C214 Pre-Test Q & A

A company issues bonds at a market price of $925. The face value is $1000. The bond matures in 10 years, and the coupon rate is 6% compounded semiannually. What is the yield to maturity (YTM) on the company's bonds?

7.06%

A company issues bonds at a market price of $925. The face value is $1000. The bonds mature in 10 years, and the coupon rate is 6% compounded semiannually. What is the yield to maturity (YTM) on the company's bonds?

7.06% PV = -925 FV = 1000 PMT = 30 (= 6% × 1000)/2 semiannually n = 20 10 years x 2 semiannually Solve for I/Y =3.529 X2 to bring back to annually

Partial financial data for the company is as follows assets $10,000,000 Liabilities $4,000,000 Equity $6,000,000 Sales $25,000,000 Profit margin 20% Dividends $500,000 Divided payout ratio 10% ROA 50% ROE 83% What is the sustainable growth rate for the company?

75% ROE x (1 - dividend-payout ratio) b is the dividend payout ratio (dividends/net income) .83 x (1-.10) .747 Sometimes its a 1-

A company has a market value of $500 million. It has a market value of equity of $200 million, a market value of long-term debt of $150 million, and a market value of short-term debt of $150 million. The cost of equity is 12%, the cost of long-term debt is 8%, and the cost of short-term debt is 6%. The marginal tax rate is 35%. What is the weighted average pre-tax cost of capital (WACC) for this company?

9.0%

A company has a before-tax cost of common equity of 14%, a pre-tax cost of debt 6%, a cost of preferred equity 8%, and a marginal tax rate of 34%. The current market value of the company is $150 million, with $75 million common equity, $50 million debt, and $25 million preferred equity. What will the company's weighted average pre-tax cost of capital be?

9.7%

Degree of Operating Leverage is known as Business Risk

A DOL of 2.5 means that if there is a 1% increase/decrease in Sales it will lead to a 2.5% +/- in EBIT

What is the definition of a current asset?

A current asset is cash or any other asset that can be converted to cash within 12 months.

What is the definition of a current liability?

A current liability is any liability that has to be paid within 12 months.

How does the anticipation of bankruptcy affect a firm's capital structure?

A firm facing bankruptcy will reduce debt to avoid associate high levels of bankruptcy costs

How does the anticipation of bankruptcy affect a firm's capital structure?

A firm facing bankruptcy will reduce debt to avoid associated high levels of bankruptcy costs

How does the anticipation of bankruptcy affect a firms capital structure?

A firm facing bankruptcy will reduce debt to avoid associated high levels of bankruptcy costs. TRUE!

What do cash flows from investing activities generally relate to?

A firm's purchase and sale of long-term assets

FCFF(free cash flow to firm)

A measure of financial performance that expresses the net amount of cash that is generated for the firm, consisting of expenses, taxes and changes in net working capital and investments.

How does credit rating impact the cost of capital?

A rating downgrade will increase the cost of capital.

APR v. APY (on exam!!!)

APY (aka: effective yield OR effective annual rate). The difference between APR & APY is compounding frequency. Recall, that m is the number of compounds per year. (APR equals the APY when interest compounds are exactly annually) If compounding frequency is greater than once per year (m > 1), then the effective yield(APY) will be greater than the APR. This is because the APY includes the compounding nature of interest. Effective yield(APY) = [1 + (i / m)]m - 1 Where i is the stated (or annual) rate. For our savings example, the effective yield is: Effective yield = (1 + .02)4 - 1 = 8.24% EX: The equation to compute the APY is: APY = (1 + APR / m)m - 1 where m is the number of compounds in a year. So suppose you are interested in a semiannual bond with a 3% APR, this is how you would compute the APY: APY = (1 + (0.03 / 2))2 - 1 = 3.0225%. At first blush, the APY looks very close to the APR; there is a difference of only 0.0225%. However, realize the compounding period was only semiannual. Let's suppose you have a credit card with a 18% stated rate (APR) that compounds daily. What would be that APY? APY = (1 + (0.18 / 365))365 - 1 = 19.716%. After tax, tax @ .30, then 1-30=70, so (19.716 -70%) = 5.91

APY Compounding question: Which of the following gives the largest rate (APY)?

APY Compounding question: 18.6% compounded DAILY Largest effective rate is Higher with Frequency

APY: Suppose that an investment will pay 24% APR for a year and that the interest will be compounded monthly. What is the expected return (APY) of the investment?

APY: =0.2682 or 26.82% APY=(1+APR/n)12th -1 where "n"= the # of compounding periods. APY=(1+(0.24/12))12th -1

What is the acceptance criterion when using internal rate of return to evaluate a project?

Accept when project is great than the required return. TRUE!

What is the acceptance criteria when using internal rate of return to evaluate a project?

Accept when the project return is greater than the required return

Finance v Accounting

Accounting- is backward-looking and risk free. Finance- is forward-looking and involves massive uncertainty.

Which financial ratio is used to measure a company's effectiveness in extending credit as well as collecting debts?

Accounts Receivable Turnover

Which financial ratio is used to measure a company's effectiveness in extending credit as well as collecting debts?

Accounts Receivable Turnover. TRUE!

Which type of investment will a risk-averse investor most likely invest in?

Actively managed funds. FALSE! The correct answer would be Index Funds. TRUE!

Bond (ratings)

All publicly traded bonds have ratings that measure the level of risk of bonds. Ratings are given by prof rating agencies that evaluate the creditworthiness of the co. that issued the bond (like S&P, Moody's, and Fitch). EX: If a firm has high debt ratios and low liquidity ratios, it will be viewed as more risky than a firm with similar operations and market share but lower debt ratios and higher liquidity ratios. AAA-BBB = very low risk, investment grade bonds BB and below = very high risk (speculative or high-yield debt bonds, aka: JUNK BONDS)

Which 2 techniques would be considered effective ways to manage the growth of a firm, if additional financing is not available?

Alter capacity Increase sales price

What leads to an increase in APY?

An increase in the frequency of compounding - like going from annual to monthly compounding.

What statement are required to be filed with the SEC?

Annual audited financial statements.

Under which circumstances will annual percentage yield (APY) is greater than the annual percentage rate (APR)?

Any time the number of compounding periods is greater than annual

Under which circumstances will annual percentage yield (APY) be greater than the annual percentage rate (APR)?

Anytime the number of compounding periods is greater than annual

What is the basic equation for a balance sheet?

Assets = Liability + Equity

Balance Sheet

Assets= Liabilities -Eq (or) Equity = Assets - Liabilities Assets = Eq (If liab is 0)

What is the basic equation for a balance sheet?

Assets=liabilities+equity

Balance Sheet: Basic equation for the Balance Sheet is?

Balance Sheet: Equity = Assets - Liabilities, or it can also be seen as Assets = Liabilities + Equity

Dodd-Frank regulates which segment of the US Economy?

Banking Industry.

Income Statement (simple)

Basic equation Rev-Exp(all)=NI Rev-Exp[COGS(DM&DL)]= GP GP - Operating Exp= EBIT(op profit) EBIT - Int Exp= EBT EBT- Tax Exp= NI(earnings) Note: Tax expense as reported on the income statement may have little resemblance to taxes actually paid.

Why are American regulators focused on international investing in a global marketplace?

Because international investing in a global marketplace is the concern of American investors

Why are American regulators focused on international investing in a global marketplace?

Because international investing in a global marketplace is the concern of American investors. TRUE!

Bond (valuation)

Bond Valuation = PV of its cash flows and means the "Intrinsic Value of any Asset = PV of the Stream of Expected Future Cash Flows Discounted at an appropriate Required Rate of Return." "Four solve Five" Four inputs defines the unknown-the fifth button- this unknown will usually be PV or I/Y (in bonds I/Y= yield to maturity). IF YTM and Coupon Rate are equal, then FV=PV(ignoring transaction costs) aka: "Issuing at Par".

What is one of the two basic types of financial instruments?

Bonds

Bonds

Bonds the primary method for raising capital b/c they avoid the costs of the intermediary; bankster costs! Bond Valuation = PV of its cash flows, this means the intrinsic value of any asset is the "PV of the Stream of Expected Future Cash Flows Discounted at an appropriate Required Rate of Return." Bonds make up about 75% of capital supplied to firms. Bonds are classified as fixed-income securities, meaning they pay a fixed interest pmt each year. - Pmts are most commonly paid semiannually on corporate bonds, but may be paid annually or even monthly (common on some gov bonds). The bond market is about three times as big as the stock market on a world scale. - Typical bond cash flows resemble those of an interest-only loan—none of the principal is repaid until the end of the bond. Bond cash flows are comprised of two distinct parts: 1. Stream of annual or semiannual interest payments (an annuity) 2. Final principal repayment (a lump sum).

A broker is considering purchasing common stock in a co. that has average but consistent ops performance. Which factor should lead broker to purchase shares in co?

Broker would purchase if price is BELOW Intrinsic Value. TRUE!

TVM in Valuation and Risk Assessment

Business decisions that involve cash flows stretching farther than a few months in future involves TVM analysis. To optimize decision making at your firm, TVM analysis needs to be as basic as breathing!! Applications used: Entrepreneurial Finance: Early stage companies frequently need to attract capital to develop products and markets. Venture capitalists require compensation for investing in these risky ventures and use TVM extensively to evaluate the benefits and related costs of investing. Capital Budgeting: is the process of deciding in which potential projects a firm will invest. This requires an exacting calculation of cash flows over time. TVM calcs the benefits and costs of accepting a project. The creation of value within the firm requires careful analysis of these complex long-lived cash flows. Regulatory Compliance: When evaluating the regulatory structure of potential new markets or products or faced with regulatory changes, TVM tools allows managers to evaluate compliance alternatives (i.e., outsourcing, capital investment, and whether to partake in an specific industry.) Social Responsibility: Corporate citizenship can be an important part of firm operations in that alternatives involve long-term decisions, TVM is valuable in optimizing decisions. Risk Assessment: TVM plays a critical role in risk assessment. Frequently takes one of two forms: 1. Risk buckets: Projects are grouped into "risk buckets" with different return requirements. (i.e., high-risk projects are assessed in one bucket with high return requirements. TVM is used to assess the expected return of each project for comparison to the appropriate required return. 2. Sensitivity analysis: TVM is used to assess the PV of projects under diff input assumptions. (i.e., if evaluating a potential merger, "sensitivity analysis" allows you to find the value of the target firm under diff revenue and/or cost projections. Valuations inform managers about risk of merger at various prices.

How can a private firm appropriately maximize shareholder value?

By making decisions that keep control of the business with the owners. TRUE!

How can a private firm appropriately maximize a sharholder value?

By making decisions that keep the control of the business with the owners

How can a private firm appropriately maximize shareholder value?

By making decisions that keep the control of the business with the owners

How does the SEC regulate the financial industry?

By requiring public disclosure of information about entities that sell public equity or debt

How does the Securities Exchange Commission (SEC) regulate the financial industry?

