Principle of Finance Exam 3
Three important points should be noted in the equation for ra (or WACC):
1) For computational convenience, it is best to convert the weights into decimal form and leave the individual costs in percentage terms 2) The weights must be non-negative and sum to 1.00. (WACC must account for all financing costs within the firm's capital structure) 3) The firm's common stock equity weight, ws, is multiplied by either the cost of retained earnings, rr, or the cost of new common stock, rn.
Trade-Off Theory
1) Interest is tax-deductible expense 2) Interest Rates 3) So, there is a threshold debt level 4) Theory and empirical evidence support these ideas 5) Hence, the capital structure is a trade off between tax benefit and bankruptcy cost 6) Many large, successful firms use much less debt than the theory suggests, leading to the development of signaling theory
Five Steps of the Capital Budgeting Process:
1) Proposal Generation 2) Review and Analysis 3) Decision Making 4) Implementation 5) Follow-Up
Two forms of common stock financing
1) Retained Earnings 2) New Issues of Common Stock
What two things does the cost of capital represent?
1) The firm's total cost of financing (what they pay to get capital) as a % of the total financing, and 2) The minimum rate of return as a % that an investment must earn to add value to the firm (what they need to earn as a % of the total investment)
The three ways to determine pre-tax cost of debt
1) Using market quotations 2) Calculating the cost 3) Approximating the cost
Duchess Corporation has a 40% tax rate. Using the 9.452% before-tax debt cost calculated using Excel or a financial calculator, we find an after-tax cost of debt of:
5.67%, which is 9.453% * (1-0.40).
Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he realize?
: Realized return = 28%
Beta coefficient (b)
A relative measure of nondiversifiable risk. An index of the degree of movement of an asset's return in response to a change in the market return; An asset's historical returns are used in finding the asset's beta coefficient; The beta coefficient for the entire market equals 1.0. All other betas are viewed in relation to this value
Net Present Value (NPV)
A sophisticated capital budgeting technique; found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate of equal to the firm's cost of capital NPV = Present Value of Cash Inflows - Initial Investment
Asset P has a beta of 0.9. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset's required rate of return is ________. A) 13.4 percent B) 22.0 percent C) 15.4 percent D) 6.0 percent
A) 13.4 percent
If a project's payback period is greater than the maximum acceptable payback period, we would reject it. A) True B) False
A) True
A firm is evaluating three capital projects with no budget constraints. The net present values for the projects are as follows: Project NPV 1 $100 2 $10 3 -$100 The firm should ________. A) accept Projects 1 and 2, and reject Project 3 B) accept Projects 1 and 3, and reject Project 2 C) accept Project 3, and reject Projects 1 and 2 D) accept all projects
A) accept Projects 1 and 2, and reject Project 3
Since retained earnings are viewed as a fully subscribed issue of additional common stock, the cost of retained earnings is ________. A) less than the cost of new common stock equity B) equal to the cost of new common stock equity C) greater than the cost of new common stock equity D) not related to the cost of new common stock equity
A) less than the cost of new common stock equity
We look for a signal from management action
An action taken by a firm's management that provides clues to investors about how management views firm's capital prospects
What do most firms attempt to maintain?
An optimal mix of debt and equity financing (capital structure)
Operating Expenditures
An outlay of funds by the firm resulting in benefits received within 1 year
Capital Expenditure
An outlay of funds by the firm that is expected to produce benefits over a period of time greater than 1 year
Robin wishes to determine the return on two stocks she owned in 2012. At the beginning of the year, Apple stock traded for $411.23 per share, and Wal-Mart was valued at $60.33. During the year, Apple paid dividends of $5.30, and Wal-Mart shareholders received dividends of $1.59 per share. At the end of the year, Apple stock was worth $532.17 and Wal-Mart sold for $68.23. Calculate the annual rate of return, r, for each stock
Apple: ($5.30 + $532.17 - $411.23) ÷ $411.23 = 30.7% Wal-Mart: ($1.59 + $68.23 - $60.33) ÷ $60.33 = 15.7%
Norman Company wants to choose the better of two investments, A and B. Each requires an initial outlay of $10,000 and each has a most likely annual rate of return of 15%. Management has estimated the returns associated with each investment Asset A Asset B Initial Investment - $10,000 - $10,000 Annual Rate of Return Pessimistic. 13% 7% Most Likely. 15% 15% Optimistic 17% 23% Range 4% 16%
Asset A appears to be less risky than asset B. The risk averse decision maker would prefer asset A over asset B, because A offers the same most likely return with a lower range (risk).
