Business Finance Test 2

You are planning to make monthly deposits of $450 into a retirement account that pays 10% compounded monthly. If your first deposit will be one month from now, how large will your retirement account be in 30 years?

$1,017,219.56

What is the future value of $1,000 that earns 10% interest for one year?

$1,100

What's the present value of a $500 3-year annuity at 10%?

$1,243.43

-A borrower has a five-year, 9%, $5,000 loan. -What are the monthly payments? (amortizing example)

$1,285.96

You wan to buy a new car for $68,000. The loan is for 60 months with payment at the beginning of the period (annuity due). The APR is 6.4%. What will the monthly payments be?

$1,320.27

What is the future value of $1,000 that earns 10% compound interest for three years?

$1,331

What is the present value of $500 3 year annuity due at 10%?

$1,743.43

What's the value of a $1,000 a year perpetuity at 10%

$10,000

What would the loan payments be for a 3-year interest only loan of $1,000 at 10%? (interest only example)

$100

I need $20,000 for a down payment on a house 5 years from now. How much do I need to save today? Assume 10% interest

$12,418.43

You are offered an investment that will pay 3 installments of $5,000 each. The first $5,000 will pay out in 4 years, and the remaining 2 installments will pay out in year 5 and 6 respectively. What is the present value at 10%?

$12,434.26 >>> $9,342.04

What's the value of a $1,000 a year perpetuity that has an interest rate of 10% and the payment grows at 2% forever

$12,500

You have just received notification that you have won the $1 million first prize in the Centennial Lottery. However, the prize will be awarded on your 100th birthday (assuming you are around to collect), 80 years from now. What is the present value of your windfall if the appropriate discount rate is 15%?

$13.94

You want to be a millionaire when you retire in 40 years. How much do you have to save each month if you earn 10.5% per year? How much do you have to save if you wait 10 years before you start investing?

$135.70

A borrower can repay $25,000 in 5 years. If the lender wants to earn 12% on the loan how much should they lend today? (pure discount)

$14,185

You have won a lawsuit and the court has arranged for the defendant to pay you $7,500 per year for the next three years. If the appropriate discount rate is 8 percent, what is the value of your settlement today?

$19,328.22

You are looking to purchase a home automation system when you graduate in two years. You plan to deposit the money in an investment account earning 8 percent annually. The anticipated cost of the system in two years is $2,500. How much must you deposit today?

$2,143.35

You plan to save for a Caribbean cruise. You deposit $500 today, $250 in two years, and $1,000 in three years. If your investment account earns 9 percent per year, how much will you have in five years?

$2,281.17

You open a bank account today with $7,000. You expect to deposit $4,000 at the end of each of the next three years. Interest rates are 8%, compounded annually. How much will you have in your account in three years?

$21,803.58

If you deposit $4,000 at the end of each of the next 20 years into an account paying 9.7% interest. How much will you have in 20 years?

$221,439.14

Valuing Level Cash Flows: Annuities and Perpetuities -What's the future value of a $2,000 30-year annuity at 8%

$226,566.42

I need $200,000 18 years from now for my kid's college. How much do I need to save today? Assume 10% interest.

$35,971.76

You deposit $5,000 into a savings account at the end of the year. You plan on withdrawing the money and closing the account exactly 30 years from the day you make the deposit. Interest rates are 7%, compounded annually, and will remain constant over the 30 years. What is your account balance at the end of 30 years? Simple interest? Compound Interest?

$38,061.27

When you were born 21 years ago, your Aunt Burtha put $2,000 into a saving account for you. The account has earned an average annual return of 4 percent per year, and nothing else has been deposited or withdrawn from the account. How much is there today?

$4,557.54

DG Inc. pays a $2,000 annual dividend that yields 7% and the dividend grows by 2% per year. How much would you pay for the preferred stock?

$40,000

What if you know you need $2,000 one year from now and $2,000 more two years from now, and $2000 more 3 years from now. If you can earn 6% on your money, how much do you need today? What's the PV of the three cashflows?

$5,346.02

What's the annuity payment when the present value is $1,243.43 on a 3-year annuity at 10%?

$500

You just found out your great uncle left you an inheritance of $500,000. You understand the importance of college and also know how much it cost! You want to make sure your niece is able to attend debt free. She was just born, so she has 18 years before she starts college. If you can earn 7% on your money, how much do you need to set aside for her so that she'll have $250,000 for college (remember inflation??)

$73,965.98

EAR formula

(1+(quoted rate/m))^m -1 -- m # of compounding periods per year

What is the DuPont identity?

