Finance Exam 1 AGAIN

Why is a corporation the most important form of business?

- corporations can enter into contracts - Corps. can sue and be sued - A corp. is a separate legal entity with the ability to acquire ans exchange property

The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the:

- cost of capital

The financial goal of profit maximization is associated with:

- cutting costs - critical inventory reduction - maintenance deferment

1. Compensation

- design a pay package that ties management pay to stock performance • Salary • Bonus - based on stock price or profitability • Options - based on stock price or profitability. Options give a manager the right to buy shares of stock at a fixed price for some extended period of time.

_________________ risk is reduced as more securities are added to the portfolio

- diversifiable - unique - unsystematicc

Present value you _________ by the PVIF and FV you __________ by the FVIF

- divide - multiply

Characteristics of a general partnership

- each owner has unlimited liability for all firm debts - its difficult to transfer ownership

Who are considered to be shareholders of a company?

- employees - government - suppliers

The controller is responsible for:

- financial accounting - tax reporting

A good financial decision will:

- increase market value of shareholder's equity - increase the value of the firm's existing stock

What does the security market line depict?

- it is a graphical depiction of the capital asset pricing model. It shows the relationship between expected return and beta

What does the variance measure?

- it measures the dispersion of the sample of returns - it measures the riskiness of a security's return

What does variance measure?

- it measures the riskiness of the securitie's return - it measures the dispersion of the sample of returns

Corporations in other countries are often called:

- joint stock companies - public limited companies - limited liability companies

Which of the following are included in a firm's capital structure?

- long term debt - equity

A treasurer's responsibilities include:

- making financial plans - managing capital expenditure decisions - handling cash flows

Studying market history can reward us by demonstrating that:

- on the average , investors will earn a reward for bearing risk - the greater the potential reward is, the greater the risk

Inventory is a:

- part of working capital - current asset

Important (negative) considerations of a partnership

- personal liability for firm debts - fund raising limitations - taxation of partnership income

Present value of annuity due

- shifting all payment towards today (payments start today) - present value of the annuity due has a greater value than the present day annuity

What is true abut variance?

- standard deviation is the square root of variance - variance is a measure of the squared deviations of a security's return firm its expected return

When a corporation is formed, it is granted which of the following?

- state citizenship for jurisdictional purposes - the ability to issue stock - legal powers to sue

Which of the following types of risk is not reduced by diversification?

- systematic, or market risk

Expected return

- the return that an investor expects to earn on a risky asset in the future

What is the intercept of the security market line (SML)?

- the risk free rate

What are the two components of the expected return on the market?

- the risk free rate - the risk premium

From the stockholders' perspective, what is the primary purpose of awarding stock options to managers?

- to increase shareholders' wealth

The risk of owning an asset comes from:

- unanticipated events - surprises

What two factors determine a stock's total return

- unexpected return - expected return

________________ risk is reduced as more securities are added to the portfolio

- unique - diversifiable - unsystematic

What is true about variance?

- variance is a measure of the squared deviations of a security's return from its expected return - standard deviation is the square root of variance

Example of FVA problem: Ex 1: 500 each year for 5 years, r=15% Ex 2: $600 received at end of each year for 4 years, r=10%

= 500[(1+.15)^5 - 1/.15)] = 3371.2 N=5 i=15 PMT=500 FV=3371.2 = 600[(1+.1)^4 - 1]/.1 N= 4 i=10 PMT=600 FV= 2784.6

ex: Annuity due: Using the cash flows above, a stream of $600 per year starting today for 4 years, r=8%, find the present value:

= 600[1-(1+.08)^-4/.08](1+.08) =2146 pmt=600 i=8% n=4 pva=??? 1987.28

Rule of 72

= 72/rate = how long it takes to double your money = 114/rate = how long to triple your money =144/rate = how long to quadruple your money PV=-1 FV=2 N=10 i=?? =7.2

Rule of 72

= 72/rate = how long it takes to double your money (put rate as regular number, not a decimal) = 114/rate = how long to triple your money =144/rate = how long to quadruple your money PV=-1 FV=2 N=10 i=?? =7.2

