Fin 310 Final

maturity

Years until bond must be repaid

Credit Instruments

"Secured contracts" that legally record the "trust or confidence of a creditor in a customer's ability and intention to pay at some future time, shown by allowing money or goods to be taken or services to be used without immediate payment." 1) Open account 2) Promissory Note 3) Commercial drafts - buyer accepts & commits to before delivery 4) "Trade acceptance," by buyer, which the seller may keep or sell

Non-conventional cash flows - IRR

- Cash flows change sign more than once - Most common: • Initial cost (negative CF) • A stream of positive CFs • Negative cash flow to close project • For example, nuclear power plant or strip mine - More than one IRR .... - Which one do you use to make your decision?

Floating Rate Bonds

- Coupon rate "floats" depending on some interest rate index value - Examples - adjustable rate mortgages and inflation-linked Treasuries* - Less price risk with floating rate bonds: • Coupon floats, so is less likely to differ substantially from the yield-to-maturity - Coupons may have a "collar" - the rate cannot go above a specified "ceiling" or below a specified "floor"

Dealers vs. Brokers

- Dealer: Maintains an inventory Ready to buy or sell at any time Think "Used car dealer" - Broker: Brings buyers and sellers together They don't hold an inventory of securities Think "Real estate broker"

municpal bonds

- Debt of state and local governments - Varying degrees of default risk, rated similar to corporate debt - Interest received is tax-exempt at the federal level - Interest usually exempt from state tax in issuing state

Interest rate (r)

- Discount rate (PV) - Cost of Capital (Capital Budgets) - Opportunity cost of capital - Required return - Terminology depends on usage

If you own a share of stock, you can receive cash in what two ways?

- If the company pays dividends - You sell your shares, either to another investor in the market or back to the company

Zero Coupon Bonds

- Make no periodic interest payments (coupon rate = 0%) - Entire yield-to-maturity comes from the difference between the purchase price and the par value (capital gains) - Cannot sell for more than par value • Sometimes called zeroes, or deep discount bonds • As discussed earlier, treasury Bills and U.S. Savings bonds are good examples of zeroes

What does maximizing shareholder wealth mean?

- Maximizing firm value - Minimizing WACC

Government Bonds

- Municipal Securities - Treasury Securities

Conflicts between NPV and IRR

- NPV directly measures the *increase in value* to the firm (Vf). - Whenever there is a *conflict between NPV and another decision rule*, you should *always use NPV* Remember IRR is unreliable in the following situations: - Non-conventional cash flows - Mutually exclusive projects

Debt

- Not an ownership interest - No voting rights - Interest is tax-deductible (tax shield) - Creditors have legal recourse if interest or principal payments are missed - Excessive debt can lead to financial distress and bankruptcy

Equity

- Ownership interest - Common stockholders vote to elect the board of directors and on other issues - Dividends are not tax deductible (double taxation) - Dividends are not a liability of the firm until declared. Stockholders have no legal recourse if dividends are not declared - An all-equity firm cannot go bankrupt

Amortized Loans with fixed principal payment

- Periodic, declining payments to cover interest and fixed portion of principal - The reason total payments decline is that the loan balance goes down, resulting in a lower interest charge in each period, while the principal reduction is constant

Bond Markets

- Primarily over-the-counter transactions with dealers connected electronically - Extremely large number of bond issues (far greater than equities), but generally low daily volume in single issues - Getting up-to-date prices difficult, particularly on small company or municipal issues (munis) - Treasury securities are an exception

Primary vs. Secondary Markets

- Primary = new-issue market (IPOs) - Secondary = existing shares traded among investors

Interest-Only Loans

- Principal paid in a lump sum in the future - Periodic coupons ex .bullet bonds

Bond Classifications

- Registered vs. Bearer Bonds - Security: • Collateral - secured by financial securities • Mortgage - secured by real property, normally land or buildings • Debentures - unsecured with 10 or more years to maturity • Notes - unsecured debt with original maturity less than 10 years - Seniority: • Senior versus Junior, Subordinated

coupon rate

- Stated interest rate - Multiply by par value to get coupon payment coupon payment = coupon rate x par

Yield to Maturity (YTM)

- The market required rate of return for bonds of similar risk and maturity - The discount rate used to value a bond - Return if bond held to maturity & does not default- Usually at issue, the coupon rate is set to equal yield to maturity - Quoted as an APR (aka Bond Equivalent Yield)

Reasons for Holding Cash

-Speculative Motive = take advantage of unexpected opportunities -Precautionary Motive = in case of emergencies -Transaction Motive = to pay day-to-day bills Trade-off: opportunity cost of holding cash & transaction cost of converting marketable securities to cash

Constant Growth Model Conditions

1) Dividend expected to grow at g forever 2) Stock price expected to grow at g forever 3) Expected dividend yield is constant 4) Expected capital gains yield is constant and equal to g 5) Expected total return, R, must be > g 6) Expected total return (R): = expected dividend yield (DY) + expected growth rate (g) = dividend yield + g

NYSE

1) Operational goal = attract order flow 2) NYSE DMMs: - Assigned broker/dealer • Each stock has one assigned DMM • All trading in that stock occurs at the "DMM's post" - Trading takes place between customer orders placed with the DMMs and "the crowd," in essence, they "referee" the trading flow - "Crowd" = Floor brokers and SLPs

Features of Preferred Stock

1) Preferred Dividends - Must be paid before dividends can be paid to common stockholders - Not a liability of the firm - Can be deferred indefinitely - Most preferred dividends are cumulative • Previously missed preferred dividends have to be paid before common dividends can be paid 2) Preferred stock generally does not carry voting rights, but does obtain priority of claim in case of liquidation 3) Some features are similar to debt

Interest Rate Risk 1. Change in price due to changes in interest rates (r_, B_ and vice versa) which direction will arrows go? 2. Long-term bonds have _____ price risk than short-term bonds, all else equal 3. Lower coupon rate bonds have _____ price risk than high coupon rate bonds, all else equal

1. (r↑, B↓ and vice versa) 2. more 3. more

Good Decision Criteria

1. All cash flows considered? 2. Is time value of money (TVM) considered? 3. Is it risk-adjusted? 4. Do you have the ability to rank projects? 5. Does the analysis indicate added value to the firm (VF)?

Five Cs of Credit

1. Character = willingness to meet financial obligations 2. Capacity = ability to meet financial obligations out of operating cash flows 3. Capital = financial reserves 4. Collateral = assets pledged as security 5. Conditions = general economic conditions related to customer's business

What criteria does NPV consider?

1. Considers all CFs 2. Considers the TVM 3. Adjusts for risk 4. Can rank mutually exclusive projects

Components of Credit Policy

1. Terms of sale - Credit period (usually 30-120 days) - Cash discount and discount period - Type of credit instrument 2. Credit analysis - Distinguishing between "good" customers that will pay and "bad" customers that will default 3. Collection policy - Effort expended on collecting receivables

reinvestment rate risk

1. Uncertainty concerning rates at which cash flows can be reinvested 2. When interest rates fall, CFs will be reinvested at lower rates 3. Short-term bonds have more reinvestment rate risk than long-term bonds 4. High coupon rate bonds have more reinvestment rate risk than low coupon rate bonds

Which bonds will have the higher coupon, all else equal? 1. debenture/Secured debt 2. senior debt/Subordinated debenture 3. A bond with a sinking fund/one without 4. A callable bond/a non-callable bond

1. debenture 2. Subordinated debenture 3. one without 4. A callable bond

Webster's currently has an inventory turnover of 15.7, a payables turnover of 9.6, and a receivables turnover of 8.4. How many days are in the cash cycle? 28.68 days 33.70 days 56.51 days 84.39 days 104.72 days

28.68 days Cash cycle = (365/15.7) + (365/8.4) - (365/9.6) = 28.68 days

A firm offers terms of 2/5, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount? 21.69 percent 24.42 percent 28.97 percent 31.08 percent 34.31 percent

34.31 percent

A firm grants credit with terms of 2/5, net 20. The firm's customers have ___ days to pay in order to receive a _____ percent discount. 2; 5 5; 2 15; 2 20; 2 30; 5

5; 2

Which one of the following has the highest effective annual rate? 6 percent compounded annually 6 percent compounded semi-annually 6 percent compounded quarterly 6 percent compounded monthly All the above answers have the same effective annual rate.

6 percent compounded monthly

Which one of the following has the highest effective annual rate? A. 6 percent compounded annually B. 6 percent compounded semi-annually C. 6 percent compounded quarterly D. 6 percent compounded monthly

6 percent compounded monthly

Which one of the following bonds is the least sensitive to changes in market interest rates? Zero-coupon, 10 year 6 percent annual coupon, 10 year Zero-coupon, 4 year 8 percent annual coupon, 4 year 6 percent annual coupon, 4 year

8 percent annual coupon, 4 year

Lisa has $1,000 in cash today. Which one of the following investment options is most apt to double her money? 6 percent interest for 3 years 12 percent interest for 5 years 7 percent interest for 9 years 8 percent interest for 9 years 6 percent interest for 10 years

8 percent interest for 9 years

Lisa has $1,000 in cash today. Which one of the following investment options will come closest to doubling her money? A. 12 percent interest for 5 years B. 7 percent interest for 9 years C. 8 percent interest for 9 years D. 6 percent interest for 10 years

8 percent interest for 9 years

Which one of the following most likely represents the greatest political risk for a U.S.-based firm? A. A Boeing airplane assembly plant located in Canada B. A Koch Industries oil refinery in a port in Venezuela C. A Merck pharmaceutical sales office in Germany D. A Ford automotive parts plant in Korea that uses U.S. made components

A Koch Industries oil refinery in a port in Venezuela

Suppose the exchange rate goes from 7.45 Kronas per USD to 12 Kronas per USD. Which currency is appreciating and which depreciating?

