units, so the firm can expect a positive cash flow.

​(Individual or component costs of​ capital) Compute the cost of capital for the firm for the​ following: a. A bond that has a ​$1,000 par value​ (face value) and a contract or coupon interest rate of 11.0 percent. Interest payments are ​$55.00 and are paid semiannually. The bonds have a current market value of ​$1,125 and will mature in 10 years. The​ firm's marginal tax rate is 34 percent. b. A new common stock issue that paid a ​$1.80 dividend last year. The​ firm's dividends are expected to continue to grow at 7.0 percent per​ year, forever. The price of the​ firm's common stock is now ​$27.50. c. A preferred stock that sells for ​$125​, pays a dividend of 9.0 ​percent, and has a​ $100 par value. d. A bond selling to yield 12.0 percent where the​ firm's tax rate is 34 percent. a. the after-tax cost of debt is b. the cost of common equity is c. the cost of preferred stock is d. the after-tax cost of debt is

a. N 10x2= 20 I ? *x2* = 4.54 *x2* = 9.07 PV -1125 PMT 55 FV 1000 9.07 x (1-.34) = 5.99% b. [Do(1+g)]/Po +g [1.80(1.07)]/27.50 +.07 = 14% c. Dps/Po Dps= 100 x .09 = 9 9/125 = 7.2% d. 12 x (1-.34) = 7.92%

​(Calculating operating cash​ flows) The Heritage Farm Implement Company is considering an investment that is expected to generate revenues of $3,000,000 per year. The project will also involve annual cash expenses​ (including both fixed and variable​ costs) of $900,000​, while increasing depreciation by $400,000 per year. If the​ firm's tax rate is 34 percent, what is the​ project's estimated net operating profit after​ taxes? What is the​ project's annual operating cash​ flow? a. At a tax rate of 34​%, the​ project's estimated net operating profit after taxes​ (NOPAT) is b. the project's annual operating cash flow is

a. revenue -expenses -depreciation =NOI -taxes =NOPAT 3,000,000 -900,000 -400,000 =1,700,000 1,700,000 x .34 = 578,000 1,700,000 -578,000 =1,122,000 b. NOPAT +depreciation =operating cash flow 1,122,000 +400,000 =1,522,000

​(Using break-even​ analysis) Mayborn​ Enterprises, LLC runs a number of sporting goods businesses and is currently analyzing a new​ T-shirt printing business.​ Specifically, the company is evaluating the feasibility of this business based on its estimates of the unit​ sales, price per​ unit, variable cost per​ unit, and fixed costs. The​ company's initial estimates of annual sales and other critical variables are shown​ here: unit sales 7500 price per unit 16 variable cost per unit 10 fixed cash exp per year 10000 depr exp 4000 a. Calculate the accounting and cash​ break-even annual sales volume in units. b. Bill Mayborn is the grandson of the founder of the company and is currently enrolled in his junior year at the local state university. After reviewing the accounting​ break-even calculation done in part a​, Bill wondered if the depreciation expense should be included in the calculation. Bill had just completed his first finance class and was well aware that depreciation is not an actual​ out-of-pocket expense but rather an allocation of the cost of the printing equipment used in the business over its useful life. What do you​ think? What can you learn from the cash and accounting​ break-even points?

a. 10,000+4,000=14,000 14,000/(16-10) = 2333 units b. 10,000/(16-10) = 1667 The accounting break-even point tells us the level of sales necessary to cover our total fixed and variable operating costs where total fixed costs include both cash fixed costs and depreciation expense​ (which is not a cash expense for the​ period), while the cash break-even point tells us the level of sales where we have covered our cash fixed costs​ (ignoring depreciation) and as a result our cash flow is zero.

​(Individual or component costs of​ capital) You have just been hired to compute the cost of capital for​ debt, preferred​ stock, and common stock for the Mindflex Corporation. a. Cost of​ debt: Since​ Mindflex's bonds do not trade very​ frequently, you have decided to use 9.00 percent as your cost of​ debt, which is the yield to maturity on a portfolio of bonds with a similar credit rating and maturity as​ Mindflex's outstanding debt. In​ addition, Mindflex faces a corporate tax rate of 34 percent. b. Cost of common​ equity: ​ Mindflex's common stock paid a ​$1.25 dividend last year. In​ addition, Mindflex's dividends are growing at a rate of 6.0 percent per year and this growth rate is expected to continue into the foreseeable future. The price of this stock is currently ​$30.00. c. Cost of​ debt: Now​ let's assume that​ Mindflex's bonds are frequently traded. A Mindflex bond has a ​$1,000 par value​ (face value) and a coupon interest rate of 13.0 percent that is paid semiannually. The bonds are currently selling for ​$1,125 and will mature in 20 years. ​ Mindflex's corporate tax rate is 34 percent. d. Cost of preferred​ stock: ​ Mindflex's preferred stock pays a dividend of 7.0 percent on a ​$125 par value. ​ However, the market price at which the preferred shares could be sold is only ​$90.00. a. the after-tax cost of debt for the firm is b. the cost of common equity for the firm is c. the after-tax cost of debt for the firm is d. the cost of the preferred stock for the firm is

a. 9 x (1-.34) = 5.94% b. [Do(1+g)]/Po +g [1.25(1.06)]/30 +.06 = 10.42% c. N 20x2= 40 I ? *x2* = 5.7*x2* = 11.4 PV -1125 PMT 1000x.13= 130 */2* = 65 FV 1000 11.4 x (1-.34) = 7.52 d. Dps/Po Dps= 125 x .07 = 8.75 8.75/90 = 9.72%

(Calculating NPV,​ PI, and​ IRR) ​Fijisawa, Inc. is considering a major expansion of its product line and has estimated the following cash flows associated with such an expansion. The initial outlay would be ​$10,800,000​, and the project would generate cash flows of ​$1,250,000 per year for 20 years. The appropriate discount rate is 9.0 percent.

a. Calculate the NPV CF -10,800,000 CO1 1,250,000 FO1 20 NPV I=9 CPT =610,682 b. Calculate the PI (profitability index) 1.06 c. Calculate the IRR CF -10,800,000 CO1 1,250,000 FO1 20 IRR CPT =9.79% d. Should this project be accepted? Yes, because the NPV is positive, the IRR is greater than the required discount rate, and the PI is greater than 1.

​(Saving for retirement—future value of an​ annuity) Selma and Patty Bouvier are twins and both work at the Springfield DMV. Selma and Patty Bouvier decide to save for​ retirement, which is 35 years away. ​ They'll both receive an annual return of 8 percent on their investment over the next 35 years. Selma invests $2,000 per year at the end of each year only for the first 10 years of the​ 35-year period—for a total of $20,000 saved. Patty​ doesn't start saving for 10 years and then saves $2,000 per year at the end of each year for the remaining 25 years—for a total of $50,000 saved. How much will each of them have when they​ retire?

a. How much will Selma have when she retires? step 1: N 10 I 8 PV 0 PMT -2000 FV ? = 28973.12 step 2: N 25 I 8 PV 28973.12 PMT 0 FV ? = 198421.73 b. How much will Patty have when she retires? N 25 I 8 PV 0 PMT -2000 FV ? = 146211.88

​(NPV and IRR​ calculation) East Coast Television is considering a project with an initial outlay of​ $X (you will have to determine this​ amount). It is expected that the project will produce a positive cash flow of $50,000 a year at the end of each year for the next 15 years. The appropriate discount rate for this project is 10 percent. If the project has an internal rate of return of 14 percent, what is the​ project's net present​ value?

