Finance 402 Midterm

Pro-Forma Financial Statements

projected financial statements

Common Financial Ratios

see review sheet

Predicting External Financing Needed (EFN)

that portion of a firm's requirements for financing that exceeds its sources of internal financing (ie. the retention of earnings) - Difference between what is needed in Assets and what is available through Liabilities and Equity EFN = Assets - Liabilities - Equity

Annual Percentage Rate (APR)

the annual rate that is quoted by law. APR = period rate*(# of periods per year) Period Rate: the APR in relation to a period of time. Period rate = APR/# of periods per year Note: You should NEVER divide the Effective Annual Rate (EAR) by the number of periods per year - it will NOT give you the period rate!

Operating Cycle

time between acquisition of inventory and collection of cash from receivables 1. Inventory Period - inventory purchased to inventory sold 2. AR Period - inventory sold to cash received Operating Cycle = Inventory Period + Accounts Receivable Period

Cash Cycle

time between cash disbursement and cash collection, measured from when firm actually pays for the inventory 1. AP Period - inventory purchased to cash paid for inventory 2. Cash Cycle - cash paid for inventory to cash received Cash Cycle = Operating Cycle - Accounts Payable Period *you can have a negative cash cycle*

Ordinary Annuity vs Annuity Due

Ordinary Annuity - PV & FV in END mode Annuity Due - PV and FV in BEGIN mode

Chapter 1

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Chapter 18

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Chapter 2

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Chapter 4

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Chapter 5 & 6

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Plowback Ratio

1 - Payout Ratio 1- (Dividend/NI)

Three APR Calculation Examples: 1) What is the APR if the monthly rate is 0.5%? 2) What is the APR if the semiannual rate is 0.5%? 3) What is the monthly rate if the APR is 12% with monthly compounding?

1) 0.5*(12) = 6% 2) 0.5*(2) = 1% 3) 12/12 = 1% Note: The interest rate and time period must ALWAYS match! [ For annual periods, use annual rate; For monthly periods, use a monthly rate, etc.]

Sensitivity Analysis

1) Worst Case: most pessimistic 2) Normal Case: most likely 3) Best Case: most optimistic

Chapter 3

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Ideal Financing of Current Assets

"Ideal" Economy: ST assets financed with ST liabilities; LT assets financed with LT debt and equity. Current Assets: "sawtooth" pattern; Current Liabilities paid off exactly with sale of Current Assets. Fixed Assets: LT Debt + Common Stock would increase exactly with Fixed Assets.

ROE (Dupont Equation)

(NI/Sales) x (Sales/Assets) x (Assets/Equity) OR simplified = (NI/Equity)

Cash Budget Format

*Net Cash Flow *[Cash Inflows - Cash Outflows] *+ Beginning Cash* *= Cumulative Cash* [i.e. Expected Cash @ End of Month] *Minimum Cash* *+/- Monthly Borrowing* [Add Loan Amount or Deduct Repayment] *Cumulative Loan Balance* [Assume = $0 to start unless told otherwise] *+/- Marketable Securities* [Increase = Surplus Cash; Decrease = Shortage Cash] *Cumulative Marketable Securities* [Assume = $0 to start unless told otherwise] *Ending Cash Balance* [Cumulative Cash + Any Borrowing -Marketable Sec.] (look at day 7 slide for practice)

Cash Budget: Three Steps

1) DETERMINE CASH RECEIPTS - Sales forecast, credit sales collection schedule, historical data on % collection of receivables, interest earned, etc. 2) ESTIMATE CASH DISBURSEMENTS - Analyze production process (level or demand-based), A/P, CapEx, wages, taxes, dividends, interest payments, etc. 3) CREATE CASH BUDGET - Net Cash Flow + Beginning Cash (Net Cash Flow = Cash Inflows - Cash Outflows) Determine Borrowing vs. Repayment Confirm Marketable Security Activity

Role of Financial Planning

1) Examine Interactions: Help management see the interactions between decisions. 2) Explore Options: Give management a systematic framework for exploring its opportunities (short term: < 12 months and long term: > 12 months). 3) Avoid Surprises: Help management identify possible outcomes and plan accordingly (i.e. worst, normal, best case scenarios). 4) Ensure Feasibility and Internal Consistency: Help management determine if goals can be accomplished and if the various stated (and unstated) goals of the firm are consistent with one another.