A USD now buys more Kronas, so: - The USD is appreciating (strengthening) - The Krona is depreciating (weakening)

Which of the following statements is FALSE? A. The yield to maturity is a bond's rate of return that is required by the market place. B. When a bond's yield to maturity is less than a bond's coupon rate, the bond is selling at a premium. C. A convertible bond initially sells at a deep discount and pays no interest payments. D. The invoice amount that an investor actually pays to purchase an outstanding bond is not its 'clean' quoted price.

A convertible bond initially sells at a deep discount and pays no interest payments.

Which one of the following statements is correct, all else held constant? Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. The aftertax cost of debt increases when the market price of a bond increases. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. WACC is only applicable to firms that issue both common and preferred stock.

A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.

Which one of the following statements is correct? 1) Firms should generally finance all of their assets with long-term debt. 2) Firms that follow restrictive financial policies can generally avoid short-term debt financing. 3) Short-term borrowing is generally more expensive than long-term borrowing. 4) Long-term interest rates tend to be more volatile than short-term rates. 5) A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

Which one of the following best defines legal bankruptcy? 1) Negotiating new payment terms with a firm's creditors 2) A temporary technical insolvency 3) A legal proceeding for liquidating or reorganizing a business 4) The internal process of revising the capital structure of a firm 5) The failure of a firm to meet its financial obligations in a timely manner

A legal proceeding for liquidating or reorganizing a business

NASDAQ

A nationwide electronic system that links dealers across the nation so that they can buy and sell securities electronically.

American Depositary Receipt (ADR)

A security issued in the United States representing shares of a foreign stock and allowing that stock to be traded in the United States.

Which of the following statements is TRUE? A. The Gordon Growth Model assumes constant dividend growth but implies that stock prices grow at a different rate. B. A stock's price is the present value of its future cash flows, namely, its expected capital gains and dividends. C. Brokers buy and sell securities from their own inventory, while dealers bring buyers and sellers together to complete transactions. D. Holders of common stock have greater voting rights in corporate decisions than holders of preferred stock, but they have less voting rights than creditors of the corporation.

A stock's price is the present value of its future cash flows, namely, its expected capital gains and dividends.

Weighted Average Cost of Capital (WACC)

A weighted average of the component costs of debt, preferred stock, and common equity.

In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first? 1) Technical insolvency definition 2) Absolute priority rule 3) Accounting insolvency definition 4) Chapter 7 of the Federal Bankruptcy Reform Act of 1978 5) Securities and Exchange Commission

Absolute priority rule

The cash cycle is equal to which one of the following? 1) Inventory period minus the accounts payable period 2) Operating cycle plus the accounts payable period 3) Operating cycle minus the accounts receivable period 4) Accounts receivable period minus the accounts payable period plus the inventory period 5) Inventory period minus the accounts receivable period minus the accounts payable period

Accounts receivable period minus the accounts payable period plus the inventory period

Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project? 1) Boone Brothers' cost of capital 2) Ace Builders' cost of capital 3) Average of Boone Brothers' and Ace Builders' cost of capital 4) Lower of Boone Brothers' or Ace Builders' cost of capital 5) Higher of Boone Brothers' or Ace Builders' cost of capital

Ace Builders' cost of capital

Risk-Adjusted WACC

Adjusting for risk changes the decisions IRR>Required Return = accept

Advantages & Disadvantages of DGM

Advantage - easy to understand and use Disadvantages - Only applicable to companies currently paying dividends - Not applicable if dividends aren't growing at a reasonably constant rate - Extremely sensitive to the estimated growth rate - Does not explicitly consider risk - Historical growth rates may no reliably predict future growth rates

Advantages & Disadvantages of Profitability Index

Advantages - Closely related to NPV, generally leading to identical decisions • Considers all CFs • Considers TVM - Easy to understand and communicate - Useful in capital rationing (first invest in projects with higher PI) Disadvantages - May lead to incorrect decisions in comparisons of mutually exclusive investments (can conflict with NPV)

Advantages and Disadvantages of AAR

Advantages - Easy to calculate - Needed information usually available Disadvantages - Not a true rate of return - Time value of money ignored - Uses an arbitrary benchmark cutoff rate - Based on accounting net income and book values, not cash flows and market values

Advantages and Disadvantages of Payback

Advantages - Easy to understand - Adjusts for uncertainty of later cash flows - Biased towards liquidity Disadvantages - Ignores the time value of money - Requires an arbitrary cutoff point - Ignores cash flows beyond the cutoff date - Biased against long-term projects, such as research and development, and new projects

Advantages and Disadvantages of SML

Advantages - Explicitly adjusts for systematic risk - Applicable to all companies, as long as beta is available Disadvantages - Must estimate the expected market risk premium, which does vary as different time periods are used - Must estimate beta, which also varies over time - Relies on the past to predict the future, which is not always reliable

Advantages and Disadvantages of IRR

Advantages • Preferred by executives - Intuitively appealing - Easy to communicate the value of a project • If the IRR is high enough, may not need to estimate a required return • Considers all cash flows • Considers time value of money • Provides indication of risk Disadvantages • Can produce multiple answers • Cannot rank mutually exclusive projects • Reinvestment assumption flawed

Which one of the following statements is true concerning annuities? 1) All else equal, an ordinary annuity is more valuable than an annuity due. 2) All else equal, a decrease in the number of payments increases the future value of an annuity due. 3) An annuity with payments at the beginning of each period is called an ordinary annuity. 4) All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity. 5) All else equal, an increase in the number of annuity payments decreases the present value and increases the future value of an annuity.

All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity.

Bill just financed a used car through his credit union. His loan requires payments of $275 a month for 5 years. Assuming that all payments are paid timely, his last payment will pay off the loan in full. What type of loan does Bill have? Amortized Complex Pure discount Lump sum Interest-only

Amortized

Which of the following statements is FALSE? A. With simple interest, the interest is not reinvested, so interest is earned each period only on the original principal. B. Both lenders and investors prefer more compounding. C. Amortizing a loan allows for a portion of principal to be paid with the interest each period principal so that the actual payments to interest will increase with each payment. D. Treasury Bills are pure discount loans sold by the US government that repay a fixed amount as one lump sum at some time in the future.

Amortizing a loan allows for a portion of principal to be paid with the interest each period principal so that the actual payments to interest will increase with each payment

Which one of the following statements concerning annuities is correct? 1) The present value of an annuity is equal to the cash flow amount divided by the discount rate. 2) An annuity due has payments that occur at the beginning of each time period. 3) The future value of an annuity decreases as the interest rate increases. 4) If unspecified, you should assume an annuity is an annuity due. 5) An annuity is an unending stream of equal payments occurring at equal intervals of time.

An annuity due has payments that occur at the beginning of each time period.

All else held constant, which one of the following statements is correct concerning the accounts payable period? 1) The accounts payable period is equal to 365/(Sales/Average accounts payable). 2) A decrease in the accounts payable period will increase the operating cycle. 3) An increase in the accounts payable period will decrease the cash cycle. 4) A decrease in the accounts payable period will decrease the operating cycle. 5) An increase in the accounts payable turnover rate decreases the cash cycle.

An increase in the accounts payable period will decrease the cash cycle.

Periodic Rate

An interest rate applied to your balance to calculate the finance charge. Periodic rate = APR/# periods per year

Other things equal, investors will require higher yields on, and be willing to pay lower prices for, bonds with the following characteristics, except those which: A. Are unsecured B. Have less protective covenants C. Have lower credit quality D. Are convertible into common shares

Are convertible into common shares

Which one of the following methods of analysis ignores cash flows? Profitability index Net present value Average accounting return Modified internal rate of return Internal rate of return

Average accounting return

Which one of the following methods of analysis is most similar to computing the return on assets (ROA)? Internal rate of return Profitability index Average accounting return Net present value Payback

Average accounting return

Which of the following statements is FALSE? A. The APR should not be used to compare two investments with different compounding periods. B. Lenders prefer less frequent compounding. C. Treasury Bills are pure discount loans with no coupon payments. D. Typical bullet bonds are interest-only loans where the principal is not amortized.

B. Lenders prefer less frequent compounding.

For which one of the following instruments does a bank guarantee payment by the buyer? Money market preferred stock Commercial paper Banker's acceptance Invoice Time draft

Banker's acceptance

Which one of the following statements is correct? 1) A prepack is a plan of liquidation used to distribute a firm's assets. 2) Bankruptcy courts have "cram-down" powers. 3) The absolute priority rule must be strictly followed in all bankruptcy proceedings. 4) Creditors cannot force a firm into bankruptcy even though they might like to do so. 5) A reorganization plan can only be approved if the firm's creditors all agree with the plan.