Finding the Interest Rate in Annuities

= A

Future value of annuity (FVA)

= A + A(1+r)^1 + A(1+r)^2 + A(1+r)^3 + A(1+r)^4 + A(1+r)^5

PVA Final equation

= A((1-(1+r)^-n/r)) (look in written notes)

Present value of the annuity due (PVAD)

= A[ 1-(1+r)^-n/r] (1+r)

Value equation

= Bonds + Stock

Networking capital equation

= Current Assets - Current Liabilities

Total risk

= Diversifiable Risk +Non Diversifiable Risk

Present value (PV)

= FV/(1+r)^n

FV for 1 year

= PV (1 + r )

FV for year 2

= PV (1 + r)^2

FV for year 3

= PV (1 + r)^3

Future value of an annuity short hand formula (FVA)

= PVA (1+r)^n (look in written notes) = A[(1+r)^n -1/r]

Expected or required return on the jth security

= Return on the risk free asset + ( B(return in the market portfolio - Return on the risk free asset)

Present value interest factor of an annuity (PVIFA)

=(1-(1+r)^-n/r) (look in notes)

Total risk is measured by _____ and systematic risk is measured by _____.

standard deviation; beta

Which one of the following should earn the most risk premium based on CAPM?

stock with a beta of 1.23

When an investor is diversified only ___________ risk matters

systematic

When an investor is diversified only ____________________ risk matters

systematic

The primary responsibility of financial managers is to increase the value of ________

the existing shares of stock

PV

the present value of some amount of money today

How are the unsystematic risks of two different companies in two different industries related?

there is no relationship

B= Index of Systematic Risk

this shows how the individual stock varies with the market.

Standard deviation measures _____ risk.

total

The officer responsible for managing the firm's cash flows is the

treasurer

The average squared difference between the actual return and the average return is called the:

variance

The expected return on a stock given various states of the economy is equal to the:

weighted average of the returns for each economic state.

Which of the following can be used to encourage managers to act in the best interests of shareholders

- better prospects of promotion - stock options and bonuses - managerial compensation ties to performance

2 basic classifications under which most potential financial goals fall?

- controlling risk - earning or increasing profits

What is the expected return of a portfolio consisting of stock A and stock B if the expected return is 10% f% for B? Assume you are equally invested in both the stocks.

12.5%

Ex of PVA: You receive $500 at the end of each year for 5 years r = 15%, calculate PVA

= 500 [(1- (1+.15)^-5))/.15) (look in written notes) N= 5 i=15 PMT=500 PV=? FV= None PV= 1676.07

Present value of an uneven cash flows to get Net Present Value example 2

$100 a year from now, $150 2 years from now and a stream of 6 $325 payments after that. PV = 100/1.12 + 150/1.12^2 + 325/1.12^3 +...... 325/1.12^6 OR PV= 100/(1+.12) + 150/(1+.12)^2 +325[1-(1+.12)^-6/.12]/(1+.12)^2 PV=1274.08

Future value of of uneven cash flows

$100 in yr 1, $150 in yr 2, and $325 in yr 3, r=12% = 100(1+.12)^2 + 150(1+.12)^3 + 325 =618.44 OR FV=PV(1+r)^n

present value of uneven cash flows example

$100 in yr 1, $150 in yr 2, and $325 in yr 3, r=12% PV= (100/1+.12) + (150/1+.12)^2 + (325/1+.12)^3 =440.19

If the security has a beta of 1.5 and security XYZ has a beta of 1, what is the beta of a portfolio that is equal invested in both securities?

(.5 x 1.5) + (.5 x 1) = 1.25

Future Value Interest Factors

(1+r)^n

Assume that P1 is the purchase cost, P2 represents the sale proceeds, and d represents dividend income. Given these definitions, which one of the following is the correct formula for the annual return on an equity security?

(P2 - P1 + d) / P1

The weighted average of the standard deviations of the assets in Portfolio C is 12.9%. Which of the following is a possible value for the standard deviation of the portfolio?