Reasons Working Capital Management is Important

1) Frequency [Ongoing, Day-to-Day] 2) Identifies Unique Liquidity Needs 3) Prioritizes Cash Out vs. Stockout 4) Firm Future Viability [Avoid Bankruptcy] 5) Firm Growth & Long Term Value

Best Policy: How Do We Decide?

1) Ideal Cash Reserve - Reduce financial distress, emergency defense, take advantage of unexpected opportunities, lower return as zero NPV investment. 2)Align Using Maturity Hedging - Difficult task, refinance fees, repricing risk and credit risk. 3)Expectation for Interest Rates - ST cheaper in typical yield curve, sudden rate change, fixed vs. floating preference.

Internal Growth Rate

1) Internal Growth Rate: maximum growth that can be achieved with no external financing of any kind. Point at which EFN = 0 (Assets = RE) Internal Growth Rate = (ROA x b) / 1- (ROA x b) ROA = Return on Assets b = plowback ratio

Four Items Needed for Financial Plan

1) Liquidity Needs (NWC) 2) Capital Structure 3) Capital Budgeting: 4) Dividend Policy: Payout vs. Plowback

Business Cycles

1) Operating Cycles 2) Cash Cycles The operating cycle is the period from inventory purchase until the receipt of cash. The cash cycle is the period from when cash is paid out to when cash is received. *go to Day 6 Pt. 1 slides for practice problems*

Percent of Sales Method

1) Project sales revenues and expenses 2) Estimate current assets and fixed assets needed to support projected sales 3) Calculate External Financing Needed [EFN aka DFN - discretionary funds needed] 4) Analyze Financing—Reasonable?

4 Ways to Reduce EFN

1) Slow Sales Growth -Increase Price = Increase Net Margin, Net Income, Cash -Lower Sales = Decrease Forecasted Assets and thus DFN -Elasticity of Demand...Increase Value and Profitability? 2) Full Capacity? -Fixed Assets are "Chunky" -Outsource, Joint Venture, Strategic Alliance? 3) Lower Payout -Payout vs. Plowback -Stockholder's Reaction? 4) Higher Net Margin -Cut Costs, Economies of Scale, "Manage" Managed Expenses

Partnership (2 types)

1. General: all share gains/losses; unlimited liability 2. Limited: general partners active & unlimited; limited partner inactive & limited to contribution

Market Types

1. Primary 2. Secondary 3. Dealer 4. Auction

Suppose Rosengarten has $1,000 in sales in 20x1 and is operating at 65% capacity, Net PPE $1,800. Question 1: What would maximum sales be at full capacity? Question 2: What is the fixed asset capital intensity ratio at full capacity? Question 3: If sales are projected to be $1,250 in 20x2, what would be the required amount of fixed assets?

1. Sales/Capacity %: $1,000/0.65 = $1,538.46 2. Fixed Assets/Full Capacity Sales: $1,800/1,538.46 = 1.17 [At Full Capacity Rosengarten needs $1.17 of fixed assets to generate $1 of sales.] 3. Projected Sales x FA Capital Intensity Ratio: $1,250 x 1.17 = $1,462.50 in Fixed Assets

Suppose Rosengarten has $1,000 in sales in 20x1 and is operating at 80% capacity, Net PPE $1,800 Question 1: What would maximum sales be at full capacity? Question 2: What is the fixed asset capital intensity ratio at full capacity? Question 3: If sales are projected to be $1,250 in 20x2, what would be the required amount of fixed assets?

1. Sales/Capacity %: $1,000/0.80 = $1,250 2. Fixed Assets/Full Capacity Sales: $1,800/1,250 = 1.44 [At Full Capacity Rosengarten needs $1.44 of fixed assets to generate $1 of sales.] 3. Projected Sales x FA Capital Intensity Ratio: $1,250 x 1.44 = $1,800 in Fixed Assets

Suppose Rosengarten has $1,000 in sales in 20x1 and is operating at 95% capacity, Net PPE $1,800. Question 1: What would maximum sales be at full capacity? Question 2: What is the fixed asset capital intensity ratio at full capacity? Question 3: If sales are projected to be $1,250 in 20x2, what would be the required amount of fixed assets?