By requiring public disclosure of information about entities that sell public equity or debt

What advantage does the capital asset pricing model (CAPM) have over the Gordon growth model?

CAPM considers risk of a stock relative to the market to determine expected return

What advantage does the capital asset pricing model (CAPM) have over the Gordon growth model?

CAPM considers risk of a stock relative to the market to determine expected returns

What advantage does the CAPM have over the Gordon Growth?

CAPM considers risk of stock relative to the market to determine expected returns. TRUE! CAPM model considers risk.

What are 2 primary benefits of the capital asset pricing model (CAPM)?

CAPM provides a way to determine the expected return for stocks CAPM provides a way to incorporate risk

What are two primary benefits of the capital asset pricing model (CAPM)?

CAPM provides a way to determine the expected return for stocks. CAPM provides a way to estimate the required returned.

CFO(Cash Flows from Operations)

CFO includes all cash flows related to producing and selling the firm's product, such as cash coming in from customers, cash flowing out for raw materials and operating expenses, and cash flowing out for taxes. While this may appear to be the same way net income is calculated, don't be fooled. Net income is an accounting concept—it is not CFO. CFO = Net Income + depreciation expense +/- changes in operating assets (Note: add decreases and subtract increases) -/+ changes in operating liability accounts (Note: add increases and subtract decreases)

Capital Asset Pricing Model: Where along the line will a highly risk-averse investor likely fall?

Capital Asset Pricing Model: C1 - on a graph. Pick the most dense area.

Capital Structure. Degree of Financial Leverage: What is the DFL given Sales of $100k, Variable costs of $60k, Fixed Costs of $15k and Interest Expense of $4k?

Capital Structure. Degree of Financial Leverage: Calculate EBIT by Sales-VariableCosts-FixedCosts =EBIT is 100k-60k-15k=25k DFL=EBIT/(EBIT-IntExp) = 25k/(25k-4k) =25k/21k=1.19

Cash Flow from Finance Activities (Cash Inflow): If net change in long term liabilities is $20k, there is no change in common stock, and dividends paid are $5k, what is the cash flow from financing activities?

Cash Flow from Finance Activities (Cash Inflow): CFFFA=Net Change in Common Stock + Net Change in Liabilities - Dividends =0+20k-5k=$15k Cash Inflow from FA

Cash Flow from Investing Activities: Last year firm recorded Net PP&E of $4,600, this year Net PP&E at $4,500. If depreciation expense for last year and this year are $500 and $800, what is the CFI of company?

Cash Flow from Investing Activities: ($700) CFI=$4,600+ X - $800 = $4,500 X=4500-4600+800=700 700 of PPE was purchased, cash outflow of (700)

Cash Flow from Investing Activities: If net change in PPE is $10k and depreciation expense is $2k, what is the Cash Flow from investing activities?

Cash Flow from Investing Activities: End PPE=Beg PPE + X - Depreciation (End PPE-Beg PPE)+Dep=X X=$10k+$2k=$12k Cash Outflow from investing activities

Cash Flow from Investing Activities: Which of the following would be considered a cash outflow in the Investing Activities section of the Statement of Cash Flows?

Cash Flow from Investing Activities: Purchase of equipment.

Cash Flow from Operating Activities: A company reports an increase in $5k in Accounts Receivable for the year and half will be collected next year. What is the impact on the cash flow from operations?

Cash Flow from Operating Activities: $5,000 decrease in cash flow for the year Accounts Receivable +/- decrease/increase in Current Assets

Cash Flow from Operating Activities: Which of the following would be added to Net Income in the operating activities section of a Statement of Cash Flows prepared using the indirect method?

Cash Flow from Operating Activities: ...an Increase (+) in Accounts Payable

Cash Flow from Operating Activities: Examples of Current Liabilities?

Cash Flow from Operating Activities: Accounts Payable -/+ decrease/increase in Current Liabilities

Cash Flow from Operating Activities: Examples of Current Asset?

Cash Flow from Operating Activities: Accounts Receivable +/- decrease/increase in Current Assets

Cash Flow from Operating Activities: If a company reports net income of $100k, depreciation of $20k, and an increase in Accounts Payable of $5k, what is the cash flow from operating activities?

Cash Flow from Operating Activities: CFFOA=$100k+$20k+$5k = $125k Inflow Accounts Payable -/+ decrease/increase in Current Liabilities

Cash Flow from Operating Activities: If a company reports net income of $100k, depreciation of $20k, and an increase in Accounts Receivable of $5k, what is the cash flow from operating activities?

Cash Flow from Operating Activities: CFFOA=$100k-$20k-$5k = $115,000 Inflow Accounts Receivable +/- decrease/increase in Current Assets

What does free cash flow represent?

Cash available for distribution after funding required reinvestment

What does Free Cash Flow represent?

Cash available for distribution after funding required reinvestment. TRUE!

Cash Flow

Cash flow is a fact; net income is an opinion.

Which transaction is reflected in cash flow from operating activities?

Cash sales to customers

Cash v Accrual

Cash syst: yr 2001=Exp $75K (NI=$0, thus $75K loss); yr 2002 = Rev @ $100K (thus, 100K Net Inc) Accr syst: yr 2001=Exp $0 ($0 net income); yr 2002 = Rev $100K and Exp $75K ($25K Net Inc)

Regression analyses

Common type: Ordinary Least Squares The slope of the regression line: BETA (not alpha) Slope of this regression line? 4.2 & 3: 4.2/3 =1.4 Covariance: 3.5 & 2: 3.5/2= 1.75

What is an example of a timing difference?

Companies using different fiscal years.

Company A has a degree of operating leverage of 1.85 and Comapny B has a degree of operating leverage of 6.5. What does the degree of operating leverage say about the 2 companies?

Company A has lower risk than Company B

Company A has a degree of operating leverage of 1.85 and Company B has a degree of operating leverage of 6.5. What does the degree of operating leverage say about the two companies?

Company A has lower risk than Company B

Computation of Net Income: A co. sold products in 2014 for $120k and collected $100k cash and remainder in 2015. Co. incurred $70k expenses for 2014 and paid $100k which included $30k for expenses incurred in 2013. What is net income for 2014?

Computation of Net Income (R-E=NI) $50,000 Net Income = $120k - $70k = $50k, or Revenues - Expenses Incurred = Net Income

Compute After Tax Proceeds on Sale of Equipment - Terminal Cash Flow: Equipment w/a book value of $10k sold for $15k. Tax rate 30%. What is the proceeds from sale of equip?

Compute After Tax Proceeds on Sale of Equipment - Terminal Cash Flow: Gain on equip=$15k-$10k=$5k Tax on Gain=0.30*$5k=$1,500 Proceeds from sale of equip=$15=$1,500=$13,500

Current Ratio: Lil Corp's total current assets 390k, non-current assets 630k, current liabilities $330k, long-term liabilities $420k stockholders' equity $270. The Current Ratio is closest to?

Current Ratio: 1.18 CurrentRatio=CurrentAssets/CurrentLiabilities $390,000/$330,000=1.18 Means $1.18 in Liquid assets to $1 in Current Liabilities!

The figure below represents the levels of market efficiency. Which investment option is less desirable for a prudent investor? A, B, C, D

D

Which investment option is less desirable for a prudent investor?

"E" The lower right quadrant which has Low yield and Hight risk.

A broker is considering buying a dividend-paying stock. The dividend will be paid at the end of the year. The analyst consensus is the stock will be worth $36 in one year. The company pays a $2.25 annual dividend (ex. dividend date is not a consideration, the broker will receive the full $2.25), and the broker expects a 12% rate of return. What is the highest price the broker should be willing to pay for the stock?

$34.15 I/Y = 12, n = 1, FV = 38.25

Ratios (efficiency)

(measure how effectively a company/management team uses assets to generate sales or profits) 1. Total Asset turnover (TAT)= sales / total assets 2. Fixed Asset turnover(FAT) = sales / fixed assets 3. OIROI = operating income / total assets

Terminal Cash Flow consists of?

...after tax proceeds from the sale of asset and release of working capital.

Ratios (most common)

1) Liquidity ratios- a firm's ability to meet short-term obligations. Used by short-term creditors such as banks and suppliers. 2) Asset use efficiency 3) Financing 4) Profitability

Security Exchange Commission Exceptions are two?

1) Regulation S: If company wants to sell securities in foreign country, no need to get SEC permission 2) Rule 144A: When company sells equity to a large institutional investor, no need to get SEC permission. Certain private resales of minimum of $500,000 units of restricted securities to qualified institutional buyers.

A person buys shares of a company at $45. They recently paid a $2 annual dividend which is expected to grow by 10% per year. What is the expected return per year?

14.9 ERR formula Gorden Growth formula ((2(1 + .10)) ÷ 45) + .10 = .149 14.9%

A person buys shares of a company at $45. They recently paid a $2 annual dividend which is expected to grow by 10% per year. What is the expected return per year?

14.9%

Based on data below what is the current ratio? Accounts Rec $600 Inventory $800 Fixed Assets $1,000 Accounts Pay $500 LongtrmDebt$900 CommnStock$400

2.8 Current ratio = (CurrentAssets)/Accounts Payable (600+800)/500=2.8

A bond pays $27.50 semiannually, matures in 9 years, and is currently priced at $1,090. What is the yield to maturity for this bond?

4.28%

Bond pays $27.5 semi-annual (x2), par value $1k, matures 9 yrs and priced at $1,090. What is the Yield-to-Maturity?

4.28% N=18(9yrs*2 for semi-annual) I/Y=??? (should be 4.28%) PV=1,090 PMT=27.5 FV=1,000 Multiply answer (2.14) by 2 (semi-annual) to get YTM of 4.28%

A company has a before-tax cost of common equity of 14%, a pre-tax cost of debt 6%, a cost of preferred equity 8%, and a marginal tax rate of 34%. The current market value of the company is $150 million, with $75 million common equity, $50 million debt, and $25 million preferred equity. What is the company's weighted average pre-tax cost of capital?

6.5% key is pre tax, if it says pre-tax dont

A company has a market value of $500 million. It has a market value of equity of $200 million, a market value of long-term debt of $150 million. The cost of equity is 12%, the cost of long -term debt is 8%, and the cost of short-term debt is 6%. The marginal tax rate is 35%. What is the weighted average per-tax cost of capital (WACC) for this company?

9.0%

A company has a before tax cost of common equity of 14%, pretax cost of debt 6%, cost of preferred equity 8%, marginal tax 34%. Current Market Value $150 million w/$75 million common equity, $50 million debt and $25 million preferred equity. What is the After tax weighted average cost of capital?

9.7% WACC=(75/150)*0.14+ (50/150)*(.06*.66) +(25/150)*.08 = .09653 or 9.7%

Why do companies strive for lower cost of capital?

A lower cost of capital positively affects credit rating. TRUE!

What is Beta?

A measure of systematic risk, relative to market risk.

