Cooperate Finance Test 2

Examples of an annuity payment

Car payment House payment

2/10, n/30 problem

Interest= Principal x Rate x Time Rate is always an annual rate Time is always a fraction of a year If we miss the discount; Paying $98 to keep $2 an extra 20 days $2 = $98 (R) (20/365) R= .38 EW

When financing strategy is to be preferred when rates for loans are now low, but are on the way up

Longer term financing to lock in the current low rate

Ordinary Annuity

Payment comes at the end of the period

REMEMBER

Present value is ALWAYS less than future value

Tobin Supplies Company expects sales next year to be $500,000. Inventory and accounts receivable will increase $90,000 to accommodate this sales level. The company has a steady profit margin of 12 percent with a 40 percent dividend payout. How much external financing will Tobin Supplies Company have to seek? Assume there is no increase in liabilities other than that which will occur with the external financing.

$500,000 Sales 0.12 Profit margin 60,000 Net income - 24,000 Dividends (40%) $ 36,000 Increase in retained earnings $ 90,000 Increase in assets - 36,000 Increase in retained earnings $ 54,000 External funds needed

Two risks of relying too much on short term financing

1. The possibility of increasing interest rates 2.the possibility of not being able to renew the financing

Two primary goals of financing, which are inherently at odds with each other

1.dont run out of cash 2.minimize the cost of financing

How is a cash budget used to help manage current assets?

A cash budget helps minimize current assets by providing a forecast of inflows and outflows of cash. It also encourages the development of a schedule as to when inventory is produced and maintained for sales (production schedule), and accounts receivables are collected. The cash budget allows us to forecast the level of each current asset and the timing of the buildup and reduction of each.

What is a yield curve

A graphical representation of the relative level of short term interest rates and long term interest rates at a point in time

What's the permanent current asset ?

A minimum balance of a current asset that is always on the balance sheet

Annuity

A series of payments of equal amounts spaced over equal time intervals

Present value to future value

Compounding

Basis points

Difference between 6.3% and 6.9% 690-630 = 60 basis points

Future value to present value

Discount

Discuss the relative volatility of short- and long-term interest rates.

Figure 6-10 shows the long-run view of short- and long-term interest rates. Normally, short-term rates are much more volatile than long-term rates.

Investing Example - Who is going to make more money ? Person A : 1,000 a year 40 years 8% or Person B: 2,000 a year 20 years 8%

For this example us the charts in the back of your book - Appendix C (future value of annuity) Person A 40=N 8%=I The number you should find is 259.06 Then compute 259.06 x 1,000 = 259,060 Person B 20=N 8%= I The number you should find is 45.762 Then compute 45.762 x 2,000 = 91,524 -Person A is going to have ALOT more money than person B

Explain how rapidly expanding sales can drain the cash resources of a firm.

Rapidly expanding sales will require a buildup in assets to support the growth. In particular, more and more of the increase in current assets will be permanent in nature. A non-liquidating aggregate stock of current assets will be necessary to allow for floor displays, multiple items for selection, and other purposes. All of these "asset" investments can drain the cash resources of the firm.

Assuming a normal yield curve : interest expense will be lower with __________- term financing

Short

What is a range of balance sheet values for a current asset which may fluctuate size over time ?

Temporary current asset

What is the general rule to apply when deciding upon the length of the term of financing ?

The term of the financing should match the life of the asset being financed.

Identify a benefit of using short term debt to finance assets

Typically has lower interest costs This allows for higher net income in the short run

Example Question of finding present value

What is the present value of 7,900 in 10 years at 11%? n=10 (the period) I=11 (the percent) PV= 7900(.352) = 2780.8 .352 comes from the tables in the back of the book (Appendix B) Go to period 10 and 11% it will bring you to .352 Then, 7900(.352) =2780.8 This would be your present value (Think about if your number would make sense)

Annuity Due

When a payment comes at the beginning

Sinking fund

When the bank pays YOU interest

Example Question of finding future value

You invest 9,000 for 25 years at 14% what is your future value? n=25 I=14% Use the tables in the back of the book to find the value for this question use Appendix A (Future Value) Go to period 25 then go across to 14% You should find the value of 26.462 26.462(9,000)= 238158 = Future value This question was compounded annually Pretend you want to compound semi-annually I=7% N=50 years Your value should now be 29.457 29.457 (9,000) = 265113 = Future value