- 10.9% - 12.9% ( The standard deviation of a portfolio is less than or equal to the weighted average of the standard deviations of the assets in the portfolio)

Example: An example of this is: Assume that the risk free rate is 3%, the beta of OWL stock is 1.2, the expected market return is 9%, and you observe or expect the return on OWL to be 12.3%, what can you say about OWL?

- Using the CAPM: E(ROWL) = 3 + 1.2(9-3) = 10.2% - comparing this with what you observe or expect, 12.3%, we see that this is similar to point A in the diagram above and we conclude that OWL is underpriced.

Which one of the following is a primary market transaction? - a dealer selling shares of stock to an individual investor - a dealer buying newly issued shares of stock from a corporation - an individual investor selling shares of stock to another individual - a bank selling shares of a medical firm to an individual - a sole proprietor buying shares of stock from an individual investor

- a dealer buying newly issued shares of stock from a corporation

Ex of unsystematic risks

- a hostile takeover attempt by a competitor - the death of the CEO

The calculation of a portfolio beta is similar to the calculation of:

- a portfolio's expected return

Examples of systematic risk

- an increase in the corporate tax rate - an increase in the federal funds rate

A stock has an expected return of 10.2 percent, the risk-free rate is 4.1 percent, and the market risk premium is 7.2 percent. What must the beta of this stock be?

1) 10.2 = 4.1 + B (7.2) 2) (10.2 -4.1)/7.2 = .85

Let's look at an example of Present Value: look in written notes 1) Assume $500 to be received at the end of 4 years. Discount at 15% 2) You receive $400 in 2 years and r = 10%

1) = 500/(1+.15)^4 = 285.8 N=4 i=15% FV=500 2)PV = 400/(1+.10)^2 = 330.58 N=2 i=10% FV= 400

corporate finance looks at 3 basic issues

1) Capital budgeting 2) Capital Structure 3) Working capital management

What are the 4 steps in computing variance

1. calculate the expected return 2. calculate the deviation of each return from the expected return 3. square each deviation 4. calculate the average squared deviation

You recently purchased a stock that is expected to earn 16 percent in a booming economy, 12 percent in a normal economy, and lose 8 percent in a recessionary economy. There is a 20 percent probability of a boom, a 70 percent chance of a normal economy, and a 10 percent chance of a recession. What is your expected rate of return on this stock?

10.80 percent (Multiply each % times their probability and then add them up)

Baker's Chocolate common stock had annual returns of 13.7 percent, 11.3 percent, 4.6 percent, and 8.9 percent over the last four years, respectively. What is the standard deviation of these returns?

11.8 percent (INCORRECT)

The risk-free rate of return is 5.2 percent and the market risk premium is 8.4 percent. What is the expected rate of return on a stock with a beta of 1.34?

16.46 percent

You purchased 300 shares of stock at a price of $35.86 per share. Over the last year, you have received total dividend income of $336. What is the dividend yield?

3.1 percent

A stock had the following prices and dividends. What is the geometric average return on this stock? year, price, dividend 1,2,3,4,5 22.57, - 22.90, .30 22.26, .31 24.08, .33

3.6 percent

What are the geometric and arithmetic average returns for a stock with annual returns of 5 percent, 10 percent, 8 percent, and 16 percent?

5.37 percent; 5.75 percent

Eight months ago, you purchased 300 shares of Stadford, Inc. stock at a price of $48.30 a share. The company pays quarterly dividends of $.40 a share. Today, you sold all of your shares for $45.20 a share. What is your total percentage return on this investment?

6.4 percent (INCORRECT)

Maximum value of the stock price

= (Price) x (# of shares)

You own a stock portfolio invested 20 percent in Stock Q, 30 percent in Stock R, 35 percent in Stock S, and 15 percent in Stock T. The betas for these four stocks are .84, 1.17, 1.08, and 1.36, respectively. What is the portfolio beta?