Operating Income

AKA: EBIT (earnings before Interest and taxes)

Which financial ratio is used to measure a company effectiveness in extending credit as well as collecting debts?

AR turnover

Long-Term debt takes how many months?

Beyond 12 months

What is one of the two basic types of financial instruments

Bonds

Where along this line will a highly risk-averse investor likely fall? efficient frontier chart

C1

What is an example of accounting difference?

Companies using different accounting methods.

Initial Outlay consists of?

Cost of the Asset Shipping Costs Investment in Working Capital

EBIT

Earnings Before Interest & Taxes (AKA: Operating income)

What is the formula for Retained Earnings?

Ending Retained Earnings= Beginning RE+NI-Dividends

Free Cash Flow = Cash Flow from Operations - Change in Net working capital Investment in PPE

Free Cash Flow = ((EBIT)*(1-Tax rate) + Depreciation) - Change in Net working capital - Investment in PPE

Market risk premium

Is the difference between the expected return for the market and the risk free rate

Why do companies strive for a lower cost of capital?

Less money dedicated to financing means more money is available for production and operations.

Stock Orders (2 types)

Market orders- are time sensitive and would execute at the current ask price. Limit orders- -Buy Limit Order can only be executed at the limit price or lower -Sell Limit Order can only be executed at the limit price or higher.

A person needs to determine the cost o replace a company's property, plant, and equipment using the replacement cost method. Which value does this person need to consider in order to make this determination?

Market value

Which securities are issued by local gov and are usually tax exempt at fed level?

Municipal Bonds. TRUE!

Fixed Asset Turnover =

Net Sales / Average Net Fixed Assets

Which document is required to be made available prior to a firm going public, according to the Securities Act 1933?

Prospectus

What factors are considered for the initial outlay of a new investment?

Purchase price of new equipment Shipping costs Investment in working capital.

Which action is an important part of managing accounts receivable?

Setting credit terms

Do stock holders or bond holders have voting rights?

Stock holders have voting rights.

What are inventory related costs?

Storage costs Opportunity costs Product costs

Spread

The difference between the bid price and the ask price. If the price of a particular stock begins to heavily fluctuate, then the specialist will INCREASE the spread.

What is the Par Value (face value) of a bond?

The par value is the amount that is payable on maturity. TRUE!

Which happens to risk level in a portfolio as the number of assets in the portfolio increase?

There is a linear decrease risk. FALSE! The risk decreases but the decrease is NOT linear. TRUE!

What is the risk associated with debt financing?

Too much debt can lead to bankruptcy.

A company is preparing a pro forma balance sheet. The company forecast $10 million in projected sales. The projected cash needed 6% of sales, AR are 19% of sales, and PP&E are 50% of sales. Accounts payable has been 12% of sales, historically. Shareholders equity is $1.5 million. Pro forma income is $3.6 million. The company has no long-term debt. What is the total discretionary amount for the pro forma balance sheet?

$1.2 million

A company preparing a pro forma balance sheet. The company forecast $10 million in projected sales. The projected cash needed 6% of sales, accounts receivable are 19% of sales, and PP&E are 50% of sales. Accounts payable has been 12% of sales, historically. Shareholders' equity is $1.5 million. Pro forma income is 3.6 million. The company has no long-term debt. What is the total discretionary amount for the pro forma balance sheet?

$1.2 million

The market rate of return is 9%. The face value of the bond is $1000, the coupon rate is 9% with annual compounding, and the bond matures in 10 years. What is the value of the bond?

$1000

The market rate of return is 9%. The face value of the bond is $1000, the coupon rate is 9% with annual compounding, and the bond matures in 10 years. What is the value of the bond?

$1000 N = 10 FV = 1000 PMT = 1000*.09 = 90 I = 9 solve for PV=1000

A teacher won $100,000 and invests this money for 5 years at an interest rate of 4% (compounded annually). How much will the teacher have in principal and interest at the end of the 5 years?

$121,655 PV=-100,000 I/Y=4 N=5 CPT FV

A teacher won $100,000 and invests this money for 5 years at an interest rate of 4% (compounded annually). How much will the teacher have in principal and interest at the end of the 5 years?

$121,665

Year 2010 ending retained earnings were $2,000,000. Year 2011 forecasted sales are $100,000 with a 25% net margin and 20% dividend payout ratio. What are the forecasted retained earnings for Year 2011?

$2,020,000

Year 2010 ending retained earnings were 2 millions. Year 2011 forecasted sales are $100,000 with a 25% net margin and 20% dividend payout ratio. What are the forecasted retained earnings for Year 2011?

$2,020,000

A company would like to invest in a capital budget project that will be worth $500,000 in 40 years. How much should the company invest today, assuming an average inflation rate of 2% and a 10% annual return?

$23,015 inflation adjusted return. That is done by doing the following: (1 + Return Rate) ----------------------- - 1 = Inflation Adjusted Rate of Return (1 + Inflation Rate) If Annual Return = 10% Inflation = 3% (1 + .10) 1.10 ----------- - 1 = ----- - 1 = .068 or 6.8% (1 + .03) 1.03 Once you have the adjusted return it becomes your I/Yr number.

An investor deposits $2000 per year (beginning today) for 10 years in a 4% interest bearing account. The last cash flow is received 1 year prior to the end of the tenth year. What is the investor's future balance after 10 years?

$24,012 n=10, I/Y=4, PMT=2000 solve for FV

A company would like to invest in a capital budget project what will be worth $500,000 in 40 years. How much should the company invest today, assuming an average inflation rate of 2% and a 10% annual return?

$24,393

An investor deposits $2,000 per year (beginning today) for 10 years in a 4% interest bearing account. The last cash flow is received 1 year prior to the end of the tenth year. What is the investor's future balance after 10 years?

$24,973

An accountant is 40 years old with an anticipated retirement age of 70 years old. The accountant plans to save $6,000 per year at the end of the next 30 years to fund retirement. How much will the accountant have upon retirement, if the accountant is able to earn 4% annually on his investment?

$336,510

An accountant is 40 years old with an anticipated retirement age of 70 years old. The accountant plans to save $6,000 per year at the end of the next 30 years to fund retirement. How much will the accountant have upon retirement, if the accountant is able to earn 4% annually on this investment?

$336,510 N=30 PMT=-6,000 I/Y=4 solve for FV

A broker is considering buying a dividend-paying stock. The dividend will be paid at the end of the year. The analyst consensus is the stock will be worth $36 in one year. The company pays a $2.25 annual dividend (ex dividend date is not a consideration, the broker will receive the full $2.25), and the broker expects a 12% rate of return. What is the highest price the broker should be willing to pay for stock?

$34.15

What is the firms cash flow from investments, using the data above and assuming no asset disposals?

$5,300 outflow **CFI = Change in Net PP&E + Depreciation Expense

A corporation established its projected sales at $210 million. It is using its current year balance sheet as a basis for creating a pro forma balance sheet. They estimate cash will be 7% of projected sales, accounts receivable will be 19% of projected sales, and PP&E will be 55% of projected sales. Accounts payable are estimated to be 12% of projected sales. Owners' equity is $34 million. Long-term debt is $90 million. Additionally, the firm raised $12.9 million of equity capital. What is the amount of discretionary financing needed?

$8 million

A corporation established its projected sales at $210 million. It is using its current year balance sheet as a basis for creating a pro forma balance sheet. They estimate cash will be 7% of projected sales, accounts receivable will be 19% of projected sales, and the PP&E will be 55% of the projected sales. Accounts payable are estimated to be 12% of projected sales. Owner's equity is $34 million. Long-term debt is $90 million. Additionally, the firm raised $12.9 million of equity capital. What is the amount of discretionary financing needed?

$8 million

Corp Projected Sales (PS) at $210 million. Cash at 7% PS, Accounts Receivable at 19% PS, and PP&E at 55% PS. Accounts Payable at 12% PS. Owners Equity at $34 million. Long-term debt $90 million. Firm also raised $12.9 million in equity capital. What is the amount of DFN?

$8,000,000 DFN=(Projected Assets+PA) - Projected Liabilities - Owner's Equity - Long-term debt - Raised Equity Capital DFN=(.07x21)+(.19*210)+(.55*21) - (.12*210)-34-12.9-90 = 8 million

Cashflows (SCF-statement of cashflows)

(3 subdivisions) Operations, investing, and financing refer to the three types of decisions made by managers: 1. Operational decisions- (CFO-cash from ops), include what to produce, how to produce it, whom to sell it to, whom to use for suppliers, etc. CFO measures the net cash impact of operating decisions. 2. Investing activities- (CFI-cash from investing, acquisitions, and PP&E) involve decisions concerning the purchase and sale of long-term assets, such as conveyor belts or the construction of new production facilities. CFI measures the net cash impact of investing decisions. 3. Financing decisions- (CFF-cash from financing) deal with the issuance of debt and equity, the repayment of debts or repurchase of stock, and the payment of dividends. CFF measures the net cash impact of financing decisions.

CFI (Cash Flows from Investments)

(An increase in gross PP&E from one year to the next represents a use of cash (we had to use cash to purchase more fixed assets-cash outflow. an increase in assets represents an OUTFLOW of cash.) Formulas: CFI = Gross PP&E (end) - Gross PP&E (begin) or CFI = Change in Net PPE + depreciation expense. _____________________________________________________ (no assets sold) assume a firm has depreciation expense for 20x2 of $250, and reports net PP&E as 20X1 $1,100 20X2 $1,300 Net PP&E: = 1,300-1,100=200 (Change in NPPE)200 + (depr exp for X2) 250= 450 CFI=450 ------------------------------------ *Change in Gross PP&E Gross PP&E (X1=3300; X2=3500) so Gross PPE = $200 *Changes in Net PPE (if gross PPE not given) EX 1: Net PP&E = Gross PP&E - Accumulated Depreciation; (so add depr to NetPPE to get gross) $1,100 = Gross PP&E - $500 or (1,100+500=1600) Gross PP&E = $1,600 EX 2: X1: NetPPE=900 accum depr=2,400 X2: NetPPE=1,000 acumdepr: 2500 1,000-900=100; 2500-2400=100 CFI=(change in NPPE)=100 + (Change in accum depr AKA: depc exp)=100 So CFI= 100+100= $200

Ratios ( liquidity)

(are firms' ability to meet short-term obligations) 1. Current ratio = current assets / current liabilities 2. Quick ratio("Acid test") = (current assets - inventory) / current liabilities 3. AR turnover = credit sales / AR ...or (net sales/avg AR)? 4. Average collection period = 365 / AR turnover 5. Inventory turnover = COGS / inventory 6. Days on hand = 365 / inventory turnover