Bankruptcy courts have "cram-down" powers.

Terms of Sale

Basic Form: 2/10 net 45 - 2% discount if paid in 10 days - Total amount due in 45 days if discount is not taken

Which one of the following statements is correct? 1) Bond markets have less daily trading volume than equity markets. 2) There are less bond issues than there are equity issues. 3) Municipal bond prices are highly transparent. 4) Bond markets are dealer based. 5) Most bond trades occur on the NYSE.

Bond markets are dealer based.

Eurobond

Bond sold in multiple countries but denominated in one (the issuer's home) currency

A broker is an agent who: A. Trades on the floor of an exchange for himself or herself. B. Buys and sells from inventory. C. Offers new securities for sale to dealers only. D. Brings buyers and sellers together.

Brings buyers and sellers together.

Gilts

British and Irish government securities

Which one of the following is the equity risk arising from the daily operations of a firm? Strategic risk Financial risk Liquidity risk Industry risk Business risk

Business risk

What is the float management goal?

reduce collection delay

Discount

Calculation of the present value of some future amount.

Suppose you improve cash collection and control cash disbursements...what do you do with any idle cash surplus?

Can invest in money market securities - Financial instruments with original maturities ≤ one year Temporary Cash Surpluses - Seasonal or cyclical activities • Buy marketable securities with seasonal surpluses • Convert back to cash when deficits occur - Planned or possible expenditures • Accumulate marketable securities in anticipation of upcoming expenses

Capital Budgeting

Capital budgeting deals with: 1. Analysis of potential projects 2. Long-term decisions 3. Large expenditures 4. Difficult/impossible to reverse 5. Determines firm's strategic direction

What is the name given to a subsidiary of a firm that exists solely to handle the credit functions of the parent company? Internal credit organization Bank Credit association Captive finance company Credit union

Captive finance company

Capital Structure: Three Special Cases

Case I - no taxes or bankruptcy costs - No optimal capital structure Case II - corporate taxes but no bankruptcy costs - Optimal capital structure = 100% debt - Each additional dollar of debt increases the cash flow of the firm Case III - corporate taxes and bankruptcy costs - Optimal capital structure is part debt and part equity - Occurs where the benefit from an additional dollar of debt is just offset by the increase in expected bankruptcy costs

Which one of the following statements concerning financial leverage is correct? 1) The benefits of leverage are unaffected by the amount of a firm's earnings. 2) The use of leverage will always increase a firm's earnings per share. 3) The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage. 4) Changes in the capital structure of a firm will generally change the firm's earnings per share. 5) Financial leverage is beneficial to a firm only when the firm has negative earnings

Changes in the capital structure of a firm will generally change the firm's earnings per share.

Which of the following refers to a customer's willingness to meet his or her credit obligations? A. Character B. Capacity C. Capital D. Conditions

Character

Which one of the following refers to a customer's willingness to meet his or her credit obligations? Capital Conditions Capacity Character Collateral

Character

Collection float

Checks received increase book balance before the bank credits the account Available balance at bank - book balance < 0

Which one of the following correctly matches a country with its currency? Canada - pound China - yuan Mexico - real Japan - lira United Kingdom - euro

China - yuan

Which one of the following is the quoted price of a bond? Par value Discount price Face value Dirty price Clean price

Clean price

Which one of the following types of securities has no priority in a bankruptcy proceeding? Convertible bond Senior debt Common stock Preferred stock Straight bond

Common stock

The Bond Indenture ("Deed of Trust")

Contract between issuing company and bondholders includes: - Basic terms of the bonds- Total amount of bonds issued - Secured versus Unsecured- Sinking fund provisions - Details of protective covenants - Call provisions: • Deferred call • Call premium

Modified Internal Rate of Return (MIRR)

Controls for some problems with IRR a capital budgeting method that converts a project's cash flows using three methods: 1. Discounting Approach = Discount future outflows to present and add to CF0 2. Reinvestment Approach = Compound all CFs except the first one forward to end 3. Combination Approach - Discount outflows to present; compound inflows to end - MIRR will be unique number for each method - Discount (finance) /compound (reinvestment) rate externally supplied

Which one of the following generally pays a fixed dividend, receives first priority in dividend payment, and maintains the right to a dividend payment, even if that payment is deferred? Cumulative common Noncumulative common Noncumulative preferred Cumulative preferred Senior common

Cumulative preferred

An agent who buys and sells securities from inventory is called a: A. Specialist B. Dealer C. Broker D. Floor Trader

Dealer

Which one of the following will decrease the present value of an annuity? Increase in the annuity's future value Increase in the payment amount Increase in the time period Decrease in the discount rate Decrease in the annuity payment

Decrease in the annuity payment

Which one of the following activities is a source of cash? Decreasing long-term debt Increasing inventory Repurchasing shares of stock Increasing fixed assets Decreasing accounts receivable

Decreasing accounts receivable

All else constant, which one of the following will decrease the cash cycle? Decreasing the credit period granted to a customer Decreasing the inventory turnover rate Decreasing the accounts payable period Decreasing the accounts receivable turnover rate Increasing the receivables period

Decreasing the credit period granted to a customer

Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected? A. Interest rate risk premium B. Taxability premium C. Default risk premium D. Liquidity premium

Default risk premium

Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected? Interest rate risk premium Inflation premium Liquidity premium Taxability premium Default risk premium

Default risk premium

FOREX quotations

Direct = USD per foreign currency Indirect = Units of foreign currency per USD

Which one of the following is the price that an investor pays to purchase an outstanding bond? Dirty price Face value Call price Bid price Clean price

Dirty price

Which one of the following defines the internal rate of return for a project? 1) Discount rate that creates a zero cash flow from assets 2) Discount rate which results in a zero net present value for the project 3) Discount rate which results in a net present value equal to the project's initial cost 4) Rate of return required by the project's investors The project's current market rate of return

Discount rate which results in a zero net present value for the project

Which one of the following best represents the transaction motive for holding cash? 1) Buying extra inventory in response to an unexpected sale offered by a supplier 2) Distributing the weekly paychecks 3) Increasing the minimum cash balance for the firm's main bank account 4) Unexpectedly purchasing a competitor's firm 5) Holding cash in anticipation that the firm may need to close for a few days if floodwaters keep rising

Distributing the weekly paychecks

When _____ is higher, leverage is beneficial

EBIT

Which one of the following is the primary advantage of payback analysis? Incorporation of the time value Ease of use Research and development bias Arbitrary cutoff point Long-term bias

Ease of use

Payback Period

How long does it take to recover the initial cost of a project? Should not consider for primary decision rule. • Computation: 1. Estimate the cash flows 2. Subtract the future cash flows from the initial cost until initial investment is recovered. 3. A "break-even" type measure • Decision Rule - Accept if the payback period is less than some preset limit

How can we estimate all future dividend payments?

Estimating Dividends: 1. Constant dividend/Zero Growth - Firm will pay a constant dividend forever - Like preferred stock - Price is computed using the perpetuity formula 2. Constant dividend growth - Firm will increase the dividend by a constant percent everyperiod 3. Supernormal growth - Dividend growth is not consistent initially, but settles down to constant growth eventually

how are currencies typically qouted?

Euros and British pounds normally quoted as direct quotations - "The pound (₤) is selling at 1.5649 USD" All other currencies quoted as indirect

Which one of the following terms is inclusive of both direct and indirect bankruptcy costs? Financial distress costs Capital structure costs Financial leverage Homemade leverage Cost of capital

Financial distress costs

Which one of the following statements concerning financial leverage is correct? 1) Financial leverage increases profits and decreases losses. 2) Financial leverage has no effect on a firm's return on equity. 3) Financial leverage refers to the use of common stock. 4) Financial leverage magnifies both profits and losses. 5) Increasing financial leverage will always decrease the earnings per share.

Financial leverage magnifies both profits and losses.

Which one of the following is the equity risk arising from the capital structure selected by a firm? Strategic risk Financial risk Liquidity risk Industry risk Business risk

Financial risk

Which of the following statements is FALSE? A. Float equals the difference between the cash balance available at the bank and the cash balance recorded on the firm's books, and float also equals the sum of the disbursement float and the collection float (which is negative). B. Firms prefer to maintain a net collection float, rather than a net disbursement float, because they are receiving more money than they are spending. C. Firms often invest idle cash in money market securities which are short-term, safe, and easily marketable D. The income from investing excess cash in T-Bills is exempt from all state taxes, but the income from investing it in munis is exempt from all federal taxes.

Firms prefer to maintain a net collection float, rather than a net disbursement float, because they are receiving more money than they are spending.