1. Sales/Capacity %: $1,000/0.95 = $1,052.63 2. Fixed Assets/Full Capacity Sales: $1,800/1,052.63 = 1.71 [At Full Capacity Rosengarten needs $1.71 of fixed assets to generate $1 of sales.] 3. Projected Sales x FA Capital Intensity Ratio: $1,250 x 1.71 = $2,137.50 in Fixed Assets

3 Forms of Business Organizations

1. Sole Proprietorship 2. Partnership 3. Corporation

3 Aspects of Role of Financial Manager

1. Working Capital Management 2. Capital Structure 3. Capital Budgeting

Income Statement

A financial statement showing the revenue and expenses for a fiscal period. FORMAT: Revenue -COGS *Gross Profit* -Operating Expenses *Net Operating Income (NOI or EBIT)* -Interest Expense -Income Taxes *Net Income* -Dividends on Com/Pref Stock *Increase in RE*

Balance Sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date. New RE = Old RE + NI - Dividendes

Corporation

A legal "person" separate and distinct from its owners. It has many rights, duties, and privileges of an actual person (i.e. borrow $, own property, sue/be sued, enter into contracts, etc.). Articles of Incorporation and Bylaws.

New RE Calculation

Addition to RE: [Projected Sales x Net Margin x (1-Payout Ratio)] New RE = Old RE + Addition to RE New RE = Old RE + [Projected Sales x Net Margin x Plowback Ratio]

Sandar Satellites has a debt-equity ratio of 0.5, a profit margin of 3%, a dividend payout ratio of 40%, and a capital intensity ratio [total assets] of 1. What is the sustainable growth rate using the ending method formula?

Assets to Equity Ratio Calculation: Debt/Equity = 0.5 ; D = o.5E; A = L + E: A = 0.5E + E A = 1.5E Equity Multiplier: Assets/Equity Ratio = 1.5 Return on Equity DuPont Method: ROE: Profit Margin x Asset Turnover x Equity Multiplier ROE: 0.03 x 1 x 1.5 = 0.045 = 4.5% Sustainable Growth Ending Method: SGR: (ROE x b)/[1-(ROE x b)] = SGR: (0.045 x 0.60)/[1-(0.045 x 0.60)] = SGR: 0.027/(1- 0.027) SGR: 0.027/0.973 = 0.02775 = *2.78%*

Sandar Satellites has a debt-equity ratio of 0.5, a profit margin of 3%, a dividend payout ratio of 40%, and a capital intensity ratio [total assets] of 1. Sandar desires a 10% sustainable growth rate and plans to achieve this goal by improving profit margins. What would the profit margin need to be for the firm to grow at 10%? [Use the Ending Method formula to solve.]

Assets to Equity Ratio Calculation: Debt/Equity = 0.5 ; D = o.5E; A = L + E: A = 0.5E + E A = 1.5E Equity Multiplier: Assets/Equity Ratio = 1.5 Sustainable Growth Ending Method w/Dupont: SGR: (ROE x b)/[1-(ROE x b)] = ROE: Profit Margin x Asset Turnover x Equity Multiplier 0.10 = (PM x 1.5 x 0.60)/[1-(PM x 1.5 x 0.60)] = 0.10 x [1-(0.9PM )] = 0.9PM 0.10 - 0.09PM = 0.9PM 0.10 = 0.99PM; PM = 0.10/0.99 = 0.10101 = *10.1%*

Allison would like to buy a new Land Rover Range Rover. She has $60,000 saved in her Range Rover fund, but the car costs $126,500. Allison is currently earning 7.5% on her investment account and she is depositing $1,000 at the beginning of each month to her Range Rover fund. If Allison pays cash for her car, how many years until she will be able to buy the new Range Rover?