a. If the project has an internal rate of return of 14%, then the project's initial outlay is N 15 I 14 PV ? =307,108 PMT 50,000 FV 0 b. If the discount rate is 10​%, then the​ project's NPV is CF -307108 CO1 50,000 FO1 15 NPV I=10 CPT =73,196

(Future value of a complex​ annuity) Springfield mogul Montgomery​ Burns, age 80​, wants to retire at age 100 so he can steal candy from babies full time. Once Mr. Burns​ retires, he wants to withdraw $1 billion at the beginning of each year for 10 years from a special offshore account that will pay 20 percent annually. In order to fund his​ retirement, Mr. Burns will make 20 equal​ end-of-the-year deposits in this same special account that will pay 20 percent annually. How much money will Mr. Burns need at age​ 100, and how large of an annual deposit must he make to fund this retirement​ account?

a. If the retirement account will pay 20 percent​ annually, how much money will Mr. Burns need when he​ retires? N 10 I 20 PV ? *x1.20* PMT 1 billion FV 0 PV = 4.19 *x1.20* = 5.031 billion b. How large of an annual deposit must he make to fund this retirement account? N 20 I 20 PV 0 PMT ? FV 5.031 billion PMT = .02695 = 26.95 million

​(Future value of an​ annuity) ​ Let's say you deposited $160,000 in a 529 plan​ (a tax advantaged college savings​ plan) hoping to have $420,000 available 12 years later when your first child starts college. ​However, you​ didn't invest very​ well, and 2 years later the account balance dropped to $140,000. Let's look at what you need to do to get the college savings plan back on track.

a. If you invested $160,000 into a fund 2 years ago and hoped to have ​$420,000 available 12 years later when your first child starts​ college, what was the original annual rate of return needed to reach your goal when you started the fund 2 years​ ago? N 12 I ? PV -160000 PMT 0 FV 420000 I = 8.37 b. Now with only ​$140,000 in the fund and 10 years remaining until your first child starts​ college, what annual rate of return would the fund have to earn to reach your ​$420,000 goal if you add nothing to the​ account? N 10 I ? PV -140000 PMT 0 FV 420000 I = 11.61 c. If you decide to transfer the $140,000 to a new fund that promises to pay a guaranteed return of 6 percent compounded monthly and make the necessary​ end-of-the-month deposits, how large of a monthly deposit must you make into this new fund to meet your $420,000 goal in 10 ​years? N (10x12) =120 I (6/12) =.5 PV -140000 PMT ? FV 420000 PMT = 1008.57 d. Now you decide to invest the $140,000 today and $500 at the end of each month for the next 10 years into a fund consisting of 50 percent stock and 50 percent bonds and hope for the best. What annual rate of return would the fund have to earn in order to reach your $420,000 goal? N (10x20) =120 I ? *x12* PV -140000 PMT -500 FV 420000 I = .7069 *x 12* = 8.48

(Common stock​ valuation) The common stock of NCP paid ​$1.32 in dividends last year. Dividends are expected to grow at an annual rate of 8.00 percent for an indefinite number of years. a. If your required rate of return is 10.50 percent​, what is the value of the stock for​ you? b. Should you make the​ investment?

a. If your required rate of return is 10.50 percent, the value of the stock for you is: D1 = Do (1 + g) =1.32(1.08) Vcs = D1/(k-g) =1.32(1.08)/(.1050-.08) = 57.02 b. You should make the investment if your expected value of the stock is greater than the current market price because the stock would be undervalued.

​(Expected rate of return using​ CAPM) a. Compute the expected rate of return for Intel common​ stock, which has a 1.2 beta. The​ risk-free rate is 3.5 percent and the market portfolio​ (composed of New York Stock Exchange​ stocks) has an expected return of 16 percent. b. Why is the rate you computed the expected​ rate?

a. The expected rate of return for Intel common stock is: Risk Free Rate + Beta(Return on the Market - Risk Free Rate) 3.5 + 1.2(16-3.5) = 18.5% b. The rate is fair and expected because the CAPM provides a theory of how risk and expected return are connected or traded off in the capital markets. *true*

​(Capital Asset Pricing​ Model) Johnson​ Manufacturing, Inc., is considering several investments. The rate on Treasury bills is currently 4 ​percent, and the expected return for the market is 10 percent. What should be the expected rate of return for each investment​ (using the​ CAPM)?

a. The expected rate of return for security​ A, which has a beta of 1.50​, is: 4.5+1.50(10-4) = 13%

​(Bond valuation) ​Pybus, Inc. is considering issuing bonds that will mature in 20 years with an annual coupon rate of 8 percent. Their par value will be $1,000​, and the interest will be paid semiannually. Pybus is hoping to get a AA rating on its bonds​ and, if it​ does, the yield to maturity on similar AA bonds is 7.5 percent. ​ However, Pybus is not sure whether the new bonds will receive a AA rating. If they receive an A​ rating, the yield to maturity on similar A bonds is 8.5 percent. What will be the price of these bonds if they receive either an A or a AA​ rating?

a. The price of the Pybus bonds if they receive a AA rating will be: N (20x2) =40 I (7.5/2) PV ? = 1051.38 PMT (1000x.08)/2 =40 FV 1000 b. The price of the Pybus bonds if they receive an A rating will be: N (20x2) =40 I (8.5/2) PV ? = 1051.38 PMT (1000x.08)/2 =40 FV 1000

​(Bond valuation​ relationships) A bond of Telink Corporation pays ​$110 in annual​ interest, with a ​$1,000 par value. The bonds mature in 20 years. The​ market's required yield to maturity on a​ comparable-risk bond is 9 percent. a. Calculate the value of the bond. b. How does the value change if the​ market's required yield to maturity on a​ comparable-risk bond​ (i) increases to 12 percent or​ (ii) decreases to 6 ​percent? c. Interpret your findings in parts a and b.

a. What is the value of the bond if the​ market's required yield to maturity on a​ comparable-risk bond is 9 percent? N 20 I 9 PV ? = 1182.57 PMT 110 FV 1000 b. ​(i) What is the value of the bond if the​ market's required yield to maturity on a comparable risk bond increases to 12 ​percent? N 20 I 12 PV ? = 925.31 PMT 110 FV 1000 (ii) What is the value of the bond if the​ market's required yield to maturity on a comparable risk bond decreases to 6 ​percent? N 20 I 6 PV ? = 1573.50 PMT 110 FV 1000 c. The change in the value of a bond caused by changing interest rates is called​ interest-rate risk. Based on the answers in part b​, a decrease in interest rates​ (the yield to​ maturity) will cause the value of a bond to *increase*; by contrast, an increase in interest rates will cause the value to *decrease* ​Also, based on the answers in part b​, if the yield to maturity​ (current interest​ rate): equals the coupon interest​ rate, the bond will sell at *par​*; exceeds the​ bond's coupon​ rate, the bond will sell at a *discount*​; and is less than the​ bond's coupon​ rate, the bond will sell at a *premium*.