The combination of debt and equity used to finance a firm:
Assist the firm in acquiring assets and in providing operational working capital
How do we capture all of the relevant financing costs?
Assuming some desired mix of financing, we need to look at the overall cost of capital rather than just the cost of any single source of financing
The approximate before-tax cost of debt for a 15-year, 10 percent, $1,000 par value bond selling at $950 is ________. A) 10 percent B) 10.7 percent C) 12 percent D) 15.4 percent
B) 10.7 percent
What is the payback period for Tangshan Mining company's new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4? A) 4.33 years B) 3.33 years C) 2.33 years D) 1.33 years
B) 3.33 years
Risk aversion is the behavior exhibited by managers who require ________. A) an increase in return, for a given decrease in risk B) an increase in return, for a given increase in risk C) no changes in return, for a given increase in risk D) decrease in return, for a given increase in risk
B) an increase in return, for a given increase in risk
The ________ is the rate of return that a firm must earn on its investments in order to maintain the market value of its stock. A) yield to maturity B) cost of capital C) internal rate of return D) modified internal rate of return
B) cost of capital
Capital Asset Pricing Model (CAPM)
Basic theory that links risk and return for all assets; Quantifies the relationship between risk and return; Measures how much additional return an investor should expect from taking a little extra risk
What is the only relevant risk?
Because any investor can create a portfolio of assets that will eliminate virtually all diversifiable risk, the only relevant risk is nondiversifiable risk
Trade-Off Theory: So, There is a Threshold Debt Level
Below this point, the effects are immaterial; Beyond this point, the higher interest rates reduce the tax benefits and along with much higher bankruptcy costs lower the value of the stock
How is the length of the maximum acceptable payback period determined?
By management
A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources and target market value proportions: Source of Capital | Target Market Proportions | After- Tax Cost Long-Term Debt | 40% | 6% Preferred Stock | 10% | 11% Common Stock Equity | 50% | 15% The weighted average cost of capital is ________. A) 6 percent B) 10.7 percent C) 11 percent D) 15 percent
C) 11 percent
A firm has issued preferred stock at its $125 per share par value. The stock will pay a $15 annual dividend. The cost of issuing and selling the stock was $4 per share. The cost of the preferred stock is ________. A) 7.2 percent B) 12 percent C) 12.4 percent D) 15 percent
C) 12.4 percent
The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 for the next three years is 3.33 years. A) 1.11 years B) 2.22 years C) 3.33 years D) 2.33 years
C) 3.33 years
The before-tax cost of debt for a firm, which has a marginal tax rate of 40 percent, is 12 percent. The after-tax cost of debt is ________. A) 4.8 percent B) 6.0 percent C) 7.2 percent D) 12 percent
C) 7.2 percent
________ projects have the same function; the acceptance of one ________ the others from consideration. A) Capital; eliminates B) Independent; does not eliminate C) Mutually exclusive; eliminates D) Replacement; eliminates
C) Mutually exclusive; eliminates
Systematic risk is also referred to as ________. A) business specific risk B) internal risk C) nondiversifiable risk D) maturity risk
C) nondiversifiable risk
Cost of debt varies with ______
Capital Structure
Opportunity Costs
Cash flows that could be realized from the best alternative use of an owned asset Opportunity costs should be included as cash outflows when one is determining a project's incremental cash flows (warehouse, lease out or convert to production line)
Intermediate Cash Inflows
Cash inflows received prior to the termination of the project
Sunk Costs
Cash outlays that have already been made (past outlays) and therefore have no effect on the cash flows relevant to a current decision, Sunk costs should not be included in a project's incremental cash flows (market research)
What can reduce the overall variability of a portfolio's returns?
Combining assets that have a low correlation with each other
Cost of Each Source of Capital for the Firm
Cost of Long-Term Debt Cost of Preferred Stock Cost of Common Stock Cost of Using Retained Earnings
The differences in the timing of cash flows between the two projects ____________ (does/does not) affect the ranking provided by the IRR method
Does not
Changes in the use of debt will cause changes in?