BEGIN Mode PV = -60,000 FV = 126,500 PMT = -1,000 I/Yr = 0.625% [7.5/12 = 0.625%] N = ? N = 42.22 months = 3.518 years

BEG METHOD: Hoeke Hats has a net income of $20 and a plowback ratio of 60%. Beginning assets are $100 and the debt-equity ratio is 25%. What is the sustainable growth rate?

Beginning Equity: Debt/Equity = 0.25 ; D = o.25E; A = L + E: 100 = 0.25E + E 100 = 1.25E E = $80 Return on Equity Beginning Method: ROE: NI/Beginning Equity = 20/80 = 0.25 = 25% Sustainable Growth Beginning Method: SGR: ROE x b = 0.25 x 0.60 = 0.15 = *15.0%*

BEG METHOD: Denise's Dance Studio has a net income of $1,156 and a plowback ratio of 70%. Beginning assets are $9,860 and the debt-equity ratio is 45%. What is the sustainable growth rate?

Beginning Equity: Debt/Equity = 0.45 ; D = o.45E; A = L + E: 9860 = 0.45E + E 9860 = 1.45E E = $6,800 Return on Equity Beginning Method: ROE: NI/Beginning Equity = 1156/6800 = 0.17 = 17% Sustainable Growth Beginning Method: SGR: ROE x b = 0.17 x 0.70 = 0.119 = *11.9%*

What is a cash budget?

Budget: forecast of future events recording an estimate of cash receipts [cash in] and disbursements [cash out].

Sterling has determined that in order to enjoy the good life when he retires, he needs to have $4,000,000 saved for retirement. Sterling is currently 26 years old and he plans to retire at age 68. If Sterling plans to save money at the beginning of each month and he will earn an average of 7% annually on his investment, how much money must he save each month in order to reach his $4,000,000 goal?

CALCULATOR SOLUTION: BEGIN Mode P/Yr = 1 PV = 0 FV = 4,000,000 N = 504 [68-26=42; 42 x 12 = 504] I/Yr = 0.58333 [7/12 = 0.58333] PMT = ? -1306.5808 PMT: $1,306.58

Tawnya is considering the purchase of a membership to an exclusive country club in order to have unlimited access to the swimming pool. The annual membership dues are $850. Tawnya cannot afford to pay the entire $850 right now, but she has the option to make monthly payments at the end of each month. Tawnya must pay $100 upfront and the remaining $750 will be amortized over 12 months, with the outstanding balance accruing interest at 6% per year (0.5% per month).How much will Tawyna pay at the end of each month for her membership?

CALCULATOR SOLUTION: END Mode P/Yr = 1 PV = 750 FV = 0 N = 12 [1 x 12 = 12] I/Yr = 0.5 [6/12 = 0.5] PMT = ? -64.5498 PMT: $64.55

Primary Concern in Short-Term Financing...

Delay Payments and/or Accelerate Receipts. Timing is Everything!!! 1) Order raw materials - How much inventory do we need? 2) Pay for raw materials - Should we borrow or use our cash balance? 3) Manufacture product - What production technology is best to use? 4) Sell Product - To whom should we extend credit? 5) Collect sales rev - How do we enforce? Should we offer discounts?

Payout Ratio

Dividend/NI

END METHOD: Hoeke Hats has a net income of $20 and a plowback ratio of 60%. Beginning assets are $100 and the debt-equity ratio is 25%. What is the sustainable growth rate?

Ending Equity: Ending Equity = Beginning Equity + (NI x Plowback Ratio) Ending = 80 + (20 x 0.60) Ending = 80 + 12 = $92 Return on Equity Ending Method: ROE: NI/Ending Equity = 20/92 = 0.2174 = 21.74% Sustainable Growth Ending Method: SGR: (ROE x b)/[1-(ROE x b)] = SGR: (0.2174 x 0.60)/[1-(0.2174 x 0.60)] = SGR: 0.13044/(1- 0.13044) SGR: 0.13044/0.86956 = 0.15 = *15%*

Which Policy Invests more Money in Current Assets?

Flexible: Maintains high ratio of current assets to sales (day 7 ch 18 pt 2 slide 11)

Suppose this year's sales will total $32 million. Next year, we forecast sales of $40 million. What is this $8 million increase in percentage terms?