​(Net present value​ calculation) Big​ Steve's, makers of swizzle​ sticks, is considering the purchase of a new plastic stamping machine. This investment requires an initial outlay of ​$100,000 and will generate net cash inflows of ​$18,000 per year for 10 years.

a. What is the​ project's NPV using a discount rate of 10 percent​? CF -100,000 CO1 18,000 FO1 10 NPV I=10 CPT =10,602 The project should be accepted because the NPV is positive and therefore adds value to the firm. b. What is the​ project's NPV using a discount rate of 15 percent​? CF -100,000 CO1 18,000 FO1 10 NPV I=15 CPT =-9662 The project should not be accepted because the NPV is negative and therefore does not add value to the firm. c. This project's internal rate of return is CF -100,000 CO1 18,000 FO1 10 IRR CPT =12.41% If the​ project's required discount rate is 10​%, then the project should be ​accepted, because the IRR is higher than the required discount rate. If the​ project's required discount rate is 15​%, then the project should not be ​accepted, because the IRR is lower than the required discount rate.

(Bond valuation​ relationships) The 15​-year, ​$1,000 par value bonds of Waco Industries pay 8 percent interest annually. The market price of the bond is ​$1,085​, and the​ market's required yield to maturity on a​ comparable-risk bond is 10 percent. a. Compute the​ bond's yield to maturity. b. Determine the value of the bond to you given the​ market's required yield to maturity on a​ comparable-risk bond. c. Should you purchase the​ bond?

a. What is your yield to maturity on the Waco bonds given the current market price of the​ bonds? N 15 I ? = 7.06 PV -1085 PMT 80 FV 1000 b. What should be the value of the Waco bonds given the​ market's required yield to maturity on a​ comparable-risk bond? N 15 I 10 PV ? = 847.88 PMT 80 FV 1000 You should not purchase the Waco bonds at the current market price because they are currently overpriced.

​(Calculating project cash flows and​ NPV) ​Garcia's Truckin', Inc. is considering the purchase of a new production machine for ​$200,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $50,000 per year. To operate this machine​ properly, workers would have to go through a brief training session that would cost $5,000 after tax. In​ addition, it would cost ​$5,000 after tax to install this machine correctly. ​ Also, because this machine is extremely​ efficient, its purchase would necessitate an increase in inventory of ​$20,000. This machine has an expected life of 10 ​years, after which it will have no salvage value. ​ Finally, to purchase the new​ machine, it appears that the firm would have to borrow ​$100,000 at 8 percent interest from its local​ bank, resulting in additional interest payments of $8,000 per year. Assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a 34 percent tax​ rate, and a required rate of return of 10 percent. a. What is the initial outlay associated with this​ project? b. What are the annual​ after-tax cash flows associated with this project for years 1 through 9​? c. What is the terminal cash flow in year 10 ​(that is, the annual​ after-tax cash flow in year 10 plus any additional cash flows associated with termination of the​ project)? d. Should this machine be​ purchased?

a. capital expenditures +installation +training +incr in net operating working capital =initial cash outlay 200,000 +5,000 +5,000 +20,000 =230,000 b. net operating profit (EBIT) -taxes =NOPAT +depreciation =operating cash flow depr= (200,000+5,000+5,000)/10 = 21,000 50,000 -17,000 =33,000 +21,000 =54,000 c. 54,000 + net incr in net working capital (20,000) = 74,000 d. the machine should be purchased because the NPV is $109,517, making it a worthwhile investment for the company.

​(Individual or component costs of​ capital) Compute the cost of capital for the firm for the​ following: a. A bond that has a ​$1,000 par value​ (face value) and a contract or coupon interest rate of 11.1 percent. Interest payments are ​$55.50 and are paid semiannually. The bonds have a current market value of ​$1,127 and will mature in 10 years. The​ firm's marginal tax rate is 34 percet. b. A new common stock issue that paid a ​$1.83 dividend last year. The​ firm's dividends are expected to continue to grow at 7.9 percent per​ year, forever. The price of the​ firm's common stock is now ​$27.17. c. A preferred stock that sells for ​$140​, pays a dividend of 9.1 ​percent, and has a​ $100 par value. d. A bond selling to yield 11.3 percent where the​ firm's tax rate is 34 percent.

a. cost of after tax debt N 10x2= 20 I ? PV -1,127 PMT 55.50 FV 1,000 = 4.5679x2= 9.1358 9.1358(1-.34)= 6.03 b. cost of common equity (1.83 x (1+.079)/27.17)+ .079= .15167= 15.17% c. cost of preferred stock 100x.091/140= .065= 6.50% d. after-tax cost of debt 11.3x(1-.34)= 7.46%

(Calculating the geometric and arithmetic average rate of​ return) Marsh Inc. had the following​ end-of-year stock prices over the last five years and paid no cash​ dividends: 1 $10 2 $12 3 $18 4 $7 5 $10 a. Calculate the annual rate of return for each year from the above information. b. What is the arithmetic average rate of return earned by investing in​ Marsh's stock over this​ period? c. What is the geometric average rate of return earned by investing in​ Marsh's stock over this​ period? d. Considering the beginning and ending stock prices for the​ five-year period are the​ same, which type of average rate of return​ (the arithmetic or​ geometric) better describes the average annual rate of return earned over the​ period?

a. rate of return = (end price + dividends - beginning price) / beginning price The annual rate of return at the end of year 2 is: (12+0-10)/10 = 20% The annual rate of return at the end of year 3 is: (18+0-12)/12 = 50% c. The geometric average rate of return earned by investing in​ Marsh's stock over this period is: N 5 I ? = 0% PV -10 PMT 0 FV 10 d. Considering the beginning and ending stock prices for the​ five-year period are the​ same, the *geometric* average rate of return better describes the average annual rate of return earned over the period.

Project Black Swan requires an initial investment of​ $115,000. It has positive cash flows of​ $140,000 for each of the next two years. Because of major demolition and environmental clean−up costs, cash flow for the third and final year of the project is​ $(170,000). If the company​ 's required rate of return is​ 12%, the project should be

accepted because the NPV is positive at​ 12%

(Break-even analysis) The Marvel Mfg. Company is considering whether or not to construct a new robotic production facility. The cost of this new facility is ​$618,000 and it is expected to have a​ six-year life with annual depreciation expense of ​$103,000 and no salvage value. Annual sales from the new facility are expected to be 2,040 units with a price of ​$1,070 per unit. Variable production costs are ​$620 per​ unit, and fixed cash expenses are $85,000 per year. a. Find the accounting and the cash​ break-even units of production. b. Will the plant make a profit based on its current expected level of​ operations? c. Will the plant contribute cash flow to the firm at the expected level of​ operations?

accounting break even= total fixed costs/ price per unit- variable cost per unit cash break even= total fixed costs-depreciation/price per unit- variable cost per unit a. accounting>>103,000+85,000/1,070-620= 418 cash>> 85,000/1,070-620= 189 b. From part a​, we can observe that for making an accounting profit we have to sell only 418 ​units, but our expected units of sale is 2,040​, so we would make an accounting profit. c. From part a​, we can observe that the cash​ break-even units of production is 189 ​units, but the firm expects to sell 2,040 ​units, so the firm can expect a positive cash flow.