Earnings per share, and thus, in the stock price
For a project that has an initial cash outflow followed by cash inflows, the profitability index (PI) is simply....
Equal to the present value of cash inflows divided by the initial cash outflow
True or False: A firm's capital structure is the mix of the current liabilities, long-term debt, and equity maintained by the firm.
False
True or False: The internal rate of return (IRR) is defined as the discount rate that equates the net present value with the initial investment associated with a project.
False
True or False: The three major cash flow components include the initial investment, nonoperating cash flows, and terminal cash flow.
False
Review and Analysis
Financial managers perform formal review and analysis to assess the merits of investment proposals
Factors that influence the formulation of Capital Structure
Firm's risk Firm's tax position Firm's financial flexibility Firm's managerial attitude Firm's long-term strategy (competitive position 3 to 5 years from now)
Risk and return characteristics can increase or decrease a _____________
Firm's share price
Decision Making
Firms typically delegate capital expenditure decision making on the basis of dollar limits
Implementation
Following approval, expenditures are made and projects implemented. Expenditures for a large project often occur in phases
Net Present Value Profiles
Graphs that depict a project's NPVs for various discount rates
When companies evaluate investment opportunities using the PI, the decision rule they follow is to invest in the project when they index is:
Greater than 1.0
What does the CAPM rely on?
Historical data, which means the betas may or may not actually reflect the future variability of returns
What do relevant cash flows represent?
How much better or worse off the firm will be if it chooses to implement the proposal
IRR Decision Criteria
If the IRR is greater than the cost of capital, accept the project If the IRR is less than the cost of capital, reject the project
Decision Criteria for NPV
If the NPV is greater than $0, accept the project If the NPV is less than $0, reject the project
If the NPV is greater than $0, the firm will earn a return greater than its cost capital. Such action should....
Increase the market value of the firm, and therefore the wealth of its owners by an amount equal to the NPV
Three Basic Components of cash flows of any project
Initial Investment, Operating Annual Net Cash Flows, and terminal Cash Flow
What does IRR assume?
Intermediate cash flows are reinvested at the IRR
What does NPV assume?
Intermediate cash flows are reinvested at the cost of capital
Common method for scenario analysis
Involves considering pessimistic (worst), most likely (expected), and optimistic (best) outcomes and the returns associated with them for a given asset
The pre-tax cost of debt, rd
Is simply the rate of return (YTM) the firm must pay on new borrowing
What should you do to reduce overall risk?
It is best to diversify by combining (or adding to the portfolio) assets that have the lowest possible correlation
What does the payback methods popularity result from?
Its computational simplicity and intuitive appeal
Typically, the cost of long-term debt for a given firm is always _____ than the cost of preferred or common stock
Less
Trade-Off Theory: Interest is Tax-Deductible Expense
Less expensive than equity as interest is tax deductible; Equity's dividend payments are not tax deductible (financial pecking order: Retained Earnings -> Debt -> New Stock Issues)
Sources of Capital (Cash)
Long Term Debt (Bonds) Equity (Stock) - Preferred Stock - Common Stock Retained Earnings
Sources of Capital
Long-Term Debt Stockholders' Equity Preferred Stock Common Stock Equity Common Stock Retained Earnings
Signal Theory, Basic Assumption
Managers have better information about the firm's prospects than do outside investors (called asymmetric infromation)
How does a company determine its optimal capital structure?
Maximizing the firm's stock price
For replacement decisions, identifying relevant cash flows for replacement decisions is ________________
More complicated, because the firm must identify the incremental cash outflow and inflows that would result from the proposed replacement
How do you find the after-tax cost of debt (ri)
Multiplying the before-tax cost, rd, by 1 minus the firm's tax rate, T, as state in the following equation:
A project's __________________ are the net incremental after-tax cash flows over a project's life
Net Cash Flows
Using market quotations
Observe the yield to maturity (YTM) on the firm's existing bonds or bonds of similar risk issued by other companies (typically received from investment bankers)
Scale Problem
Occurs when two projects are very different in terms of how much money is required to invest in each project
How is the value of preferred stock found?