= .84(.20) + 1.17(.30) + 1.08(.35) + 1.36(.15) = 1.10

Present value interest factor (PVIF)

= 1/(1+r)^n

Present value of an annuity (PVA) ex: $300 per year for four years, r = 10%

Basically each year added up = (A/(1+r)^1) + (A/(1+r)^2) + (A/(1+r)^3) + (A/(1+r)^4) .... = (300/(1+.1)^1) + (300/(1+.1)^2) + (300/(1+.1)^3) + (300/(1+.1)^4) = $950.96

The rules used by a corporation to regulate its existence

Bylaws

Suppose a stock had an initial price of $80 per share, paid a dividend of $.60 per share during the year, and had an ending share price of $88. What was the dividend yield and the capital gains yield? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Dividend yield % Capital gains yield %

Ch 12 # 2 The dividend yield is the dividend divided by the beginning of the period price, so: Dividend yield = $.60 / $80 Dividend yield = .0075, or .75% And the capital gains yield is the increase in price divided by the initial price, so: Capital gains yield = ($88 - 80) / $80 Capital gains yield = .1000, or 10.00%

Suppose you bought a bond with an annual coupon rate of 7.4 percent one year ago for $900. The bond sells for $940 today. a. Assuming a $1,000 face value, what was your total dollar return on this investment over the past year? Total dollar return $ b. What was your total nominal rate of return on this investment over the past year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Nominal rate of return % c. If the inflation rate last year was 2 percent, what was your total real rate of return on this investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Real rate of return %

Ch 12 # 3 a. The total dollar return is the increase in price plus the coupon payment, so: Total dollar return = $940 - 900 + 74 Total dollar return = $114 b. The total percentage return of the bond is: R = ($940 - 900 + 74) / $900 R = .1267, or 12.67% Notice here that we could have simply used the total dollar return of $114 in the numerator of this equation. c. Using the Fisher equation, the real return was: (1 + R) = (1 + r)(1 + h) r = (1.1267 / 1.020) - 1 r = .1046, or 10.46%

Returns Year X Y 1 17 % 22 % 2 31 32 3 12 16 4 - 24 - 29 5 10 23 Using the returns shown above, calculate the arithmetic average returns, the variances, and the standard deviations for X and Y. (Do not round intermediate calculations. Enter your average return and standard deviation as a percent rounded to 2 decimal places, e.g., 32.16, and round the variance to 5 decimal places, e.g., 32.16161.) X Y Average return % % Variance Standard deviation % %

Ch 12 # 4 The average return is the sum of the returns, divided by the number of returns. The average return for each stock was: formula4.mml formula5.mml Remembering back to "sadistics," we calculate the variance of each stock as: formula10.mml formula11.mml formula12.mml The standard deviation is the square root of the variance, so the standard deviation of each stock is: σX = (.04117)1/2 σX = .2029, or 20.29% σY = (.05787)1/2 σY = .2406, or 24.06%

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 13 percent, -8 percent, 16 percent, 16 percent, and 10 percent. a. What was the arithmetic average return on Crash-n-Burn's stock over this five-year period? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.) Average return % b-1 What was the variance of Crash-n-Burn's returns over this period? (Do not round intermediate calculations and round your answer to 5 decimal places, e.g., 32.16161.) Variance b-2 What was the standard deviation of Crash-n-Burn's returns over this period? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Standard deviation %

Ch 12 # 5 a. To find the average return, we sum all the returns and divide by the number of returns, so: Average return = (.13 - .08 + .16 + .16 + .10) / 5 Average return = .094, or 9.4% b. Using the equation to calculate variance, we find: Variance = 1/4[(.13 - .094)2 + (-.08 - .094)2 + (.16 - .094)2 + (.16 - .094)2 + (.10 - .094)2] Variance = .01008 So, the standard deviation is: Standard deviation = (.01008)1/2 Standard deviation = .1004, or 10.04%

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 12 percent, -12 percent, 19 percent, 24 percent, and 10 percent. Suppose the average inflation rate over this period was 2.5 percent and the average T-bill rate over the period was 3.2 percent. a. What was the average real return on Crash-n-Burn's stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Average real return % b. What was the average nominal risk premium on Crash-n-Burn's stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.) Average nominal risk premium %

