Fundamentals of Finance
Which of the following is one of the weighted terms in the weighted average cost of capital (WACC) formula?
(% of debt) x (after-tax cost of debt)
What is the equation in words for the weighted average cost of capital (WACC)?
(% of debt)(after-tax cost of debt) + (% of preferred stock)(cost of preferred stock) + (% of common stock)(cost of common stock)
What is the present value of a perpetuity with a payment of $35 per year, forever, if the current interest rate is 3%?
1,166.66 (35/0.03)
A project costs $63,000 and earns $18,000 every year. What is the payback period for this investment?
3.5 years
Vineeta currently has $300,000 and would like to double her money through investing by her planned retirement in 20 years. At what interest rate must she invest to achieve this goal?
3.53% (300000 x (1+r) ^ 20)
What is the internal rate of return (IRR) of a project that costs $90,000 and will earn $50,000 the first year, $30,000 the second year, and $20,000 the third year?
6.47
What are the expected returns for stock XYZ if its beta is .9, the risk-free rate is 5%, and the expected market returns are 7%?
6.8
Daily purchases: $3,000
7 days
Daily purchases: $9,000
8.5
Which rating would cause a bond to be considered "medium grade" by S&P and Fitch?
A+
What needs to be calculated before calculating the weighted average cost of capital (WACC)?
All of the above
In which kind of financial instrument does an issuer promise to pay a portion of its profits to an owner?
An equity instrument
What is the convention for quoting bond prices?
As a percentage of par value
How are bond prices and yields related?
As yields rise, bond prices fall
Which option is a common pitfall in using weighted average cost of capital (WACC)?
Assuming that the marginal rate is the same as the historical rate
What creates financial leverage?
Borrowing money
How do regulators ensure the soundness of the financial system?
By acting as a lender of last resort
Which statement about finance and business is correct?
Finance is essential for business because it helps maximize the value of the company's stock.
How does finance differ from economics?
Financiers focus on risk vs. return whereas economists focus on supply vs. demand.
What characterizes a moderate, maturity-matching policy?
Fixed assets are financed with long-term debt and current assets are financed with short-term debt.
What is the term for all costs incurred by the issuing and selling of a security?
Flotation costs
What limits the usefulness of the dividend discount model (DDM)?
Future dividend payments are uncertain
Based upon the learning activities in Topic 2, calculate the Internal Rate of Return (IRR), Net Present Value (NPV) and Profitability Index (PI) of earning an MBA at a university assuming the initial cost of one-year MBA program is $20,000 (upfront) that earns you a promotion that increases your annual salary (take-home pay) by $10,000 annually for 5 years. Your cost of capital is 15%.
IRR = 41.041 NPV = 13521.55 PI = 1.6761
Which statement is true of internal rate of return (IRR)?
IRR is reliable as a decision criterion only when cash flows are ordinary, with outflows being followed by inflows
Which statement about risk aversion and finance is true?
In financial arrangements, the more risk averse party usually rewards the bearer of more risk
How does operating leverage increase risk?
Increased fixed costs of operations may not lead to increased profits
How can companies use dividends as a signaling tool?
Increasing dividend payments indicate that the company is investing in high-growth endeavors.
Operationally unrelated projects are considered what type of projects?
Independent projects
What type of projects have cash flows that are independent of the other projects selected?
Independent projects
Which type of projects are operationally unrelated to each other, so a company can choose to do none of them, all of them, or some of them?
Independent projects
Which statement is true of the capital asset pricing model (CAPM)?
It can be used to directly compare two or more stocks.
How can a company send a signal of confidence in its stock?
It can repurchase its own stock
Which statement describes a shortfall of profitability index (PI)?
It doesn't work well if an initial investment is spread out over time.
What does the dividend discount model (DDM) assume about the value of a share of stock?
It equals the present value of all future dividends
Why is diversification a good strategy?
It helps lower risk
Why does society need a financial system?
It links borrowers with lenders
If a debt will never be collected, what should happen to it eventually?
It must be written off as an expense
What measure is used to estimate the future beta for a company?
Its historical data
Which type of finance involves making decisions for the purpose of operating a business?
Managerial finance
Which type of risk is due to factors that affect the entire market?
Market risk
When does compounding typically occur?
More than once a year
What is the reason why businesses need a financial system?
Most businesses need to efficiently borrow money from lenders.
When only one project can be selected from a set of projects, what are the projects called?
Mutually exclusive
Which capital budgeting method involves discounting all of the cash flows for an investment to the present, adding inflows and subtracting outflows?
Net present value (NPV)
Which store is LEAST likely to have seasonal funding requirements?
One that sells shoes
Which loan offer has the highest effective interest rate?
One with a 18.1% APR compounded daily
What kind of financing involves a specific asset being offered as collateral?
Secured financing
Which regulator oversees OTC markets?
Securities and Exchange Commission (SEC)
Which type of interest is determined each period from principal only?
Simple interest
For which type of project is the payback period analysis most appropriate?
Smaller projects that involve very little risk
Considering the good of society as well as the maximization of shareholder wealth is the cornerstone of which idea?
Social responsibility
Which type of business has a single owner?
Sole proprietorship
How can $100 today be directly compared to $150 six months from today?
The amounts cannot be directly compared
What is the coupon rate of a bond?
The annual total of the coupon payment expressed as a percentage of the par value
What is finance?
The application of economic principles
Which model for calculating the cost of equity looks at the relationship between the return for a given stock and the nondiversifiable risk for that stock using beta (β)?
The capital asset pricing model
Based upon the Learning Activities in Topic 2, the optimal capital structure is governed by a variety of factors, including taxes and the costs of financial distress. Compare and contrast the capital structure of JP Morgan Chase with one other non-banking member of the Dow Jones Industrial Average using at least five different factors described in Topic 2.
The capital structure of DIJA-listed companies Apple Inc. and JP Morgan Chase to better understand the many aspects that affect the ideal capital structure. While JP Morgan's capital structure is mostly debt-financed, Apple Inc's is primarily equity-financed. Legislation is crucial to capital structure because it mandates that banks follow stringent capital structure requirements. Due to Apple Inc's larger capitalization of debt and JP Morgan's higher net income, the latter company pays higher taxes.
What do steady dividend payments indicate?
The company has a stable cash inflow
Which financial manager concentrates on a firm's reporting activities, tax management, and accounting?
The controller
Which of the following is NOT calculated before calculating the weighted average cost of capital (WACC)?
The cost of equity
What is marginal debt cost?
The cost of new issuance of debt
Which of the following statements is true about the cost of preferred stock relative to debt?
The cost of preferred stock is usually higher than the after-tax cost of debt.
Which statement about the cost of preferred stock is true?
The cost of preferred stock is usually higher than the after-tax cost of debt.
Which method for calculating the cost of equity makes an estimation based on historic data about cost of debt?
The debt plus risk premium model
Which model for calculating the cost of equity uses the following formula?
The dividend discount model
What does interest represent at a fundamental level?
The opportunity cost of an investment AND the risk of an investment
What is the principal on a loan?
The original borrowed amount
What is the principal of a bond called?