It breaks down ROE into three parts: operating efficiency, asset use efficiency, and financial leverage - it decodes ROE - ROE by itself can be misleading - RO = profit margin x asset turnover x equity multiplier

Receivables Turnover

Sales / Accounts Receivable

To find the PV of an annuity

Solve like it was an ordinary annuity starting with payment 1 and then add the payment at time 0 to the PV of the ordinary annuity

Growing perpetuity

an annuity in which the cash flows continue forever and grow at a constant rate.

inventory turnover ratio

cost of goods sold/average inventory

current ratio

current assets/current liabilities

Why do we have APR?

In large part the government requires it by law for the majority of consumer loans

■What is the future value of $1,000 that earns 10% compound interest for six years? -Formulas - FVt = PV0 x (1 + r)^t -FV = the amount of money you will have in 6 years. This is what we are solving for -PV = the initial amount of your investment. In this example $1,000 -R = interest rate = 10% -T = time = 6 years ■What is the difference between compound interest and simple interest?

- $1,771.56 - $171.56

You are trying to save to buy a new $60,000 car. You have $22,000 today that can be invested at your bank. The bank pays 4 percent annual interest on its accounts. How long will it be before you have enough to buy the car? ■What is the future value in the equation? ■What is the present value in the equation? ■What is the unknown variable in the equation? In other words, what are you solving for? ■What is the interest rate? ■ How long will it be before you have enough to buy the car?

- $60,000 - $22,000 - time - 4% - 25.58

■Which bank has the highest EAR (Effective Annual Rate) -Bank A - 15% compounded daily -Bank B - 15.5% compounded quarterly -Bank C - 16% compounded annually

- 16.18% - 16.42% - 16%

You plan to invest $17,000 at the end of the year that you will invest for six years at 10% per year. How much will you have at the end of six years? ■Q5. Using the financial calculator, what number should you use as N ■Q6. Using the financial calculator, would $17,000 be PV or FV? ■Q7. On the financial calculator I/Y is the same as what variable in the FV formula? ■Q8. On the financial calculator N is the same as what variable in the FV formula? ■Q9. How much money will you have at the end of six years?

- 6 - PV - 10 - rate - Time

If you invest $1,000 today for 5 years and it grows to $3,000 what rate of return did you earn? What was the interest rate?

-- dont have answer yet

You found a rental property that you think would make a good investment. After doing your research you believe that annual rent would be $11,500 per year, and you'll have the following expenses - $1,150 property management, $1,000 insurance, $300 property taxes, $500 lawn care, and $500 miscellaneous. If you want to earn 8% on your net operating income, how much should you pay for the house?

---big lots of answers---

Perpetuity

-An annuity in which the cash flow continues forever ■Ex. - Preferred stock that pays a dividend of $500/year (forever)

problems with financial statement analysis

-Conglomerates - ex.) GE - aviation, finance, power -Who are their peers? -Difficulty understanding segments -Latitude in accounting procedures

What is ratio analysis?

-Creating metrics from balance sheet and income statement figures to be used for comparative purposes ■Ex.) profit margin = net income/sales -Company A has $5 million in net income and $40 million of sales -Company B has $1 million in net income and $2 million of sales ■Co A has a profit margin of 12.5% ■Co B has a profit margin of 50%

Examples of investments must beat inflation to maintain todays buying power

-Ex.) Investment return = 10% and Inflation = 3% = the real value of your $ is growing at 7% -Ex.) Investment return = 2% and Inflation = 4% = the real value of your $ is declining at 2%

Time trend analysis

-How benchmarks change over time -What has the profit margin done over 10 years?

Peer group analysis

-How benchmarks compare against competition ■PE Ratio over years ■ROA and ROE over years ■Inventory Turn over years

Why would anyone valuate financial statements?

-Internal Use ■Management assesses health of the company ■Compensation -External Use ■Creditors and Investors assess the health of the company ---Lenders ---Suppliers/Vendors ---Competition ---Acquisition

Why are APR and EAR not the same thing?

-It's because the government dictates how the APR must be calculated ■Ex. Car loan of 1% per month = 12% APR What's the EAR?

Amortizing loan payments consist of a principal and interest component.

-Principal payment portion reduces the amount of the outstanding loans -Interest payment portion goes to the lender as interest income

Annuity Due

-an annuity for which the cash flows occur at the beginning of the period ■Ex.) Rent payment on apartment - paid on the 1st of the month, not 30th

Perpetuity

-an annuity in which the cash flows continue forever. -PV of a perpetuity = C/r

Stated Interest Rate

-the interest rate expressed in terms of the interest payment made each period. ■An APR (Annual Percentage Rate) is a stated interest rate ■Ex.) 10% compounded semiannually -$1 * 1.05^2 = $1.1025 vs. $1 * 1.1 = $1.10

How many annuity payments are made when the present value is $1,243.43 and the monthly payments are $500 and the interest is10%?