Accrual Accounting & Matching Principle

(regardless of when a company incurs cost or revenue, it is reported only when the associated cost or revenue is recognized. Neither COGS not revenue represents actual cash.) allows managers to decide what is "recognized" on the financial statements. Accrual accounting: Revenues are recognized when the earnings process is complete; expenses are "matched" to recognized revenues. *The accrual system also employs the matching principle. The matching principle requires that revenue recognized must be matched with the expenses incurred to generate the revenue. *So, while both accrual and cash systems report $0 in revenue during 20x1, an accrual firm matches $0 revenues with $0 expenses. No revenues, no expenses! Likewise, the revenue from the two systems will be the same in 20x2. However, the accrual system "matches" the $100,000 in revenue with the $75,000 in expenses incurred to generate the revenue. Cash syst: yr 2001=Exp $75K (NI=$0, thus $75K loss); yr 2002 = Rev @ $100K (thus, 100K Net Inc) Accr syst: yr 2001=Exp $0 ($0 net income); yr 2002 = Rev $100K and Exp $75K ($25K Net Inc)

Annuities (due)

**Calc: (shift-BGN; shift-SET; shift-QUIT) =BGN back to END (shift-BGN; shift-SET; shift-QUIT)=END Ordinary annuity calculations assume payments occur at the end of the period. Annuities Due assume the payments come at the beginning of the period. Annuity Due simply shifts the timing of the PVA and FVA one period further into the future. PVA at the time of the first pmt or FV at period after last pmt = use Annuity Due approach. ( Leases are an example when contract and pmt are due @ same time.) PVA one period before the first pmt? use Ordinary Annuity approach. Characteristics of annuity due: 1. Payments are equally spaced 2. Payments of equal amounts 3. Payments are made at the "BEGIN" of each period

Market Prices

-Convey info to consumers. Perhaps the newly priced milk is of lower quality or the grocer has excess inventory. -Affect incentives. For instance, a sophisticated consumer might not be in the market for a brand new car at its current price. However, the dealership could incentivize the consumer by dramatically lowering the price. -Affect the distribution of income. Nearly all students would agree that the price of garbage collection is lower than the price of health care.

The Statement of Cash Flows is?

...explains the change in the cash balance for one period of time.

Differential Annual Cash Flows consist of?

...incremental cash flow generated every year.

Internal Rate of Return (IRR) is defined as?

...the discount rate that results in a Zero Net Present Value.

Net Present Value (NPV) is defined as?

...the net present value of after tax cash flows and is the most commonly used method in Capital Budgeting.

Capital Budgeting refers to?

...the process used in making investment decisions involving projects that generate cash flows over a multi-year horizon (more than a year).

What is portfolio ROR? Expansion prob 55%, Recess prob 45% Stock A - Expan R is 15%, Recess R 2% Stock B - Expan R is 12%, Recess R -3% We own $75k of A and $15k of B

.0851 E(r) for A=((.45*.02)+(.55*.15))*75k=6852.5 E(r) for B=((.45*-.03)+(55*.12))*15k=787.5 Portfolio Return=((6852.5+787.5))/90000=.0851

What is the expected ROR for a stock where treasury bills are returning 2.5% and the market as a whole is returning 15%. The stock has a beta of 1.25?

.181 E(r)=Rr + Beta (Rm-Rr) E(r)=.025+(1.25*(.15-.025))=.181

What is the Sustainable Growth rate given the following: Sales are 2.5 million Total Expenses 2 million Total Assets 3 million Equity 1.3 million Dividend payout ratio is .25

.2885 find out Net Income 2.5mil -2 mil NI=500,000 ROE is net income/equity 500,000/1.3mil ROE is .3846 Sustainable Growth Rate = ROE *(1-dividend payout ratio) .3846*(1-.25) = .2885

Types of Projected Liability?

1) Accounts Payable 2) Long-Term Debt

Which three pieces of data are needed to perform a capital budget analysis?

1) Annual Cash Flows for the life of the project 2) Initial Cost of the new project 3) Cash Flow when the firm terminates the project TRUE!

What are two primary benefits of the capital asset pricing model (CAPM)?

1) CAPM provides a way to determine the expected return for stocks 2) CAPM provides a way to incorporate risk TRUE!

Three types of Projected Total Assets?

1) Cash 2) Accounts Receivable 3) Property, Plant and Equipment (PP&E)

What are the two benefits of unbundling and offshoring?

1) It reduces costs and results in higher sales and employment 2) It allows for sale of intermediate and final goods at lower prices and increases employment

Secondary Markets (2 types)

1. Auction Market- an auction financial market has a physical location and prices are determined by the highest price an investor is willing to pay. The New York Stock Exchange (NYSE), the world's largest secondary financial market. NYSE has a single dealer that provides liquidity. *Some high frequency traders provide liquidity to the rest of the market. *If providing liquidity becomes more risky, then dealers will increase the spread. *If the price of a particular stock begins to heavily fluctuate, then the specialist will INCREASE the spread. 2. Dealer market- does not require a physical location. Securities are bought and sold through a network of dealers that trade for themselves. a dealer might hold inventory for particular stock and willing to sell to those that demand the stock and buy from those that will supply the stock. NASDAQ, (second-largest secondary market worldly), is example of a dealer market. Most stocks that are listed on NASDAQ have multiple dealers for each. The idea behind having multiple dealers providing liquidity to investors is that the dealers must compete with one another, thus lowering the cost of transacting.

Equity (importance)

1. Equity (usually common stock) will likely constitute a large portion of an individual's investment portfolio and retirement fund. (Investors need to understand the sources of stock value.) 2. Understanding how to determine the value of a company will help in deciding whether to join it. 3. Stock options derive their value from the stock of the company. (Understanding stock valuation will help in calculating the real value of the total compensation package.) 4. The stock market is one of the vehicles through which capitalism functions. (Those living in a capitalistic society need to understand stock valuation and the stock market to truly grasp the workings of their economy.)

Financial Securities (3 types)

1. Gov Securities(treasury bonds)- gov invest in natl defense to freeways. Loans provide by the public to gov. When tax revs fall short to cover expenditures, gov issues bonds from 60 days-30yrs. 2. Corporate Bonds- Google might be looking to invest another $50 billion in low-orbiting satellites; however, because of its size, the company cannot walk into a local bank hoping for a $50-billion loan. Instead, Google will likely issue bonds with a face value of $1,000 that make one or two annual coupon payments a year and might be paid back over a 20-year period. Corporate finance is NOT devoted to understanding various types of financial instruments; investments are. *Corporate finance focuses on the decision making by the management of the firm. 3. Stocks- share of ownership in a co. If Google did not want to borrow money from bondholders to finance the $50-billion low-orbiting satellite project, Google could sell shares of ownership in the company.

What is the beta of a stock where the expected ROR is 14%, the market premium is 7% and the Risk Free Rate is 3%?

1.57 Beta=(E(r)-Rf)(Rm-Rr) Beta=(.14-.03)/.07=1.57

Suppose that an investment will pay 24% APR for a year and that the interest will be comounded monthly. What is the expected return (APY) of the investment?

26.82% APY = [1 + (0.24 / 12)]12 - 1 APY = (1 + APR / m)m - 1 where m is the number of compounds in a year. So suppose you are interested in a semiannual bond with a 3% APR, this is how you would compute the APY: APY = (1 + (0.03 / 2))2 - 1 = 3.0225%.

A companys year end balance sheet for 2013: AR: 900 Inventory: 1200 Fixed assets: 1000 AP: 1300 Sales: 4000 Salaries: 275 What is their fixed asset turnover ratio?

4.0

A bond pays $27.50 semiannually, matures in 9 yrs, and is currently priced at $1090. What is the yield to maturity for this bond?

4.28 PMT =27.50 N=18 2x9 FV=1000 PV=-1090

Cash based accounting

cash in = revenue; cash out = expense

What is the difference between a common stock and a preferred stock?

common stock has no fixed maturity and preferred stock has a fixed maturity.

Markowitz Efficient Frontier

consists of a frontier of various portfolios of a given set of stocks that are efficient, or, in other words, have the highest level of expected return for a given level of risk. A risk averse investor that has a penchant for higher returns and lower risk will select a portfolio of stocks that is on the Markowitz Efficient Frontier, which will be located in Quadrant 1.

Line Items (non-spontaneous or discretionary accounts)

do not increase automatically with sales, left to the discretion of management in order to increase or decrease these accounts. (i.e., long-term debt, N/P, and common stock accounts, PP&E)

Syndicate

is a group that is temporarily formed to handle a bond or stock issue. Syndicates are generally made up of large investment banks or other types of institutional investors. These large investment banks that make up a syndicate might also be the underwriters of the security issue. An underwriter has the responsibility of determining the value of the security and then, in some cases, the underwriter will purchase all of the securities from the issuer and then sell them to other investors. Two ways a firm issuing a bond can place the bonds with a syndicate: 1. Competitive Sale- Those wishing to underwrite the bond issue will submit bids (on bond's prices and interest rate) to the issuing firm. Firm will then select the underwriter that offered the highest price and lowest interest rate. Underwriter will sell bonds to various investors at (hopefully) a slightly higher price than purchase price. 2. Negotiated Sale- like the competitive sale, a negotiated sale is the process of underwriters submitting proposals including bids. However, this latter type of sale involves a more thorough interview process with the underwriters. Further, the issuing firm will carefully select the management team that will place these bonds.

Equity (preferred stock)

is a hybrid security; has some elements that resemble equity and others that resemble debt and only 15% of corps issue ps. Most Angel or VCs (investment groups) want convertible ps. Util offer ps b/c they're regulated and pay heavy divs. Equity side: it is like common stock b/c has no fixed maturity. Debt side: Like bonds and loans, pmts (dividends) from preferred stock are fixed and shareholders typically do not have voting rights. Preferred stock pays same dividend yearly, no matter how well or poorly the co performs. Unlike debt payments, companies are allowed to skip pmts of preferred stock dividends without default. Penalty for skipping ps dividends is the company can't pay anything to cs until ps are paid in full and aka: "Holding Dividends in Arrears". Most preferred stock is cumulative. If a co. skips pmt of a ps dividend one year, it's still required to pay that dividend sometime in the future before paying any common dividends! Payoff or claim hierarchy: the claim or payoff order is first, debt holders, second, preferred stockholders, and third, common stockholders.

CFF (Cash flows from Financing)

is the net cash impact from financing and includes cash flows from increased borrowing, debt repayment, stock issuance, stock repurchase, or dividend payment. (Increase in financing signals a CASH INFLOW; decreases indicate CASH OUTFLOW like repaying lenders or repurchasing stock. ^NP +100 ^LTD +200 ^RE -120 NI= +170 CFF= ^EQ + ^Debt - Div ^EQ = 0 ^Debt (200+100) - Div: (RE= NI - Div) OR (-120=170-?) OR -120-170=-290 (290) CFF= 0 + 300 - 290 = 10

beta (β)

is the ratio of the co-variance of a stock's returns and market returns to the variance of market returns. In the CAPM, β measures the firm's systematic risk.