The par value
The value of a stock with a constant dividend stream is best estimated using which formula?
The perpetuity formula
Which form of the efficient market hypothesis (EMH) argues that all public information has been accounted for by the market?
The semi-strong form
Which of the following statements is an assumption about the value of a stock share in the dividend discount model (DDM)?
The share equals the present value of all future dividends.
What does it mean if a stock has a beta of 1.0?
The stock will move in proportion with the market
What is the cash conversion cycle?
The time it takes for a company to convert cash invested in operations into cash received
The idea that a dollar received today has a greater value than a dollar to be received in the future is the basis for which principle?
The time value of money principle
Which of the following is used for expected rate of return?
The weighted mean of the possible investment outcomes
What events or apparent changes in market conditions triggered such a change in the spread between the yields on corporate bonds and treasury securities?
There have been several events and changes in market conditions that have contributed to the narrowing of the spread between corporate and Treasury yields over the past year. These include the improving economic outlook and expectations for increased corporate earnings, which have boosted demand for corporate debt. Additionally, the Federal Reserve's commitment to keeping interest rates low and providing ongoing support to the bond market has increased investor confidence and reduced perceived risk, leading to lower yields on corporate debt. Finally, the passage of the American Rescue Plan Act in March 2021, which provided significant fiscal stimulus to the economy also likely contribute to the narrowing of the spread by boosting investor confidence in the economic recovery.
Why are aggressive strategies riskier?
There is less cash on hand to cover unexpected expenses
What is the tax adjustment for preferred stock dividends?
There is no tax adjustment
What is the advantage of short-term investments such as CDs and commercial paper?
They can help generate interest on idle cash while still keeping it readily available.
What is a risk averse person like?
They prefer less risk to more risk
What does it mean for shareholders to have a residual claim on a firm's assets?
They receive dividends after all the firm's other claims have been paid
Why is it important to calculate effective interest rates?
To directly compare two or more loan offers
Why do companies use sensitivity analyses and scenario analyses?
To examine risk
What is one of the major purposes of a financial system?
To facilitate all types of trade
Why do some companies prefer to refuse the trade discount and pay bills on the last day they are due?
To keep as much money as possible on hand for as long as they can
What is the goal of managerial finance?
To maximize shareholder wealth
What is the goal of capital rationing?
To select value-maximizing projects that the firm can afford
What is the main objective of capital rationing?
To select value-maximizing projects that the firm can afford
What does it mean to factor accounts receivable?
To sell them
For what purpose are accounts receivable factored?
To sell them outright
The cash conversion cycle is the time it takes for a company to perform which activity?
Turn cash invested in operations into cash received
Which statement about cash conversion cycles is true?
Typically, the shorter the cash conversion cycle, the better.
Which type of costs include payments to investment bankers for selling securities?
Underwriting costs
Which of the following is a shortfall of using net present value (NPV) to select projects?
Using NPV requires a discount rate
When does it become difficult to calculate a net present value (NPV)?
When an accurate gauge of the cost of capital is unavailable
Which statement about projects is true?
When considering independent projects, firms should undertake each project that adds value to the company
In what situation are two projects considered mutually exclusive?
When only one project can be pursued
When is an annuity called an annuity due?
When payment in each period occurs at the beginning instead of the end
When does equity raise cash for a company?
When the shares are originally issued to investors
When is a bond trading at a discount?
When trading below its par value
Which statement about perpetuities is true?
Withdrawing less than the interest earned each period will cause the principal balance to grow.
The day-to-day management of cash, inventories, receivables, accruals and payables is the focus of which job?
Working capital management
The day-to-day supervision of cash, inventories, receivables, accruals and payables is the focus of which activity?
Working capital management
Which of the following is NOT a period where the broad market index returns are used to calculate beta?
Yearly
A project's net present value (NPV) is negative. Is this a realistic occurrence?
Yes. Because a project's NPV may sometimes be negative.
What is involved in a stock repurchase?
a company buying its own stock
Which company has the capacity for the most debt?
a company that has large amounts of fixed capital
What is a hybrid instrument?
a financial instrument that has some characteristics of debt instruments and some characteristics of equity instruments
What is a stock split?
a financial transaction that decreases the stock price
What is a dividend?
a portion of a company's profits paid back to investors in the form of a cash payment
Which project should NOT be accepted based on its net present value (NPV)?
a project that costs $50,000 and will earn $20,000 each year for three years (discount rate = 10%) (A project that costs $50,000 and will earn $20,000 a year for three years has a negative NPV if the discount rate is 10% (NPV = -$262.95), so it should not be accepted. The other projects have positive NPVs, so they should be pursued.)
Which project would be the most attractive to a company based on its profitability index (PI), assuming a discount rate of 10%?
a project that costs $55,000 and will earn $24,000 each year for three years (highest PI is most attractive)
Which project should NOT be accepted based on its net present value (NPV)?
a project that costs $80,000 and will earn $30,000 each year for three years (discount rate = 6.5%)
What is an example of an externality?
a river that is polluted as a result of a manufacturing process
What is the preferred habitat theory?
a theory used to explain the yield curve by economists
What investment should investors expect the highest return?
airline stock
Why do owners of corporations have limited liability protection?
because corporations are legal entities distinct from their owners
How should investors compensate for market risk?
by demanding higher returns for those securities which have a larger sensitivity to broad market events
How do regulators promote competition and efficiency in the financial system?
by making the entry and exit of firms as cheap and easy as possible
How should the standard deviation of a portfolio be calculated?
by solving for the portfolio returns and then using them to find the standard deviation
How is the weighted average cost of capital (WACC) computed?
by taking the return from each component and weighting it based upon the percentage used for financing
How can a person quantify the risk of an asset?
calculate the standard deviation of the outcome returns
Which option presented here is a terrible investment?
cash
Which credit category (5 C's) consists of the borrower's property or assets which secure or back a loan?
collateral
Net working capital is the difference between which two things?
current assets and current liabilities
How are stock exchanges different from over-the-counter (OTC) markets?
exchanges have centralized locations while OTC markets are dealers connected with telecommunication devices
What does the capital asset pricing model (CAPM) calculate?
expected return
What is the proper comparison between a present value and a future value?
find the present value of each cash flow
What is diversification?
having a variety of different assets in a portfolio
What is used to evaluate what a company's future beta will be?
its historical beta
What is the annual rate of return on a bond, assuming the bond is held to maturity?
its yield to maturity (YTM)
Which type of projects are good candidates for calculating the equivalent annual annuity?
mutually exclusive, repeatable projects with differing time lengths
What is amortization?
spreading out the principal payments of a loan over time
How would you define prime rate?
the rate a bank gives its best customers
What is the prime rate?
the rate a bank gives its best customers
What is the net present value (NPV)?
when all the cash flows for an investment are discounted to the present, subtracting outflows and adding inflows
When should beta be estimated in the capital asset pricing model (CAPM)?
when stock has yet to be issued
When does the APR equal the effective interest rate?
when the compounding period is annual
What may be predicted from the following yield curve? Maturity Yield (%) 1 month 1.90 3 months 1.90 6 months 2.00 1 year 2.00 2 years 2.01 3 years 2.01 5 years 2.01 7 years 2.01 10 years 2.02 20 years 2.04
Future short-term interest rates and long-term interest rates will be near identical.