Ch 12 # 6 a. To find the average return, we sum all the returns and divide by the number of returns, so: Average return = (.12 - .12 + .19 + .24 + .10) / 5 Average return = .106, or 10.6% To calculate the average real return, we can use the average return of the asset, and the average inflation in the Fisher equation. Doing so, we find: (1 + R) = (1 + r)(1 + h) formula19.mml = (1.106 / 1.025) - 1 formula19.mml = .0790, or 7.90% b. The average risk premium is simply the average return of the asset, minus the average risk-free rate, so, the average risk premium for this asset would be: Average risk premium = Average return − Average risk-free rate Average risk premium = .106 − .032 Average risk premium = .074, or 7.4%

A stock has had the following year-end prices and dividends: Year Price Dividend 1 $ 43.51 - 2 48.49 $ .81 3 57.41 .84 4 45.49 .95 5 52.41 1.00 6 61.49 1.08 What are the arithmetic and geometric returns for the stock? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Arithmetic return % Geometric return %

Ch 12 # 7 To calculate the arithmetic and geometric average returns, we must first calculate the return for each year. The return for each year is: R1 = ($48.49 - 43.51 + .81) / $43.51 = .1331, or 13.31% R2 = ($57.41 - 48.49 + .84) / $48.49 = .2013, or 20.13% R3 = ($45.49 - 57.41 + .95) / $57.41 = -.1911, or -19.11% R4 = ($52.41 - 45.49 + 1.00) / $45.49 = .1741, or 17.41% R5 = ($61.49 - 52.41 + 1.08) / $52.41 = .1939, or 19.39% The arithmetic average return was: RA = (.1331 + .2013 - .1911 + .1741 + .1939) / 5 RA = .1022, or 10.22% And the geometric average return was: RG = [(1 + .1331)(1 + .2013)(1 - .1911)(1 + .1741)(1 + .1939)]1/5 - 1 RG = .0907, or 9.07%

What are the portfolio weights for a portfolio that has 134 shares of Stock A that sell for $44 per share and 114 shares of Stock B that sell for $34 per share? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.) Portfolio weights Stock A Stock B

Ch 13 # 1 The portfolio weight of an asset is the total investment in that asset divided by the total portfolio value. First, we will find the portfolio value, which is: Total value = 134($44) + 114($34) Total value = $9,772 The portfolio weight for each stock is: WeightA = 134($44) / $9,772 WeightA = .6034 WeightB = 114($34) / $9,772 WeightB = .3966

You own a portfolio that has $3,400 invested in Stock A and $4,400 invested in Stock B. If the expected returns on these stocks are 12 percent and 15 percent, respectively, what is the expected return on the portfolio? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Portfolio expected return %

Ch 13 # 2 The expected return of a portfolio is the sum of the weight of each asset times the expected return of each asset. The total value of the portfolio is: Total portfolio value = $3,400 + 4,400 Total portfolio value = $7,800 So, the expected return of this portfolio is: E(RP) = ($3,400 / $7,800)(.12) + ($4,400 / $7,800)(.15) E(RP) = .1369, or 13.69%

Consider the following information: State of Economy Probability of State of Economy Portfolio Return If State Occurs Recession .18 − .14 Normal .54 .15 Boom .28 .23 Calculate the expected return. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Expected return %

Ch 13 # 3 The expected return of an asset is the sum of each return times the probability of that return occurring. So, the expected return of the asset is: E(R) = .18(−.14) + .54(.15) + .28(.23) E(R) = .1202, or 12.02%

You own a stock portfolio invested 35 percent in Stock Q, 25 percent in Stock R, 25 percent in Stock S, and 15 percent in Stock T. The betas for these four stocks are .88, 1.21, 1.05, and 1.23, respectively. What is the portfolio beta? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) Portfolio beta

Ch 13 # 5 The beta of a portfolio is the sum of the weight of each asset times the beta of each asset. So, the beta of the portfolio is: βP = .35(.88) + .25(1.21) + .25(1.05) + .15(1.23) βP = 1.06