Which of the following would increase the net working capital for a​ project? An increase in

accounts receivable

Banks collect the savings of individuals and businesses and then lend these pooled savings to other individuals and businesses. In this​ role, banks​ are:

acting as a financial intermediary, making money by changing a rate of interest to borrowers that exceeds the rate they pay to savers

When managers have little or no ownership in the​ firm, they are less likely to work energetically for the​ company's shareholders. We call this type of conflict​ a(n)

agency problem

The cost of capital is

all of the above ( the opportunity cost of using funds to invest in new projects, the rate of return the firm must earn on its investments in order to satisfy the required rate of return of the​ firm's investors, the required rate of return for new capital investments which have typical or average risk)

A​ firm's capital structure consists of which of the​ following?

all of the above (common stock, bonds, preferred stock)

Relevant incremental cash flows include

all of the above (retained sales that would have been lost to new competing products, incremental sales brought to the firm as a whole, sales captured from the​ firm's competitors.)

par value

amount you get at maturity (generally $1000)

beta > 1

amplifies movement in the market

perpetuity

an annuity that goes on forever PV = PP / i PP = the equal dollar amount received forever

call option

an option to buy something (you want the price to go up)

Which of the following is a real option with respect to a capital budgeting​ decision?

an option to expand the scale of the project.

put option

an option to sell something (you want the price to go down)

accounts receivable turnover

annual credit sales / accounts receivable

valuation of preferred stock

annual dividend/required rate of return

Approx nominal rate equation

approx nominal rate = real rate + anticipated inflation

secondary markets

are concerned with the trading of previously issued securities between investors.

A negative coefficient of correlation implies that

asset returns tend to move in opposite directions.

In​ finance, we assume that investors are generally

averse to risk

Which of the following is an example of a sunk​ cost?

Market study expenses incurred in order to decide if a firm should accept a project

Which of the following is a reasonable conclusion from the Tradeoff theory of capital​ structure?

Modest levels of debt have a more favorable impact on a​ firm's average cost of capital and stock price than no debt.

You are thinking of buying a miniature golf course. It is expected to generate cash flows of​ $40,000 per year in years one through four and​ $50,000 per year in years five through eight. If the appropriate discount rate is​ 10%, what is the present value of these cash​ flows?

N I PV PMT FV

(Yield to​ maturity) The market price is $900 for a 10​-year bond ($1,000 par​ value) that pays 8 percent annual​ interest, but makes interest payments on a semiannual basis ​(4 percent​ semiannually). What is the​ bond's yield to​ maturity?

N (10x2) =20 I ? *x2* = 4.79 *x2* = 9.58% PV -900 PMT (1000x.08)/2 =40 FV 1000

Ingrid Birdman can earn a nominal annual rate of return of​ 12%, compounded semiannually. If Ingrid made 40 consecutive semiannual deposits of​ $500 each, with the first deposit being made​ today, how much will she accumulate at the end of Year​ 20? Round off to the nearest​ $1.

N (20x2) =40 I (12/2) =6 PV 0 PMT -500 FV ? *x1.06* FV = 77380.98 *x1.06* =82024

Edward Johnson decided to open up a Roth IRA. He will invest​ $1,800 per year for the next 35 years. Deposits to the Roth IRA will be made via a​ $150 payroll deduction at the end of each month. Assume that Edward will earn​ 8.75% annual interest compounded monthly over the life of the IRA. How much will he have at the end of 35​ years?

N (35x12) I (8.75/12) PV 0 PMT -1800 FV ? *(/12)* FV = 4972859.61 */12* =414405

What is the expected rate of return on a bond that pays a coupon rate of​ 9% paid semi−​annually, has a par value of​ $1,000, matures in five​ years, and is currently selling for​ $1071?

N (5x2)=10 I ?*x2*=7.28 PV -1071 PMT (1000x.09)/2=45 FV 1000

The current market price of an existing debt issue is​ $1,125. The bonds have a​ $1,000 par​ value, pay interest annually at a​ 12% coupon​ rate, and mature in 10 years. The firm has a marginal tax rate of​ 34%. The after−tax cost of this debt issue is

N 10x2 I ? PV -1,125 PMT 60 FV 1000 =4.9972x2= 9.9944 9.9944x(1-.34)= 6.58

You wish to borrow​ $2,000 to be repaid in 12 monthly installments of​ $170.30. The annual interest rate is

N 12 I ? *x12* PV 2000 PMT -170.30 FV 0 I = .33 *x12* =4

​(Cost of​ debt) Belton Distribution Company is issuing a ​$1,000 par value bond that pays 7.1 percent annual interest and matures in 15 years that is paid semiannually. Investors are willing to pay ​$962 for the bond. The company is in the 20 percent marginal tax bracket. What is the​ firm's after-tax cost of debt on the​ bond?

N 15x2= 30 I ? PV -962 PMT 35.50 FV 1000 = 3.7635x2=7.5260 7.5260x(1-.20)= 6.02%

​(Cost of​ debt) Belton Distribution Company is issuing a $1,000 par value bond that pays 7.0 percent annual interest and matures in 15 years that is paid semiannually. Investors are willing to pay $958 for the bond. The company is in the 18 percent marginal tax bracket. What is the​ firm's after-tax cost of debt on the​ bond?

N 15x2= 30 I ? *x2* = 3.74*x2* = 7.47 PV -958 PMT 1000x.07= 70 */2* = 35 FV 1000 7.47 x (1-.18) = 6.13

How much money must you pay into an account at the beginning of each of 20 years in order to have​ $10,000 at the end of the 20th​ year? Assume that the account pays​ 12% per​ annum, and round to the nearest​ $1.

N 20 I 12 PV 0 PMT ? */1.12* FV 10000 PMT = 138.79 */1.12* =124

Alpha has an outstanding bond issue that has a​ 7.75% semiannual​ coupon, a current maturity of 20​ years, and sells for​ $967.97. The​ firm's income tax rate is​ 40%. What should Alpha use as an after−tax cost of debt for cost of capital​ purposes?

N 20x2= 40 I ? PV -967.97 PMT 1000x .075= 75/2= 37.5 FV 1000 = 3.9097x2= 7.8193 7.8193x(1-.40)= 4.85%

What is the present value of​ $250 received at the beginning of each year for 21​ years? Assume that the first payment is received today. Use a discount rate of​ 12%, and round your answer to the nearest​ $10.

N 21 I 12 PV ? *x1.12* PMT 250 FV 0 PV = 1890.5 *x1.12* = 2117

Harry just bought a new four−wheel−drive Jeep Cherokee for his lumber business. The price of the vehicle was​ $35,000, of which he made a​ $5,000 down payment and took out an amortized loan for the rest. His local bank made the loan at​ 12% interest for five years. He is to pay back the principal and interest in five equal annual installments beginning one year from now. Determine the amount of​ Harry's annual payment.

N 5 I 12 PV (35000-5000) = 30000 PMT ? = 8322 FV 0

Recently you borrowed money for a new car. The loan amount is​ $15,000 to be paid back in equal annual payments which begin​ today, and will continue to be payable at the beginning of each year for a total of five years. Interest on the loan is​ 8%. What is the amount of the loan​ payment?

N 5 I 8 PV 15000 PMT ? *(/1.08)* FV 0 PMT = 3756.85 */1.08* = 3478.31

What is the present value of an annuity of​ $27 received at the beginning of each year for the next six​ years? The first payment will be received​ today, and the discount rate is​ 10% (round to nearest​ $10).

N 6 I 10 PV ? *x1.10* PMT 27 FV 0 PV = 117 *x1.10* = 130

What is the yield to maturity of a nine−year bond that pays a coupon rate of​ 20% per​ year, has a​ $1,000 par​ value, and is currently priced at​ $1,407? Assume annual coupon payments.

N 9 I ? =12.28% PV -1407 PMT (1000x.2)=200 FV 1000

Your company has received a​ $50,000 loan from an industrial finance company. The annual payments are​ $6,202.70. If the company is paying​ 9% interest per​ year, how many loan payments must the company​ make?