Cost of Capital

required return from those who provide capital

Note that when a bond is selling at the same price as the face value,

the YTM will be equal to the coupon rate

What happens to the risk level in portfolio as the number of assets in the portfolio increases?

there is a linear decrease in risk, false. The risk decreases but the decrease is not linear

Calculating Security Returns

two types: 1. Dollar returns- are calculated by taking the difference between the previous price and current price, plus any additional cash flow that came from the security. (EX: bonds pay a coupon (or interest) payment 1 or 2 times yearly; stocks pay a dividend. Mathematically, dollar returns are calculated in the following way. Pt - Pt-1 + CFt In this equation, Pt is the sold price, Pt-1 is the bought price, and CFt is the cash flow (coupons for bonds; dividends for stocks). 2. Percentage returns- Percentage returns are calculated by simply dividing the dollar returns by the price of the security at time t-1, or the previous time period. Pt-Pt-1/Pt-1 + CFt/Pt-1

Percent of Sales

used to estimate the year after forecast. Usually calculated by dividing the asset by sales. Engineering fees / sales = %, then take % and multiply against current year's sales to get the estimate.

What statement is true about fluctuations in bond prices?

when the market interest rate fluctuates the bond fluctuates.False. The coupon rate never fluctuates with fluctuation in the market rates

Income

when thinking about net income, remember the following: Cash-based income While not a formal metric, cash income is based on cash in and cash out of the firm. Many think net cash from operations as "profit." Intuitively, cash-based income is similar to what we call Cash Flow from Operations (i.e., CFO). Income for tax purposes government has its own system for calculating income. not simple like cash-based income, "income for tax purposes is more straightforward than accounting income." This is the income used to determine the amt of tax a firm must pay. Income for tax purposes generally involves fewer managerial choices than accounting income. Accounting income "is reported on the firm's income statement as net income." Calculation of net income requires managers to make many choices. Every line itemin an income statement involves significant discretion about what is reported. Hence, the interpretation of net income requires a solid understanding of the accrual accounting process (GAAP). *Accounting income is the best metric for understanding the operations of the firm. Unfortunately, it is also the most complicated. *Best case, we must know what principles management is using as they compile the income statement. Worst case, management uses their discretion to "manage" the reported results. Either way, we must be a skeptic!

Bond (types)

Debentures: are not secured w/ collateral; very risky! Subordinated debentures: Like normal debentures, subordinated debentures are debentures that have a lower claim to assets if firm liquidates than normal debentures. Mortgage bonds: has specific collateral backing it(i.e., real estate). Issued w/ specific asset as collateral. If corp defaults, mortgage bondholders receive that asset. Zeros: (aka: zero coupon bonds), zeros pay no coupon payments—their coupon rate is 0%! Traded at deep discounts. Eurobonds: are payable in currency not native to the country in which it is issued. (i.e., An American bond, issued in Europe, that is payable in dollars, is a specific type of Eurobond called a Eurodollar bond.) Foreign bonds: A bond that is issued in a domestic market by a foreign entity, in the domestic market's currency. They are paid in a different currency than the country's issuing it(i.e., if a Chinese firm floats debt in the US and the debt is payable in dollars, then China has floated a foreign bond.) Muni-bonds: (short for municipal bonds) are floated by local governments (states, cities, and counties) to usually fund infrastructure improvements (i.e., roads, gov buildgs, and are almost always exempt from fed tax-attractive for investors in high tax brackets.) Treasury bonds: are bonds issued by the fed gov to support deficit spending and range from (short-term 3-month T-bills) to (long-term, 30-year T-bonds). B/c they are backed by fed gov taxing, they're often used as risk-free investments in financial models. Convertible bonds: Convertibility refers to the ability to convert a bond into equity securities, usually common stock and may be added to any of the above bond types. Gives investor rights to trade each bond for a set number of shares of com stk whenever s/he chooses.

Why would a company prefer to raise capital by issuing debt instead of issuing new equity?

Debt financing provides interest tax benefits

Why would a company prefer to raise capital by issuing debt instead of issuing new equity?

Debt financing provides optimal capital structure

Annuities (deferred)

Deferred Annuities: A deferred annuity is just an equal series of payments that starts sometime in the future. Calculating the PV of deferred annuities requires multiple steps. EX: Suppose you retire 30 yrs from today and desire an annual income of $100,000/yr for 20 yrs starting in exactly 30 yrs. Disc is 8%. What is the PV today? calculation requires two steps: Step 1: Find the amount needed in the future. The PV of the $100,000 payments can be calculated either as an ordinary annuity or as an annuity due. Using the ordinary annuity approach, 100,000 [PMT], 8 [I/YR], 30 [N] and solve for [PV] = $1,125,778 (note: we used the ORDINARY ANNUITY approach...so this is a time 29 value!) Step 2: To discount $1,125,778 back to today, the PV from Step 1 becomes the FV in step 2: 1,125,778 [FV], 8 [I/YR], 29 [N] and solve for [PV] = $120,827 So, if you have $120,827 to deposit in your savings account today (and you have a savings account that pays 8%), you can fully fund your retirement goals!

Degree of Operation Leverage: What is the DOL given Sales of 100k. Variable Costs of 75k and EBIT of 10k?

Degree of Operation Leverage: 2.5 DOL=(Sales-VariableCosts)/EBIT=2.5 (100k-75k)/10k=2.5

What is included in the Income Statement and NOT in the Statement of Cash Flows?

Depreciation Expense

What is the differential cash flow given the following? Sales $50k Expenses $30k Depreciation $10K Taxes (.40) $4k

Differential Cash Flow: $16,000 Diff CF=(50k-30k)- ((50k-30k-10k)*.4) = 16k ...if 4k taxes not given...

Which company control is required by the Sarbanes-Oxley Act?

Disclosure of off-balance sheet debts

Discount rate(interest rate)

Discount rate (interest rate)- the rate at which a dollar changes in value due to the passage of time. It's AKA: Cost of Capital, the Opportunity Cost of Capital, or the Hurdle Rate. You can think of the discount rate, r, as a function of several parts: r = Real Risk-Free Rate + Inflation + Risk Premium Where r = Nominal discount rate (note: nominal means inflation is included) Real risk-free rate = The rate earned on riskless investments with 0% inflation Inflation = The annual decay in the purchasing power of money Risk premium = Compensation for bearing the risk of a particular investment

Discretionary Financing Needed: Projected total assets $500k w/projected total liabilities $230k and projected owner's equity $100k. What amount of discretionary financing is needed?

Discretionary Financing Needed: $170,000 DFN=500k-230k-100k

Gordon Growth Models

Do= dividend paid: $5.00 g= 10% D1= D0 x (1+g) = D1 = 5.00 × 1.10 = $5.50. This makes sense—if we assume that dividends will grow at 10% each year forever, then D1 is simply going to be 10% larger than D0. We can employ the Gordon Growth Model: V0 = D1 / (kcs - g) = $5.50 / (.15 - .10) = $110.00 p/s Solve for Kcs: Kcs = D1 / V0 + g Solve for g: g = Kcs - D1 / V0 Preferred stock has no growth; only fixed % of dividends paid. P = D1 / (kps) GGM can be manipulated to solve for D or kps D = V * kps kps = D/V

Dupont Equation 4: ROE ratio?

Dupont Equation 4: ROE ratio= NetProfits/Equity

Expected Returns

E[R] is a more appropriate calculation that accounts for various economic states in the upcoming year. This equation says that the expected return is equal to the weighted average of returns in the jth economic state, where the weights are the probabilities π of that state occurring.

CFO vs. Free Cash Flow (FCF)

FCF is distributable cash! it represents the cash that can be "distributed AFTER funding required reinvestment in PP&E as well as increased working capital." (FCF is one of the most important concepts in finance!) FCF comes in two flavors: 1. FCF to the firm (FCFF)- is the cash distributable to all the providers of capital (i.e., to both debt and equity holders) and is most commonly used in financial analysis. FCFF = EBIT (1-tax rate) + Depreciation - CAPEX - Increases in NWC Where: Tax rate = percent of earnings a firm pays in tax Depreciation = Depreciation expense EBIT = Earnings before interest and taxes CAPEX = Capital expenditure on PP&E; frequently measured as CFI (required reinvestment) NWC = Net working capital (current assets - current liabilities) changes (required reinvestment) *EBIT and (1-tax rate) are referred to as Net Operating Profit After Taxes (NOPAT) 2. FCF to equity (FCFE)- is the cash distributable to the equity holders after satisfying all obligations to debt holders. Dividends are the cash actually distributed to stockholders; FCFE is cash that is distributable to stockholders after funding required reinvestment. FCFE = NI + Depreciation - CAPEX - Increases in NWC + Increases in Debt where: Increases in debt = new borrowings minus any repayment of old debt FCFE measures the cash distributable to equity holders after all obligations (including interest and principle to debt holders) and required reinvestment are satisfied.

FCFE(free cash flow to equity)

FCFE measures the cash distributable to equity holders after all obligations (including interest and principle to debt holders) and required reinvestments are satisfied.

Ratios (legalities)

Failure to operate in prevailing legal constraints can be catastrophic. Though subtle, ratios can clue us to the compliance culture of the firm. (i.e., gyrations in the macro economy impact firm's operating performance.) If management is willing to "stretch" accounting rules to minimize volatility in reported results, the compliance culture of the firm is likely to be poor or corrupt!!!

Which legislative act made it easier and potentially more lucrative for employees to blow the federal government has somehow been defrauded?

False Claims

Financial Calculator: The market ROR 8%. Par value of bond $1,000, coupon rate 10% w/annual compounding, bond matures in 5 yrs. What is the value of the bond?

Financial Calculator: FV=1,000 (is the par value) N=5 I/Y=8 (is market ROR) PMT=100 (is 1000*0.10) PV=? (should be $1,079.85)

What did the Dodd-Frank Act seek to prevent?

Financial institutions becoming too big to fail

Ratios (financing)

Firms can have dramatically different strategies when it comes to financing assets. Financing, or solvency, ratios are intended to highlight a co's strategic differences. All assets MUST be financed. Financing ratios describe in what proportions the firm uses equity and/or debt to finance assets. 1. Debt ratio = total liabilities/total assets 2. Interest-bearing debt to total capital (IBDTC) = interest-bearing debt/total capital 3. Times interest earned (TIE) = EBIT / Interest expense 4. Financial leverage ratio (FLR) = total assets/equity

What are the issues with understanding foreign financial statements?

Foreign financial statements use international financial reporting standards and they are different from US accounting standards.

CAPM (Capital Asset Pricing Model) 4-elements:

Four elements of CAPM: 1. E(R) = Required Rate of Return 2. Rf = Risk Free Rate (consistent, no fluctuations...i.e., Treasury bond) 3. Β = Beta (Measure of stock volatility, standard deviation, derivations) 4. Rm = Market Rate (based on an average return from a basket of stocks) (Rm-Rf) = market premium

Free Cash Flow. Cash Flow from Operations: A company reports EBIT of $1,000,000, depreciation of $30,000, change in working capital of ($10,000), net capital expenditures of $15,000 and tax rate of 40%. What is the free cash flow?