Formula: (New-Old) / Old (40-32)/32 = 0.25 25%

Your company has received a $50,000 loan from an industrial finance company. The annual payments are $6,202.70. If the company is paying 9% interest per year, how many loan payments must the company make? a) 15 b) 13 c) 12 d) 19 e) None of the above

a) 15 [set-up: 50,000 PV; -6202.70 PMT; 9 I/Yr; 0 FV -> N]

Gabriella and Sean Madsen are both concerned with building their rainy day fund. Gabriella adds $3,000 to her savings account on the first day of each year (starting this year). Sean adds $3,000 to his savings account on the last day of each year (starting this year). They both earn a 9% annual rate of return. What is the difference in their savings account balances at the end of 30 years? a) $35,822 b) $36,803 c) $38,911 d) $39,803 e) $40,115

Gabriella Madsen BEGIN Mode N=30 PMT=-3000 I/Yr=9 PV=0 FV=? FV: $445,725.65 Sean Madsen END Mode N=30 PMT=-3000 I/Yr=9 PV=0 FV=? FV: $408,922.62 $445,725.65 - 408,922.62 = $36,803.03

Capital Structure

How does a firm acquire money?

Working Capital Management

How much money does a firm need?

Secondary Market

Involved one owner creditor selling to another

Tankville, Inc. is a seasonal firm that uses level production so budgeting is critical. Assume all sales are on credit and 100% collection; 75% collected in the month of sale and 25% the month after sale. Actual December sales were $220,000. Projected sales for January and February are $120,000 and $80,000, respectively. Estimate the cash receipts for January and February.

January Receipts Calculation: $220,000 in December x 0.25 = $55,000 $120,000 in January x 0.75 = $90,000 Total January Collections: $145,000 February Receipts Calculation: $120,000 in January x 0.25 = $30,000 $80,000 in February x 0.75 = $60,000 Total February Collections: $90,000

Compromise Policy

Lies in the middle of Flexible policy and Restrictive policy. With a compromise policy, the firm keeps a reserve of liquidity that is uses to initially finance seasonal variations in current asset needs. Short-term borrowing is used when the reserve is exhausted.

Tankville, Inc. is concerned with shortage costs, but not carrying costs so they use level production. Monthly Labor = $70,000 Paid in month incurred Monthly Raw Materials Purchases = $50,000 Paid one month after purchase Estimate Total Monthly Outflows

Monthly Labor = $70,000 paid in month incurred level production Monthly Materials Purchases = $50,000 paid one month after purchase level production [i.e. every month the same] Total Cash Outflows: $120,000

Elaine is considering an investment that will pay $1,175 in three years, $1,500 in five years, $1,500 in seven years, and $1,250 in years nine and ten. She can earn 10% annually on this investment. What is this investment worth?

NPV @ 10% = $3,595.97

Derrick is considering an investment that will pay $350 in years two through five, $475 in years six and seven, $550 in year eight, and $775 in years nine and ten. Derrick can earn 5.75% annually on this investment. What is this investment worth?

NPV @ 5.75% = $3,077.57

Tankville's Net Cash Flow

Net Cash flow = Cash Inflow - Cash Outflow January: $145,000 - $120,000 = $25,000 February: $90,000 - $120,000 = $(30,000)

Gerald's Gym currently has $50,000 in current assets and $20,000 in current liabilities. NWC is therefore $30,000 ($50,000-$20,000 = $30,000). Management needs $10,000 in cash and is considering two options: 1) borrow $10,000 as long-term debt or 2) borrow $10,000 as short-term loan. Determine the change to NWC and cash under each scenario. [Remember: NWC = CA - CL]

Option 1: Long-Term Debt NWC = (CA + cash) - CL: (50,000 + 10,000) - 20,000 = $40,000 ∆NWC: 40,000 - 30,000 = $10,000 Both cash and NWC increase by $10,000. Option 2: Short-Term Loan NWC = (CA + cash) - (CL + ST Loan): (50,000 + 10,000) - (20,000 + 10,000) = $30,000 Cash increases by $10,000, but NWC remains at $30,000. The source of cash matters for ∆ NWC!

