finance 4010 Final

forecasts sales on a customer by customer basis

"Bottom-up" approach

uses macroeconomic and industry forecast to establish sales goals

"Top-down" approach

Balance Sheet

"snapshot" of the financial position at a specific point of time

Quick Ratio

(Current Assets-Inventory)/(Current Liabilities)

PLUG

-External Fund Needed is also known as the ____________ -the BS account that will indicate whether external financing is needed (EFN)

Minimum cash balance

-Minimum amount of cash that you want to have on hand -set by firms in their Short-term Financial Plan

-Cash=Long-term Debt+Equity+Current Liabilities-Non-Cash Current Assets-Fixed Assets -Current Assets+Fixed Assets=Current Liabilities+Long-term Debt+Equity -Assets=Liabilities+Equity

The Balance-Sheet identity is: (all the ways to write it)

Shorter

The Cash Cycle is _________ than the Operating Cycle (shorter/longer)

Project A

Your firm, FedererTennisMarketing, follows the NPV decision rule. If you firm's WACC is 5% and Projects A and B are mutually exclusive, which project would you decide to undertake?

If you have IS and BS you can derive the numbers of SCF

•If you can pick to look at only 2 of the 3 financial statements we discussed. Which ones would you pick and why?

•Coastal Water Sports

•Pro-forma statements •DSO, DPO, Cash Cycle, Liquidity Issues, Min. Cash Balance •Implicit cost of trade credit vs. bank loan •PLUG = External Funds Needed

•P&C Electric, Inc

•Statement of cash flows, financial ratios, evaluating firm's financial health •Trade Credit terms; are they taking advantage of the discount? •Liquidity issues, lengthening AP

Build a new warehouse

P&C Electric took out a loan primarily to:

Help finance inventory if they switch to Level production

Polar Sports is considering extra external financing to:

Income Statement and Balance Sheet for the next financial period -month(s), quarter(s), year

Pro-Forma Statements:

True

T/F: IRR is found when linear line crosses the X Axis

Project A

Your firm follows the NPV decision rule. If you firm's WACC is 5% and Projects A and B are mutually exclusive, which project would you decide to undertake?

zero NPV investment

when cash earns ZERO return...

They are a "middleman" - a distributor that purchases from (and works with) several major manufacturers and that sells to a multitude of small retail businesses.

CWS's positioning in its business is:

NO

Can a firm's Cash Cycle be LONGER than Operating Cycle?

Yes, when their customers pay them before they have to make payments to their suppliers. -Very desirable

Can firms have a NEGATIVE Cash Cycle? If so, how? Is this desirable?

(EBIT + Depreciation) / interest

Cash Coverage

True

T/F: You DO NOT include INTEREST (also called Financing Costs) in the Income Statement pro-forma statements used for Capital Budgeting as you need to find cash flows for an unlevered firm.

False

T/F: corporate bonds are riskier than corporate equities?

True

T/F: trade-off: flexible firms prefer liquidity at the expense of profitability and restrictive firms prefer profitability at the expense of liquidity

True

T/F:In aggregate, debt offerings are much more common than equity offerings and typically much larger as well.

50% return in 1 day

You give a friend $10 today, they return $15 tomorrow. What is your return?

The firm is struggling with liquidity problems and is having difficulties paying their suppliers on time.

CWS is facing the following issue/problem, as discussed in the case:

Market ratios

-Relate the firm's market value (not book value) to its certain accounting values -Provide analysts with insight into how the investors think the firm is performing & will perform in the future. -Typically, Market Ratios are used as valuation ratios.

Constrained firms

-risker firms, they are paying a higher spread (interest) -get loans with shorter maturity

PEG ratio, Price/Earnings To Growth

-widely employed indicator of a stock's possible true value and it is favored by many over the price/earnings ratio because it also accounts for growth. -ratios between 1 and 2 are generally considered to be in the range of normal values.

-Working capital management -financing -investment

3 broad categories of corporate financial management

DIO

365/Inventory Turnover

DPO

365/Payables Turnover

DSO

365/Receivables Turnover

External Funds needed to finance the assets

A company's long-term financial plan typically tries to find out about the following (GOAL):

I, II and V

A firm is evaluating a new project. All of the followings are related to this project. Which of them should be included into the free cash flow when computing the NPV of the project? I. Initial account receivable increase of $2,500 II. $20 installation costs connected with the purchase of equipment for this project III. $100 a firm spent last year to improve the roof on the building where a project will be housed IV. $20 property tax increase connected to the roof improvement; this expense is tax deductible V. The annual sales of an existing product of the firm will decrease by $100 if the new product is introduced to the market.

Yes, you should bid as the NPV is positive

A firm needs someone to supply it with 120,000 cartons of screws at a price of $20 per carton to support its manufacturing needs over the next four years. If you want to bid this project, it will cost you $720,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. The salvage value at the end of the project is $50,000. Your fixed production costs will be $300,000 per year, and your variable production costs should be $10 per carton. For simplicity, assume no working capital is needed. If your tax rate is 35 percent and you require a 15 percent return on your investment, shall you bid this project?(Hint: just create a regular capital budgeting Income Statement pro-forma, find OCF, initial investment, after-tax salvage value (there are no changes in NWC), then calculate FCF and find NPV. Examine NPV)

$21,000

A firm that has $100,000 in debt on which it pays 8% has a tax rate of 21%. The present value of total perpetual tax cost saving associated with this debt is:

$38.9

A piece of asset was bought at $300 three years ago. The depreciation follows a three-year MACRS and asset is depreciated to 0. This year it is sold for $50. The tax rate is 40%. The after-tax salvage value is $____ in Yr3.