Which type of bond is considered the LEAST risky?
Government bonds
Which of the following is NOT a source where companies can obtain external funding?
Government subsidies
Which option below is NOT a primary source of external funding for many companies?
Government subsidies
III. It is usually best to have a high level of net working capital--the more, the better.
I and II
III. U.S. Treasury Bills have historically generated a higher total return than long-term corporate bonds because U.S. Treasury Bills have historically had a lower standard deviation than long-term corporate bonds.
I and II are true
IV. Increase the payables deferral period.
I, II, and IV
Which of these statements regarding the cost of capital is correct?
If a corporation fails to generate a return greater than its cost of capital, the value of its stock will decrease.
When should a project be taken on?
If it meets the minimum capital budgeting requirements
What does it mean for a credit term to be 3/7 net 30?
If the balance is paid within 7 days, a 3% discount is offered; if it is not paid within 7 days, then the balance is due by the 30th day after the purchase.
Based on this information, what action should the company take?
If they can do only one project, they should do project B (lower payback period, higher NPV, higher IRR, higher PI, higher MIRR)
Which type of intermediary issues policies that mature if some contingency occurs?
Insurance companies
Which aspect of investing represents the risk and the opportunity costs of an investment?
Interest
Why is it important to take taxes into account when evaluating debt cost?
Interest payments made on debt are tax deductible.
What does r represent in the formula used to calculate payment of a perpetuity?
Interest rate
To evaluate a potential project, an investor has set the net present value (NPV) of the project at zero and solved for r. Now he is comparing the results to the cost of capital to determine whether or not to pursue the project. Which capital budgeting strategy is this investor using?
Internal rate of return
Which capital budgeting strategy calculates the return we will receive over the life of an investment?
Internal rate of return
Which of the following is true if semi-strong form of the efficient market hypothesis (EMH) is true?
Investments based upon the fundamentals of a company shouldn't be able to earn excess profits.
Which statement about risk and return is true?
Investors should demand higher returns for investments that have higher market risks.
What is the benefit of a stock buyback?
It allows a company to distribute earnings differently from a dividend
Which statement about net present value (NPV) is true?
It can be difficult to calculate an NPV if the cost of capital is unknown.
What does it mean if a company has a conservative (or relaxed) policy regarding the amount of cash it has on hand?
It holds more current assets at any given time.
What is one major critique of the capital asset pricing model (CAPM)?
It ignores systematic risk factors outside of market risk.
What is the major weakness of the price to earnings (P/E) ratio?
It is too simple to capture everything about a company
What happens to bad debt eventually?
It must be written off as an expense
What does "going public" mean for a company?
It offers shares for public sale.
What is one of the criticisms of the capital asset pricing model (CAPM)?
It only accounts for market risk
What does it mean for a firm to "go public"?
It registers its shares with the SEC and offers them for sale.
Which statement about secured financing is true?
It usually comes with higher interest rates due to higher administrative costs
What does the yield curve typically look like?
It usually slopes upward
How can companies use dividends as a signaling tool?
Keeping dividend payments steady indicates a stable cash inflow
What is the effect of withdrawing less than the interest earned in a perpetuity?
Less money is received this year but the principal balance will grow
What is the difference between short-term debt and long-term debt?
Long-term debt takes longer to obtain than short-term debt
What does the following yield curve predict? Maturity Yield (%) 1 month 3.54 3 months 3.43 6 months 3.02 1 year 2.75 2 years 2.60 3 years 2.41 5 years 1.97 7 years 1.43 10 years 1.14 20 years 1.03
Lower short term interest rates
What does the following yield curve predict? Maturity Yield (%) 1 month 3.45 3 months 3.47 6 months 3.48 1 year 3.49 2 years 3.50 3 years 3.53 5 years 3.55 7 years 3.56 10 years 3.59 20 years 3.62
Lower short-term interest rates
What is the grade rating for an A+ bond?
Medium
An investor would like to determine which project to pursue, and she wants to account for the fact that all cash inflows will need to be reinvested at the weighted average cost of capital, not the rate of return on her investment. Which capital budgeting strategy should this investor use?
Modified internal rate of return
What is the capital budgeting strategy that assumes that cash inflows will be reinvested at the weighted average cost of capital?
Modified internal rate of return
Based upon the content in Topic 2, why is the Capital Asset Pricing Model (CAPM) possibly less useful for smaller companies (size effect) in light of the Efficient Market Hypothesis?
The Capital Asset Pricing Model is possibly less useful for smaller companies in light of the Efficient Market Hypotheses because the model does not take into account the size of the company and this can have a significant impact on the risk and return of an investment. The model may not be accurate for smaller companies, which can lead to an underestimation of the risk and return of an investment.
During the past week, why did the Dow (DJIA) rise or fall in terms of market specific risk?
The Dow rose during the past week due to a decrease in market specific risk which is the risk that is specific to a particular market, not the investment itself. This can be caused by political instability, natural disasters, or changes in the economy. A decrease in market specific risk means the market is becoming more stable and predictable, and investors are more confident in the future of the market.
Which statement about present value (PV) and future value (FV) is true?
The PV and FV of an investment cannot be directly compared
Which statement about present value (PV) and future value (FV) is true?
The PV and FV of an investment cannot be directly compared.
Based upon the content in Topic 3, what is the current shape of the yield curve for Treasury securities and what does it tell you about the current view of economic growth and inflation in the U.S.?
The current shape of the yield curve for Treasury securities is generally upward-sloping, with higher yields on longer-term bonds compared to shorter-term bonds. This suggests that the market expects interest rates to rise in the future and that inflation may also increase over time. A steepening yield curve can also indicate that investors are more optimistic about future economic growth, which could lead to higher demand for credit and an increase in borrowing costs.
What is a stock's risk premium?
The expected return in excess of the risk free rate
Which of the following statements is true regarding an amortized loan when the principal decreases?
The interest due also decreases
What is the difference between the interest rate and the coupon rate?
The interest rate can change over time while the coupon rate is typically constant.
Which statement accurately describes how the coupon rate differs from the interest rate?
The interest rate may fluctuate over time but the coupon rate typically remains the same.
Which of the following factors results in a higher valuation for an investment?
The investment produces cashflow quickly for the investor
Which of the following statements provides the best advice regarding ratings of creditworthiness?
Ratings should be taken into account, but not considered as the absolute truth.
In which approach to dividends is the dividend a leftover amount paid after all suitable investment opportunities have commenced?
Residual theory of dividends
Which of the following is NOT one of the four factors of value?
Returns on previous investments
Which statement about weighted average cost of capital (WACC) and risk is true?
Risk can be incorporated into WACC calculations at the level of division or project.
Describe capital budgeting risk and two of the methods used in capital budgeting to identify the uncertainties associated with any given capital project.