Melody went a little crazy buying gifts for Christmas this year and for the first time she couldn't pay the full balance. Melody can only afford to pay the $35 minimum monthly payment towards her $1,500 credit card balance and the APR is 23.76%. Question #1: How long [months and years] will it take for Melody to finish paying for Christmas? Question #2: How much will Melody pay before her $1,500 balance is paid off? How much will she pay in interest?

PV = $1,500 FV = 0 I/Yr = 1.98% [23.76/12 = 1.98] PMT = -35 N = ? N = 96.276 mos; 8.023 yrs Total Paid = Monthly Payment x # Payments $35 x 96.276 = $3,369.66 Total Paid: $3,369.66 Total Interest = Total Paid - Original Balance $3,369.66 - $1,500 = $1,869.66 Total Interest: $1,869.66

What should you be willing to pay in order to receive $2,750 quarterly forever, if you require 10% per year on the investment?

PV = $2750/0.025 = $110,000

Four years ago, Erwin deposited $2,500 of his award from winning the science fair into an account earning 5.75% APR [i.e. "quoted" rate]. How much is Erwin's investment worth today? How much of this is simple interest? How much is compound interest?

PV = -2,500 FV = ? I/Yr = 5.75% PMT = 0 N = 4 FV = $3,126.52 Simple Interest = Quoted Rate x Principal x # Years Invested 0.0575 x $2,500 x 4 = $575 [$143.75 per year] Simple Interest: $575 Compound Interest = Future Value - Principal - Simple Interest $3,126.52 - $2,500 - $575 = $51.52 Compound Interest: $51.52

Hailey has always wanted to spend two years living and traveling in Europe. Hailey contributes $1,850 at the end of each month to her "Europe Fund" and currently has $67,144 saved. She is earning 4.8% APR on her money. Hailey estimates she will need $6,000 per month for living and travel expenses, but believes she can earn $2,500 of the $6,000 needed each month as a freelance photographer. Hailey just found a great deal online for airfare to Edinburgh, Scotland, but must leave within two weeks. Question 1: Can Hailey afford to leave now? Question 2: If not, how soon can Hailey leave?

PV = ? FV = 0 I/Yr = 0.4% [4.8/12 = 0.4] PMT = -3,500 [6,000 - 2,500 = 3,500] N = 24 PV = $79,941.76 No, Hailey cannot afford 2 full years in Europe yet. PV = -67,144 FV = 79,941.76 I/Yr = 0.4% [4.8/12 = 0.4] PMT = -1,850 N = ? N = 5.98 months Hailey can leave in 6 months.

Present Value of a Perpetuity

PV = PMT/i

Uneven Cash Flows using Calculator

Press CF and enter the cash flows beginning with year 0. You have to press the "Enter" key for each cash flow. Use the down arrow key to move to the next cash flow. The "F" is the number of times a given cash flow occurs in consecutive periods. Use the NPV key to compute the present value by entering the interest rate for I, pressing the down arrow, and then computing the answer. Clear the cash flow worksheet by pressing CF and then 2nd CLR Work.

Rather than waiting about 3½ years to pay $126,500 in cash, Allison decides to buy the Range Rover when she has $91,500 for the down payment and finances the remaining $35,000 at 3.84% APR with a 3 year car loan that will be due at the beginning of each month. Q1: What will be Allison's monthly payment? Q2: After making the 36th loan payment, how much will Allison have paid for the Range Rover [including interest]?

Question #1 Answer: BEGIN Mode PV = 35,000 FV = 0 I/Yr = 0.32% [3.84/12 = 0.32] N = 36 [3 x 12 = 36] PMT = ? PMT = -$1,027.56 Question # 2 Answer: Total Paid = Down Payment + Loan Payments Down Payment: $91,500 Loan Payments: 1027.56 x 36 = $36,992.23 Total Paid: $91,500 + $36,992.23 = $128,492.23

In 20x1, Pete's Pottery had a net income of $1,527, total assets of $2,697, and an internal growth rate of 8.75%. What is the plowback ratio?