Free Cash Flow. Cash Flow from Operations: $625,000 FCF: (1,000,000)*(1-.4) + 30,000) - (10,000) - 15,000 = $625,000

Gordon Growth Model: A stock is expected to pay a dividend of $5 per year in perpetuity. If the required ROR is 10%, what is the max amount that should be paid for the stock today?

Gordon Growth Model: $50 It's GGM because the word "perpetuity" which means the same amount or "0" $5/.10 - 0 = $50

Gordon Growth Model: A stock is expected to pay dividend of $5 for current year and is expected to grow at rate of 4% per year. If required ROR is 10%, what is the max amount that should be paid for the stock today?

Gordon Growth Model: $83.33 GGM=5/(.10-.04)=$83.33 Tip: "grow rate of dividend" language = GGM

Gordon Growth Model: A person buys shares of a co at $45. Recently paid a $2 annual dividend which is expected to grow by 10% per year. What is the expected return per year?

Gordon Growth Model: 14.9% $45=(2x1.10) / (ER-.10) $45ER - $45x.10=$2.20 ER=($4.5+$2.2)/45=14.9%

Ratios (The DuPont Decomposition)

Granddad of ratios (aka "the DuPont equation") ROE = Net Income / Sales × Sales / Total Assets × Assets / Equity = Net Margin × TAT × FLR *Common alternate form of the DuPont equation is: ROE = ROA x FLR

What does SOX require companies to do?

Have internal control audits.

If a company has a high degree of financial leverage, what does that tell us about the firm's risk profile?

Higher profits to shareholders

Historical Cost Principle & Fair Value

Historical Cost Principle most of the line items on the balance sheet are stated at historical cost meaning that when an asset is purchased (or liability incurred) it is recorded at cost. *Accrual accounting makes no adjustment for changes in the market value of assets reported at historical cost. Fair Value most analysts are interested in fair, or market, value.

Idiosyncratic & Systematic (non-diversifiable) risks

Idiosyncratic risk: portion of risk that is diversifiable. Risk that is specific to an asset or a small group of assets. Idiosyncratic risk has little or no correlation with market risk, and can therefore be substantially mitigated or eliminated from a portfolio by using adequate diversification. Systematic (non-diversifiable) risk: portion of risk that is not diversifiable. Only systematic risk affects the expected return of an individual stock.

Impact of Inflation on Cash Flows: If the cash flow today is $100,000 and the annual inflation rate is 5%, what is the value of the cash flow at end of one year?

Impact of Inflation on Cash Flows: Value of cash flow= (1-.05)*$100,000=$95,000

Which two techniques would be considered effective ways to manage the growth of a firm, if additional financing is not available?

Increase sales prices Alter capacity

Which type of investment will a risk-averse investor most likely invest in?

Index funds

Cash Flow consists of?

Initial Outlay Differential Annual Cash Flows Terminal Cash Flow

Investment: Simple Interest: An investment of $10k made today at 8% simple interest for 3 yrs and 9 mo. will yield in principle and interest of?

Interest: Simple Interest $13,000 Principal + Interest = $10,000 + (10k x .08x3.75) = $13k

Investment returns: A stock will be worth $36 at EOY and will pay dividend of $2.25. How much should an investor pay for the stock if investor expects a 12% rate of return?

Investment returns: Highest price for stock = X+0.12= $36+$2.25/1.12 (add "1" to 12% as "X" variable) = $38.25/$1.12 = $34.15

Investment: Probability Distribution What is expected ROR for stock where 60% chance of recession and 40% chance of expansion? The stock return 2% during recession and 8% in expansion.

Investment: Probability Distribution .044 Cycle Prob Stock Reces. 60% .02 Expan 40% .08 E(r)=(.6*.02)+(.4*.08)=.044

Investment: Rate of Return You want to purchase Ord common stock at $55/share, hold 1 year, and sell after $3 dividend is paid. What would stock price be to satisfy your required ROR of 15%?

Investment: Rate of Return $60.25 Price=$55 + (.15x$55) -3 = $60.25

Investment: Stock A broker purchased stock that pays $1.15 annual dividend for %16 w/a required ROR of 15%. What is the actual return if sold at EOY 1 for $19?

Investment: Stock ROR=(($1.15+$19)-16) /16 = .259 or 25.9% ((Dividend+EOY stock price)-begin stock price) / by begin stock price = actual return %.

Investment: Stocks Two types of expected returns when investing in stocks?

Investment: Stocks 1. Dividends 2. Appreciation of the price of stock = Total return in the investment of stock

What does the current ratio measure?

It is a measure of short-term liquidity to pay short-term obligations.

Is depreciation and salvage value on an asset precise or is it an estimate?

It is an estimate.

What is differential cash flow?

It is the amount of net cash flow generated by a new asset in a yearly basis.

What is the main benefit associated with holding inventory?

It makes it possible to meet the demands of customers

What is the main benefit associated with holding inventory?

It makes it possible to meet the demands of the customers

What does the efficient frontier measure?

It maximizes expected return for a given level of risk.

What does cash flow from investing activities measure?

It measures investments in long-term assets such as: Building Equipment Machinery

What is one of the roles of the SEC?

It regulates public disclosures of entities that sell debt and equity to the public.

What does FINDRA or Financial Industry Regulation Authority do?

It regulates stock brokers in the US. It makes sure that stock brokers are honest and that they don't defraud investors.

What is true about the content and structure of a Balance Sheet?

It reports the Assets, Liabilities, and Equity (ALE) at a point in time. TRUE!

What is true about the content and structure of a balance sheet?

It reports the assets, liabilities, and equity at a point in time

What is true about the content and structure of a balance sheet?

It reports the assets, liabilities, and equity at a point in time.

Company Y has a greater degree of financial risk than Company Z. What will happen if there is a 1% decrease in EBT for both companies?

It will result in a greater percentage decrease in Company Y's pre-tax profit.

Company Y has a greater degree of financial risk than Company Z. What will happen if there is a 1% decrease in EBIT for both companies?

It will result in a greater percentage decrease in Company Y's pre-tax profit.

What is Cash Flow from Operating Activities?

It's cash flow generated for sale of products and services.

What is an example of an inventory method for accounting purposes?

Last in, first out method

Why do companies strive for a lower cost of capital?

Less money dedicated to financing means more money is available for production and operations

A bond that matures in 30 months is sold at a premium. What is the yield to maturity (YTM)?

Lower than the coupon rate

Market Rate: A bond that matures in 30 years is sold at a premium. What is the Yield to Maturity?

Market Rate: Less that coupon rate Market Rate <CouponRate; Bonds will sell at a premium

Market Rate=CouponRate; Bonds will sell at par value Market Rate >CouponRate; Bonds will sell at discount Market Rate <CouponRate; Bonds will sell at a premium

Market Rate=CouponRate; Bonds will sell at par value Market Rate >CouponRate; Bonds will sell at discount Market Rate <CouponRate; Bonds will sell at a premium Coupon Rate is rate company promises to pay on their debt. Market Rate is what everyone else pays on similar debt = yield to maturity

A person needs to determine the cost to replace a company's property, plant, and equipment using the replacement cost method. Which value does this person need to consider in order to make this determination?

Market Value

Which securities are issued by local governments and are usually tax exempt at the federal level?

Municipal bonds

What bonds are not taxed at a federal level?

Municipal bonds.

Cash Flow from Operating Activities consists of?

Net Income + Depreciation +/- Decreases/Increases in Current Assets +/- Decreases/Increases in Current Liabilities

Why does a long-term bond resemble an interest-only loan?

None of the principle is repaid until the bond matures

Why does a long-term bond resemble an interest-only loan?

None of the principle is repaid until the bond matures.

A bond that matures in 30 months is sold at a premium. What is the yield to maturity

Not enough information to determine YTM

Which term describes the amount of cash a firm needs in order to pay its immediate bills?

Operating balance

Gordon Growth Model

P = D1 / (k-g) P = stock value based on model D1 = Expected dividend per share one year from now k = Required rate of return for equity investor g = Growth rate in dividends (in perpetuity)

Bond (Terms)

Par value: (aka: face value of the bond) is the sum of money that the corp promises to pay at the bond's expiration. The firm will not see all of the $1,000 and will actually receive $1,000 minus all transaction costs. Majority of corporate bonds have a par value of $1,000; if no other value stated, par value of $1,000 should be assumed. Coupon rate: (is the interest rate of the bond, also known as the "coupon yield".) It is contractually set when the bond is issued and cannot be changed during the life of the bond. Multiplying the coupon rate by the par value gives the amount of the bond's yearly coupon/interest pmt. (i.e., $1,000 par value bond with a 9% coupon rate will pay $1,000 × .09 = $90 in interest annually.) Maturity: (The rate of return investors recv on bonds is called "yield to maturity".) Bonds are finite-term securities b/c they have a starting or issue date, and an ending or expiration/maturity date. Maturity is number of yrs from when bond is issued to its expiration. (as short as 3 mos to 30 yrs., and 100 years in Japan.) Annual & Semiannual pmts: Most US bonds pay interest semiannual; European bonds typically pay int annually. For annual payments, the amount of the payment is simply the coupon (or interest) rate times the par value of the bond. In the example above, this yielded an annual interest payment of $1,000 × .09 = $90/year; semiannual payments (every 6 mos), bondholder recvs half of the annual payment ($45 every 6 months.) Covenants: The indenture lists the covenants associated with the bond. These covenants outline things the company is obligating itself to do or not do in order to protect bondholders. There are two types of bond covenants: 1. Affirmative covenants- describe things the co. pledges itself to do. (i.e., paying taxes on time, maintaining a certain level of working capital, and maintaining a minimum debt ratio.) 2. Negative covenants- are things the company pledges to not do (i.e., not to sell off certain assets, not to pay out large dividends, or not to issue new debt with a superior client.) If co. does not comply w/ covenants in its bond indentures, it's in default!

Annuities (ordinary)

Payments are equally spaced, equal amounts. Payments are made at the "END" of each period. FVA ordinary = pmt [({1 + r} n - 1) / r] = 100 [({1 + 0.13} 3 - 1) / 0.13] = $340.69 PVA ordinary = pmt [(1 - {1 / (1 + r)n}) / r] = 100 [1 - {1 / (1.13)3} / .13] = $236.12

Annuities (perpetuities)

Perpetuities: A perpetuity is a "perpetual annuity" or an unending series of equal pmts. Perpetuities are frequently associated with charitable giving. PVperpetuity = CF / r (note: r is in decimal form) Back to our hospital example, if invested funds can earn 5%, the amount you would have to donate today to provide $100,000 per year forever is: 100,000 / .05 = $2,000,000

Ratio analysis

Popular tool for three reasons: 1. Standardization is standardizing each firm's debt by an economically meaningful variable (assets) to discover that one firm has 90% of assets financed with debt and the other only 20%. This gives better insight into the relative debt load of the firms. 2. Flexibility Ratio analysis is not governed by a set of rules such as Generally Accepted Accounting Principles (GAAP). Rather, the process of calculating and evaluating ratios is economic analysis governed only by the expertise of the analyst. Ratio analysis is a Darwinian process where the best analysts achieve the greatest benefit. 3. Focus Ratios allow us to quickly discover areas in need of investigation and not what is happening in a company. Ratios don't answer questions about the company; ratios tell you what questions to ask. A ratio that changes through time or deviates from industry norms is essentially a red flag saying, "FOCUS HERE." Ratio changing does not tell us much, but the reason behind the change could make a huge difference in our analysis and subsequent actions.