A stock has a beta of 1.36, the expected return on the market is 10 percent, and the risk-free rate is 2.5 percent. What must the expected return on this stock be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Expected return %

Ch 13 # 6 CAPM states the relationship between the risk of an asset and its expected return. CAPM is: E(Ri) = Rf + [E(RM) − Rf] × βi Substituting the values we are given, we find: E(Ri) = .025 + (.10 − .025)(1.36) E(Ri) = .1270, or 12.70%

A stock has an expected return of 12 percent, the risk-free rate is 3.5 percent, and the market risk premium is 5 percent. What must the beta of this stock be? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) Beta of stock

Ch 13 # 7 We are given the values for the CAPM except for the β of the stock. We need to substitute these values into the CAPM, and solve for the β of the stock. One important thing we need to realize is that we are given the market risk premium. The market risk premium is the expected return of the market minus the risk-free rate. We must be careful not to use this value as the expected return of the market. Using the CAPM, we find: E(Ri) = .120 = .035 + .050βi βi = 1.70

A stock has an expected return of 16.5 percent, its beta is 1.30, and the risk-free rate is 6.5 percent. What must the expected return on the market be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Market expected return %

Ch 13 # 8 Here we need to find the expected return of the market using the CAPM. Substituting the values given, and solving for the expected return of the market, we find: E(Ri) = .165 = .065 + [E(RM) − .065](1.30) E(RM) = .1419, or 14.19%

Investment X offers to pay you $4,700 per year for 9 years, whereas Investment Y offers to pay you $6,800 per year for 5 years. If the discount rate is 5 percent, what is the present value of these cash flows? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Present value Investment X $ Investment Y $ If the discount rate is 15 percent, what is the present value of these cash flows? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Present value Investment X $ Investment Y $

Ch 6 #2 PVA = C({1 - [1 / (1 + r)t]} / r ) At an interest rate of 5 percent: X@5%: PVA = $4,700{[1 - (1 / 1.05)9 ] / .05 } = $33,406.76 Y@5%: PVA = $6,800{[1 - (1 / 1.05)5 ] / .05 } = $29,440.44 And at an interest rate of 15 percent: X@15%: PVA = $4,700{[1 - (1 / 1.15)9 ] / .15 } = $22,426.44 Y@15%: PVA = $6,800{[1 - (1 / 1.15)5 ] / .15 } = $22,794.65

covariance

E[(R1 -E(R1))(R2-E(R2))]

The equation for the capital asset pricing model?

Expected return on security= (Risk free rate) + (Beta) x (Return on market - Risk free rate)

You deposit $400 into an account, earning 8% compounded annually. After 10 years, what is the the future value or value of the future account?

FV = 400 (1.08)^10 FV= 863.57 N=10 i=.08 PV=400

Ex question: You're trying to save to buy a new $192,000 Ferrari. You have $42,000 today that can be invested at your bank. The bank pays 5 percent annual interest on its accounts.

FV=PV(1+r)^n 1) Solve for n FV=-192000 PV=42000 r=5 N= 31.15

Ex question: Assume that in January 2013, the average house price in a particular area was $275,400. In January 2000, the average price was $192,300.

FV=PV(1+r)^n 1) Solve for r r=(FV/PV)^(1/n)-1 r= (275,400/192,300)^(1/13)-1 r= .028 or 2.8%

Calculating Real Returns and Risk Premiums

For Problem 9, suppose the average inflation rate over this period was 3.5 percent and the average T-bill rate over the period was 4.2 percent. a. What was the average real return on Crash-n-Burn's stock? b. What was the average nominal risk premium on Crash-n-Burn's stock? 1) rate of real return= (1+norminal rate) = (1+real rate) (1+pi^e) [(1+.128)/(1+.035)] -1 =8.9855% 2) 12.8 -4.2 = 8.6%

Compound Interest

In one year you get paid the principal + interest on the principal and then

What is unsystematic risk?

It is a risk that affects a single asset or a small group of assets

What is systematic risk?

It is a risk that pertains to a large number of assets

What is a risk premium?