Return on Assets: ROA: NI/TA = 1527/2697 = 0.56618 = 56.618% Plowback Ratio from Internal Growth Rate: IGR: (ROA x b)/[1-(ROA x b)]= 0.0875 = (0.56618 x b)/[1-(0.56618 x b)] 0.0875*(1-0.56618b) = 0.56618b 0.0875 - 0.04954b = 0.56618b 0.0875 = 0.61572b b =0.0875/0.61572 = 0.14211 = *14.21%*

In 20x1, Roger's Recycling had a net income of $189, total assets of $1,148, and retained earnings increased by $68. What is the internal growth rate?

Return on Assets: ROA: NI/TA = 189/1148 = 0.1646 = 16.46% Plowback Ratio: b: ∆RE/NI = 68/189 = 0.35979 = 35.98% Internal Growth Rate: IGR: (ROA x b)/[1-(ROA x b)]= (0.1646 x 0.35979)/[1-(0.1646 x 0.35979)] = 0.05922 / 0.94078 = 0.06295 = *6.3%*

In 20x1, Doug's Design had a net income of $2,555, total assets of $5,978, and an internal growth rate of 10.25%. What is the plowback ratio?

Return on Assets: ROA: NI/TA = 2555/5978 = 0.4274 = 42.74% Plowback Ratio from Internal Growth Rate: IGR: (ROA x b)/[1-(ROA x b)]= 0.1025 = (0.4274 x b)/[1-(0.4274 x b)] 0.1025*(1-0.4274b) = 0.4274b 0.1025 - 0.04381b = 0.4274b 0.1025 = 0.47121b b =0.1025/0.47121 = 0.21753 = *21.75%*

In 20x1, Hoffman Company had a net income of $66, total assets of $500, and retained earnings increased by $44. What is the internal growth rate?

Return on Assets: ROA: NI/TA = 66/500 = 0.132 = 13.2% Plowback Ratio: b: ∆RE/NI = 44/66 = 0.6667 = 66.67% Internal Growth Rate: IGR: (ROA x b)/[1-(ROA x b)]= (0.132 x 0.6667)/[1-(0.132 x 0.6667)] = *9.65%*

In 20x1, Shirley's Scraps had a net income of $851, total assets of $699, and an internal growth rate of 9.5%. What is the payout ratio?

Return on Assets: ROA: NI/TA = 851/699 = 1.21745 = 121.75% Plowback Ratio from Internal Growth Rate: IGR: (ROA x b)/[1-(ROA x b)]= 0.095 = (1.21745 x b)/[1-(1.21745 x b)] 0.095*(1-1.21745b) = 1.21745b 0.095 - 0.11566b = 1.21745b 0.095 = 1.33311b b =0.095/1.33311 = 0.07126 = 7.12% Payout Ratio from Internal Growth Rate: Payout Ratio: 1-plowback ratio 1-0.07126 = 0.92874 = *92.88% *

Max sales at full capacity

Sales / Capacity %

Business Process for Public Companies

Shareholders -> Elect BOD -> Hire Management Team -> Responsible for running company -> Repeat Ultimate Goal: Maximize Shareholder Wealth!

Arthur and Ruthelda are considering a conservative investment that will pay them $300 in odd numbered years from year one to year 13 except year 5 and year 9 and $200 in even numbered years from year four to year ten; all other years they will receive $0. They can earn 6% annually on this investment. What is this investment worth?

Solution: NPV @ 6% = $1,569.68

Spontaneous vs. Non-Spontaneous Accounts

Spontaneous: typically grow in proportion with sales 1. Most Current Assets [usual assumption] 2. Accounts Payable 3. Accruals [accrued wages, etc.] Non-Spontaneous: not accumulated automatically from day-to-day functions 1. Notes Payable 2. Long-Term Liability Accounts 3. Common Stock 4. Interest (assume no change unless otherwise directed) 5. Retained Earnings (End RE = Beg RE + NI - Div) independently forecasted

Temporary vs. Permanent CA

Temporary? Seasonal Sales: require corresponding inventory build-up in certain months. "Peak" Time: short-term spike in CA requirements. CA Pattern: level of temporary current assets will decrease as sales occur. Permanent? Minimum CA Required: amount of current assets a firm must generally need to carry at all times. Constant Level: CA requirements remain constant. CA Pattern: level of "permanent" assets do not decrease as sales occur.