$38.9

A piece of asset was bought at $300 three years ago. The depreciation follows a three-year MACRS and asset is depreciated to 0. This year it is sold for $50. The tax rate is 40%.The after-tax salvage value =:

7%

A typical payment that underwriters receive after a successfully completed IPO is a spread (difference between underwriter's buying price and offering price) of:

-it reduces or eliminates roll over risk, they don't have to go to the bank every year and ask for a new loan

ADV of long-term debt:

lower interest rates

ADV of short-term debt:

taxable ; not taxable

Acquisition and merger transactions where target shareholders receive cash for their shares are _____ . However, when target shareholders exchange their shares in a stock exchange during a merger and become shareholders of a merged firm, such transactions are ______.

6.64%

Addisons Equipment has 40,000 bonds outstanding that are selling at 103% of par. These bonds have a $1,000 face value. Bonds with similar characteristics are yielding 6 percent. The company also has 1.5 million shares of common stock outstanding which trade at $53.31 a share. Therefore, Addisons capital structure is 66% equity and 34% debt. The common stock has a beta of 1.2. The U.S. Treasury bill is yielding 1 percent and the expected return on the market is 7 percent. The corporate tax rate is 40 percent. The WACC for Addisons is closest to

Base rate + Spread

All-in-rate formula

-TAT -Inventory Turnover -Receivables Turnover

Asset Utilization ratios

increases / decreases or stays the same / increases slightly

At the announcement of the merger or acquisition (M&A), the share price of the target firm __________________ on average, while the share price of the acquiring firm ___________, on average. Therefore, the combined firm value generally ____________.

No, because its 2003 Days Payable Outstanding (based on Purchases) is 65 days .

CWS current trade credit terms with their suppliers are 2/10 net 30. Given the information available to you in the case, is CWS taking advantage of the trade credit discount in 2003?

-High cash reserves mean that firms will be less likely to experience financial distress and are better able to handle emergencies or take advantage of unexpected opportunities -Cash and marketable securities earn a lower return and are zero NPV investments

Cash reserves:

Cash Ratio

Cash/(Current Liabilities)

$204,000

CheckYourSalvage Inc. purchased a piece of equipment of $630,000 for a project that will last 5 years. The firm is going to depreciate this equipment using 7 year straight depreciation. At the end of year 5 it can sell the equipment for $220,000. What is the after-tax salvage value of this equipment if the tax rate is 40%?

-sunk costs -salvage value (full before-tax), the market value you receive for the sale of equipment in the last year of the project -depreciation (full) -financing charges (also called 'interest') -opportunity costs at original value, which is essentially the original price you paid maybe 10 years ago

Circle all of the cash flows we DO NOT consider when evaluating Free Cash Flows (FCF) from a project for the purposes of Capital Budgeting. (Here you are asked to identify IRRELEVANT cash flows that we would not include in our Capital Budgeting analysis. What is the 1 question you need to ask yourself when evaluating whether the cash flow is relevant or not?)

17.75%

Coca Cola is considering launching a new line of business - personal computer. Coca Cola's beta is 1.2, and Dell's beta is 1.9. Risk free rate is 3.5%, market return is 11%. What is the appropriate discount rate for this new project (assume the firms are financed only by equity)?

industry

Compare ratios to past performance and to the ____________

Acquiring inventory, paying cash, making the product, selling the product

DIO

Acquiring inventory, paying cash

DPO

selling the product, collecting cash

DSO

(short term debt + long term debt) / total assets

Debt to asset ratio

TD / TE

Debt to equity ratio

The overall NPV of the project will increase

Describe what you would expect to happen to the NPV of the project evaluated by OLP, the firm described in the longer questions above, if at the end of the project's life the equipment could be sold for $1,000,000 (instead of the $650,000 in the original evaluation).

Flexible and Restrictive Financial Policies

Deviations from maturity matching

-Fiscal year differences or seasonality in nature -One-time events (asset sales, property acquisitions) -Conglomerate with unrelated lines of business -Operations vary geographically -Recent merger -Using different accounting procedures than other firms in the industry

Difficulties when comparing firms:

DIA and SPY

ETFs (or similar) of DOW and S&P500 market indexes and are tradable

TA / TE

Equity Multiplier

24 days

Evans, Inc. has a DSO (days sales outstanding) of 42 days, a DPO (days payables outstanding) of 36 days, and an Inventory turnover of 20. What is the length of the cash cycle? Assume a year has 360 days.

Retained Earnings

External Funds can include all of the following, except:

zero

Firm 4010GreatClass created pro-forma statements for 2016. It has determined that with 15% sales growth it will grow exactly at the Internal Growth Rate. How much is the External Funds Needed (EFN) to meet the 15% growth in sales?