Risk linked with planning investments in fixed assets like buildings and machinery is known as capital budgeting risk. The three most common used capital budgeting methods are internal rate of return analysis, payback period, and net present value. The popularity of the payback period technique can be attributed to its simplicity. The payback period is a computation of the amount of time it will take to recover the initial investment. The internal rate of return is a less complex alternative to the net present value method. The internal rate of return strategy is used by employing a discount rate that makes the present value of future cash flows equal to zero. The present value of anticipated future cash flows is calculated using the net present value approach using the investor's needed rate of return.
What is the term for a person who prefers a more risky investment to a less risky one?
Risk seeking
What type of analysis measures how much a project changes when one variable changes?
Sensitivity analysis
How does short-term debt differ from long-term debt?
Short-term debt can usually be obtained more quickly than long-term debt
Based upon the content in financial systems and goals of a firm, why do some experts consider maximizing shareholder value or wealth a dumb idea?
Some experts are considering maximizing shareholder value a dumb idea because they believe that a company will have a large number of stakeholders and that companies should be trying to act in the best interests of all stakeholders such as society, employees, and government rather than only shareholders. It will help the company to enhance its reputation over the long run and create value for its stakeholders. Focusing on just the maximization of shareholders' value will result in a lot of distrust among other stakeholders and lower the performance of the company.
How are dividend levels used as a signaling tool for companies?
Steady dividend payments indicate a stable cash inflow
What is the effective interest rate of a loan with a 17% APR compounded daily?
18.53%
A firm believes that if its earnings before interest and taxes (EBIT) changes by 5%, its net income will increase by 10%. What is its degree of financial leverage?
2
If the nominal interest rate is approximately 10% and the real interest rate is 8%, what is the expected inflation rate?
2%
Jonathan's $4,540 balance in his bank account will earn 3% each year forever. If he withdraws only $45.40 a year from the annual payment, what is the growth rate of this perpetuity?
2% (he is withdrawing 1% of the available 3% so the growth rate is 2%)
What is the FV of $2,000 that is invested for three years at a 4% interest rate compounded annually?
2,249.73 (2000 x (1 + 0.04)^3
We have invested 25% of our portfolio in ABC stock, 25% in EFG stock, and 50% in XYZ stock. The return on ABC was 5%, the return on EFG was 10%, and the return on XYZ was -3%. What was our portfolio's return?
2.25
Lucas currently has $50,000 and would like to double his money through investing by his planned retirement in 27 years. At what interest rate must he invest to achieve this goal?
2.6%
Stock DEF has a beta of .4, the risk-free rate is 2.4%, and the expected market returns are 3.4%. What are the expected returns for stock DEF?
2.8
Margo's Taffy has $30,000 in inventory, sells $2,400 worth of goods each day, has $30,000 in receivables, and has an average daily revenue of $4,000. What is its operating cycle?
20 days
What is the FV of $100 that is invested for 12 years at a 6% interest rate compounded annually?
201.22
What is the operating cycle of a company that has $50,000 in inventory, sells $4,000 worth of goods each day, has $60,000 in receivables, and has an average daily revenue of $6,000?
22.5
A company has $50,000 in cash, $180,000 in inventory, and $30,000 in A/R. Their A/P is stable at $40,000. What is this company's permanent funding need?
220000 (50000+180000+30000-40000)
A firm believes that if their earnings before interest and taxes (EBIT) changes by 2%, their net income will increase by 6%. What is their degree of financial leverage?
3 (6/3)
What is the dividend yield for stock that is selling at $80/share with an expected dividend of $3?
3.75 (3/80)
Stock XYZ has a beta of .5, the risk-free rate is 3.7%, and the expected market returns are 4.1%. What are the expected returns for stock XYZ?
3.90 (Using the capital asset pricing model (CAPM), the expected return for this stock can be calculated as follows: .037 + .5(.041 - .037) = .039 or 3.9%)
wps = 30%
3.93
Takako purchased 100 shares of stock at $10 a share. She received five payments of $100 and then sold her shares for $8 a share. What was Takako's rate of return?
30%
Takako purchased 100 shares of stock at $10 a share. She received five payments of $100 and then sold her shares for $8 a share. What was Takako's rate of return?
30% (1300 cash inflow, 1000 cash outflow, return of 300, divided by initial investment of 100)
Ksenia has $1,000 in her bank account which will earn 5% each year forever. If she withdraws only $10 a year from the annual payment, what is the growth rate of this perpetuity?
4%
Nicole has $9,700 in her bank account which will earn 6% each year forever. If she withdraws only $194 a year from the annual payment, what is the growth rate of this perpetuity?
4%
Carlos wants to have $5,000 in his savings account in five years. If the interest rate is 4% compounded annually, how much must he deposit now?
4,109.64
We have invested $15 thousand in KLM stock, $25 thousand in OPQ stock, and $10 thousand in RST stock. KLM returned 3%, OPQ returned 4%, and RST returned 7%. What was our portfolio's return?
4.3%
wps = 35% (weight of preferred stock used by company)
4.39 (The formula to calculate WACC is:
Stock ABC has a beta of .6, the risk-free rate is 4%, and the expected market returns are 5%. What are the expected returns for stock ABC?
4.6 (Using the capital asset pricing model (CAPM), the expected return for this stock can be calculated as follows: .04 + .6(.05 - .04) = .046 or 4.6%)
What is the present value (PV) of an annuity due with a payment of $700 per year at an interest rate of 8% for 10 years?
5,072.82
What is the present value (PV) of an annuity with a payment of $1,000 per year at an interest rate of 12% for 10 years?
5,650
We have invested $30 thousand in JKL stock, $20 thousand in MNO stock, and $10 thousand in PQR stock. JKL returned 8%, MNO returned 2%, and PQR returned 5%. What was our portfolio's return?
5.5 (.5*.08 + .33*.02 + .17*.05)
Mei-yu owns a six-year annuity due. The payment is $100 per year at an interest rate of 4%. What is the present value (PV) of this annuity due?
545.18 (Pvdue-Pvordinary+(PMT-PMT/(1+r)n)
Valencia invests $500 for five years at a 2% interest rate compounded annually. What is the FV of her investment?
550
Steven purchased 100 shares of stock at $12 a share. He received six payments of $150 and then sold his shares for $10 a share. What was Steven's rate of return?
58% (received 1900 in cash inflow, minus 1200 in cash outflow, return is 700 divided by 1200)
If the real interest rate is 3% and the expected inflation is 3%, what is the approximate nominal interest rate?
6%
What is the cost of debt if a company has $100,000 of debt with an annual interest rate of 8% and an income tax rate of 25%?
6% (In this scenario, the company will be paying $8,000 in interest each year, but $2,000 will be saved in taxes ($8,000 x .25), so a total of $6,000 will be spent on interest each year, meaning that the cost of debt is 6% ($6,000 ÷ $100,000)
The present value of a perpetuity is $2,000 and the current interest rate is 3%. What is the payment per year forever?
60
What is the present value (PV) of an annuity due with a payment of $7,300 per year at an interest rate of 6.5% for 12 years?
63,430.01
Company A's most recent dividend was $2.60, dividend growth is expected to be 4% per year, and investors require 8%. What should the stock's price be?