N ? =15 I 9 PV 50000 PMT -6202.70 FV 0

You are considering investing in U.S. Steel. Which of the following is an example of nondiversifiable​ risk?

NONE: Risk resulting from oil exploration by Marathon Oil​ (a U.S. Steel​ subsidy); Risk resulting from a strike against U.S. Steel; Risk resulting from foreign expropriation of U.S. Steel property

When various capital budgeting techniques rank mutually exclusive projects​ differently, which of the following is theoretically most​ reliable?

NPV

operation profit margin

Net Operating Income (EBIT) / Sales

Which of the following expenses should be included when estimating cash flows for investment​ projects?

Opportunity costs

​(Present value of a​ perpetuity) At a discount rate of 8.50​%, find the present value of a perpetual payment of $1,000 per year. If the discount rate were lowered to 4.25​%, half the initial​ rate, what would be the value of the​ perpetuity?

PV = PMT / i discount rate were 8.50% = (1000 / .0850) = 11764.71 discount rate were 4.25% = (1000 / .0425) = 23529.41

value

PV benefits

net value

PVinflows - PVoutflows (benefits). (costs)

overconfidence effect

People that make money in the market think they have done so because they're smart rather than lucky, as a result, when they make money they take more risks than they should

Which of the following would be considered a capital budgeting​ decision?

Pfizer develops a new therapy and brings it to market.

Which of the following is true about Preferred​ Stock?

Preferred dividends must be paid before the company can pay a dividend on its common stock.

Differences b/t common and preferred stock: Dividends

Preferred stock: fixed dividend (like bonds) Common stock: can vary, must be declared and can be omitted

Differences b/t common and preferred stock: Preference

Preferred stock: has a preference in terms of claims in bankruptcy and income for dividends (PS gets dividends first, then CS if they want)

Preferred stock is an equity security that has seniority rights.

Preferred stock​ dividends, which are unpaid due to a lack of profits may accrue to be paid later when the corporation returns to profitability; Preferred stock is sometimes referred to as a hybrid security; Owners of preferred stock receive their dividends before dividends are distributed to common stock shareholders; During the liquidation of a​ company, holders of preferred stock would have a claim on assets before any claims by common stock shareholders.

Which of the following is a typical capital budgeting​ decision?

Replacement of manufacturing equipment with more modern and efficient equipment

You are considering buying some stock in Continental Grain. Which of the following is an example of nondiversifiable​ risk?

Risk resulting from a general decline in the stock market

You are considering investing in Ford Motor Company. Which of the following is an example of diversifiable​ risk?

Risk resulting from uncertainty regarding a possible strike against Ford

Income Statement equation

Sales - COGS =Gross Profit -Operating Expenses =Operating Income -Interest Expense =Earning before taxes (EBT) -Income taxes =Earnings after taxes (EAT) or net income -Preferred stock dividend =Net Income available to common shareholders

​(IRR of an uneven cash flow​ stream) Microwave Oven​ Programming, Inc. is considering the construction of a new plant. The plant will have an initial cash outlay of $7 million​ (​ =−​$7 million), and will produce cash flows of ​$3 million at the end of year​ 1, $4 million at the end of year 2, and $2 million at the end of years 3 through 5. What is the internal rate of return on this new​ plant?

The IRR of the project is CF -7,000,000 CO1 3,000,000 FO1 1 CO2 4,000,000 CO3 2,000,000 CO4 2,000,000 CO5 2,000,000 IRR CPT =28.53%

Which of the following is generally used to measure the market when calculating​ betas?

The Standard​ & Poors 500 Index

Quirk Drugs sold an issue of 30−​year, $1,000 par value bonds to the public that carry a​ 10.85% coupon​ rate, payable semiannually. It is now 10 years​ later, and the current market rate of interest is​ 9.00%. If interest rates remain at​ 9.00% until​ Quirk's bonds​ mature, what will happen to the value of the bonds over​ time?

The bonds will sell at a premium and decline in value until maturity.

Is the firm more or less risky than the market​ portfolio? beta = .5

The firm is less risky than the market portfolio because the estimated beta is less than the market beta of 1.

Which of the following statements about bonds is​ true?

The market value of a bond moves in the opposite direction of market interest rates.

​(Present value of an​ annuity) Determine the present value of an ordinary annuity of​$1,000 per year for 10 years, assuming it earns 10 percent. Assume that the first cash flow from the annuity comes at the end of year 8 and the final payment at the end of year 17. That​ is, no payments are made on the annuity at the end of years 1 through 7. Instead, annual payments are made at the end of years 8 through 17.

The present value of the annuity at the end of year 7 is: ​N 10 I 10 PV ? PMT 1000 FV 0 PV = 6144.57 The present value of the annuity today is: N 7 I 10 PV ? PMT 0 FV -6144.57 PV = 3153.14

(Present value of a complex​ stream) Don Draper has signed a contract that will pay him $80,000 at the end of each year for the next 6 ​years, plus an additional $100,000 at the end of year 6. If 8 percent is the appropriate discount​ rate, what is the present value of this​ contract?

The present value of the contract is: step 1: N 6 I 8 PV ? = 369833.96 PMT -80000 FV 0 step 2: N 6 I 8 PV ? = 63016.96 PMT 0 FV 100000 369833.96 + 63016.96 = 432847.33

Which of the following overhead expenses is a​ relevant, incremental cash​ flow?

The project will increase the number of employees by​ 10%, so an additional human resources assistant must be hired to handle personnel issues directly related to the project.

Which of the following best describes a​ firm's cost of​ capital?

The rate of return that must be earned on its investments in order to satisfy the​ firm's investors

Which of the following is true about​ bonds?

They have a fixed​ maturity, and they pay an amount equal to the maturity value times the coupon rate each year.

Which of the following is the best example of an incremental cash​ inflow/outflow?

What the total cash flows will be to the company if the project is undertaken as opposed to what they would have been if the project had not been undertaken

(Cost of common​ equity) Salte Corporation is issuing new common stock at a market price of $27.00. Dividends last year were $1.45 and are expected to grow at an annual rate of 6.0 percent forever. What is​ Salte's cost of common​ equity?

[Do(1+g)]/Po +g [1.45(1.06)]/27 +.06 = 11.69%

​(Cost of common​ equity) The common stock for the Bestsold Corporation sells for $58.00 a share. Last year the firm paid a ​$4.00 dividend, which is expected to continue to grow 4.0 percent per year into the indefinite future. If​ Bestsold's tax rate is 34 percent, what is the​ firm's cost of common​ equity?