Perpetual Annuity model
Mutually Exclusive Projects
Projects that compete with one another, so that the acceptance of one eliminates from further consideration all other projects that serve a similar function
Independant Projects
Projects whose cash flows are unrelated to (or independent of) one another; the acceptance of one does not eliminate the others from further consideration
Proposal Generation
Proposals for new investment projects are made at all levels within a business organization and are reviewed by finance personnel
Weighted Average Cost of Capital (WACCC) ra
Reflects the expected average future cost of capital over the long run
To evaluate investment opportunities, financial managers must determine the ___________________
Relevant Cash Flows
Follow-Up
Results are monitored and actual costs and benefits are compared with those that were expected. Action may be required if actual outcomes differ from projected ones
Trade-Off Theory: Interest Rates
Rise as the debt ratio (debt to assets) increases; The probability of bankruptcy increases as debt increases and the debt ratio increases
Two Key Financial Considerations
Risk and Return
Three categories used to describe how investors respond to risk
Risk averse, risk neutral, risk seeking
What two parts can Capital Asset Pricing Model (CAPM) be divided into?
Risk-Free Rate of Return and Risk Premium
Required returns specified by the model should be used only as _________________
Rough approximations
The cash flows associated with the sale of Duchess Corporation's bond issue are as follows (from the corporation's point of view) End of Year(s) Cash Flow 0 $960 1-20 -$90 20 -$1,000 We can determine the cost of debt by finding the YTM, which is the discount rate that equates the present value of the bond outflows (coupon payments and par amount to the initial inflow (price of the bond).
Solution = 9.452
What is the most common statistical indicator of an asset's risk?
Standard Deviation
Benjamin Corporation, a growing computer software developer, wishes to determine the required return on asset Z, which has a beta of 1.5. The risk-free rate of return is 7%; the return on the market portfolio of assets is 11%.
Substituting bZ = 1.5, RF = 7%, and rm = 11% into the CAPM yields a return of: rZ = 7% + [1.5 ´ (11% - 7%)] = 7% + 6% = 13%
Market Risk Premium
The (rm - Rf) portion of the risk premium; It represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets
Signal Theory: The firm builds reserve borrowing capacity
The ability to borrow money at a reasonable cost when good investment opportunities arise Firms often use less debt than optimal to ensure that they can obtain debt capital later if it is needed
What does the incremental cash flows represent?
The additional after-tax cash flows (outflows or inflows) that will occur only if the firm makes the investment
Terminal Cash Flow
The after-tax non operating cash flow occurring in the final year of a project it is usually attributable to liquidation of the project
Payback Method
The amount of time required for a firm to recover its initial investment in a project, as calculated from cash inflows
What is the major weakness of the payback period?
The appropriate payback period is merely a subjectively determined number It cannot be specified in light of the wealth maximization goal because it is not based on discounting cash flows to determine whether they add to the firm's value
Cost of a New Issue of Common Stock, rn
The cost of common stock, net of underpricing and associated flotation costs
Internal Rate of Return (IRR)
The discount rate that equates the NPV of an investment opportunity with $0 (because the present value of cash inflows equals the initial investment); The rate of return that the firm will earn if it invests in the project and receives the given cash inflows
What does the cost of capital reflect?
The entirety (all of) of the firm's financing activites
Required return on common stock equation
The equation indicates that the cost of common stock equity can be found by dividing the dividend expected at the end of year 1 by the current market price of the stock (the "dividend yield") and adding the expected growth rate (the "capital gains yield")
Accept-Reject Approach
The evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criterion
Capital Rationing
The financial situation in which a firm has only a fixed number of dollars available for capital expenditures, and numerous projects for these dollars
Unlimited Funds
The financial situation in which a firm is able to accept all independent projects that provide an acceptable return
What do the IRR decision criteria guarantee?
The firm will earn at least its required return. Such an outcome should increase the market value of the firm and, therefore, the wealth of its owners
What does the interest expense on debt reduce?