67.60 (2.6 * (1+0.04) / (.08-.04)
What are the expected returns for stock EFG if its beta is 1.5, the risk-free rate is 1%, and the expected market returns are 5%?
7 (Using the capital asset pricing model (CAPM), the expected return for this stock can be calculated as follows: .01 + 1.5(.05 - .01) = .07 or 7%)
What is the payables conversion period for a company that has $90,000 in payables and purchases $12,000 in raw materials per day?
7.5 days (90000/12000)
What is the yield to maturity (YTM) on a bond that was purchased for $965.52, has an annual rate of 7%, makes one payment annually, will mature in 10 years, and has a $1,000 par value?
7.5%
What is the cost of debt if a company has $1,000,000 of debt with an annual interest rate of 9% and an income tax rate of 15%?
7.65
What is the cost of taking the trade discount for the terms of 3/15 net 30?
75.25 (3/(100-3)(365/15)
What is the cost of taking the trade discount for the terms of 4/10 net 30?
76.10 (4/(100-4)(365/20)
What is the inventory conversion period for a company that has $160,000 in inventory and sells $20,000 worth of goods each day?
8 days (160000/20000)
Which statement is true of stocks with a beta of 1.0?
They will move in the same proportion as the market.
A project costs $200,000 and will earn $60,000 the first year and $20,000 every year thereafter. What is the payback period for this investment?
8 years
What are the expected returns for stock ABC if its beta is 1.6, the risk-free rate is 2%, and the expected market returns are 6%?
8.4 (Using the capital asset pricing model (CAPM), the expected return for this stock can be calculated as follows: .02 + 1.6(.06 - .02) = .084 or 8.4%)
Using the capital asset pricing model (CAPM), what is rs if the risk-free rate is 5%, the market return is 7% and beta is 1.9?
8.8
If Adriana deposits $8,000 into a savings account with a 2% interest rate compounded annually, what will her balance be in ten years?
9,751.96
Most of the year, a company has $15,000 in cash, $75,000 in inventory, and $30,000 in A/R. Their A/P is stable at $23,000. However, during the summer season, their inventory peaks at $150,000 and their A/R peaks at $50,000. How much extra funding does this company need during the summer season?
95000
Which quoted price below indicates that the bond is trading at a discount?
99.35
From the following options, net present value (NPV) is calculated using what spreadsheet function?
=NPV(periodic rate, cash flows from period 1 to n) + net of initial cash flows
What function within the spreadsheet is used to calculate net present value (NPV)?
=NPV(periodic rate, cash flows from period 1 to n) + net of initial cash flows
What is the spreadsheet function to calculate net present value (NPV)?
=NPV(periodic rate, cash flows from period 1 to n) + net of initial cash flows
What is a loan packaged as a tradable security?
A bond
Which investor has the strongest claim to a firm's assets?
A bondholder
Which statement about dividends is true?
A company that can pay higher dividends should demand a higher stock valuation
In which kind of financial instrument does a borrower promise to pay a fixed sum on a fixed date to a lender?
A debt instrument
Which type of risk addresses the possibility that a scheduled payment will not be paid?
A default risk
Which of the following is NOT a result of a stock split?
A dividend is issued
What is an interconnected network of intermediaries, facilitators, and markets called?
A financial system
What may be predicted from the following yield curve? Maturity Yield (%) 1 month 5.00 3 months 4.90 6 months 4.70 1 year 4.50 2 years 4.30 3 years 4.00 5 years 3.70 7 years 3.20 10 years 2.90 20 years 2.60
A future recession
Based upon the last video in Topic 3, how will the market generally interpret a dividend cut combined with a stock repurchase?
A good combination of dividend payments and share buybacks may greatly boost shareholder returns. A reduced dividend payout would translate to reduced revenue received. Stock repurchase means that the company is focused on the future returns of its shareholders. With the idea of double taxation on dividends, the market would translate the move as consideration for its shareholders. When the two are combined, the market can translate it as goodwill from the company and the company will attract more interested shareholders and the value of its shares will go up in the stock market.
What is the chief difference between a line of credit and a loan?
A line of credit is flexible, making money available to customers as needed, whereas a loan provides a lump sum.
How do a loan and a line of credit differ?
A line of credit makes money available to customers as needed, whereas a loan provides a lump sum.
What is the difference between a line of credit and a loan?
A loan must be paid back in multiple payments, whereas a line of credit must be paid off in one lump sum
During the past week, why did a particular component (company) of the Dow (DJIA) rise or fall due to a change in a company-specific risk?
A particular component of the Dow rose due to a decrease in the company specific risk. This can be caused by factors such as financial mismanagement, legal problems, or changes in the company's products or services. Again, a decrease in company specific risk means that the market is becoming more stable and predictable and investors are more confident in the future of the market.
What is the name of an arrangement in which constant periodic payments are received forever?
A perpetuity
Which project would be the most attractive to a company based on its profitability index (PI), assuming a discount rate of 8%?
A project that costs $12,000 and will earn $7,000 each year for three years
Which statement about net present value (NPV) is true?
A project's NPV may sometimes be negative.
Based upon the content in financial systems and goals of a firm, why do businesses focus their attention on maximizing shareholder value rather than just maximizing profits?
Businesses are focusing on the maximization of shareholder value rather than the maximization of profits because the managers are the agents for shareholders of the company and managers need to act in the best interests of shareholders because of the separation of ownership and management. They need to maximize the value of shareholders as shareholders are owners of the company and their interest should be taken care of by their agents. Maximization of profits will not directly result in an increase in the value of shareholders because maximization of profits can be done by taking additional financial leverage which will increase the interest tax advantage but it will expose the shareholders to higher risk.
How do regulators promote competition and efficiency while maintaining transparency?
By making it cheap and easy for firms to enter and exit the market
Which activity involves using a series of analyses to help decide which project is best to pursue?
Capital budgeting
In which market are securities with a year or more to maturity traded?
Capital market
Which strategy involves firms having a determined amount of funds available to allocate to capital projects?
Capital rationing
Which option is a factor that companies can control?
Capital structure
We have $50,000 invested in DEF stock, $30,000 invested in HIJ stock, and $20,000 invested in LMN stock. DEF has a beta of 1.2, HIJ has a beta of .9, and LMN has a beta of .5. What is our portfolio's beta?
0.97
What is the present value of a perpetuity with a payment of $70 per year forever if the current interest rate is 5%?
1,400
An investment costs $5,000 and will produce a cash flow of $2,000 a year for four years. What is the net present value (NPV) of this investment assuming an interest rate of 8%?