-18.5% -15.12%

Firm A and Firm B have identical assets and operations. Firm A is 100% equity financed, and has a beta of 1.5. Firm B has 300,000 shares of common stock outstanding at a market price of $25 per share. Firm B also has 8,000 bonds outstanding with a face value of $1,000 per bond. The bonds are selling at 102 percent of face value. Firm B's cost of debt is 4% and cost of equity is 28.75%. The tax rate is 35 percent. Market return is 13%, risk free rate is 2%.-What is the cost of capital (WACC) of Firm A?-What is the cost of capital of Firm B (select the closest answer)?

lower than

Firm A and firm B have identical assets and operation, but firm B has 30% more leverage in its capital structure. Accordingly, the weighted average cost of capital (WACC) for firm B will be __________ the WACC for firm A.(Hint: Think about cost of equity (Re) and cost of debt (Rd) for both firm A and firm B. What is generally higher Re or Rd? Think about the WACC formula for firm A and B and how the weights for debt and equity would influence WACC for firms A and B)

Higher; since firm B is more levered ; higher

Firm A and firm B have identical assets and operation, but firm B has 30% more leverage in its capital structure. Firm A is an all equity firm with a beta of 1.5. The beta of firm B is _____________ than that of firm A, ___________________. Accordingly, the cost of equity (Re) of firm B is ____________________ than that of firm A.

117

Firm A has net fixed assets of $100 in 2007 and it is operating at 90% capacity. Assume it cannot dispose of its redundant fixed assets. In 2008, sales are projected to grow by 30%. How much net fixed assets would firm A have in 2008? (Note, there will be another question in this quiz that is very similar but it will use a 10% growth rate)

100

Firm A has net fixed assets of $100 in 2017 and it is operating at 90% capacity. Assume it cannot dispose of its redundant fixed assets. In 2018, sales are projected to grow by 10%. How much net fixed assets would firm A have in the 2018 pro-forma? (Note, there will be another question in this quiz that is very similar but it will use a 30% growth rate)

Both, the dividend payment and the retained earnings dollar amounts, will increase

Firm AshleighBartyWinsAustralianOpen2022 has a 30% Dividend payout ratio, in other words it pays out 30% of its Net Income to its shareholders. How would a decline in a this firm's tax rate from 35% to 21% influence the dollar amount of its dividend payment and its retained earnings?

more

Firms A and B each have Sales of $1,000,000 this year and are both projected to grow their Sales at 15% next year. This year Firm A is operating at full capacity (meaning it is using all of its equipment to manufacture their product). Then in order to accommodate the projected Sales growth for next year Firm A will need _________ external funds (EFN) than Firm B, which is NOT operating at full capacity (meaning it is not using all of its equipment to manufacture their products, they might be using only 80% of the equipment) this year, all else equal.

•1. Acquiring inventory •2. Paying suppliers •3. Making the product •4. Selling the product •5. Collecting cash •Tropicana of Pepsi Co. •Buy oranges •Pay farmers •Make OJ •Sell to Walmart •Collect money from Walmart

Firms operating activities, Five stages:

-have higher agency costs of debt, where the interests of stockholders and lenders clash -have high volatility (variation) in earnings and cash flows -have higher costs of bankruptcy (direct and indirect) -have a lot of intangible assets -have lower credit ratings

Firms should hold LESS debt when they can derive lower benefits and are exposed to the higher costs of debt. So, firms would hold LESS debt if firms (select all that apply):

-Collect from customers faster -Means having shorter DSO -Turn inventory over faster -Means having shorter DIO -Pay their suppliers slower -Means having longer DPO

Firms want to have cash on hand. To improve this, they can:

•safer •higher liquidity, but earns lower investment returns •maintain a high ratio of current assets to sales •less short-term debt and more long-term debt

Flexible (conservative) Financial Policy

-internally generated funds which are left after Dividend Payments -access to external funds which is limited by management-determined Debt/Equity Limits

Funds available include:

-market value, its asset base, the number of people it employs -most firms measure growth in terms of SALES

Growth can be defined by increases in firms:

corporate equity

Highest risk and return

•Not a conflict between a company and regulatory body/government •Governance is not CEO or managers •Agency is not stockholders

INCORRECT STATEMENTS

NO, DPO is 39

If Smolira's trade credit terms are 2/10 net 30, is Smolira taking advantage of the trade credit discount?

horizontal acquisition

If a firm acquires another firm in the same industry, this is known as a

using Short Term Debt, also known as Notes Payable

If a firm is projecting an increase in its Current Assets (such as Inventories and Accounts Receivable) for next year and it needs to raise external financing, how should it finance this increase in Current Assets? (Note, the firms usually follow the maturity matching principal)

Cash is a zero-return asset

If firms with flexible policy hold more cash why is this policy associated with lower investment returns?

a discount to par

If the yield-to-maturity (YTM) is 7% and the coupon rate on the bond is 5%, then the bond will be priced at

•2/10 net 30 has an annualized cost of trade credit of 37.24% {$2/$98=2.041% for 20 days} [2.041% / 20 * 365 = 37.24%]

Implicit Cost of Trade Credit!!! Vs. a bank loan

Market values of debt and equity

In calculating weights in the WACC formula you would ideally use:

Surplus

In case of a _________ a firm can engage in short-term investing

Deficit

In case of a ___________ a firm would need to make/have short-term borrowing arrangements

sales/NWC

NWC turnover

Net Cash Flow = Operating Revenue - Operating Costs

Net cash flow formula

NPV will increase given the increase in Revenues, Taxable Income and OCF

OLSC Inc. produces screws and plans to supply HomeManufacturing Inc. with 120,000 cartons of specialized screws over the next 4 years. The NPV of the current project that supplies 120,000 cartons of screws is about $1.15 million. HomeManufacturing just called and changed its order to 500,000 cartons of specialized screws without changing the price it will pay OLSC for these screws. No additional equipment will need to be purchased to meet the 500,000 carton production. Variable costs will stay the same at the per unit basis (but will increase overall given the higher number of cartons needed). How, if at all, would the NPV of this project change with the updated order?