The firm's taxable income and, therefore, the firm's tax liability
One underlying cause of conflicting ranking is
The implicit assumption concerning the reinvestment of intermediate cash inflows
Operating Annual Net Cash Flows
The incremental net cash inflows resulting from implementation of a project during its life
How to find the IRR using the preprogrammed function in a financial calculator
The keystrokes for each project are the same as those for the NPV calculation, except that the last two NPV keystrokes (punching I and then NPV) are replaced by a single IRR keystroke
The NPV approach favors the investment that makes the investor ___________
The most money (like the $1,000 investment that yields $1,100 in one day)
The Cost of New Asset
The net outflow necessary to acquire a new asset (land/design and permitting/construction costs/equipping costs/merchandising costs)
Target Capital Structure
The optimal mix of debt, preferred stock, and common equity with which the firm plans to finance its investments May change over time Intentional trade-off between risk and return to achieve goal of maximizing the price of stock
Despite its theoretical superiority, however, financial managers prefer to use the IRR approach just as often as the NPV method because of ______________________.
The preference for rates of return
Capital Budgeting
The process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth
Ranking Approach
The ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return
Cost of Common Stock Equity, rs
The rate at which investors discount the expected dividends of the firm to determine its share value (stock price)
Another reason why the IRR and NPV methods may provide different ranking for investment options has to do with the differences in ________________
The timing of cash flows
By measuring how quickly the firm recovers its initial investment, the payback period also gives implicit consideration to _____________________.
The timing of cash flows
Why do new shares need to be underpriced?
To encourage investors to purchase it
True or False: Combining negatively correlated assets can reduce the overall variability of returns.
True
True or False: Most managers are risk-averse, since for a given increase in risk they require an increase in return
True
True or False: NPV and IRR methods should reach the same conclusion about the acceptability or non-acceptability of the same project.
True
New shares are ________ if the stock is sold at a price below its current price, P0
Underpriced
Two components of flotation costs
Underwriting costs and administrative costs
In earlier examples, we found the costs of the various types of capital for Duchess Corporation to be as follows: -Cost of debt, ri = 5.67% -Cost of preferred stock, rp = 10.61% -Cost of retained earnings, rr = 13.05% -Cost of new common stock, rn = 14.05% - The company uses the following weights in calculating its weighted average cost of capital: -Weight of long-term debt = 40% -Weight of preferred stock = 10% -Weight of common stock equity = 50% Weight of new common stock equity = 0%
WACC = 9.86%
How do you find the weighted average cost of capital (WACC)?
Weighting the cost of each specific type of capital by its proportion in the firm's capital structure
How do you determine fi you used the cost of retained earnings or the cost of new common stocks in WACC?
Which cost is used depends on whether the firm's common stock equity will be financed using retained earnings, rr, or new common stock, rn.
Portfolio
a collection, or group, of assets
Range
a measure of an asset's risk, which is found by subtracting the return associated with the pessimistic (worst) outcome from the return associated with the optimistic (best) outcome
Risk
a measure of the uncertainty surrounding the return that an investment will earn or, mor formally, the variability of returns associated with a given asset
Probability Distribution
a model that relates probabilities to the associated outcomes
Efficient Portfolio
a portfolio that maximizes return for a given level of risk
Correlation
a statistical measure of the relationship between any two series of numbers
If the payback period is less than the maximum acceptable payback period, ________ the project
accept
Scenario Analysis
an approach for assessing risk that uses several possible alternative outcomes (scenarios) to obtain a sense of the variability among returns
Constant-Growth Valuation (Gordon) model
assumes that the value of a share of stock equals the present value of all future dividends (assumed to grow at a constant rate) that it is expected to provide over an infinite time horizon
A third weakness of payback is its failure to recognize __________ that occur after the payback period
cash flows
Total Risk
combination of a security's nondiversifiable risk and diversifiable risk
Underwriting Costs
compensation earned by investment bankers for selling the security (1/2% to 2% of total value)`
Conflicting Rankings
conflicts in the ranking given a project by NPV and IRR, resulting from differences in the magnitude and timing of cash flows
Because it can be viewed as a measure of risk exposure, many firms use the payback period as a ___________________ or as a supplement to other decision techniques
decision criterion
Perfectly negatively correlated
describes two negatively correlated series that have a correlation coefficient of -1
Perfectly positively correlated
describes two positively correlated series that have a correlation coefficient of +1
Uncorrelated
describes two series that lack any interaction and therefore have a correlation coefficient close to zero
Negatively correlated
describes two series that move in opposite directions
Positively correlated
describes two series that move in the same direction
If debt goes up, interest goes up, net profit goes _______, stock price goes _______
down; down
When much of a project's cash flows arrive ______ in its life, the project's NPV will not be particularly sensitive to the discount rate.