1,624.25
A firm's payables conversion period is the average amount of time between which two activities?
acquiring raw materials and paying the supplier for them
What is one of the four major functions of regulators in the financial system?
acting as a lender when necessary
Which of the following is a period where the broad market index returns are used to calculate beta?
all the periods described
What are the main reasons of a financial system?
allocating capital, sharing risks, and facilitating trade
What is involved in finding the net present value of an investment?
discounting all of the cash flows for an investment to the present, adding inflows and subtracting outflows
What quantity is computed for the expected rate of return?
each possible outcome weighted by the probability of that outcome
When considering a project from the net present value (NPV) perspective, what makes a project most attractive?
having the highest NPV
What does the debt plus risk premium model use to make an estimation?
historic data about the cost of debt
What does a sensitivity analysis measure?
how a change in one variable might affect a project
What is a compounding period?
how frequently interest on interest is determined
Why shouldn't the standard deviation of a portfolio be taken by the weighted average of the standard deviations of the individual assets?
if the assets don't move in perfect tandem, then the diversification will cause the returns of the portfolio to be less volatile
What is one of the four major functions of regulators?
increasing the disclosure of financial information
What type of person prefers more risky investments as compared to a less risky one?
risk seeking
What do modified internal rate of return calculations assume?
that cash inflows will be reinvested at the weighted average cost of capital (WACC)
What does it mean when a loan has an annual compounding period?
the APR is the same as the effective interest rate
What is the biggest factor that affects which capital structure will be best for a firm?
the ability to make debt payments on time
Which of the following options is NOT needed to calculate expected return with the capital asset pricing model (CAPM)?
the amount of firm-specific risk
Who decides when a company pays a dividend?
the company management and the board of directors
What is an annual percentage rate (APR)?
the compounding period's interest rate multiplied by the number of periods in a year
What is the weighted average cost of capital (WACC)?
the cost of debt, preferred stock, and common stock multiplied by the percentage of each component used for financing
Which one of the following options describes the marginal debt cost?
the cost of new issuance of debt
What are flotation costs?
the costs of issuing and selling a security
What is an effect of compounding related to APR?
the effective interest rate is higher than the quoted APR
What is the effective interest rate of a loan that is compounded monthly?
the equivalent rate if the loan were to be compounded annually
Describe a stock's risk premium?
the expected return in excess of the risk free rate
Which of the following affects the capital structure chosen by a firm?
the firm's confidence in being able to pay debt
What is part of operating leverage?
the fixed costs needed to keep a business running
What is a firm's operating cycle?
the length of time from the receipt of raw materials to the collection of payment for the goods sold
What is a firm's capital structure?
the mix of debt and equity that a firm uses to finance its operations
What is the result of a stock split?
the number of shares held by each stockholder increases
When deciding among investments, which one is most attractive based upon the net present value (NPV)?
the one with the highest NPV
What is the "dirty" price of a bond?
the price of the bond plus any outstanding interest accrued
What is beta?
the ratio of a company's risk premium versus the market's risk premium
What is one source of agency costs?
the separation of ownership from control of a business
What does consistent payment of a dividend indicate?
the strength of a firm's underlying income stream
What is float?
the time before a check is cashed when the money has been spent but has not yet left a company's bank account
What does the cash conversion cycle measure?
the time passed from the beginning of the production process to collection of cash from the sale of the finished product
The price or yield of bonds is calculated using which equation(s)?
the time value of money (TVM) equations
Which equation(s) is/are used to solve for the price or yield of bonds?
the time value of money (TVM) equations
What does a yield curve show?
the yields of bonds of different maturities at a given moment
Why should investors use modified internal rate of return (MIRR)?
to compensate for IRR's overstatement of the expected rate of return
Why do lenders charge compound interest on many loans?
to compensate for increased opportunity costs with each passing period
What is the primary function of a venture capital firm?
to invest money in new businesses for a private equity arrangement
Which of the following options is NOT a major function of financial instruments?
to specify the level of risk to the person entitled to payments
When should the Fisher equation be used to calculate nominal interest rate?
when there are large inflation rates
What is the date on which all persons who are on record as owning a share of stock will receive the dividend?
Date of record
How does financial leverage increase risk?
Debt increases the variability of potential returns
Who are the owners of a mutual corporation such as a credit union?
Depositors
Who is a mutual corporation owned by?
Depositors
What may be predicted from the following yield curve? Maturity Yield (%) 1 month 1.90 3 months 1.90 6 months 2.00 1 year 2.00 2 years 2.01 3 years 2.01 5 years 2.01 7 years 2.01 10 years 2.02 20 years 2.04
Future short term interest rates and long term interest rates will be near identical
What does it mean if the yield curve is flat?
yields for bonds of different maturities are identical
A lawsuit against a corporation that affects the value of the corporation's stock is an example of which type of risk?
Firm specific risk
Diversification can virtually eliminate which type of risk?
Firm specific risk
Why is the dividend discount model (DDM) of limited use?
Future dividend payments are uncertain
What is the profitable index (PI) of a project that costs $250,000 and will earn $100,000 the first year, $90,000 the second year, $80,000 the third year, and $70,000 the fourth year, assuming a discount rate of 10%?
1.09
We have $30,000 invested in ABC stock, $20,000 invested in EFG stock, and $10,000 invested in JKL stock. ABC has a beta of 1.7, EFG has a beta of 1.1, and JKL has a beta of .8. What is our portfolio's beta?
1.35 (The beta of a portfolio of stocks is the average (weighted mean) of the betas of the components. In this case, ABC stock is 50% of our investment, EFG stock is 33% of our investment, and JKL stock is 17% of our investment. Our portfolio beta is calculated as follows: (.5 x 1.7) + (.33 x 1.1) + (.17 x .8) = 1.35)
Yaga Yoga believes that if sales increase by 10%, its net income will increase by 15%. What is its degree of total leverage?
1.5
A firm believes that if sales increase by 5%, their net income will increase by 8%. What is their degree of total leverage?
1.6 (8/5)
Marcela purchased 10 shares of stock at $80 a share. She received 12 payments of $5 and then sold her shares for $82 a share. What was Marcela's rate of return?
10% (received 880 in cash inflow, minus 800 cash outflow, return of 80, divided by initial investment 800)
What is the modified internal rate of return (MIRR) of a project that costs $18,000 and will earn $5,000 each year for five years if the discount rate is 10% and the rate of reinvestment is 9%?
10.70
Which quoted price below indicates that the bond is trading at a premium?
101.36
A project costs $65,000 and will earn $22,000 per year for four years. If we assume a discount rate of 6%, what is the net present value (NPV) of this project?
11,232.32
Using the Fisher equation, what is the nominal interest rate if the real rate of interest is 3% and the rate of inflation is 8%?
11.24%
What is the price of a bond with a coupon payment of $100 annually, eight years to maturity, a $1,000 par value and a yield of 7%?
117.19
Daily purchases: $1,500
12
Company M's most recent dividend was $5.70, dividend growth is expected to be 6% per year, and investors require 11%. What should the stock's price be?
120.84
If $500 is invested at a 5% interest rate, how much simple interest will be earned in five years?
125 (500*0.05*5)
Company A bonds are yielding 8% and comparable companies have a cost of equity about 5% higher than their cost of debt. According to the debt plus risk premium model (D + RP), what is rs?
13 (0.08+0.05)
Daily purchases: $800
13 days
If investors require a 6% annual return on an 8% preferred stock with a par value of $100, what should the stock's price be?
133.33
What is the component cost of preferred stock for a company with $10 million in preferred stock that sells for $55 a share and pays a dividend of $7.86 each year?
14.29%
A company has 10 million shares of common stock selling at $60/share. It pays a dividend of $5 this year and the dividend is growing at 6%. According to the dividend discount model (DDM), what is rs?