$4,844 mln. In the American Home Products (AHP) case in order to evaluate which level of debt (30%, 50%, or 70% debt) was the most beneficial to AHP, you had to calculate the value of levered firm (Vl) at each level of debt. Since Vl = Vu + Tax Benefits of Debt - PV Costs of Financial Distress (where Vl is the value of the levered firm, Vu is the value of the unlevered firm and the perpetual tax benefits of debt can be calculated as D*T (Debt amount * Tax Rate)) you estimated that Vl at 30% debt was about $4,844 mln. Since the tax benefits of debt at 30% are D*T=376.1*0.48=180.53 and PV Costs of Financial Distress = Probability of Distress * Firm Value * % of firm value lost in bankruptcy = 0.007*(4,674+180.53)*0.3 = 10.19. then Vl =$4,674 + $180.53 - 10.19 = 4,844.34.

In the American Home Products (AHP) case in order to evaluate which level of debt (30%, 50%, or 70% debt) was the most beneficial to AHP, you had to calculate the value of levered firm (Vl) at each level of debt. Since Vl = Vu + Tax Benefits of Debt - PV Costs of Financial Distress (where Vl is the value of the levered firm, Vu is the value of the unlevered firm and the perpetual tax benefits of debt can be calculated as D*T (Debt amount * Tax Rate)) you estimated that Vl at 30% debt using Total Capital from the case was about _____. Assume that the value of the unlevered firm is $4,674 mln., 30% debt is $376.1 mln., AHP is subject to 48% tax, at 30% debt their probability of default is 0.7%. Also, note that generally direct and indirect bankruptcy costs add up to about 30% of firm value. You can also use any information from the case Exhibits.

Book value of the firm

In the American Home Products (AHP) case you evaluated whether the company can benefit from adding debt and examined three alternatives: adding 30%, 50%, or 70% debt. Exhibit 3 suggest that debt percentages are based on Total Capital. In the AHP case the Total Capital on which debt percentages are based is ________ (which is ironically incorrect).

A 6% rate of sales growth (instead of the current 2%) and a reduction in various costs was assumed and built into the free cash flow (FCF) calculation.

In the Cooper Industries case, Cooper was bidding for Nicholson and you estimated the price per share that Cooper could offer to pay for Nicholson's shares given the synergies that Cooper expects to take place if they acquire Nicholson. How were these synergies reflected in your valuation?

-white knight: VLN -corporate raider that used a tender offer: Porter

In the Cooper Industries, Inc. case define which firm acted as a

To keep outsourcing the 10- and 12-inch pipes or to start producing them in-house

In the LFPT case the management is deciding whether...

Higher than / lower than

In the world with taxes but no bankruptcy costs (Case II) the firm value of the LEVERED firm will be _______ that of the UNLEVERED firm due to the tax savings associated with debt. Accordingly, WACC of the LEVERED firm will be __________ that of the UNLEVERED firm.

SHORT-TERM INVESTING

Instead of keeping excess balances in non-interest-bearing accounts, a company will hold some "near-cash" assets in the form of short-term investments, often labeled marketable securities.

-Short-term rates are normally lower than long-term rates, so it may be cheaper to finance with short-term debt -Firms can get into trouble if rates increase quickly or if it begins to have difficulty making payments (may not be able to refinance the short-term loans)

Interest Rates:

-interest paid is reported as part of OPERATING cash flows -it as an operating cash flow because of its effect on net income through Interest Expense.

Is Interest considered under Operating, Investment or Financing Activities? How?

-dividends are a use of funds for Kayak -Kayak's Owner's Equity on the Balance Sheet will be lower -Kayak's internal financing (retained earnings) will be lower

Kayak LLC. has created Pro-Forma statements for next year and they project a Net Income of $356,000. The firm generally pays 10% of Net Income to their shareholders in a form of dividends and used that estimate in their Pro-Forma statements. What if the firm decides to pay out 30% of their Net Income as dividends instead of 10%? Identify all statements that are true for Kayak LLC. below.

Inventory, Account Receivable and Account Payable accounts

Key items of working capital

-Merger (or consolidation) -Acquisition of assets -Acquisition of stock through a Tender Offer

Legal procedures that a firm can use to acquire another firm are (select all that apply)

•Difficulty selling inventory (increase in DIO) •Difficulty collecting receivables (increase in DSO) •Faster payment to your suppliers (reduction in DPO = increase in the payable turnover cycle)

Lengthening cash cycle can mean:

-Total debt -D/E -Equity Multiplier -Times Interest Earned -Cash Coverage ratios

Leverage or LT solvency Ratios

-Current -Quick -Cash ratios

Liquidity or ST solvency Ratios

investment decisions and financing decisions both have long-term impacts on firm.

Long-term plan is important because

government/corporate bonds

Lowest risk and return

LOWER

Maintaining a high cash balance makes firms earn __________ investment returns.