early
The CAPM assumes markets are ____________
efficient
Financial managers are ethically bound to only invest in projects that they expect to _______________________________.
exceed the cost of capital
Calculating the cost
find the before-tax cost of debt by calculating the YTM generated by the bond cash flows
The cost of new common stock is normally _________ than any other long-term financing cost
greater
The cost of new issues, rn, will always be _______ than the cost of existing issues, rs, which is equal to the cost of retained earnings, rr
greater
The IRR approach (and the PI method) may favor small projects with ____________
high returns (like the $2 loan that turns into $3)
The higher the beta, the _______ the required return; The lower the beta, the ________ the required return
higher; lower
Relevant cash flows can be viewed as the _____________ after-tax cash flows attributable to the proposed project
incremental
In real-world situations the risk of any single investment would not be viewed _______ of other assets
independently
Administrative costs
issuer expenses such as legal, accounting, and printing
The NPV of projects with cash flows that arrive _______ will fluctuate more as the discount rate changes.
later
The net proceeds from sale of new common stock, Nn, will be ______ than the current market price, P0
less
Correlation Coefficient
measure of the degree of correlation between two series
Standard Deviation
measures the dispersion around the expected value
For expansion decisions, developing relevant cash flow estimates is __________________
most straightforward
Why is the cost of long-term debt for a given firm always less than the cost of preferred or common stock
partly because of the tax deductibility of interest
The ___________ method is widely used by large firms to evaluate small projects and by small firms to evaluate most projects
payback
Continuous Probability Distribution
probability distribution showing all the possible outcomes and associated probabilities for a given event
In cases of the scale problems the IRR and NPV methods may rank _____________________
projects differently
If the payback period is greater than the maximum acceptable payback period, ________ the project
reject
Higher percentages/weights of debt (higher financial leverage) increases ______
risk
Interest payments paid by the corporation to bondholders are ______________
tax deductible for the firm
Risk Neutral
the attitude toward risk in which investors choose the investment with the higher return regardless of its risk
Risk Seeking
the attitude toward risk in which investors prefer investments with greater risk even if they have lower expected returns
Risk Averse
the attitude toward risk in which investors would require an increased return as compensation for an increase in risk
Expected Value of a Return (r)
the average return that an investment is expected to produce over time
Probability
the chance that a given outcome will occur
Pretax Cost
the financing cost associated with new funds, before taxes are applied
Net Proceefs
the funds actually received by the firm from the sale of a security (the price paid by investors for the instrument less floatation costs)
Diversifiable Risk
the portion of an asset's risk that is attributable to firm-specific, random causes; can be eliminated through diversification. Also called unsystematic risk
Cost of Preferred Stock, rp
the ratio of the preferred stock dividend to the firm's net proceeds from the sale of preferred stock Where Np = net proceeds which is price - flotation costs
Initial Investment
the relevant cash outflow for a proposed project at time zero
Nondiversifiable risk
the relevant portion of an asset's risk attributable to market factors that affect all firms; cannot be eliminated through diversification. Also called systematic risk
Risk-Free Rate of Return
the required return on a risk-free asset, typically a 3-month U.S. Treasury bill
Market Return
the return on the market portfolio of all traded securities
Cost of Common Stock
the return required on the stock by investors in the marketplace
New investments must be considered in light of their impact on ...
the risk and return of an investor's portfolio of assets
Cost of Retained Earnings
the same as the cost of an equivalent fully subscribed issue of additional common stock, which is equal to the cost of common stock equity, rs rr = rs
Bar Chart
the simplest type of probability distribution; shows only a limited number of outcomes and associated probabilities for a given event
Flotation Costs
the total costs of issuing and selling a secuirty
Return
the total gain or loss experienced on an investment over a given period of time; calculated by dividing the asset's cash distributions during the period, plus change in value, by its beginning-of-period investment value
A second weakness is that this approach fails to take fully into account the _____________ in the value of money
time factor
Financial manager's goal
to create an efficient portfolio