Which hybrid security system has special claims on a corporations profits or, in case of liquidation, corporate assets?

Preferred Stock

Which hybrid security has special claims on a corporation's profits or , in case of liquidation, corporate assets?

Preferred stock

What ratio is used in the Comparables Method?

Price Earnings Ratio. Used to devaluate companies.

What does the Volcker Rule prohibit?

Prohibits banks from engaging in risky and speculative behavior or bets or trading.

Discretionary Financing Need = what?

Projected Total Assets-Projected Total Liabilities - Projected Equity =Discretionary Financing Needed It's additional money company needs to raise to finance a new project

How is the amount of discretionary financing that is needed by a firm determined?

Projected total assets - projected total liabilities - projected owner's equity

How is the amount of discretionary financing that is needed by a firm determined?

Projected total assets- projected total liabilities + projected owner's equity

Which document is required to be made available prior to a firm going public, according to the Securities Act of 1933?

Prospectus

Which company control is required by the Sarbanes-Oxley Act?

Publication of detailed prospectus for investors

WACC

Re = Cost of common equity, which is usually calculated using the Gordon Growth Model, the CAPM, or the mean of past common stock returns Rp = Cost of preferred equity, which is calculated using the perpetuity model discussed in Topic 7 Rd= Before-tax cost of debt, which is usually the yield-to-maturity on a company's bonds or the interest rate on a company's debt τ = Marginal tax rate for the company

CFO vs. Net Income

Reasons why net income will differ from CFO: 1. Revenue (used to calculate net income) is not the same as cash collected from sales because of changes in accounts receivable (AR). If AR increases, then firm recognizes sales-an increased AR as revenue but has not yet collected the cash. To determine cash rec'd, we need to subtract the increase in AR or add a decrease in AR. *(Remember, revenue does not equal cash collected!) 2. A gain/loss from sale of PP&E equip sold for more/ less than book value (Note: Gain/loss on Sale = Sale Price - Book Value). The gain(/loss is included in net income. However, a gain/loss on sale of PP&E is not attributable to CFO, but is to CFI. In a CFS(indirect method, under CFO), a gain from the sale would be subtracted; a loss would be added. B/c the gain on the sale of PP&E is included in net income but is not part of CFO; therefore, it is treated in reverse. 3. Depreciation expense a significant source difference between net income and CFO. Depreciation expense is included in the calculation of net income but it does not represent an outflow of cash. It is a non-cash expense created for tax purposes. we must add depreciation expense back to net income to adjust net income to reflect actual cash flow. *(Net income a useful concept, but doesn't represent cash. CFO is more important to financial analysts than net income in many situations.) *Warning! "NOTES PAYABLE"- notes payable is frequently included in the current liabilities section of the balance sheet but for the purposes of the SCF is considered a financing account (i.e., part of CFF). When calculating CFO, be sure to not adjust net income for changes in notes payable.

Retained Earning Statement: The beginning retrained earnings on 1/14/14 is $25k. The NI for 2014 is $50k and the dividend payout ratio is 25% of NI. What are retained earnings on 12/31/14?

Retained Earning Statement: $62,500 Retained earnings on12/31/14 = $25k + $50k - (.25x$50k) = $62,500

Retained Earnings: Firm reported RE of $300 in 12/31/12. For 12/31/13 firm reports RE of $400 and pays dividends of $25. What is NI in 2013?

Retained Earnings: Answer $125 Logic is $300 from $400 is $100 plus the $25 dividend totals out to $125. 300 + NI - 25 = 400: NI=125, so 300+125-25=400

Which statement accurately explains the recognition of revenues and expenses under accounting income and income for tax purposes?

Revenue and expenses may be recognized in one period for accounting income purposes and in a different period for income tax purposes.

Which statement accurately explains recognition of revenues and expenses under Accounting Income and Income for tax purposes?

Revenues and Expenses may be recognized in one period for Accounting Income purposes and in a different period for Income Tax purposes.

Which statement accurately explains the recognition of revenues and expenses under accounting income and income for tax purposes?

Revenues and expenses may be recognized in one period for Accounting Income purposes and in a different period for Income Tax purposes.

Which happens to the risk level in a portfolio as the number of assets in the portfolio increases?

Risk decreases at a slower rate

What does the Financial Industry Regulatory Authority (FINRA) examine to determine if a firm is in compliance with the rules of FINRA and Securities and Exchange Commision (SEC)?

Sales practices

What does the financial Industry Regulatory Authority (FINRA) examine to determine if a firm is in compliance with rules of FINRA and SEC?

Sales practices

Equity (common stock valuation-single holding period)

Single Holding Period Model: assumes that an investor buys a stock today, holds for one year, then sells it back. Investor potentially generates a return from two sources: Dividends and Stock Price Increase. Value of the stock's PV is calc'd by estimating future cash flows from two sources and then discounting them back to the present. EX: I buy one share of GrowBig stock today. We expect the stock to pay a dividend of $5.50 at year end, forecasted stock price of $120. If we require a 15% rate of return on our investment, how much is the stock today? Vo = (V1+D1)/ (1+Kcs) I/Y = 15, n = 1, FV = 125.50; PV 109.13 Single period Holding Period Return (HPR) This method is alternative, and ignores using TVM. HPR = [(P1 + D1)/P0]- 1

What is the difference between a common stock and preferred stock?

Skipping a declared preferred stock dividend results in dividends in arrears

Ratios (soc responsibility)

Some analysts cringe at "social responsibility," they prefer firms maximize value under established law. A firm may have industry-leading margins today but having poor employee relations will/may experience long-term impairment. Human capital development is vital to the health of the entire organization. Likewise, strong communities and schools lead to a productive labor force. Moreover, environmental issues impact a firm's relationship with its customer base.

CAPM (Statistics-Mean)

Statistical moment: is a measure of the shape of the distribution at a particular point. The first, and perhaps most common moment, is the mean. Mean(first moment): is the best estimate for the Expected Value. X(mean) = Xi * 1/n Standard Deviation(second moment): (σ) = √ (1/n-1) (Xi - X)*2

Equity (common stock)

Stock and equity are synonyms in the world of finance. Common stock represents equity ownership in a firm. Along with ownership comes voting rights which majority of CS includes. CS holders have the lowest/last claim on earnings and assets of the co, meaning that common stockholders receive dividends each year (and cash, in the case of company liquidation), ONLY after everyone else (debt holders and preferred stockholders) gets paid. **Corporate Governance are the control issues involved in running a company. Equity represents ownership in a firm and those stockholders have certain rights: 1. Right to Residual Claim on earnings and assets of the co. Each year, after the co. pays for its ops and pays its creditors, any residual or remaining earnings belong to the shareholders in proportion to the percentage of shares they own. Same is true if the firm fails and is liquidated. After the ops and creditors are paid, shareholders receive what's left over based on % of stock they own. 2. Right to Vote on co. mgmt and policies in regular stockholder meetings. Lrg equity positions, lrg holders of stock, and voting stock holders are permitted into meetings. Stock has no maturity or expiration date. If firm is around, the stock is in full force. Equity holders could experience 1000% returns. In finance, this unlimited earnings potential is known as "Capturing the Upside." Stocks are variable-return securities(CFs uncertain and vary); bonds are fixed-return securities(CFs are certain and fixed).

Equity (valuation)

Stock value = present value of its future expected cash flows. ........."Good Co. v Good Investment" Good Company is not necessarily a good invest. if all investors know GoodCo is a good company, they'll buy GoodCo stock, bidding up price until it's as high or higher than the intrinsic value of GoodCo's future cash flows. If you buy now at its intrinsic value or "correct" price, you're unlikely to realize substantial gains. Good Investment AveCo, (an "average" co), is selling for $10 but has an intrinsic value of $25 p/s. Invest in AveCo b/c it's undervalued and then wait for market to wise up and bid it up to its real $25 value-it's intrinsic value, the sell!

What is an example of an inventory method for accounting purposes?

Straight-line method false, the inventory methods are LIFO FIFO

What is an example of an inventory method for accounting purposes?

Straight-line method. FALSE! The inventory methods are LIFO, FIFO, etc. TRUE!

Sustainable Growth Rate: What is SGR? Sales 2.5 million Total Expenses 2 million Total Assets 3 million Equity 1.3 million Dividend payout ratio 0.25

Sustainable Growth Rate: 0.2885 Calculate ROE first. ROE=(sales-Expenses) / Equity=0.3846 SGR=0.3846*(1-0.25)=0.2885

Sustainable Growth Rate: Co. has 10% ROE and $100 net income and pays $25 dividends. What is the SGR?

Sustainable Growth Rate: SRG=ROE*(1-Dividend Payout Ratio) ROE=0.10 DPR=25/100=0.25 SGR=0.10*(1-0.25) = 0.075 or 7.5%

TVM: M wants to have $20k in 4 years. How much should M invest now in order to have $20k in 4 years if she can invest money at 16%?

TVM: $11,040 N=4 I/Y=16 FV=$20,000 CPT then PV = $11,045.82

A machine will reach the end of its useful life in year 5. The realizable salvage value is expected to be $50,000 with a book value of zero. The company's marginal tax rate is 34%. What is the tax implication on the sale of the new machine at year 5?

Tax liabilities of $17,000

A machine will reach the end of its useful life in Year 5. The realizable salvage value is expected to be $50,000 with a book value of zero. The company's marginal tax rate is 34%. What is the tax implication on the sale of the new machine at Year 5?

Tax liabilities of $17,000 salvage = sell 50,000 x .34 =17,000

"four-find-three" system

The "four-find-three" system implies we can also solve for variables other than PV or FV. Suppose you have the following retirement savings parameters: Age: 35 Retirement age: 65 Monthly savings: $350 Annual return: 9% We can calculate the amount you will have in your retirement account in 30 years as 350 [PMT], 30 × 12 = 360 [N], 9 / 12 = .75 [I/YR] and solve for [FV] = $640,760.

What is the Par Value (face value) of a bond?

The Par Value is the amount that is payable on maturity. TRUE!

A company reported an increase in accounts receivable of $5,000 during the recent period. Half this amount is expected to be collected next period. How will this change in accounts receivable affect the cash flows from operating activities section.

The change will decrease cash flows from operations by $2,500

A company reported an increase in accounts receivable of $5,000 during the recent period. Half of this amount is expected to be collected next period. How will this change in accounts receivable affect the cash flows from the operating activities section?