14.43 (5(1+.06)/60+0.06)
An investment has a 60% chance of returning 20%, a 30% chance of returning 10%, and a 20% chance of returning nothing. What is the expected rate of return on this investment?
15%
Most of the year, a company has $25,000 in cash, $80,000 in inventory, and $40,000 in A/R. Their A/P is stable at $30,000. However, during the summer season, their inventory peaks at $200,000 and their A/R peaks at $70,000. How much extra funding does this company need during the summer season?
150000
Company B bonds are yielding 10% and comparable companies have a cost of equity about 6% higher than their cost of debt. According to the debt plus risk premium model (D + RP), what is rs?
16
A company has 10 million shares of common stock selling at $17/share. It pays a dividend of $2 this year and the dividend is growing at 5%. According to the dividend discount model (DDM), what is rs?
17.35
From which type of cash flows are dividends paid?
After-tax cash flows
Which of the following cash flows are used to pay preferred stock dividends?
After-tax cash flows
Which of these investments usually has the highest return?
Airline stock
What may be predicted from the following yield curve? Maturity Yield (%) 1 month .80 3 months 1.61 6 months 2.05 1 year 2.76 2 years 3.45 3 years 4.11 5 years 5.79 7 years 7.23 10 years 8.81 20 years 9.23
All of the above
What does the semi-strong form of the efficient market hypothesis (EMH) argue?
All public information has been accounted for by the market.
Which method for calculating the cost of equity is best?
All three models
Which type of cost arises because of the separation of ownership from control of a business?
An agency cost
What is the name for a set of constant periodic payments lasting for a fixed amount of time?
An annuity
Which statement about annuities is true?
An annuity due has a slightly higher value than a regular annuity.
What does a credit score indicate?
An individual or company's credit worthiness
What is a type of intermediary that includes pension and government retirement funds?
An investment company
Which type of intermediary is a pension and retirement fund?
An investment company
Which statement about the four factors of value is correct?
An investment is more valuable if it increases cash flow sooner rather than later.
What does the following yield curve predict? Maturity Yield (%) 1 month 0.45 3 months 1.23 6 months 2.79 1 year 5.06 2 years 5.97 3 years 7.03 5 years 8.15 7 years 8.53 10 years 10.02 20 years 11.71
An upcoming economic boom
What are accounts payable?
Any liabilities due within one year
Why do agency costs occur?
Because a company is controlled by people who do not own the company
Why is there more risk associated with an aggressive strategy?
Because there is less cash available for unexpected expenses.
Which of the following investments is a terrible choice?
Cash
In what form are dividends paid to investors?
Cash payment
Which form of financing consists of short-term, unsecured promissory notes issued by firms with good credit?
Commercial paper
What should be changed to encourage firms to consider shifting their focus away from maximizing shareholder value?
Companies should be encouraged to shift their focus away from maximization of shareholders' value by engaging in a lot of corporate social responsibility work and understanding the importance of creating of long-term wealth for shareholders rather than just looking for enhancement of the market capitalization in the short run. The manager should be trying to engage in corporate social responsibility as it will enhance the reputation of the organization from the perspective of society. They should be fulfilling legal obligations adequately which will enhance the satisfaction of governments and it will overall result in enhancement of the value of the company over a longer period of time.
What is the minimum balance that must be maintained in an account?
Compensating balance
What type of interest should be assumed in a lending discussion?
Compound interest
Which type of interest is determined each period from principal and accrued interest?
Compound interest
Which type of interest is the most common?
Compound interest
Which statement below accurately describes a difference between compound interest and simple interest?
Compound interest is much more common than simple interest.
In which approach to dividends is the dividend the same percentage of earnings each year?
Constant dividend payout ratio
Has the spread on corporate bonds and Treasury securities narrowed or widened over the past year?
Corporate bonds and Treasury securities have widened over the past year. Over the past year, the spread on corporate bonds and Treasury securities have narrowed. This means that the difference in yields between the two types of bonds has decreased. One possible reason for this is the strong demand for corporate debt as companies have sought to take advantage of low borrowing costs in the current low interest rate environment. Another reason could be the accommodative monetary policy of the Federal Reserve, which has kept interest rates low and supported the bond market.
What is one of the ways that corporations differ from sole proprietorships and partnerships?
Corporations are legal entities distinct from their owners, so owners have some liability protection.
Which of the following is a primary source of external funding?
Credit terms from suppliers
Which of the following is the best method for calculating the cost of equity?
Each method has its strengths and weaknesses
Which statement below is true?
Effective interest rates are usually higher than the quoted APR.
Which capital budgeting strategy involves calculating the steady cash payment received by an annuity with the same length and net present value (NPV) as the project?
Equivalent annual annuity (EAA)
When using the capital asset pricing model (CAPM) to calculate the cost of equity, what should one do when his or her company has not yet issued stock?
Estimate beta based on a public competitor's beta
What are two sources of agency costs?
Excessive perquisites and shirking
Which two markets can be contrasted according to whether the market structure is centralized or decentralized?
Exchange vs. OTC
How do intermediaries differ from facilitators?
Facilitators broker or buy the same securities, whereas intermediaries buy and sell instruments with different risk, return, and liquidity.
What are the fixed costs of operation a part of?
Operating leverage
Which type of cost involves missing out on more desirable investments?
Opportunity cost
What does the nominal interest rate factor in?
Opportunity cost and inflation
What happens over time to the amount paid toward the principal in an amortized loan?
Over time, the amount applied to principal in each payment grows.
Which statement about amortization is true?
Over time, the amount applied to principal in each payment grows.
What is the equation to calculate the payment of a perpetuity?
PV x r = PMT
What is the term for the amount of time that will pass until an initial investment is recovered?
Payback period
What is one of the three main branches of finance?
Personal
What are the three main branches of finance?
Personal, public, and managerial
Which theory to explain the yield curve emphasizes the fact that investors' usual preference for short-term bonds can be reversed under some circumstances?
Preferred habitat
Which type of stock behaves somewhat like a bond?
Preferred stock
What is the market multiples approach used to measure?
Present value of stock
What is the most familiar indicator of stock value in the market multiples approach?
Price to earnings (P/E) ratio
In which market are newly created instruments sold for the first time?
Primary market
What are the pros and cons of the following capital budgeting techniques: Net Present Value (NPV), Modified Internal Rate of Return (MIRR) and Profitability Index (PI)?