Which of the following statements is FALSE? A. Across a longer time period, a single cash flow grows to a larger future value B. For a higher interest rate, a single cash flow has a smaller present value C. If its payments last longer, an annuity has a larger present value D. For a higher interest rate, an annuity has a smaller future value

For a higher interest rate, an annuity has a smaller future value

Which one of the following is the agreed-upon exchange rate that is to be used when currencies are exchanged at some point in the future based on an agreement made today? Spot rate ADR rate London Interbank Offer Rate Forward exchange rate Cross rate

Forward exchange rate

Disbursement float

Generated when a firm writes checks Available balance at bank - book balance > 0

What are credit management key issues

Granting credit increases sales Costs of granting credit - Chance that customers won't pay - Financing receivables Credit management = trade-off between increased sales and the costs of granting credit

call provision in a bond... A. Limits the actions of the borrower. B. Protects the borrower from unscrupulous practices by the lender. C. Allows the issuer to repurchase the bonds on the open market prior to maturity. D. Grants the issuer the option to repurchase the bonds prior to maturity at a pre-specified price.

Grants the issuer the option to repurchase the bonds prior to maturity at a pre-specified price.

Which one of the following is most indicative of a flexible short-term financial policy? A. High ratio of short-term debt to long-term debt B. High ratio of current assets to sales C. Low level of net working capital D. Relatively low level of liquidity

High ratio of current assets to sales

Which one of the following is most indicative of a flexible short-term financial policy?, 1) High ratio of short-term debt to long-term debt 2) Relatively small investment in current assets 3) High ratio of current assets to sales 4) Low level of net working capital 5) Relatively low level of liquidity

High ratio of current assets to sales

Which of the following statements is FALSE? A. The Gordon Growth Model assumes constant dividend growth and implies that stock prices grow at the same rate. B. A stock's price is the present value of the expected dividends and capital gains. C. Dealers buy and sell securities from their own inventory, while brokers bring buyers and sellers together to complete transactions. D. Holders of preferred stock have greater voting rights in corporate decisions than holders of common stock.

Holders of preferred stock have greater voting rights in corporate decisions than holders of common stock.

Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta IV. sensitivity of model to dividend growth rate 1) II only 2) I and II only 3) I and III only 4) II and IV only 5) I, II, III, and IV

II and IV only

Which of the following statements correctly relate to M&M Proposition I, with taxes? I. Debt decreases the value of a firm. II. The levered value of a firm exceeds the firm's unlevered value. III. The weighted average cost of capital (WACC) is constant. IV. The optimal capital structure is zero debt. 1) I only 2) II only 3) II and III only 4) I and IV only 5) I, III, and IV only

II only

reinvestment rate assumption

IRR assumes reinvestment at the IRR NPV assumes reinvestment at the firm's weighted average cost of capital (opportunity cost of capital) - More realistic - NPV method is best

Discount Bond

If coupon rate < YTM → Price < Par

Premium Bond

If coupon rate > YTM → Price > Par

Which of the following statements is FALSE? A. Firms seek to manage their cash by keeping no more than is needed on hand, because holding cash has an opportunity cost, namely, the returns that could be earned by investing the money. B. The optimal credit policy for a firm depends on many specific factors, but generally involves trading off the cost of granting credit, such as the carrying costs of receivables and the possibility of non-payment, against the benefits in terms of increased sales. C. In the five Cs of credit, capacity refers to the customer's willingness to meet credit obligations out of operating cash flows. D. In the five Cs of credit, collateral are the assets pledged by the customer for security incase of default.

In the five Cs of credit, capacity refers to the customer's willingness to meet credit obligations out of operating cash flows.

Which of the following statements is FALSE? A. The bid price is the price that a dealer is willing to pay for a security and is lower than the ask price. B. Bonds trade less frequently than stocks. C. In the stock market, the secondary market is the market where new securities are originally sold to investors by the issuing company. D. Dividends received by corporations have a 70% to 100% exclusion from taxable income.

In the stock market, the secondary market is the market where new securities are originally sold to investors by the issuing company.

Translation Exposure

Income from foreign operations translated back to USD for accounting purposes, even if foreign currency not actually converted: - If gains/losses flowed through directly to the income statement → significant EPS volatility - Accounting regulations require: • All cash flows be converted at the prevailing exchange rates • Currency gains and losses accumulated in a special account within shareholders' equity

A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital? Increasing the firm's tax rate Issuing new bonds at par Redeeming shares of common stock Increasing the firm's beta Increasing the debt-equity ratio

Increasing the firm's beta

Sara is investing $1,000 today. Which one of the following will increase the future value of that amount? - Shortening the investment time period - Paying interest only on the principal amount - Paying simple interest rather than compound interest - Paying interest only at the end of the investment period rather than throughout the investment period - Increasing the interest rate

Increasing the interest rate

Which one of the following terms applies to the costs incurred by a firm which is trying to avoid filing for bankruptcy? Indirect bankruptcy costs Direct bankruptcy costs Static theory cost Optimal capital structure cost Reorganization costs

Indirect bankruptcy costs

What is the primary purpose of a cash discount? 1) Customer compensation for an out-of-stock item 2) Customer compensation for faulty goods or services 3) Means of offsetting the interest charges on an account receivable 4) Inducement to pay promptly 5) Incentive to purchase a specialty item

Inducement to pay promptly

Simple Interest

Interest earned only on the original principal amount invested

Swaps

Interest rate swap = two parties exchange a floating‐rate payment for a fixed‐rate payment Currency swap = agreement to deliver one currency in exchange for another based on some pre‐specified rate

You just borrowed $3,000 from your bank and agreed to repay the interest on an annual basis and the principal at the end of 3 years. What type of loan did you obtain? Interest-only Amortized Perpetual Pure discount Lump sum

Interest-only

Which of the following statements is TRUE? A. Leverage reduces the expected values of both EBIT and net income. B. Leverage increases expected ROE but decreases expected EPS. C. Leverage decreases the volatility of both ROE and EPS. D. Investors can create their own leverage within their own portfolios.

Investors can create their own leverage within their own portfolios.

Which one of the following would be the most common evidence of indebtedness when a sale is made on open account? Sight draft Commercial draft Banker's acceptance Promissory note Invoice

Invoice

Which one of the following is a system for managing demand-dependent inventories that minimizes the amount of inventory on hand? Inventory flow log Materials requirements planning Just-in-time inventory system Kanban Keiretsu

Just-in-time inventory system

Foreign Exchange (FOREX)

Largest financial market in the world Trading = 24/7 over‐the‐counter Most trading in USD, £, ¥, and €

Which one of the following is a direct bankruptcy cost? 1) Loss of customer goodwill resulting from a bankruptcy filing 2) Legal and accounting fees related to a bankruptcy proceeding 3) Management time spent on a bankruptcy proceeding 4) Any financial distress cost 5) Costs a firm spends trying to avoid bankruptcy

Legal and accounting fees related to a bankruptcy proceeding

What is the primary purpose of bond covenants? Meet regulatory requirements Describe repayment terms Lender protection Define a bond's rating Increase a bond's seniority position

Lender protection

Which of the following statements is FALSE? A. Unlike equity holders, debt holders are not owners B. Lenders can exert control over a company's managers by voting for its board of directors. C. A corporation cannot deduct its payments to preferred shareholders before it pays taxes D. Holders of convertible bonds can force bankruptcy if their coupons are not paidB.

Lenders can exert control over a company's managers by voting for its board of directors.

The Effect of Financial Leverage

Leverage amplifies the variation in both Earnings Per Share (EPS) and Return on equity (ROE). For simplicity, we will ignore the effect of taxes at this stage

Which of the following statements is FALSE? A. Like typical large US companies, Apple uses about 60% debt in its capital structure. B. In a Chapter 7 bankruptcy liquidation, employees and trade creditors have lower priority among claimants than senior and secured lenders. C. In a bankruptcy reorganization, middle managers or 'white collar' employees lose their jobs more commonly than production workers or 'blue collar' employees. D. Following a Chapter 11 filing a few years earlier and failed attempts to negotiate concessions with its unions, Hostess again in 2012 filed for bankruptcy with the intent to liquidate its assets.

Like typical large US companies, Apple uses about 60% debt in its capital structure.

Which one of the following terms refers to the termination of a firm as a going concern? Insolvency Reorganization Chapter 11 bankruptcy Prepack Liquidation

Liquidation

Suppose a U.S. firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies, and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following? A. Short-run exposure to exchange rate risk B. Long-run exposure to exchange rate risk C. Translation exposure to exchange rate risk D. Political risk associated with the foreign operations

Long-run exposure to exchange rate risk

Suppose a U.S. firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies, and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following? Interest rate disparities Short-run exposure to exchange rate risk Long-run exposure to exchange rate risk Political risk associated with the foreign operations Translation exposure to exchange rate risk

Long-run exposure to exchange rate risk

Long‐Run Exposure

Long‐run fluctuations from unanticipated changes in relative economic conditions Managing risk - More difficult to hedge - Try to match long‐run inflows and outflows in the currency- Borrowing in the foreign country may mitigate some of the problems

Which one of the following terms refers to a bond's rate of return that is required by the market place? Coupon rate Yield to maturity Dirty yield Call yield Discount rate

Yield to maturity

Which of the following statements is FALSE? A. MM Proposition 1, if there are no taxes, states the value of the firm does not depend whatsoever on its capital structure. B. MM Proposition 2, if there are no taxes, explains how the cost of equity decreases as the firm increases its use of debt financing. C. Because interest expense is tax deductible, leverage increases the firm's value by the amount of the present value of the interest tax shield. D. Because interest expense is tax deductible, a firm's WACC decreases as firms rely more heavily on debt financing.