SGR Formula

Two Formulas: 1) ROE from BEG of period= (ROE x b) 2) ROE from END of period = (ROE x b) / 1-(ROE x b) ROE = NI/Equity b = plowback ratio *will both get the same answer but end method is preferred*

Capital Budgeting

What should the firm do with their money?

Restrictive Short-Term Policies

[i.e. Aggressive] 1) Keep small balances of cash and marketable securities. 2) Make small investments in inventory. 3) Allow few or no credit sales, thereby minimizing A/R.

Flexible Short-Term Policies

[i.e. Conservative or Accommodative] 1) Keep large balances of cash and marketable securities. 2) Make large investments in inventory. 3) Grant liberal credit terms, causing high level of A/R.

Sole Proprietorship

a business owned and operated by a single person

Primary Market

a market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities (PUBLIC OFFERING)

Auction Market

a market in which stocks or other securities are sold to the highest bidder 1) Primary purpose to match buyers and sellers 2) Exchange has a physical location [Wall Street] Example: NYSE, LSE, TSE

Principal-Agent Problem

a problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him - Commissions vs. Flat fee - Conflicts of Interest (indirect costs - lost opportunities, direct cost - unnecessary management luxuries) SOLUTION: 1. Management Compensation Tied to Stock Options 2. Job Outlook—Internal vs. External, Higher Salaries 3. Proxy Fight or Takeover Threats from Other Firms

Cash Flow Statement

a summary that shows total income and spending for a given time period Format = 1) Operating:Arises naturally from business "operations" *+* 2) Investing: PP&E, Land, LT Assets *+ * 3) Financing: BSD (i.e. Borrowing, Stock, Dividends) *=* *CHANGE IN CASH* Source = Cash INCREASES if... -liabilities increase -assets decrease -equity increases Use = Cash DECREASES if... -Liabilities decrease -Assets increase -Equity decreases

Capital Intensity Ratio

amount of assets needed to generate $1 in sales; the higher the ratio, the more capital-intensive the firm. CIR = Total Assets / Sales This ratio multiplied by projected sales will give the amount of fixed assets needed to reach sales demand

Your grandmother invested one lump sum 17 years ago at 4.25 percent interest. Today, she gave you the proceeds of that investment which totaled $5,539.92. How much money did your grandmother originally invest? a) $2,700.00 b) $2,730.30 c) $2,750.00 d) $2,768.40 e) None of the above

b) $2,730.30 [5539.92 FV; 4.25 I/Yr; 17 N; o PMT -> PV]

Keller Krafts is saving money to build a new airplane factory. Six years ago they set aside $250,000 for this purpose. Today, that account is worth $306,958. What annual rate of interest is Keller Krafts earning on this money? a) 3.43% b) 3.45% c) 3.48% d) 3.52% e) None of the above

c) 3.48% [-250,000 PV; 306,958 FV; o PMT; 6 N; -> I/Yr]

Sustainable Growth Rate (SGR)

growth rate which allows the firm to maintain debt-equity ratio AND avoid sale of new equity. Key Insight: Not the optimal growth rate! Simply maximum firm growth with current financial structure/policies.

The Eternal Gift Insurance Company is offering a policy that will pay $14,750 each year forever. The cost of the policy today is $500,000. What rate of return will be realized on this policy?

i = 14,750/500,000 = 2.95%

Interest Rate for a Perpetuity

i = PMT/PV

The Hafen Family Trust has $750,000 in funds to establish an education endowment at BYU. They plan to pay $12,000 semiannually in scholarship funds to deserving BYU students. What rate of return must they earn on the endowment to be able to perpetually fund the anticipated scholarships?

i = PMT/PV = 24,000/750,000 = 3.20%

Compound Interest

interest earned on both the initial principal and the interest reinvested from prior periods.

Simple Interest

interest earned only on the original principal invested

Dealer Market

no physical location- securities are bought & sold thru a network of dealers that trade for themselves; multi dealers per stock (NASDAQ)