-earn lower investment returns)!!! -have higher liquidity/solvency

Maintaining a high cash balance means a firms will:

-EPS -DPS -P/E -PEG -MB -Tobin's Q

Market ratios

Market price

Market value of equity + Book Value of Debt =

Morgans Equipment will have a higher beta and a higher cost of equity (Re) than Addisons Equipment

Morgans Equipment, a firm with identical assets, operation and very similar products to Addisons Equipment (from the question directly above), has 10% more debt in its capital structure. Morgans produces equipment that is an 'upscale' version of equipment produced by Addisons and Morgans' equipment sales tend to be more cyclical. Identify correct statement(s):

•problems with falling back on payables, liquidity deterioration; debt to finance a warehouse

P&C Electric Case

-ROA -ROE (and DuPont of it) -Profit Margin

Profitability ratios

Long term Solvency / Leverage

Provides information about ability to meet long term financial obligations

Profitability Ratios

Provides information about firm's ability to control expenses

asset utilization

Ratios that measure how efficiently a firm uses its assets to generate sales are known as _____ ratios.

•riskier •lower liquidity, but earns higher investment returns •maintain a low ratio of current assets to sales •more short-term debt and less long-term debt

Restrictive (aggressive) Financial Policy

Primary concerns are providing liquidity and preserving principal. Although a competitive rate of return is desirable, generating profits is not the primary purpose.

Short term investing concerns:

•use market value where possible, but while MV equity is easily available for publicly traded firms, MV debt is more difficult to get, so oftentimes BV debt is used as a proxy for the current value of debt.

Should we use Market Value or Book Value (for example in Tobin's Q)?

No, this project will have a negative NPV, since the appropriate discount rate (adjusted WACC) is higher than IRR

Smol-Kitchen Inc. has a WACC of about 10%. Specifically, its capital structure contains $1 million in equity financing with the cost of equity at 17% and $1 million in debt financing with the cost of debt of 5%. The tax rate is 40%. Smol-Kitchen Inc. is considering a project that is much riskier than typical projects in which Smol-Kitchen participates. Accordingly, it is considering an adjustment factor of 4% for this project. Should Smol-Kitchen undertake this new project if the project has an IRR of 7%?

•increase profit margin - reduce costs •increases asset turnover - boost sales •decrease leverage - pay back debt

Smolira needs to:

sales, investment income, accounts payable, common stock, debt -DECREASES in Asset Accounts -INCREASES in Liability or Equity Accounts

Sources of cash:

common size statements

Standardized statements =

empire building

Synergy occurs when the performance of the combined entity is better than the performance of separate entities. Synergy is the reason why the combined value of the firm (target+ acquirer) increases slightly at the M&A announcement. All of the following are sources of synergy, except_________

True

T/F: A firm in the above question receives "5/10, net 60" trade credit terms from its suppliers. This firm has a below investment grade (junk) credit rating, therefore the bank can only provide a loan to this firm at 20% annual interest. The firm consistently fails to pay suppliers on day 10 but pays by day 60. This firm should get a loan from the bank at 20% in order to make payments to their suppliers on day 10.

True

T/F: A firm's WACC of 12% means that 12% is the minimum rate of return that this firm must earn overall on its existing asset base to produce value for its creditors, owners, and other providers of capital. If the firm earns less than 12% on the overall portfolio of products/projects they will invest elsewhere. However, if it earns more than this, value is created.

True

T/F: A trade credit is an I.O.U. Accounts Payable reflect trade credits given by suppliers.

False

T/F: According to the pecking order theory of capital structure firms will choose to first finance with equity, then with debt and last with internal capital (i.e. retained earnings).

True

T/F: American Home Product (AHP), and all firms in general, strive to be at their optimal level of Debt (D*), which provides them with the Debt-to-Equity (D/E) ratio that achieves the lowest WACC and the highest firm value.

False

T/F: As a banker, you are concerned about extending the loan to Polar, as the pro-forma statements suggest that Notes Payable balance under level productions frequently exceeds 2/3 of account receivable and inventory combined.

True

T/F: Debt (ST and LT) and Common Stock do not automatically grow with sales.

True

T/F: Decreases in Balance Sheet Asset accounts and increases in Balance Sheet Liability accounts signify a source of cash, as the firm receives cash from inventory sales, from equipment sales, from customers paying back on the firm's Account Receivables, and from extra or new bank financing.

False

T/F: Defensive merger tactics work to the advantage of target shareholders all the time

True

T/F: Empirically, the target price premium has been on average 30%

True

T/F: Firms that choose a Flexible (Conservative) Financial Policy hold a higher ratio of current assets to sales, hold higher cash balances and rely more on long-term debt as compared to firms that choose a Restrictive (Aggressive) Financial Policy. Accordingly, firms with a Flexible Financial Policy prefer higher liquidity.

True

T/F: High cash balance (or marketable security investments) means high solvency

True

T/F: IPO markets are subject to fads which depend on investor sentiment and can appear in a form of hot and cold IPO waves.

False

T/F: IPO underpricing is larger for smaller firms but smaller when less reputable underwriters take the firm public.

True

T/F: If COGS are expected to increase from 75% to 85% of sales the NPV of the project(s) will decrease. This will occur because we will have higher expenses associated with the project but the same revenue/sales, which will result in lower OCF and lower FCF in each year 2009-2013.

True

T/F: If NPV is positive for a project, then IRR for this same project will be higher than the required rate of return of this project. (Note this project has a conventional cash flow pattern - outflow in year 0, followed by inflows in the future years of the project).