[Do(1+g)]/Po +g [4(1.04)]/58 +.04 = 11.17%

EBITDA

a common measure of cash flow from operations

futures contract

a contract to buy or sell a stated commodity (such as soybeans or corn) or a financial claim (such as US Treasury Bonds) at a specified price at some future specified time -on commodities and on securities

VIX

a measure of the market's expectation of stock market volatility over the next 30-day period. Referred to as the fear index or fear gauge - it is based on S&P 500 index options

inflation premium

a premium to compensate for anticipated inflation that is equal to the price change expected to occur over the life of the bond or investment instrument

Which of the following has a beta of​ zero?

a risk-free asset

annuities

a series of fixed payments for a specified number of years. the cash payments or receipts are constant -cash flows occur at the end of each period

​J&P Accounting purchased new tax software two years ago. The software is still​ useable, but​ faster, more comprehensive software is available. If​ J&P purchases the new​ software, the cost of the old software is

a sunk cost

​A(n) ________ gives the holder the right to buy a stated number of shares at a specified price for a limited time.

call option

The area of finance that deals with long−term investment decisions is known as

capital budgeting

When the impact of taxes is​ considered, as the firm takes on more debt

cash flows will increase because taxes will decrease.

rate of return

cash return/beginning price

The CAPM approach is used to determine the cost of

common equity

Which of the following financial instruments entails the most risk and potentially the highest returns for​ investors?

common stock

Which of the following must be adjusted for the​ firm's tax rate when estimating the weighted average cost of capital​ WACC?

cost of debt

inventory turnover

cost of goods sold / inventory

options clearinghouse

counter party clearing and selling

annual interest

coupon interest rate x par

interest paid

coupon rate x par value

acid-test (quick ratio)

current assets - inventory / current liability

current ratio

current assets / current liabilities

The weights used to determine the relative importance of the​ firm's sources of capital should reflect

current market values

Which of the following financial instruments is not traded in the capital​ markets?

debt with a maturity of less than one year

capital budgeting

decision making with respect to investment in long term assets -investments over 1 year -fixed assets

For tax​ purposes, interest on corporate debt is

deductible for the​ borrower, but not for the investor.

Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the​ ________ premium is lower for government bonds.

default

(Calculating changes in net operating working​ capital) Tetious Dimensions is introducing a new product and has an expected change in net operating income of ​$775,000. Tetious Dimensions has a 34 percent marginal tax rate. This project will also produce ​$200,000 of depreciation per year. In​ addition, this project will cause the following changes in year​ 1: W/O project: AR 55,000 Inv 100,000 AP 70,000 W project: AR 89,000 Inv 180,000 AP 120,000 What is the​ project's free cash flow in year​ 1?

differences: AR +34000 Inv +80,000 AP -50,000 (subtract AP) ----------- =64,000 775,000 x .34 = 263,500 775,000 -263,500 +200,000 -64,000 -------- = 647,500

(Calculating changes in net operating working​ capital) Tetious Dimensions is introducing a new product and has an expected change in net operating income of ​$300,000. Tetious Dimensions has a 34 percent marginal tax rate. This project will also produce ​$50,000 of depreciation per year. In​ addition, this project will cause the following changes in year​ 1: W/O project: AR 33,000 Inv 25,000 AP 50,000 W project: AR 23,000 Inv 40,000 AP 86,000 What is the​ project's free cash flow in year​ 1?

differences: AR -10000 Inv +15,000 AP -36,000 (subtract AP) ----------- =*-31,000* 300,000 x .34 = 102,000 300,000 -102,000 +50,000 *+31,000* -------- = 279,000

Spartan​ Sofas, Inc. is selling for​ $50.00 per share today. In one​ year, Spartan will be selling for​ $48.00 per​ share, and the dividend for the year will be​ $3.00. What is the cash return on Spartan​ stock?

end price + dividends - beginning price 48 + 3 - 50 = 1

​Currently, the expected return on the market is​ 12.5% and the required rate of return for​ Alpha, Inc. is​ 12.5%. Therefore,​ Alpha's beta must be

equal to 1.0

The price at which the stock or asset may be purchased from​ (or sold​ to) the option writer is referred to as

exercise or strike price

A company converts space to use as a manufacturing facility. Previously it was rented to another company as a warehouse. This is an example of a sunk cost.

false

A stock with a beta of 1.0 would on average earn the risk−free rate.

false

ABC Corporation issued and sold 10 shares of stock to Irene​ Investor, a private individual. This represents a secondary market transaction.

false

Adequate portfolio diversification can be achieved by investing in several companies in the same industry.

false

Banking regulations are essentially the same in all developed nations.

false

Because returns are more certain for the least risky​ investments, the required return on these investments should be higher than the required returns on more risky investments.

false

Betas for individual stocks tend to be stable.

false

Generic, Inc. has bonds outstanding that mature in 20 years. The bonds have​ $1,000 par​ value, pay interest annually at a rate of​ 10%, and have a current selling price of​ $875.25. The current yield on the bonds is​ 11.63%

false

If an investor earns​ 10% on her investment in the first year and loses​ 10% the next​ year, she will have neither a gain nor a loss.

false

If investors became more risk averse The SML would shift downward and the slope of the SML would fall.

false

In Financial​ markets, borrowers and lenders most both be located in the same country.

false

Maturity risk and liquidity risk are equivalent terms.

false

Miller Motorworks has a​ $1,000 par​ value, 8% annual coupon bond with interest payable semiannually with a remaining term of 15 years. The annual market yield on similar bonds is​ 6%. This bond will at a discount from par.

false

Net present value is suitable for comparing projects with unequal lives.

false

Options can only be purchased for individual​ stocks, not for funds or indexes.

false

Real options are derivative securities that derive their value from the value of the underlying projects.

false

Real options are traded on both the American Exchange and Chicago Board Options Exchange​ (CBOE).

false

Riskier investments have traditionally had lower returns than less risky investments have had.

false

The current yield is the average rate of interest a bond will from the time of purchase until it matures

false

The goal of maximize shareholder wealth inevitably conflicts with socially responsible behavior on the part of corporation.

false

The initial outlay of an asset does not include installation costs.

false

The pertinent issue for determining whether overhead costs should be part of a​ project's relevant after−tax cash flow is whether the project benefits from the overhead items.

false

The present value of a​ $100 perpetuity discounted at​ 5% is​ $1200.

false

The primary objective of all capital budgeting decisions is to increase the size of the firm.

false

The standard deviation of a portfolio is always just the weighted average of the standard deviations of assets in the portfolio.

false

When computing a​ firm's cost of​ capital, book values should be used be used because they are more objective.

false

a bond matures in less than 10 years

false

To find the present value of an annuity​ due, one could

find the present value of an ordinary annuity and multiply by​ 1+i.

When comparing annuity due to ordinary​ annuities, annuity due annuities will have higher

future values and present values

Unlike the owner of​ a(n) ________​ contract, the owner of​ a(n) ________ contract does not have to exercise it

futures, option

Real options can have the effect of

gaining information about future opportunities, increasing a​ project's NPV, reducing a​ project's risk. all of the above

the par value of a bond

generally is $1000

option

gives the owner the right to buy (call option) or sell (put option) a specified asset at a specified price ober a specific time period

Seasoned (or secondary) equity offering

gone public and need more money: SEO - when a company that already has stock outstanding issues more stock

Preferred stockholders

have prior claim on income and assets of a firm

junk bonds

have yields that are considerably higher than those of the highest rated bonds.

payback

identifies how long it takes to recoup the initial investment outlay. may require 2-5 years. accept if less or equal than the "pre-specified cut off" payback

The nominal interest rate

includes inflation and the real rate of interest.

How could you compensate an investor for taking on a significant amount of​ risk?

increase the expected rate of return

Holding all other variables​ constant, which of the following would INCREASE net working capital for given year on a​ project?

increasing inventory levels

The detailed legal agreement between a​ bond's issuer and and its trustees is known as the

indenture

The principal savers in the financial markets are

individuals

current yield

interest paid / price of bond

_____ relationship between interest rates and bond prices

inverse

The inclusion of bankruptcy costs and taxes in firm valuation

is consistent with a saucer−shaped cost of capital curve.