Pros of NPV - NPV provides a distinct measurements. It determines the value produced from a fictitious investment in today's dollars based on the discount rate used. NPV and investment size are connected. It is useful to compare modest forestry investments to substantial ones or purchases. NPV calculation is simple, especially when using a spreadsheet. NPV employs cash flows as opposed to net income, which takes non-cash expenses like depreciation into account. NPV considers the time value of money, unlike cash returns or simple payback periods. For forestry investments, which sometimes include long-term commitments, this is necessary and appropriate. Cons of NPV - The discount rate's stability over the duration of the investment or project is another assumption made by NPV. Discount rates fluctuate year to year, much like interest rates do. NPV is predicted on the idea that future cash flows can be precisely forecasted and predicted. Although it could turn out to be impenetrable, there have been occasional issues. Pros of MIRR - The MIRR accounts for all cash flows associated with the project. It addresses the concept of the time worth of money. It is a way of assessing investments that accounts for time. Cons of MIRR - The MIRR requires a capital cost estimate in order to arrive at the same choice for independent projects. There may be a problem with the MIRR since the project sizes are different. MIRR is challenging to calculate and comprehend, and it is directly tied to investment criteria. Pros of PI - PI draws the time's worth of money into consideration. It addresses the concept of the time worth of money. It alludes to an investment that boosts or depresses the company's worth and analyses each financial flow over the lifetime. Some investment vehicles will only employ cash flows that have been reported in order to achieve investment returns, or they will omit certain cash flows that are not recorded. Finding a good investment project is quick and straightforward when using the profitability index approach. It gauges the proportion of the initial investment to the present value of future cash flow. The index serves as a helpful tool for assessing investment projects and showing the value produced per investment. Cons of PI - When using PI, the interest rate and discount rate are tough to explain. If the lifespan of two projects differs, it is challenging to compute the profitability index.
Based upon the Learning Activities in Topic 3, why do some firms pay no dividends while others consistently pay dividends? In other words, what are the primary drivers behind the dividend decision?
Supporters of dividends point out that a large dividend distribution is crucial for investors since dividends guarantee a company's financial stability. Over the past few decades, businesses that have consistently paid dividends have typically been among the most stable businesses. A corporation that offers a dividend draws in investors and increase demand for its shares as a consequence. A decrease or rise in dividend payments, however, may impact a security's price. If a company stops paying dividends after a lengthy period of time, it will have a negative impact on the share price. On the other hand, businesses that have raised their dividend payments or adopted new dividend policies will probably experience an increase in the value of their stock. Dividend payments are also seen by investors as a sign of a company's strength and a sign that management has high expectations for future profits, both of which raise the stock's appeal. As demand grows, the value of the company's shares will climb. A company's desire and capacity to do so over time is solid proof of its financial stability. Paying dividends conveys a clear and powerful statement about its future performance and prospects.
In addition, compare and contrast the working capital management strategy used by Wal-Mart with the working capital management strategy used by one of the next five big retailers such as Costco, Home Depot, Target or Kroger.
The liquidity ratios of Walmart and Target show that they can both pay off their debit. First, the current ratio assesses a borrower's capacity to pay back both short and long term debts. The fact that Target has a higher ratio than Walmart means that it will be better able to pay off its obligations. Similar to the regular ratio, the fast ratio shows the capacity to pay short term and long term obligations without selling inventory because inventory is less liquidable than other assets. In this case, Target outperforms Walmart. The first of them is the debt-to-equity ratio, which is employed in this case to asset the capital based financial leverage of Walmart and Target. Generally speaking, the riskier the firm, the greater the ratio. Both Target and Walmart do a decent job of minimizing risk, although Target's debt-to-equity ratio is a little higher. The debt-to-equity ratio shows how much debt these businesses are using to fund their assets in comparison to the value reflected in shareholders' equity. Target's leverage ratio is marginally greater than Walmart's demonstrating Target's more aggressive leveraging strategies.
Why is the dividend discount model (DDM) method useful?
The method is the driver of value in stock ownership
What is a compensating balance?
The minimum balance that must be maintained in an account
Which one of the following interest rates factors in both opportunity cost and inflation?
The nominal interest rate
Which formula is best for determining the value of a stock with a constant dividend stream?
The perpetuity formula
What does profitability index (PI) indicate?
The present value per dollar of initial cost
When calculating the expected rate of return, what is each possible outcome weighted by?
The probability of the outcome
What does a scenario analysis allow us to analyze?
The range of likely outcomes for our project
What is rate of return?
The ratio of the cash inflows minus cash outflows, divided by the cash outflows
What is an interest rate?
The ratio of the interest to the principal
What is the quick trick to find the approximate time-to-double?
The rule of 72
How does an annuity due compare to a regular annuity?
The value of an annuity due is slightly higher than the value of a regular annuity.
Ngota bought an investment for $10,000 today. It will result in a cash payment of $19,000 in seven years. Which statement about this investment is true, assuming an interest rate of 6%?
This investment has a PV of $12,636.09 and an NPV of $2,636.09
An investment costs $5,000 today and will result in a cash payment of $9,000 in five years. Which statement about this investment is true, assuming an interest rate of 8%?
This investment has a PV of $6,125.25 and an NPV of $1,125.25
Why was the modified internal rate of return (MIRR) created?
To compensate for the fact that IRR overstates the expected return rate
Why is it important to calculate effective interest rates as opposed to APR?
To directly compare two or more loan offers
Based upon the learning activities in Topic 1, you should now understand that positive working capital is normally a good thing in managing liquidity and profitability. Explain how Wal-Mart manages its working capital efficiently.
Walmart strives to operate under the principles of greater liquidity and a better cash conversion cycle and it is able to maximize the greater degree of liquidity. As a result, it manages working capital effectively. Manufacturers of consumer goods and retail products benefit greatly from Walmart. Due to this, Walmart has the power to pressure suppliers into lowering their pricing. With its influence over suppliers and excellent credit rating, Walmart is able to effectively manage its working capital.
So, how does Wal-Mart manage its cash, accounts receivables, inventory and accounts payable in a way that allows them to be more profitable than Target? Hint: Calculate the cash conversion cycle for both Wal-Mart and Target and then compare the components.
Walmart's ability to deal successfully with its suppliers is what allows it to have negative working capital by design. When a company makes money so quickly that it can sell its goods to a consumer before it has to pay a supplier, it is said to have negative working capital. Target's accounts receivable turnover is lower than Walmart's. Walmart also has a greater accounts receivable turnover percentage in comparison to Target. We may infer that Walmart is significantly more efficient than Target and the industry as a whole since it has a higher asset turnover. Target is a bit more profitable than Walmart. The company's lower gross profit margin and net profit margin can be attributed to the low price guarantee policy, which is at the core of Walmart's strategy for cheap pricing.
How are bonds quoted?
as a percentage of their par value
What is the historical beta of a firm used for?
as a predictor of future beta
Which option is a common error involved in weighted average cost of capital (WACC) calculations?
assuming that the marginal rate is the same as the historical rate
What gets traded in a money market?
instruments with less than a year to maturity
What is the focus of the controller?
internal financial management of a firm
What do venture capital firms do?
invest money in companies
Sweat equity refers to which of the following situations?
long hours of work to run a new business
What type of investment is a risk averse person more likely to choose?
low risk over moderate risk
Which one of the following best describes what managerial finance involves?
making sound investment and financing decisions
Which capital structure is best?
one that minimizes WACC
Which loan offer has the lowest effective interest rate?
one with a 16% APR compounded daily
Which loan offer has the lowest effective interest rate?
one with a 18.1% APR compounded semi-annually
Which project should be undertaken if only one can be selected?
one with an EAA of $5,104.79 (highest)
What are underwriting costs?
payments to investment bankers for selling a security