True

T/F: In the Netscape case, the growth rate that you calculated in your homework and we discussed in class, to justify the $28 dollar IPO share price was about 45%

False

T/F: In the case Polar Sports stopped growing as a company and is looking into expanding its growth through acquisitions. Specifically, it is considering MountainWear and Karbon as their acquisition targets.

True

T/F: In the trade-off theory of capital structure (Case III) optimal capital structure (optimal mix of debt and equity) exists and it is obtained as a result of a trade-off between the tax benefits of debt, which are the tax saving associated with debt, and the costs of financial distress.

True

T/F: Large and profitable firms should be less likely to experience financial distress and therefore according to the trade-off theory of capital structure (Case III) are more likely to benefit from debt as they are less exposed to the cost(s) of debt (financial distress). Interestingly, a large portion of these large and profitable firms have no or very little debt.

False

T/F: Long-term debt is cheaper (charges lower interest) than short-term debt

True

T/F: Long-term financial planning aims to estimate external funds needed to finance the firm's projected growth. Typically pro-forma accounting statements (BS, IS, etc.) are created using the "Percentage of Sales" approach.

True

T/F: Most accounts on pro forma IS and BS stay as a FIXED PERCENTAGE OF SALES.

True

T/F: Net Present Value (NPV) investment decision rule evaluates all of the project's cash flows (also referred to as free cash flows (FCF)) discounted to their present value at the appropriate discount rate. Managers accept projects if NPV > 0.

True

T/F: Overall debt that a firm takes on to finance long-term growth is a capital structure decision.

False

T/F: P&C Electric's CEO, Peter Campbell, is worried about the firm's performance as he prepares to talk to the firm's banker, as Mr. Campbell believes the firm's performance in 2017 was weak due to lower than expected sales

True

T/F: P&C Electric's customers were not well-capitalized and did NOT carry excess inventory, therefore they relied on P&C Electric's fast delivery of items.

True

T/F: Robins Equipment is a firm with identical assets and operation to Addisons Equipment (which is a levered firm from two questions above). However, Robins Equipment is financed exclusively with equity. Robins Equipment has a beta of 1.10. The U.S. Treasury bill is yielding 1% percent and the expected return on the market is 7% percent. The corporate tax rate is 40 percent. The overall cost of capital (WACC) for Robins Equipment is higher than that of Addisons Equipment.

True

T/F: SHOULD always compare the cost of trade credit with the cost of bank financing

False

T/F: Seasonal production is more profitable for Polar Sports due to savings on new employee training but Polar Sports in considering Level production in order to better match its sales with production.

True

T/F: The NPV of the project with the following cash flows cannot be positive if one uses positive discount rates:CF0 -$4400CF1 $1100CF2 $1100CF3 $1100CF4 $1100

True

T/F: The cost of capital (WACC) is lower for Firm B than for Firm A. This happens because a portion of Firm B is financed with debt (leverage), which is a cheaper source of financing than equity. Even though the cost of equity is higher for Firm B than for Firm A, since Firm B has debt (leverage), the overall cost of capital (WACC) is lower for Firm B because of debt financing.

True

T/F: The costs of bankruptcy consist of direct and indirect costs. Direct bankruptcy costs generally represent 5%-10% of firm value and include bankruptcy court filing fees, payments to lawyers, and debt contract renegotiation related expenses. Indirect bankruptcy costs are more difficult to estimate and are costs that arise because the firm is believed to be in financial trouble. Indirect bankruptcy costs include lost sales, as customers lose confidence in the firm, lost managerial time, as managers worry about bankruptcy filings instead of running a business, firesales, and agency costs associated with financial distress

True

T/F: The longer the maturity rate = the riskier it is, that's why constrained firms are short maturities

True

T/F: When computing a firm's Weighted Average Cost of Capital (WACC) we use an after-tax figure for the cost of debt because interest is tax deductible. We do not use an after-tax figure for the cost of equity because there is no difference between the pre-tax and after-tax equity costs, since dividends are paid from Net Income.

True

T/F: When in default, corporate bondholders are repaid ahead of equity holders

True

T/F: When you are valuing a firm, for example a target firm, using DCF valuation, you would follow these general steps (can look in our M&A class slides for help): 1) First, you would create a capital budgeting pro-forma Income Statement for the firm to identify the free cash flows (FCF) for it as if it was unlevered. You will forecast FCF until reasonable and after that you would calculate the Terminal Value. 2) Next, you would estimate the proper discount rate for this firm by calculating its WACC. 3) Then, you would discount all the FCF using WACC to the present and sum them up to find value of the firm (V). 4) Since you are generally interested in the equity value of the firm and V=D+E (value of firm = debt + equity), you would need to find E. Given that you found V using steps above, you would subtract D from it to find E. For valuation we generally use D = long-term debt + short-term debt outside of AP - cash and marketable securities.

Cash

The Statement of Cash Flows explains the change in ONE Balance Sheet account. Specifically, Operating + Investment + Financing Cash Flows from the Statement of Cash Flows should add up to the difference in this Balance Sheet account. This account is:

-(Rd) is the Yield to Maturity (YTM) or the rate at which the company can borrow today -(Rd) has a greater effect on a firm's cost of capital, WACC, when the debt-equity ratio increases.