The change will decrease cash flows from operations by $5,000

What are two examples of sunk costs?

The cost of a market study conducted prior to the decision The cost of feasibility consulting inccured before the decision point

What are two examples of sunk costs?

The cost of a market study conducted prior to the decision The cost of feasibility consulting incurred before the decision point

How will an increase in corp tax rates affect a firm's cost of capital?

The cost of debt will decrease

How will an increase in corporate tax rates affect a firm's cost of capital?

The cost of debt will decrease

A broker is considering purchashing common stock that has average but consistent operating performance. What factor should lead the broker to purchase in this company?

The current price of the stock is 25% below its intrinsic value

A broker is considering purchasing common stock in a company that has average but consistent operating performance. Which factor should lead the broker to purchase shares in this company?

The current price of the stock is 25% below its intrinsic value.

A firm has a ROE (return on equity) of 0.27 and the industry average ROE is 0.24. Which conclusion would an analyst draw when comparing the firm to the industry?

The firm is generating higher returns to owners than the industry

A firm has a ROE of 0.27 and the industry average ROE is 0.24 Which conclusion would an analyst draw when comparing the firm to the industry?

The firm is generating higher returns to owners than the industry

A firm has a ROE of 0.27 and the industry average ROE is 0.24. Which conclusion would an analyst draw when comparing the firm to the industry?

The firm is generating higher returns to owners than the industry.

An analyst is comparing the ratios of two different firms and needs to address timing differences. What would be considered an example of a timing difference between the two firms?

The firms have different fiscal years

An analyst is comparing the ratios of 2 firms and needs to address timing differences. What would be considered an example of a timing difference between 2 firms?

The firms have different fiscal years.

An analyst is comparing the ratios of two firms and needs to address timing differences. What would be considered an example of a timing difference between the two firms?

The firms have different fiscal years. TRUE!

Which three pieces of data are needed to perform a capital budget analysis?

The initial cost of the new project Annual cash flows for the life of the new project Cash flow when the firm terminates the project

Which three pieces of data are needed to perform a capital budget analysis?

The initial cost of the new project cash flow when the firm terminates the project Annual cash flows for the life of the new project

What is the objective of portfolio diversification?

The objective is to reduce risk.

Retained Earnings (RE)

The only two options for net income is to pay it(dividends) out or plow it back(RE). Expressed as follows: ...Net Income = Dividends + Change in RE New RE equals the sum of last year's RE balance plus the change in RE from the current year, or ...New RE = Old RE(last yr) + Change in RE(NI-Div...cur yr) Solving this equation for the change in RE and substituting into the net income equation yields: ...New RE = Old RE + Net Income - Dividends

Primary Markets (Stocks & Bonds)

The primary market for stock issuance works in a similar way to the bond primary market. However, some terminology is different. A firm that is going public (or selling shares of ownership for the first time) is going to perform an initial public offering (IPO). These IPOs are sometimes called new equity offerings. However, much of the underwriting occurs in a similar manner, which we have discussed above.

Cashflows

The sum of CFO + CFI + CFF is equal to the change in cash during the period. catagorization of cash flow is flexible and is impacted by the firm's operating environment in several ways: 1. Core activities - will impact the way cash flows are catagorized. For instance, two firms can purchase similar lathes and catagorize the cash outflow differently. For a machine shop, the lathe is likely a long-term asset and the cash flow will be part of CFI; for a equipment vendor, the lathe is likely inventory and included in CFO. 2. Cash flow management - some managers will "manage" (i.e., increase or decrease) reporting of cash flows. For instance, a manager whose bonus is impacted by CFO may be tempted to recatagorize some items to make CFO appear larger. *While most of the techniques to recatagorize cash flows are beyond the scope of this course, it is relatively easy to do for a year or two without violating the rules of GAAP accounting. 3. Market pressure - even if a manager's personal income is not impacted, there are other pressures to manipulate cash flow categorization in the market place. For instance, a firm that is in the process of raising capital does NOT want to show a decrease in CFO. Hence, managers may be willing to use their discretion over accounting choices to increase the reported level of CFO. **(As with the income statement and balance sheet, the moral here is to be careful when interpreting the SCF. While gross cash flows are difficult to alter, it is relatively easy to increase one category by decreasing another.)

What is the par value (face value) of a bond?

The sum of money that the corporation promises to pay upon expiration of the bond

Maximizing Shareholder Value

There are two issues: 1. Agency costs- are real costs and the way that most firms mitigate some of these costs is by aligning managers' interests with shareholders' interests; they are costs by management not acting in the best interests of the shareholders; asymmetrical costs. Most commonly, management might be compensated with shares of ownership in the company or take on projects just because they want to. 2. Focusing solely on profits- (unethical maximization), in some cases, (Enron 2001), the pursuit of profit has led to unethical behavior. However, profitable businesses are employing other workers and are providing their employees the means to consume goods and services from other businesses in the economy.

Time Value of Money (TVM)

These forces (risk, opportunity, and inflation) fortify one another to make dollar worth more today vs. its future worth. TVM brings together three variables: 1) amount of the cash flows, 2) the timing of the cash flows, 3) the rate at which the value of the cash flows changes due to the passage of time. TVM has two basic types of calculations: 1. Present value calculation(PV) takes a sum in the future and finds a time-adjusted equivalent value at a closer point in time. EX: if you anticipate receiving $150 in 8 yrs, you may want to calculate its present value today (i.e., time 0). 2. Future value calculations (FV) move cash flows farther into the future. If you are investing $25 today for retirement, calculate its value 50 yrs in the future.

What does the Foreign Corrupt Practices Act of 1977 do?

This act prohibits american companies from bribing officials from foreign governments.

Ratios (analysis)

Three main comparison standards for ratio analysis: 1. Trend Analysis: This ratio examines a firm's ratios over time, comparing cur yr to prev yrs. (i.e., if we were analyzing Wal-Mart's ratios in 20x6, we can compare them to Wal-Mart in 20x1-20x5. Frequently, trend analysis looks backwards 5-yrs and sometimes forecasts out 3-yrs. 2. Cross-sectional analysis involves comparing a firm's ratios to a peer group (i.e., competitors, the industry, the market.) Cross-sectional analysis requires data not only target firm, but also the peer group. (sometimes referred to as "recasting" the financial statements) 3. Internal Goal Monitoring: Ratios can measure progress relative to specific goals set w/in the co. For instance, if management sets a specific goal for ROE, assessment of progress will involve ratio analysis. Two Pit Falls: Timing issues: Mixing data from the income statement and balance sheet causes problems. Consider the ROA calculation for two identical swimsuit manufacturers, one with a balance sheet date of Dec 31 the other w/ balance sheet date of June 30. Since they are identical, they report the same net income. However, the firm with the Dec statements will likely report a much higher asset value and thus a lower ROA. Accounting issues: Accounting data is the biggest potential menace in ratio analysis. Rules of accrual accounting allow for significant variation in reported results. Analysts must therefore be careful to understand each firm's accounting choices before assuming their ratios are comparable. (i.e., depr use life)

What is he reason for holding cash and cash equivalents?

To provide liquidity

What is the reason for holding cash and cash equivalents?

To provide liquidity

What bonds are taxed at the federal level?

Treasury bonds.

Ratios (risks)

Truly integrated analysis will include careful consideration of: External risks: are changes in the macro-economic cycle, competitive forces, the technological environment, and demographic/societal changes. Questions regarding the impact of the economy on revenues and costs and how the competitive environment impacts growth. Internal risks: include the financial viability and flexibility of the firm, willingness to continually innovate, attitude towards compliance w/ laws and controls, and company's culture.

Ratios (profitability)

Two categories—based on sales; based on investment (i.e., assets or equity). Investment Based: ROA = NI / assets OR (Profit Margin x Total Asset Turnover) OR (ROA = (Net Income / Sales) x (Sales / Total Assets) OR (ROA = ((Sales - Total Costs) / Sales) x (Sales / (Current Assets + Non-Current Assets) ROE = NI / equity Sales Based: Gross margin = gross profit..(sales - COGS) / sales Operating margin = EBIT / sales Net margin = NI / sales

Which two effects does the unbundling and offshoring of production have on employment when the global value chain is taken into consideration?

Unbundling and offshoring allows firms to offer intermediate and final goods at lower prices, thus increasing employment. Unbundling and offshoring decreases costs, which results in expansion of sales and higher employment

Which 2 effects does the unbundling and offshoring of production have on employment when the global value chain is taken into consideration?

Unbundling and offshoring decreases stock value and increases market share Unbundling and offshoring allows firms to offer intermediate and final goods at lower prices, thus increasing employement

Equity (preferred stock valuation)

Vps = D/kps [or] V=D/r where Vps is the value or price of the stock, D is the annual fixed dividend and kps is the discount rate or required rate of return (not the dividend rate). Using the Gordon Growth Model we can adjust by taking out "g" since there is a fixed dividend. from V0= D0(1+g)/(Kcs-g) to V0=D0/Kps EX: Xerox issued $75 million worth of 8.25% preferred stock at $50 per share par value. Required rate of return is 9.50%. What would we pay for the stock today? To calculate the fixed annual dividend, simply multiply the par value by the quoted percentage to get .0825 × $50 = $4.125 per year. Vps = D/kps Vps = $4.125 / .095 = $43.42 As with the Gordon Growth Model, the preferred stock equation can be manipulated to solve for D or kps D = V * kps kps = D/V V=D/r Perpetuity (forever pmts): CF / r [or] V= D/r

Which statement is true about fluctuations in bond prices?

When market interest rates fluctuate, the bond coupon rate is unchanged

Which statement is True about Fluctuations in bond prices?

When the market interest Fluctuates, the bond coupon Fluctuates. FALSE! The coupon rate NEVER Fluctuates with Fluctuation in market rates. TRUE!

Current Assets can be converted to cash within how many months?

Within 12 months. E.g. are "Accounts Receivable" and "Inventory"

Current Liabilities are things you need to pay within how many months?

Within 12 months. E.g., "Accounts Payable"

Yield to Maturity or Market Rate: Bond price is $920 w/a face value (or par value=FV) of $1k. Assume annual coupons are $100, which is 10% of coupon rate, and 10 yrs remaining until maturity. The YTM is?

Yield to Maturity or Market Rate: N=10 I/Y=??? (should be 11.38) PV= -920 (because two positive $ values) PMT=100 FV=1,000

What is the par value (face value) of a bond?

amount that is payable on maturity

Floatation costs

are costs incurred by a firm that issues new securities.The firm will usually hire an investment bank, underwriter or syndicate to sell these shares in a primary market, and therefore increase the cost of capital. Flotation costs are accounted for in two ways: 1. float costs are subtracted from the price of equity 2. add a percentage to the cost of capital.

Spontaneous accounts

are those that, of necessity, vary automatically with sales. Current assets (i.e., cash, marketable securities, a/r, and inv), a/p, and accrued expenses(accrued wages). Historical ratio of cash as a percent of sales would be calculated as cash/sales.