MM Proposition 2, if there are no taxes, explains how the cost of equity decreases as the firm increases its use of debt financing.

What factors influence WACC?

Market conditions, especially interest rates, tax rates and the market risk premium The firm's capital structure and dividend policy The firm's investment policy - Firms with riskier projects generally have a higher WACC

Characteristics of Short-Term Securities

Maturity - firms often limit the maturity of short-term investments to 90 days to avoid loss of principal due to changing interest rates Default risk - avoid investing in marketable securities with significant default risk Marketability - ease of converting to cash Taxability - consider different tax characteristics when making a decision

What is the primary goal of a financial manager?

Maximize stockholder wealth Choose the capital structure that will minimize WACC and maximize stockholder wealth

Profitability Index

Measures the benefit per unit cost, based on the time value of money - A profitability index of 1.1 implies that for every $1 of investment, we create an additional $0.10 in value Can be very useful in situations of capital rationing Decision Rule: If PI > 1.0 = Accept

Which one of the following actions is indicative of a restrictive short-term financial policy? 1) Granting increasing amounts of credit to customers 2) Expanding the number of inventory items carried 3) Increasing the firm's investment in the current accounts 4) Minimizing the cash balances held by the firm 5) Investing relatively large amounts in marketable securities

Minimizing the cash balances held by the firm

Eurocurrency (Eurodollars)

Money deposited in a financial center outside the country of the currency involved "Eurodollars" = dollar-denominated deposits in banks outside the U.S. banking system

NPV vs. IRR

NPV and IRR will generally give the same decision. Exceptions: Non-conventional cash flows • Cash flow sign changes more than once Mutually exclusive projects • Initial investments are substantially different • Timing of cash flows is substantially different • Will not reliably rank projects NPV should be used to choose between mutually exclusive projects

A specialist is a(n): 1) employee who executes orders to buy and sell for clients of his or her brokerage firm. 2) individual who trades on the floor of an exchange for his or her personal account. 3) NYSE member who functions as a dealer for a limited number of securities. 4) broker who buys and sells securities from a market maker. 5) trader who only deals with primary offerings.

NYSE member who functions as a dealer for a limited number of securities.

Designated market makers

NYSE members who act as dealers in particular stocks. Formerly known as "specialists" individuals on the NYSE floor who have an obligation to help maintain liquidity in their assigned stocks

Which one of the following most likely represents the greatest political risk for a U.S.-based firm? 1) A product assembly plant located in a foreign country 2) A foreign sales office 3) Accounting office which handles all payroll functions and is located in a foreign country 4) Natural ore mine in a foreign country 5) Sub-assembly plant in a foreign country that uses U.S. made components

Natural ore mine in a foreign country

Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? Payback Profitability index Accounting rate of return Internal rate of return Net present value

Net present value

What requirements are there for Absolute PPP to hold?

No transaction costs No barriers to trade (no taxes, tariffs, etc.) No difference in the commodity between locations Absolute PPP rarely holds in practice - Usually only for uniform, traded goods

Capital Structure Weights

Notation: E = market value of equity= # outstanding shares x price per share D = market value of debt, estimated if not traded= # outstanding bonds x bond price V = market value of the firm = D + E Weights: E/V = % financed with equity D/V = % financed with debt

Which one of the following commences on the day inventory is purchased and ends on the day the payment for that inventory is collected? Assume all sales and purchases are on credit. Inventory period Accounts receivable period Accounts payable period Operating cycle Cash cycle

Operating cycle

Which of the following statements is FALSE? A. A bond's yield represents the annualized return that an investor would earn by holding it to maturity, if it does not default. B. Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease. C. When interest rates increase, then bond prices fall, and more so the longer their maturity and the smaller their coupons. D. If a bond is held to maturity and it does not default, then the reinvestment rate risk will offset the price risk.

Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease.

Which of the following statements is FALSE? A. A bond's yield represents the annualized return that an investor would earn by holding it to maturity, if it does not default. B. Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease. C. When interest rates increase, then bond prices fall, and moreso the longer their maturityand the smaller their coupons. D. If a bond is held to maturity and it does not default, then the reinvestment rate risk willoffset the price risk.B.

Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease.

Which of the following statements is TRUE? A. When yields increase, bonds with shorter maturities tend to decrease in value more than bonds with longer maturities. B. Over time, if yields do not change, the values of premium bonds decrease toward par smoothly. C. A "call provision" allows the bond holder the option to determine when they want the company to buy back the bond. D. Treasury Bonds are pure discount loans sold by the US government as a means to borrow money for less than one year.

Over time, if yields do not change, the values of premium bonds decrease toward par smoothly.

Which one of the following is a use of cash? 1) Selling inventory at cost 2) Paying a supplier for inventory you purchased last month 3) Borrowing money from a local bank 4) Collecting payment from a customer 5) Selling a fixed asset such as a piece of machinery

Paying a supplier for inventory you purchased last month

BNM is comparing different capital structures. Plan A is all equity with 20m (million) shares outstanding. Plan B would result in 14m shares and $150m in debt. Plan C would result in 11m shares and $225m in debt. The interest rate on the debt is 8 percent. Ignoring taxes, compare these plans assuming that expected EBIT is $45m. Of the three plans, the firm will have the highest expected EPS with _____ and the lowest expected EPS with _____. A. Plan A; Plan B B. Plan A; Plan C C. Plan C; Plan A D. Plan B; Plan C

Plan C; Plan A Leverage increases expected EPS and ROE (but increases their riskiness too) Expected EPS(All-equity Plan A) = $45m/20m = $2.25 Expected EPS(Plan B) = [$45m - ($150m × 0.08)/14m = $2.36 Expected EPS(Plan C) = [$45m - ($225m × 0.08)]/11m = $2.45

Which one of the following indicates that a project is expected to create value for its owners? Profitability index less than 1.0 Payback period greater than the requirement Positive net present value Positive average accounting rate of return Internal rate of return that is less than the requirement

Positive net present value

Absolute Purchasing Power Parity

Price of an item is the same regardless of the currency used to purchase it or where it is selling

Newly issued securities are sold to investors in which one of the following markets? A. Proxy B. Inside C. Secondary D. Primary

Primary

Newly issued securities are sold to investors in which one of the following markets? Proxy Stated value Inside Secondary Primary

Primary

Which one of the following indicates that a project is definitely acceptable? 1) Profitability index greater than 1.0 2) Negative net present value 3) Modified internal rate return that is lower than the requirement 4) Zero internal rate of return 5) Positive average accounting return

Profitability index greater than 1.0

What does an NPV of 0 represent?

Project's inflows are "exactly sufficient to repay the invested capital and provide the required rate of return"

Which of the following statements is FALSE? A. Promissory notes are the most common credit instrument. B. The evidence of indebtedness in an open account is the invoice. C. For commercial drafts, the buyer accepts it and commits to payment before delivery. D. Banker's acceptances are commonly used in international trade.

Promissory notes are the most common credit instrument.

Cindy is taking out a loan today. The cash amount that she will receive today is equal to the present value of the lump sum payment which she will be required to pay 2 years from today. Which type of loan is this? Principal-only Amortized Interest-only Compound Pure discount

Pure discount

The variability in both _____ and _____ increases when financial leverage is increased

ROE, EPS double-edged sword effect - while leverage can increase returns when EBIT is high, it can also increase risk for shareholders when EBIT is low or negative.

London Interbank Offer Rate (LIBOR)

Rate international banks charge each other for loans of Eurodollars overnight in the London market Frequently used as a benchmark rate for money market instruments for over 40 years

Given an interest rate of zero percent, the future value of a lump sum invested today will always: A. Remain constant, regardless of the investment time period. B. Decrease if the investment time period is shortened. C. Decrease if the investment time period is lengthened. D. Be infinite in value.

Remain constant, regardless of the investment time period.

Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation? Chapter 7 bankruptcy Liquidation Technical insolvency Accounting insolvency Reorganization

Reorganization

Short‐Run Exposure

Risk from day‐to‐day fluctuations in exchange rates and the fact that companies have contracts to buy and sell goods in the short‐run at fixed prices Managing risk - Enter into a forward agreement to guarantee the exchange rate - Use foreign currency options to lock in exchange rates if they move against you, but benefit from rates if they move in your favor

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? 1) Amount of debt used to finance the project 2) Use, or lack thereof, of preferred stock to finance the project 3) Mix of funds used to finance the project 4) Risk level of the project 5) Length of the project's life

Risk level of the project

Accounts receivable financing is the term used to describe which of the following types of loans which involve either the assignment or the factoring of a firm's accounts receivables? Secured short-term loan Unsecured short-term loan Secured long-term loan Unsecured long-term loan Trust receipt loan

Secured short-term loan

By definition, an inventory loan is which one of the following types of loan? Secured short-term loan Unsecured short-term loan Secured long-term loan Unsecured long-term loan Trust receipt loan

Secured short-term loan

Which one of the following best describes a line of credit? 1) Long-term, prearranged, committed bank loan 2) Short-term loan secured by accounts receivable 3) Short-term loan secured by inventory 4) Long-term, prearranged, noncommitted bank loan 5) Short-term prearranged bank loan that can be either committed or noncommitted

Short-term prearranged bank loan that can be either committed or noncommitted

A trader in Switzerland just agreed to trade Swiss francs for British pounds based on today's exchange rate. The trade is expected to settle tomorrow. What term best describes this exchange? Arbitrage transaction Forward trade Spot trade Purchasing power parity Interest rate parity

Spot trade

Which one of the following types of bonds should an investor purchase if he or she is primarily concerned about ensuring that bond ownership will increase his or her purchasing power? OTC Death CAT PETS TIPS

TIPS

Which of the following statements is FALSE? A. Legal bankruptcy occurs when the firm or creditors bring petitions to a federal court for bankruptcy. B. Bankruptcy refers to the legal proceeding for liquidating or reorganizing a business. C. Technical insolvency occurs when a firm has a negative net worth, because the book value of its liabilities are less than the book value of its assets. D. Liquidation is the termination of the firm as a going concern, whereas reorganization is the financial restructuring of a struggling firm to attempt to continue operations as a going concern.