The cost of debt

higher than 16%

The current WACC is 16% and you calculated that a newly proposed project that is of similar risk to an average project the firm undertakes (with an upfront investment in Year 0 followed by cash inflows in subsequent years) has an NPV of $266,000 (NPV is positive $266,000). The IRR of this project is:

38%

The implicit annual cost of borrowing when using the trade credit with the terms "5/10, net 60" (and not making payments by day 10 but making them on day 60) is closest to which one of the following annual interest rates?

Higher than expected increase in Inventory

There is a large difference between the 2017 Forecast and Actual Cash Flow from Operations on the Statement of Cash Flows. It is PRIMARILY due to:

Corporate Governance

This structures the distribution of rights among different firm participants -attempts to align the interests of stakeholders

EBIT / Interest

Times Interest Earned

-Evaluate the firm's performance over time (compare historical ratios) -Compare different firms' financial performance at the same point in time -Compare firm's actual ratios to the forecasted (pro-forma) ratios

To access firm's financial health:

Collect from customers faster -Means having shorter DSO -Means spending less $ on financing AR and having lower AR balances on the BS Turn inventory over faster -Means having shorter DIO -Means spending less $ on financing Inv. and having lower Inv. balances on the BS Pay their suppliers slower -Means having longer DPO -Means taking more credit from suppliers and having higher AP balances on the BS

To shorten a firm's cash cycle = spend less time financing inventory:

$1.323 billion Correct! To find the "money left on the table" you can follow the information from our class slides and calculate it as (offer price - 1st day closing price) * # of shares offered ($26 - $44.90)*70,000,000 = (-$1.323 billion) Note this did not consider the exercise of the overallotment option (also known as the green shoe provision) . Generally overallotment options allow the investment bank to issue 15% more shares. If the questions asked you to consider the overallotment option the correct answer would have been: ($26 - $44.90)*(70,000,000 *1.15)=(-$1,521,450,000) Other answer for this question were incorrect and were based on incorrect calculations. For example, incorrect calculations could have considered the highest price on the 1st day, instead of the closing price or considered the price at which the IPO was planned instead of the one at which it actually happened.

Twitter's shares were priced at $26 for the IPO, which is $1 higher than the $25 price Twitter planned on. However, shares closed at $44.90 in the first day of trading, though they reached a price of $50.09. Ignoring the overallotment option, how much was 'left on the table" given that TWTR issued 70 million shares? (Select the closest option).

investment, inventory, dividend, interest payment, taxes -INCREASES in Asset Accounts -DECREASES in Liability or Equity Accounts

Uses of cash:

Above 10%

Using a discount rate (required rate of return) of 10%, which is appropriate for projects of similar risk, you determined that the NPV of the project with a cash outflow of $5,000 in year 0, followed by positive cash flows of $1,000 in several of the subsequent years is around $335. The IRR of this project is

Retained Earnings

What are "internally generated funds"?

1,2,3

What are the main disadvantages of the Payback Period criterion? 1) Ignores time value of money 2) Not valid evaluating irregular cash flows 3) Biased against long-term projects 4) May have multiple solutions 5) Difficult to communicate

I ,II and III

What are the main disadvantages of the Payback Period criterion? I. Ignores time value of money II. Not valid evaluating irregular cash flows III. Biased against long-term projects IV. May have multiple solutions V. Difficult to communicate

1.Non-debt credits: trade credit, deferred tax 2.Notes payable 3.Long term debt 4.New equity offering

What are the sources of external funds? Some examples:

•Invest •Increase Liquidity •Acquire another firm •Repay debt •Lower retained earnings •Buy back stock

What can the firm do with extra unused funds?

If you repay within 30 days, you get a 2% discount, otherwise the full bill is due in 90 days.

What does 2/30, net 90 mean?

NPV increases if equipment can be expensed instead of depreciated. This happens because you realize the tax savings immediately at time 0, which has the highest present value

What if the equipment can be expensed right away instead of being depreciated, does that change the NPV? If so, how and why?

Depreciation

What is an example of a non-cash expense?

0%

What is the IRR of the project with the following Cash Flows? Year 0 -100 Year 1 10 Year2 20 Year3 10 Year4 30 Year5 30

5%

What is the YTM of the bond that pays a $50 annual coupon payment, which has 25 years till maturity and a face value of $1000 and trades at par?

Growth Expectations -M/B is used to measure growth

What is the most important reason why MV does not equal BV?

She should keep operating the cafe but without the marketing campaign. While the NPV of operating with and without the campaign is positive, the one without the marketing campaign is higher.

What should Ms. Wright do? (Hint: Create pro-forma for two scenarios, one without a marketing campaign and one with it. Then you can check the Panopto video solution.)

SHORT-TERM BORROWING

When a firm has a deficit of funds or they are short of their set target cash balance, they will typically borrow short term and typically on VARIABLE RATE basis

Upstream, Massachussets

Where is Coastal Water Sports (CWS) located?

-Variable costs would be lower at $0.10 per pipe instead of $0.17 -Corporate tax rate would be reduced from 40% to 21% -You would be able to expense the equipment instead of depreciating it -Sales would grow at 5% each year instead of growing at 0% each year

Which factors would lead to a higher NPV, all else equal? (select all that apply)

Shorter Cash Cycles are desirables as firms are less likely to need external financing

Which one of the following statements is correct concerning the Cash Cycle (CC, also called the Cash Conversion Cycle)?