3

Days' Sales in Inventory

365/inventory turnover

days sales in receivables

365/receivables turnover

Aunt Burtha also put $2,000 into a different savings account for your brother when he was born 18 years ago. If his account has $4,813.24 in it today, what rate of return did his account earn?

5%

You decide to borrow money from Cousin Vinnie and he has agreed to a 20 percent interest rate per year. If you borrowed $200, and know you have to pay him in full exactly $716.64 (and make no other payments to him), how long from now until you must pay him back?

7 years

Annuities

A level stream of cash flows for a fixed period of time ■Ex. An investment that pays $5,000/month for 15 years (lottery, annuity contract with a life insurance company, legal settlement) ■Ex2. - A 30 year home loan with fixed payments of $2,400/month ■Ex3. - a 7 year car loan with fixed payments of $375/month

Compounding

Accumulating interest on an investment to earn even more interest

Cash ratio

Cash / Current Liabilities

Liquidity ratio

Can the company pay current obligations

long term solvency ratios

Can the company pay long term obligations

times interest earned ratio

EBIT/ interest expense

Common Sized Balance Sheet

Express each item as a % of total assets

Common Sized Income Statement

Express each item as a % of total sales

Present value formula

FV/(1+r)^t

Future value calcualtion

FVt = PV0 x (1 + r)^t

Asset management or turnover ratios

How effective is mngt at using assets to generate profits

Profitability Ratios

How profitable is the company in comparison to competition

Why is a dollar worth more today than in the future?

Interest and inflation -When we look into the future; money is worth less -This matters to a finance manager because all assets are valued by how much cashflow they produce in the future

Compound interest

Interest on interest

Simple interest

Interest on principal only; interest not paid on accumulated interest

Market Value ratios

Is the company over or under valued

-What is the EAR when a loan is expressed with an APR of 12% calling for monthly payments?

NULL

Return on Equity

Net Income/Total Equity

Does APR = EAR

No

Sources and Use of cash

One of the most important things in finance is to understand cash inflows and outflows

An investment offers $5,500 per year forever, with the first payment occurring one year from now. If the required rate of return is 6% What is the value of the investment? What if the $5,500 payment started in 6 years..what is it worth today?

PV = 91,666.67 PV = 68,498.67

Price Earnings Ratio

Price per share/EPS

What is the EAR for 7% compounded quarterly, monthly, daily?

Quarterly = 7.19 Monthly = 7.23 Daily = 7.25

Effective annual rate

The interest rate expressed as if it were compounded once per year -- The EAR = (1.1025/1)-1 = 10.25%

discounting

moving left on the timeline (price is like it would be in the past)

profit margin formula

net income/net sales

earnings per share

net income/shares outstanding

Amortize

reduce or pay off debt with regular payments

Future Value

the amount an investment is worth after one or more periods

inflation

the amount of buying power your money loses over time

Interest

the amount you can earn on your money - savings account

present value

the current value of future cashflows discounted at the appropriate discount rate

discount rate

the rate used to calculate the PV of future cash flow (i.e. interest rate)

total assets to debt ratio

total assets / total liabilities

Total Debt Ratio

total liabilities/total assets

Information about amortizing

■Balloon payments are a common feature in amortizing loans ■The payment is calculated using a longer term (ex 20+ years) resulting in a low monthly payment ■The full balance of the loan has a duration that is shorter than the amortizing period. Ex.) the loan is due in 5 years.

Pure discount

■Ex.) Short term U.S. Treasury - make a payment today (PV); receive a larger payment in the future (FV)

Amortized

■Ex.) home loan or car loan ■Loan payment consist of principal and interest

Interest Only

■Ex.) loan payment is interest rate * principal ■What's the loan payment for a 10% I/O loan with a $10,000 balance?

FNB charges 12.4% compounded monthly on its business loans. First United Bank charges 12.7% compounded semi-annually. As a potential borrower, which bank would you go to for a new loan?

■FNB = 13.1296 ■First United = 13.1032

Information about interest in loans

■The loan calls for interest payments only - the interest can be paid out, or the interest can accrue ■Sometimes construction loans are set up as I/O loans, usually with short durations 1-3 years ■At loan maturity the principal and any unpaid interest are due