Technical insolvency occurs when a firm has a negative net worth, because the book value of its liabilities are less than the book value of its assets.

Terry invested $2,000 today in an investment that pays 6.5 percent annual interest. Which one of the following statements is correct, assuming all interest is reinvested? 1) Terry will earn the same amount of interest each year. 2) Terry could have the same future value and invest less than $2,000 initially if he could earn more than 6.5 percent interest. 3) Terry will earn an increasing amount of interest each and every year even if he should decide to withdraw the interest annually rather than reinvesting the interest. 4) Terry's interest for year two will be equal to $2,000 × 0.065 × 2. 5) Terry will be earning simple interest.

Terry could have the same future value and invest less than $2,000 initially if he could earn more than 6.5 percent interest.

Which of the following statements is TRUE? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The APR is always strictly greater than the EAR for compounding more than once per year. C. The APR on a monthly loan is equal to (1 + monthly interest rate)^12 - 1. D. The EAR is the best measure of the actual rate you are paying on a loan.

The EAR is the best measure of the actual rate you are paying on a loan.

Which of the following statements is TRUE? A. Companies are required by law to have their bonds rated by agencies such as Moody's or S&P. B. The Fisher effect is the relationship between nominal returns, real returns, and inflation. C. Investors require higher yields on secured bonds than on unsecured bonds. D. A callable bond can be swapped for a fixed number of shares of stock before maturity at the holder's option.

The Fisher effect is the relationship between nominal returns, real returns, and inflation.

Future Value (FV)

The amount an investment is worth after one or more periods. "Later" money on a time line

Which of the following statements is FALSE? A. An easy way to compute the value of an annuity due (such as a lease) is to compute the value of a regular annuity, and then compound the result forward one period. B. The annual percentage rate (APR) is the best way to compare two investments with different compounding periods. C. Lenders and investors prefer daily compounding to annual compounding. D. The process of paying off a loan by making regular principal reductions is called amortizing.

The annual percentage rate (APR) is the best way to compare two investments with different compounding periods.

Which one of the following statements is correct? 1) Exchange rates are adjusted each morning and held constant until the next morning. 2) The four most common currencies traded in the foreign exchange market are the U.S. dollar, franc, euro, and peso. 3) All of South America uses the peso as their currency. 4) New Zealand uses the same currency as Australia and that is the A$. 5) The foreign exchange market is the largest financial market in the world

The foreign exchange market is the largest financial market in the world

Which of the following statements is FALSE? A. The future value of a single cash flow grows across a longer time period B. The present value of a single cash flow falls with a higher interest rate C. The present value of an annuity grows if the annuity lasts longer D. The future value of an annuity falls with a higher interest rate

The future value of an annuity falls with a higher interest rate

Cost of Capital Basics

The cost to a firm for capital funding = the return to the providers of those funds • The return earned on assets depends on the risk of those assets • A firm's cost of capital indicates how the market views the risk of the firm's assets • A firm must earn at least the required return to compensate investors for the financing they have provided • The required return is the same as the appropriate discount rate

Which of the following statements is FALSE? A. Credit management trades off the carrying the cost of extending credit to buyers against the goal of increasing sales. B. The credit period is typically longer for perishable goods and for buyers with higher credit risk. C. Terms of sale "2/10 net 45" indicates a 2% discount if paid within 10 days, with the total amountdue in 45 days if the discount is not taken. D. Banker's acceptances are credit commitments made before delivery, are guaranteed by banks, andare common in international trade.

The credit period is typically longer for perishable goods and for buyers with higher credit risk.

Present Value (PV)

The current value of future cash flows discounted at the appropriate discount rate. Alternatively, the current value of an amount to be receive value at t=0 on a time line

Which of the following statements is FALSE? A. The effect of compounding is great over short time periods, but then it begins to decline as the horizon grows. B. Moving cash flows to the left on a time line is called discounting, and values are additive at any one point in time. C. Future value refers to the amount of money an investment will grow to over some period of time at some given interest rate. D. To estimate the present value of future cash flows, the discount rate should be adjusted for both the timing or maturity of that cash flow and the inherent risk of that cash flow.

The effect of compounding is great over short time periods, but then it begins to decline as the horizon grows.

Cross‐rate

The exchange rate between any two currencies not involving USD Usually calculated from direct or indirect rates, based on USD exchange rates

When is a firm insolvent from an accounting perspective? A. When the firm is unable to meet its financial obligations in a timely manner B. When the firm's debt exceeds the value of the firm's equity C. When the firm has a negative net worth D. When the firm's revenues cease

When the firm has a negative net worth

Which of the following choices is NOT a CORRECT way to complete this sentence: Other things equal, a set of cash flows is more valuable ... A. The longer they last. B. The more frequently they are paid. C. The faster they grow. D. The larger the time value that investors require compensation for trading a dollar today for dollars tomorrow.

The larger the time value that investors require compensation for trading a dollar today for dollars tomorrow.

Observed Capital Structures. Which of the following is not correct? 1) The more capital intensive industries, such as airlines, cable television, and electric utilities, tend to use less financial leverage. 2) Industries with less predictable future earnings, such as computers or drugs, tend to use less financial leverage. 3) Firms with more tangible assets typically have greater needs for external financing. 4) Firms with more predictable earnings typically have greater likelihood of benefiting from the interest tax shelter.

The more capital intensive industries, such as airlines, cable television, and electric utilities, tend to use less financial leverage.

An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true? 1) The internal rate of return exceeds the required rate of return. 2) The investment never pays back. 3) The net present value is equal to zero. 4) The average accounting return is 1.0. 5) The net present value is greater than 1.0.

The net present value is equal to zero.

Which one of the following statements is correct? 1) The internal rate of return is the most reliable method of analysis for any type of investment decision. 2) The payback method is biased towards short-term projects. 3) The modified internal rate of return is most useful when projects are mutually exclusive. 4) The average accounting return is the most difficult method of analysis to compute. 5) The net present value method is only applicable if a project has conventional cash flows.

The payback method is biased towards short-term projects.

Today, Courtney wants to invest an amount less than $5,000 with the goal of receiving $5,000 back some time in the future. Which one of the following statements is correct? A. The period of time she has to wait until she reaches her goal is not affected by the compounding of interest. B. The lower the rate of interest she earns, the shorter the time she will have to wait to reach her goal. C. The length of time she has to wait to reach her goal is directly related to the interest rate she earns. D. The period of time she has to wait decreases as the amount she invests today increases

The period of time she has to wait decreases as the amount she invests today increases

Today, Courtney wants to invest less than $5,000 with the goal of receiving $5,000 back some time in the future. Which one of the following statements is correct? 1) The period of time she has to wait until she reaches her goal is unaffected by the compounding of interest. 2) The lower the rate of interest she earns, the shorter the time she will have to wait to reach her goal. 3) She will have to wait longer if she earns 6 percent compound interest instead of 6 percent simple interest. 4) The length of time she has to wait to reach her goal is directly related to the interest rate she earns. 5) The period of time she has to wait decreases as the amount she invests today increases.

The period of time she has to wait decreases as the amount she invests today increases.

Arbitrage

The practice of buying and selling equivalent goods to take advantage of a price difference A violation of the "Law of One Price" Arbitrage: - A positive cash flow - No risk

Exchange Rate Risk

The risk that the value of a cash flow in one currency translated from another currency will decline due to a change in exchange rates A natural consequence of international operations in a world where relative currency values move up and down

Suppose you could buy 1,320 South Korea won or 78 Pakistan rupees last year for $1. Today, $1 will buy you 1,318 won or 80 rupees. Which one of the following occurred over the past year? 1) The dollar appreciated against the won. 2) The dollar depreciated against the rupee. 3) The dollar appreciated against both the won and the rupee. 4) The won depreciated against the dollar. 5) The rupee depreciated against the dollar.

The rupee depreciated against the dollar.

Suppose you could buy 1,320 South Korea won or 78 Pakistan rupees last year for $1.Today, $1 will buy you 1,318 won or 80 rupees. Which one of the following occurredover the past year? A. The won depreciated against the dollar. B. The dollar depreciated against the rupee. C. The rupee depreciated against the dollar. D. The dollar appreciated against both the won and the rupee.