A​ $1,000 par value 10−year bond with a​ 10% coupon rate recently sold for​ $900. The yield to maturity

is greater than 10%

The yield to maturity on a bond

is the required return on the bond

liquidity preference theory

lenders would rather lend for short periods of time and borrowers would rather borrow for long periods of time

Project Full Moon has an initial outlay of​ $30,000, followed by positive cash flows of​ $10,000 in year​ 1, $15,000 in year​ 2, and​ $15,000 in year 3. The project should be accepted if the required rate of return is

less than 14.6%

closing price

listed as a % of par ($1000)

Capital Market securities

long-term securities (over 1 year), securities issued by corporations and gov'ts

Which of the following is NOT an example of systematic​ risk?

management risk

Jillian has purchased AAA rated corporate bonds that will mature in 20 years . She plans to sell the bonds in 10 years as she approaches retirement age. The most significant risk she faces is

maturity risk

Financial markets are often described by the maturities of the securities traded in them. __________ are markets for​ short-term debt instruments with maturities of 1 year or​ less, while_______________ are markets for​ long-term financial instruments with maturities that extend beyond 1 year.

money markets, capital markets

Return on Assets (ROA)

net income / assets

Return on Equity (ROE)

net income / common equity

net profit margin

net income / sales

Return on Investment (ROI)

net income / some measure of investment

return on investments

net income / total investment

Times Interest Earned

net operating income (EBIT) / interest expenses

Notes vs bonds maturities

notes have maturities up to 10 years, while bonds have maturities greater than 10 years

There is a _______ relationship between both the interest rate used to compound a present sum and the number of years for which the compounding continues and the future value of that sum.

positive

As interest​ rates, and consequently​ investors' required rates of​ return, change over​ time, the​ ________ of outstanding bonds will also change.

price

Price Earnings Ratio

price / earnings

The strike price is the

price at which the stock or asset may be purchased from the writer.

Firms that wish to raise funds for investment purposes issue securities in the

primary markets

Both venture capital​ (VC) firms and leveraged buyout​ (LBO) firms are types of​

private equity firms

Investment companies are specialized financial intermediaries that provide financial services to businesses. These investment companies​ include:

private equity firms, hedge funds, mutual funds

The capital asset pricing model

provides a risk−return trade−off in which risk is measured in terms of beta.

income statement

provides the following info for the firm over specific period of time -revenue earned -expenses incurred -profit earned

An investor would buy a​ ________ if he or she believes that the price of the underlying stock or asset will fall in the near future.

put option

​A(n) ________ gives the holder the right to sell a stated number of shares at a specified price for a limited time.

put option

(Common stock​ valuation) Gilliland​ Motor, Inc., paid a $3.75 dividend last year. If​ Gilliland's return on equity is 24 percent, and its retention rate is 25 percent, what is the value of the common stock if the investors require a rate of return of 20 percent?

rate of growth in dividends (g) = retention rate x return on equity =.24 x .25 = .06 D1 = Do (1 + g) =3.75(1.06) Vcs = D1/(k-g) =3.75(1.06)/(.2-.06) =28.39

hedger

reduce risk by locking in buying or selling price

Advantages to borrowing in the private market include

reduced initial costs

You are to receive a 10 yr $100,000 annuity (that means ten cash flows of $100,000 each) with the first cash flow occurring at the end of year 5. Given a 10% discount rate, what is the present value of this annuity?

refer to notes

The accounting break-even point tells us the level of sales necessary to cover our total fixed and variable operating costs where total fixed costs include both cash fixed costs and depreciation expense​ (which is not a cash expense for the​ period), while the cash break-even point tells us the level of sales where we have covered our cash fixed costs​ (ignoring depreciation) and as a result our cash flow is zero

refer to term

A machine has a cost of​ $5,575,000. It will produce cash inflows of​ $1,825,000 (Year​ 1); $1,775,000​ (Year 2);​ $1,630,000 (Year​ 3); $1,585,000​ (Year 4); and​ $1,650,000 (Year​ 5). At a discount rate of​ 16.25%, the project should be

rejected

risk

relative measure of the degree of variability of possible outcomes over time

Determining relevant cash flows​) ​Captain's Cereal is considering introducing a variation of its current breakfast​cereal, Crunch Stuff. This new cereal will be similar to the​old, with the exception that it will contain​sugar-coated marshmallows shaped in the form of stars. The new cereal will be called Crunch Stuff​n' Stars. It is estimated that the sales for the new cereal will be $25 million; however, 20 percent of those sales will draw from former Crunch Stuff customers who have switched to Crunch Stuff​n' Stars and who would not have switched if the new product had not been introduced. What is the relevant sales level to consider when deciding whether or not to introduce Crunch Stuff​n' Stars? The relevant sales level to consider when deciding whether to introduce Crunch Stuff​ n' Stars is

relevant sales level = sales for new product - sales taken from existing product lines 25 mil x .20 = 5 mil 25 mil - 5 mil = *20 mil*

equity (common stock)

represents the ownership position in a business enterprise -common stockholders are the residual or ultimate owners of a corporation

Advantages of privately placing debt include all of the following except

restrictive covenants

rate of growth in dividends (g)

retention rate x return on equity

bond's total return

return from interest payments + gains/losses from capital gains or losses

(Calculating operating cash​ flows) Assume that a new project will annually generate revenues of $2,000,000 and cash expenses​ (including both fixed and variable​ costs) of $800,000​, while increasing depreciation by $200,000 per year. In​ addition, the​ firm's tax rate is 34 percent. Calculate the operating cash flows for the new project. The firm's operating cash flows are

revenue -expenses -depreciation =NOI -taxes +depreciation =operating cash flow 2,000,000 -800,000 -200,000 = 1,000,000 1,000,000 x .34 = 340,000 1,000,000 -340,000 +200,000 =860,000

(Calculating operating cash​ flows) Assume that a new project will annually generate revenues of ​$2,200,000 and cash expenses​ (including both fixed and variable​ costs) of ​$1,100,000​, while increasing depreciation by ​$180,000 per year. In​ addition, the​ firm's tax rate is 28 percent. Calculate the operating cash flows for the new project.

revenue-cash expenses-depreciation= ()x.28=()+depreciation 2,200,000-1,100,000-180,000= 920,000x.28= 2576000>>> 920,000-257,000= 662,400+180,000= 842400

expected or required rate of return

risk free rate + beta(return on the market - risk free rate)

total asset turnover

sales / total assets

gross profit margin

sales less cost of goods sold / sales

Derivative Securities

securities whose value is based upon the value of another security or asset

Sell short

sell the stock first, then you buy it back later (closing your position) you hope the stock price falls (when you think stock value will drop or is overpriced)

The interest on corporate bonds is typically paid

semiannually

Money Market securities

short-term securities (less than 1 year)

beta

slope of the characteristic line measure of the stock's systematic or market risk is the weighted average of the individual securities beta

Uses of future contracts include

speculating on future price movements of commodities which the speculator neither uses nor produces; reducing uncertainty about the prices that will be received when a commodity is ready for market; reducing uncertainty about the future cost of key inputs.

Which of the following best measures an asset's risk?

standard deviation

coefficient of variation

standard deviation/mean relative measure variance risk and return

Corporate debt can be privately placed with

state pension funds, life insurance companies, union pension funds

Which of the following is NOT considered in the calculation of incremental cash​ flows?

sunk costs

A​ stock's beta is a measure of its

systematic risk

The​ investor's required rate of return differs from the​ firm's cost of capital due to the

tax deductibility of interest.

Find tax

taxable income x (flat rate tax of 21%) ---------------- answer

The yield on a corporate bond with a 20 year maturity would include

the risk−free rate plus a default risk​ premium, a liquidity risk premium and a maturity risk premium.