-Anticipated merger gains may not be fully achieved and then the acquirer is overpaying for the target -There is no upside to be gained as the price paid for the target might equal target's firm value, including all the synergies between target and acquirer -Acquirer management might be pursuing goals other than shareholder wealth maximization, such as empire building

Why do acquiring firm shareholders gain so little or even lose (in firm value) when the M&A is announced? (select all that apply)

-as underwriters want to reward investors for truthfully revealing what they believe the stock is worth and the number of shares they plan to buy -to attract investors otherwise unwilling to participate due to Winner's Curse -as underwriters want to ensure they can sell the full issue

Why does IPO underpricing exist? (select all that apply)

They would like to, but suppliers provide incentives for rapid repayment (Cost Of Trade Credit). Typically, best combination of price and repayment is negotiated

Why don't all firms simply increase their DPO or payable period?

Cannot negotiate good payable terms with suppliers

Why don't all firms simply increase their payable periods (also known as Days Payable Outstanding, DPO) to shorten their cash cycle?

-Inflation: Inflation makes market value higher than book value (historical cost) -Technology advances: Tech makes buying assets cheaper than before -Accounting depreciation: Accounting depreciation is discretionary: MACRS or straight line only approximate current value of assets. Growth Expectations: The market value represents investors' willingness to pay for growth, which is not implied in the book value of assets.

Why is market value different from book value for equity?

-If companies run out of cash or sources of cash, they are typically out of business--loss of liquidity -Investors measure gains from investment by company distributions (interest, dividend)

Why the focus on cash?

Using Short-term Debt (STD), also know as Notes Payables

You are projecting that your firm, MostAwesomeTennis, will increase sales by 20% next year. You are also projecting an increase in inventories of 55% for next year. •How should your firm finance this increase in inventories?

long-term debt

Your firm, which makes kayaks, is currently operating at full capacity (meaning it is using all of its equipment and molds to manufacture the kayaks). Net working capital, costs, and all assets vary directly with sales. The firm does not wish to obtain any additional equity financing. The dividend payout ratio is constant at 40 percent. If the firm has a positive external financing need (EFN), that need will be met by:

riskiest project

Your friend John, who is the CFO of ThatFirm, mentioned the following information: "You know, I had to choose between 3 different mutually exclusive projects today. All projects were of different risk, one with the highest cash flows was very risky, another had pretty typical level risk and the last one with smaller cash flows was quite safe. Once I calculated up the NPV, I decided to choose the __________ given that it had the highest NPV. Oh....you know I used the same rate to discount all cash flows."

SGR - Sustainable Growth Rate

a rate at which a firm can GROW when issuing new debt, but not new equity -the growth rate possible, given NO new equity and NO change in D to E ratio (so only debt is allowed to change)

PEG ratio, Price/Earnings To Growth

a valuation metric for determining the relative trade-off between the price of a stock (P), the earnings generated per share (E), and the company's expected future growth (g).

OC - DPO DIO + DSO - DPO -Paying cash, making the product, selling the product, collecting cash -Measures the amount of time we finance our inventory

cash cycle:

Benchmarking

compares its ratio values to those of competitors that it wishes to emulate

Working Capital

current assets - current liabilities

MATURITY MATCHING

finance short-term/current assets (such as inventory) with short-term debt and finance long-term assets (such as equipment or buildings, which are reflected in the Net Fixed Assets account on the Balance Sheet) with long-term debt.

sales/net fixed assets

fixed asset turnover

Net Cash Flow is negative and the firm cannot meet its Minimum Cash Balance

if firm has DEFICIT of funds

Net Cash Flow is positive

if firm has SURPLUS of funds

COGS/Inventory

inventory turnover

DIO + DSO -Acquiring inventory, paying cash, making the product, selling the product, collecting cash -Measures the time span a product moves through the current asset accounts

operating cycle:

purchases / AP

payables turnover

COGS / AP

payables turnover approximation

Income Statement

presents operating results over a given period of time

Net income / sales

profit margin

Sales / AR

receivables turnover

Net income / TA

return on assets (ROA)

net income / TE

return on equity (ROE)

-eliminating inefficiencies in the target firm -tax gains (lower tax payments) -reducing workforce (firing workers) in overlapping resources -cost reductions -revenue enhancement -replacing existing "toad kissing" management (see class slides for explanation)

sources of synergy

Income Statement

statement where items expressed as a percentage of sales

Balance Sheet

statement where items expressed as a percentage of total assets

DOW and S&P500

stock indexes of 30 and 500 companies

Liquidity

the ability to convert assets to cash quickly and without a significant loss in value

sales forecast

the driver of the rest of the forecast

IGR - Internal Growth Rate

the growth rate which requires no external funds (no debt growth or equity issuance)

sales/total assets

total asset turnover

(TA-TE) / TA

total debt ratio

•Polar Sports

•Tradeoff between liquidity and profitability •Minimum cash balance and active ST financial management through short term borrowing •Maturity matching: short term liabilities used to finance short term assets!!! •Operating Cycle, Cash Cycle and the influence of DIO on those during level production

1) Financing- how much capital you have 2) Investing- what am I making 3) Operating- how much debt and equity do I have

•What are the three broad categories of corporate financial management decisions?

deciding whether or not to open a new store

•Which one of the following is an investment decision?

Agency Conflict

•divergence between the interests of Managers (agents) and Shareholders (principal) due to separation of ownership and control