The rupee depreciated against the dollar.

Capital Structure Theory

The value of the firm is determined by the cash flows to the firm and the risk of the firm's assets To change firm value - Change the risk of the cash flows - Change the cash flows

The foreign subsidiary of a U.S. firm is profitable when profits are measured in the foreign currency but those profits become losses when measured in U.S. dollars. This is an example of which one of the following? Interest rate disparities Short-run exposure to exchange rate risk Long-run exposure to exchange rate risk Political risk associated with the foreign operations Translation exposure to exchange rate risk

Translation exposure to exchange rate risk

Which one of the following is an example of a perpetuity? Trust income of $1,200 a year forever Retirement pay of $2,200 a month for 20 years Lottery winnings of $1,000 a month for life Car payment of $260 a month for 60 months Apartment rent payment of $800 a month for one year

Trust income of $1,200 a year forever

Which of the following statements is FALSE? A. Interest expense reduces taxable income and net income but not EBIT. B. When a company repurchases its shares using proceeds from new issues of debt, its future expected earnings per share increases. C. 'Homemade leverage' is the use of personal borrowing to adjust the overall amount of financial leverage to which the individual investor is exposed. D. Under M&M assumptions which ignore special benefits and costs of debt, leverage has a substantial impact on total firm value and on WACC.

Under M&M assumptions which ignore special benefits and costs of debt, leverage has a substantial impact on total firm value and on WACC.

Which of the following statements is TRUE? A. Bankruptcy occurs whenever a firm is unable to meet obligations or reports negative book equity. B. A Chapter 7 bankruptcy allows a firm to reorganize and continue operations as "debtor-in-possession." C. Under bankruptcy, trade creditors have lower priority than secured bank loans. D. Financial distress and bankruptcy costs cause WACC to decrease as leverage increases.

Under bankruptcy, trade creditors have lower priority than secured bank loans.

Which one of the following is minimized when the value of a firm is maximized? Return on equity WACC Debt Taxes Bankruptcy costs

WACC

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities? Cost of equity Internal rate of return Aftertax cost of debt Weighted average cost of capital Debt-equity ratio

Weighted average cost of capital

Which one of the following is the pre-tax cost of debt? 1) Average coupon rate on the firm's outstanding bonds 2) Coupon rate on the firm's latest bond issue 3) Weighted average yield-to-maturity on the firm's outstanding debt 4) Average current yield on the firm's outstanding debt 5) Annual interest divided by the market price per bond for the latest bond issue

Weighted average yield-to-maturity on the firm's outstanding debt

Which of the following statements is FALSE? A. When market yields rise, the price of discount bonds fall further below par or face value. B. When market yields rise, the price of long-term bonds fall by a greater percent than short-term bonds. C. When market yields rise, the price of bonds with small coupons fall by a greater percent than those with large coupons. D. When market yields rise, investors redeem or 'call' the callable bonds they own, forcing the issuer of the bond to pay at least the face value.

When market yields rise, investors redeem or 'call' the callable bonds they own, forcing the issuer of the bond to pay at least the face value.

When is a firm insolvent from an accounting perspective? 1) When the firm is unable to meet its financial obligations in a timely manner 2) When the firm's debt exceeds the value of the firm's equity 3) When the firm has a negative net worth 4) When the firm's revenues cease 5) When the market value of the firm's equity equals zero

When the firm has a negative net worth

Which one of the following terms applies to a bond that initially sells at a deep discount and pays no interest payments? Callable Income Zero coupon Convertible Tax-free

Zero coupon

earning before interest and taxes (EBIT)

a financial metric that represents a company's operating profit before deducting interest expenses and income taxes. It is an important measure of a company's profitability and efficiency in generating profits from its operations, without taking into account the impact of financing decisions or tax obligations. EBIT is calculated by subtracting a company's operating expenses from its revenue.

Earnings Per Share (EPS)

a financial metric that represents the portion of a company's profit that is allocated to each outstanding share of common stock. EPS is calculated by dividing a company's net income by the number of outstanding shares of common stock. **It is an important measure of a company's profitability and is often used by investors to evaluate the financial performance of a company.**

Return on Equity (ROE)

a financial ratio that measures the amount of net income returned as a percentage of shareholders' equity. ROE is an important measure of a company's profitability and efficiency in using its equity to generate profits. It is calculated by dividing net income by shareholders' equity. **It is often used by investors to evaluate the financial performance of a company and compare it to other companies in the same industry.**

Exchange Rates

a measurement of the value of one nation's currency relative to the currency of other nations

discounted cash flow (DCF) valuation

a) calculating the present value of a future cash flow to determine its value today b) the process of valuing an investment by discounting its future cash flows

Forward trade

agree today to exchange currency at some future date and at a pre‐specified price (also called a forward contract)

Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably: 1) require the highest rate of return from division X since it has been in existence the longest. 2) assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions. 3) use the firm's WACC as the cost of capital for division Z as it provides analysis for the entire firm. 4) use the firm's WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm. 5) allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm: 1) automatically gives preferential treatment in the allocation of funds to its riskiest division. 2) encourages the division managers to only recommend their most conservative projects. 3) maintains the current risk level and capital structure of the firm. 4) automatically maximizes the total value created for its shareholders. 5) allocates capital funds evenly amongst its divisions.

automatically gives preferential treatment in the allocation of funds to its riskiest division.

Foreign bonds

bonds sold in a foreign country and denominated in that country's currency

pure discount loan

borrower receives money today, repays a lump sump in the future Treasury bills are excellent examples of pure discount loans - Principal amount is repaid at some future date - No periodic interest payments

A broker is an agent who: 1) trades on the floor of an exchange for himself or herself. 2) buys and sells from inventory. 3) offers new securities for sale to dealers only. 4) who is ready to buy or sell at any time. 5) brings buyers and sellers together.

brings buyers and sellers together.

Exchanges facilitate the flow of _____

capital Extremely important to developing countries

Capital restructuring

changing the amount of leverage without changing the firm's assets - Increase leverage by issuing debt and repurchasing outstanding shares - Decrease leverage by issuing new shares and retiring outstanding debt

M&M Proposition II, without taxes, states that the: 1) capital structure of a firm is highly relevant. 2) weighted average cost of capital decreases as the debt-equity ratio decreases. 3) cost of equity increases as a firm increases its debt-equity ratio. 4) return on equity is equal to the return on assets multiplied by the debt-equity ratio. 5) return on equity remains constant as the debt-equity ratio increases.

cost of equity increases as a firm increases its debt-equity ratio.

coupon payment

coupon rate x par value

An agent who buys and sells securities from inventory is called a: floor trader. dealer. commission broker. broker. floor broker.

dealer.

As "yields" increase, bond prices _____ and vice versa

decrease

As interest rates increase present values _____

decrease

Float

difference between the cash balance recorded at the bank and cash balance recorded in the cash account (book) Net float = disbursement float + collection float

Slowing down payments can increase _____ _____, which is desirable - but it may not be ethical or optimal to do this

disbursement float

If the forward rate < spot rate, the foreign currency is selling at a _____

discount

amortized loan with fixed payment

each payment covers the interest expense plus reduces principal

Spot trade

exchange currency immediately

You would find that the price of the stock is really just the present value of all _____ _____ _____

expected future dividends

par value (face value)

face amount. the principal amount of a bond that is repaid at the end of the term. $1,000 for corporate bonds

Treasury Securities

federal government debt - Treasury Bills (T-bills) • Pure discount bonds (zero coupon) • Original maturity of one year or less - Treasury notes • Coupon debt • Original maturity between one and ten years - Treasury bonds • Coupon debt • Original maturity greater than ten years - TIPS • Pay a "real" coupon and the principal increases with CPI inflation

What is the inventory management objective?

find the optimal trade-off between carrying too much inventory versus not enough Inventory = large percentage of firm assets Inventory costs: - Cost of carrying too much inventory - Cost of not carrying enough (shortage) inventory

Annuity

finite series of equal payments that occur at regular intervals

The higher the interest rate, the _____ the future value

higher

The longer the time period, the _____ the future value

higher

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as: M&M Proposition I. capital restructuring. homemade leverage. M&M Proposition II. financial risk management.

homemade leverage.

The present value of a lump sum future amount: increases as the interest rate decreases. decreases as the time period decreases. is inversely related to the future value. is directly related to the interest rate. is directly related to the time period.

increases as the interest rate decreases.

Perpetuity

infinite series of equal payments

Compound Interest

interest earned on principal and on interest received "Interest on interest" - interest earned on reinvestment of previous interest payments

You ALWAYS need to make sure that the _____ and the _____ match

interest rate, time period Annual periods → annual rate Monthly periods → monthly rate **If you have an APR based on monthly compounding, you have to use monthly periods for lump sums or adjust the interest rate accordingly.**

The profitability index reflects the value created per dollar: invested. of sales. of net income. of taxable income. of shareholders' equity.

invested.