All of the following operate as financial intermediaries EXCEPT

the U.S. Treasury

Annual Percentage Yield or Equivalent Annual Rate (APY or EAR)

the actual accrual interest rate earned or paid -a loan is more attractive if it offers a lower EAR -a deposit is more attractive if it offers a higher EAR

liquidity-risk premium

the additional return required by investors for securities that can't quickly be converted into cash at a reasonably predictable price

maturity-risk premium

the additional return required by investors in longer-term securities to compensate them for the greater risk of price fluctuation on those securities caused by interest rate changes

default-risk premium

the additional return required by investors to compensate for the risk of default. calculated as the difference in rates b/t a U.S. Treasury bond and a corporate bond of the same maturity and marketability

annuities due

the cash flows occur at the *beginning* of each time period. in effect, each cash flow has been moved forward by one period

ordinary annuities

the cash flows occur at the *end* of each time period

net present value (NPV)

the difference b/t the present value of benefits (cash inflows) and the PV of the costs (cash outflows) tells us how much WEALTH created

yield spread

the difference between the yield on a non-Treasury bond and the yield on a Treasury bond of comparable maturity

Internal Rate of Return (IRR)

the discount rate that equates the present values of the cash inflows with the initial investment that makes the NPV of the project equal to zero acceptance criteria: accept if IRR>required rate of return reject if IRR<required rate of return

The par value of a bond is

the face value of the​ bond, which is received by the bondholder when the bond matures at its normal maturity date

Investments that have earned the highest rates of return over 1995−2015 also have

the highest standard deviation of returns.

real risk-free interest rate

the interest rate on a fixed-income security that has no risk in an economic environment of zero inflation. It could also be stated as the nominal interest rate less the inflation, default-risk, maturity-risk, and liquidity-risk premium

nominal or quoted rate

the interest rate that is quoted and does not adjust for inflation

Assuming two investments have equal​ lives, a high discount rate tends to favor

the investment with large cash flow early.

correlation coefficient

the key in diversification standardized covariances

unbiased expectations theory

the long-term rate is an unbiased average of the short-term interest rate plus future short term interest rates expected to prevail over the life of the obligation; why the yield curve is shaped as it is

Which of the following has a beta of​ 1?

the market

Which of the following best describes the goal of the firm?

the maximization of the total market value of the firm's common stock

Which of the following is NOT a typical real option in capital​ budgeting?

the option to discount the project at a lower rate of return

coefficient of determination

the percent of variability explained in the regression (r squared)

exercise or striking price

the price you can buy the stock for (if it's a call) or the price you can sell for (if it's a put)

nominal interest rate

the quoted interest rate and is the interest rate paid on debt securities w/o an adjustment for any loss in purchasing power

When​ Starbuck's decided to acquire​ Seattle's Best Coffee​ Company, it presumably concluded that the

the rate of return they would earn on​ Seattle's Best would be equal to or higher than the rate of return they could earn on other investments of equal risk.

profitability index (PI)

the ratio of present value of cash inflows to present value of outflows (cost of project) PV future cash flows/Initial Outlay (CFo) acceptance criteria: accept if PI>1 reject if PI<1

All of the following affect the value of a bond EXCEPT

the recorded value of the firm's assets

The Security Market Line intercepts the vertical axis at

the risk-free rate

present value of an annuity

the value in today's dollars of the annuity

how can risk be eliminated

thru diversification

debt ratio

total liabilities / total assets

Secondary market

trading of securities between individuals -the corporation does not receive any money

A correlation coefficient of​ +1 indicates that returns on one asset can be exactly predicted from the returns on another asset.

true

As market interest rates​ increase, bond prices decrease.

true

As the maturity date of a bond​ approaches, the​ bond's market value approaches its par value.

true

As the time to maturity​ increases, the maturity premium increases.

true

A​ bond's value equals the present value of interest and principal the owner will receive.

true

Capital structure represents the mix of equity and interest−bearing debt used by a firm.

true

Convertible bonds can be exchanged for the issuing​ firm's common stock at a price specified at the time of issue.

true

Even though an investor expects a positive rate of​ return, it is possible that the actual return will be negative.

true

Historically, in the United States stocks have had higher returns and greater volatility than have government bonds.

true

If markets are​ efficient, stock prices go up when there is positive information about a​ company, and go down when there is negative information about the company.

true

If the issuing company becomes​ insolvent, the claims of the bondholders are honored before those of preferred stockholders.

true

In a perfectly efficient​ market, all assets would plot on the Security Market Line.

true

In an efficient market there is no reward for accepting risk that can be eliminated through diversification.

true

Long−term government bonds are not without maturity risk.

true

Most financial assets have correlation coefficients between 0 and 1.

true

Mutual Funds and ETFs provide the investor a chance to diversify without having to buy shares in numerous corporations.

true

Mutually exclusive projects may be ranked differently when higher or lower discount rates are used.

true

One characteristic of an annuity is that an equal sum of money is deposited or withdrawn each period.

true

One type of real option is to delay the beginning of a project until conditions are more favorable.

true

Options contracts all expire on the last trading day of the month.

true

Over the long​ term, mutual fund fee and expenses can have a significant impact on returns.

true

Projects may appear to have less risk when real options are considered.

true

Risky investments have the potential for higher​ returns, but also larger losses.

true

The cost of common equity is already on an after−tax basis since dividends paid to common stockholders are not tax−deductible.

true

The difference between mutual funds and ETFs is that ETFs are traded on exchanges and mutual funds are not.

true

The expected rate of return is the weighted average of the possible returns for an investment.

true

The financial crisis of 2008 and was caused in part by declining real estate values and defaults on mortgage payments.

true

The option to abandon a project before the end of its forecasted life may increase its NPV.

true

The risk−return tradeoff tells us that expected returns should be higher on investments that have higher risk.

true

The​ S&P 500 Index is commonly used to estimate the market rate of return.

true

Venture capital funds play an important role in the initial financing of new businesses.

true

When assets are positively​ correlated, they tend to rise or fall together.

true

When evaluating projects with real​ options, businesses must consider the probability that the option will be exercised.

true

When investors increase their required rate of​ return, the cost of capital increases simultaneously.

true

When replacing an existing​ asset, the cash inflow associated with the sale of the old asset and any related tax effects must be considered and accounted for in the analysis.

true

When several sign reversals in the cash flow stream​ occur, the IRR equation can have more than one positive IRR.

true

the purpose of financial markets is to bring borrowers and savers together

true

debentures

unsecured bonds

return in a portfolio

weighted average expected return on the individual securities in the portfolio

premium

what you pay for the option

An optimal capital structure is achieved

when a​ firm's weighted average cost of capital is minimized.

Primary market

when securities are sold by the corporation or gov't to the public -IPO and SEO are sales in the primary market

If the market price of a bond​ increases, then

yield to maturity decreases

The Fisher effect can be expressed mathematically as

​(1+ the nominal​ rate)= (1+the real rate of​ interest) (1​ + the inflation​ rate).

Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital budgeting methods in which​ order?

​IRR, NPV,​ Payback, Discounted​ Payback, Profitability Index

Accounting break−even analysis uses

​sales, variable costs and fixed costs for a single period.

The appropriate measure for risk according to the capital asset pricing model is

beta

speculator

betting on the future movement of the asset's price

The limitation on taking a tax deduction for interest expense makes...

borrowing money more expensive

Buy (long position)

buy low, sell high (if you expect stocks to go up in value)