Interest Rate Parity

investors should expect to earn the same return on similar‐risk securities in all countries

The cost of preferred stock: increases when a firm's tax rate decreases. is constant over time. is unaffected by changes in the market price. is equal to the stock's dividend yield. increases as the price of the stock increases.

is equal to the stock's dividend yield.

When a bond's yield to maturity is less than the bond's coupon rate, the bond: had to be recently issued. is selling at a premium. has reached its maturity date. is priced at par. is selling at a discount.

is selling at a premium.

A prepack: 1) guarantees full payment to all creditors but lengthens the time span of the debt. 2) is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan. 3) protects the interests of both the current creditors and the existing shareholders. 4) applies only if a firm files under Chapter 7 of the bankruptcy code. 5) extends the time that a firm is protected by the bankruptcy process.

is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan.

Fill in the blanks: An annuity is worth _______ than a perpetuity, and a constant annuity is worth _______ than a growing annuity. (assuming the normal circumstance where the discount rate exceeds the growth rate and where the growth is positive) more, more B. more, less C. less, more D. less, less

less, less

Fill in the blanks: Stock prices fall if investors either expect _________ growth rates or require _________ returns. A. higher, higher B. higher, lower C. lower, higher D. lower, lower

lower, higher

Inside quotes are defined as the: 1) bid and asked prices presented by NYSE specialists. 2) last bid and asked price offered prior to the market close. 3) lowest asked and highest bid offers. 4) daily opening bid and asked quotes. 5) last traded bid and asked prices.

lowest asked and highest bid offers.

The Treasury yield curve plots the yields on Treasury notes and bonds relative to the ____ of those securities. face value market price maturity coupon rate issue date

maturity

Net Present Value (NPV)

net gain in shareholder wealth NPV = PV of Inflows - Cost0 Dominant method - always prevails as it directly related to increases in value added to firm (Vf) • How much value is created from undertaking an investment? • The essential steps: - Step 1: Estimate the expected future cash flows. - Step 2: Estimate the required return for projects of this risk level. - Step 3: Find the present value of the cash flows and subtract the initial investment to arrive at the Net Present Value.

Optimal Credit Policy

occurs at the point where marginal carrying costs are equal to the marginal opportunity costs

A call provision grants the bond issuer the: 1) right to contact each bondholder to determine if he or she would like to extend the term of his or her bonds. 2) option to exchange the bonds for equity securities. 3) right to automatically extend the bond's maturity date. 4) right to repurchase the bonds on the open market prior to maturity. 5) option of repurchasing the bonds prior to maturity at a pre-specified price.

option of repurchasing the bonds prior to maturity at a pre-specified price.

Capital Structure

percent of debt and equity used to fund the firm's assets in relation to WACC The weights are determined by how much of each type of financing is used (Capital Structure)

If the forward rate > spot rate, the foreign currency is selling at a _____ (when quoted as $ equivalents)

premium

Credit Analysis

process of deciding which customers receive credit Credit information - Financial statements - Credit reports/past payment history - Banks - Payment history with the firm Determining creditworthiness - 5 Cs of Credit - Credit Scoring

Given an interest rate of zero percent, the future value of a lump sum invested today will always: - remain constant, regardless of the investment time period. - decrease if the investment time period is shortened. - decrease if the investment time period is lengthened. - be equal to $0. - be infinite in value.

remain constant, regardless of the investment time period.

A firm's WACC reflects the _____ of an average project undertaken by the firm "Average" → risk = the firm's current operations

risk

WACC Different divisions/projects may have different _____

risks - The division's or project's WACC should be adjusted to reflect the appropriate risk and capital structure

For a given interest rate, the longer the time period (# of periods), the _____ the present value

smaller

For a given number of periods, the higher the interest rate, the _____ the present value

smaller

Triangle Arbitrage

the act of exchanging through three currencies to exploit a mispriced trio of currency quotes

Annual Percentage Rate (APR) "Nominal"

the annual rate quoted by law APR = periodic rate X number of periods per year aka quoted or stated rate

annuity due

the first payment occurs at the beginning of the period

ordinary annuity

the first payment occurs at the end of the period

Effective Annual Rate (EAR)

the interest rate expressed as if it were compounded once per year used to compare two alternative investments with different compounding periods

indirect quotation

the reciprocal of a direct quotation Direct Quotation = 1/Indirect Quotation

A note is: 1) unsecured debt that is generally payable within the next ten years. 2) a formal type of loan that is secured by real estate. 3) long-term debt secured by part, or all, of the assets of the borrower. 4) debt that is secured by a borrower's accounts receivables. 5) the written agreement which details the information relative to a bond issue.

unsecured debt that is generally payable within the next ten years.

Leverage

use of debt in capital structure

What do we use to value stocks that don't currently pay dividends (or have erratic dividend growth rates)?

we can value them using the price-earnings (PE) ratio and/or the price-sales ratio| The price-sales ratio can be especially useful when earnings are negative.

A credit card has an annual percentage rate of 12.9 percent and charges interest monthly. The effective annual rate on this account: will be less than 12.9 percent. can either be less than or equal to 12.9 percent. is 12.9 percent. can either be greater than or equal to 12.9 percent. will be greater than 12.9 percent.

will be greater than 12.9 percent.

Average Accounting Return (AAR)

• Computation: AAR = Average Net Income / Average Book Value NOTE: Average book value depends on how the asset is depreciated. - Requires a target cutoff rate... - Decision Rule: Accept the project if the AAR is greater than target rate (arbitrary but must be given)

Capital Budgeting in Practice

• Consider all investment criteria when making decisions • NPV and IRR are the most commonly used primary investment criteria • Payback is a commonly used secondary investment criteria • All provide valuable information Method - What it measures - Metric 1) NPV - $ increase in VF - $$ 2) Payback - Liquidity - Years 3) AAR - Acct. return (ROA) % 4) IRR - E(R), risk - % 5) PI - if rationed, rank - ratio

Factors Affecting Required Return

• Default risk premium - bond ratings • Taxability premium - municipal versus taxable • Liquidity premium - bonds that have more frequent trading will generally have lower required returns • Maturity premium - longer term bonds will tend to have higher required returns.

Dividend Characteristics

• Dividends are not a liability of the firm until declared by the Board of Directors - A firm cannot go bankrupt for not declaring dividends • Dividends and Taxes - Dividends are not a tax deductible expense for the firm - Taxed as ordinary income for individuals (double taxation) - Dividends received by corporations have a minimum 70% exclusion from taxable income

Bond Ratings - Investment Grade

• High Grade: - Moody's Aaa and S&P AAA & Moody's Aa and S&P AA - Capacity to pay is extremely or very strong • Medium Grade: - Moody's A and S&P A & Moody's Baa and S&P BB - Capacity to pay is strong (or adequate), but more susceptible to changes in circumstances

NPV - Decision Rule

• If NPV is positive, accept the project • NPV > 0 means: - Project is expected to add value to the firm - Will increase the wealth of the owners • NPV is a direct measure of how well this project will meet the goal of increasing shareholder wealth

Bond Ratings - Speculative (High-Yield FKA "Junk")

• Low Grade: - Moody's Ba, B, Caa and Ca & S&P BB, B, CCC, CC - Considered speculative with respect to capacity to pay. The "B" ratings are the lowest degree of speculation. • Very Low Grade: - Moody's C and S&P C - income bonds with no interest being paid - Moody's D and S&P D - in default with principal and interest in arrears

MIRR versus IRR

• MIRR correctly assumes reinvestment at opportunity cost =WACC or cost of capital • MIRR avoids the multiple IRR problem • Managers like rate of return comparisons, and MIRR is better for this than IRR

Internal Rate of Return (IRR)

• Most important alternative to NPV • Widely used in practice • Intuitively appealing • Based entirely on the estimated cash flows • Independent of interest rates IRR = discount rate that makes the NPV = 0 Decision Rule: - Accept the project if the IRR is greater than the required return Without a financial calculator or Excel, this becomes a trial-and-error process

Cost of Preferred Stock

• Preferred pays a constant dividend every period - Dividends expected to be paid forever - Preferred stock is a perpetuity (constant)

Cost of Debt

• The cost of debt = the required return on a company's debt: - Method 1 = Compute the yield to maturity on existing debt (YTM could be lower than the promised yields when default probability is high) - Method 2 = Use estimates of current rates based on the bond rating expected on new debt

Cost of Equity

• The cost of equity is the return required by equity investors given the risk of the cash flows from the firm • Two major methods for determining the cost of equity: - Dividend growth model (DGM) - SML or CAPM

Managing Float

• This involves controlling the collection and disbursement of cash • "Collect early and pay late" • Collection and disbursement time: 1. Mailing time 2. Processing delay 3. Availability delay To speed collections, decrease one or more To slow disbursements, increase one or more

Features of Common Stock

• Voting Right - Stockholders vote to elect directors - Cumulative voting vs. Straight voting - Boards are often staggered, or "classified" - Proxy voting • Classes of stock - Class A - one vote per share - Founders' shares and Class B Shares - more votes per share • Other Rights - Share proportionally in declared dividends - Share proportionally in remaining assets during liquidation - "Preemptive right" = Right of first refusal to buy new stock issued to maintain proportional ownership if desired (maintain ownership proportion) - Voting on matters of importance (e.g., mergers)