It is additional compensation for taking risk, over and above the risk free rate

If a security's expected return is equal to the risk free rate of return, and the market-risk premium is greater than zero, what can you conclude about the value of the security's beta based on CAPM?

It is equal to 0

when payment starts TODAY

Looking to find the the ANNUITY DUE

Lower correlation =

Lower risk

How is ownership transferred in a corporation?

Ownership is transferred by gifting or selling shares of stock

The common stock of PDS has a beta of .98 and an expected return of 12.34 percent. The risk-free rate of return is 4.1 percent and the market rate of return is 11.65 percent. Which one of the following statements is true given this information?

PDS stock is underpriced.

Lump sum

PV + FV

FV formula

Pv(1+r)^n Ex: What is the future value of $100 deposited today after earning 10% annually for 4 years? The formula for this is: 100(1.1)^4 N=4 PV= 100 i= 10 FV=?? FV= 146.41

Calculating Returns formula

R=(End price -Initial price +$ per share)/ Initial price Suppose a stock had an initial price of $79 per share, paid a dividend of $1.45 per share during the year, and had an ending share price of $88. Compute the percentage total return. =(88-79+1.45)/79=

(return in the market portfolio - Return on the risk free asset) (Rm - RRF)

Risk premium that entices investors into investing in the market portfolio rather than just the Risk-Free asset. This is usually positive.

NonDiversifiable Risk or Systematic Risk

Risks due to fluctuations in general economic conditions, examples are a recession, a rise in inflation, etc.

Diversifiable Risk or Nonsystematic Risk

Risks specific to the firm or security, examples would be declining earnings, the Firestone tire disaster, etc.

Security Market Line (SML)

Shows the equilibrium Expected Return for a given Beta. Any vertical line represents and a different risk class of security with a different level of systematic risk. In equilibrium all assets are supposed to line up along the SML which shows the Expected Return for a given level of systematic risk.

Lump sum of PV and FV

r = (FV/PV)^(1/n) - 1 Ex: $100 deposited for 5 years, we end up with $248.9, what is the rate? r = (248.9/100)^1/5 -1 = .2 N=5 i=?? PV= -100 (have to put a negative in to get the answer!) FV=248.9 i=20%

When an investor is diversified only __________ risk matters

Systematic

The systematic risk principle argues that the market does not reward risks:

That are borne unnecessarily

Organized action markets include:

The New York Stock Exchange

The liability of a shareholder in a corporation is limited to:

The amount the shareholder invested in the corporation

Portfolio Beta

The beta for a portfolio is, similar to all the other grouping in finance, a market weighted average of the individual stock betas. (look on last page of typed notes to see the chart) Wi Beta X: .2 2.2 Y: .4 1.1 Z: .4 .7 = .2(2.2) + .4(1.1) + .4(.7) =1.16

A security has a beta of 1, the market risk premium is 8%, and the risk free rate is 3%. What will happen to the expected return if the beta doubles?

The expected return will increase to 19% from 11%

Capital Structure

The firm's mixture of financing its operations and purchases of long-term assets; how much short- and long-term debt versus stock. Value = Bonds + Stock

Future Value

The future value of a sum of money compounded at a rate of r% for the n years

Working capital management

The management of short-term operating cash flow. Net Working Capital = Current Assets - Current Liabilities

Capital budgeting

The process of deciding which long-term assets the firm should invest in. The investments should provide positive net cash flows to the firm.

What is one reason managers make good decisions

To avoid hostile take over

What is the objective of the firm?

To maximize firm value or shareholders' wealth

What is the main goal of financial manager?

To maximize shareholder wealth

What is the main goal of financial managment

To maximize shareholders wealth

Two Types of Risk

Total Risk, p, can be broken down into two types.

Which one of the following categories of securities had the lowest average risk premium for the period 1926 - 2013?

U.S. Treasury bills

The owners of a corporation are called

shareholders

Risk reduction

When p = 1 => No Risk Reduction When p < 1 => Risk Reduction When p = -1 => Maximum Risk Reduction

Calculating Returns and Variable

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 7 percent, -13 percent, 21 percent, 34 percent, and 15 percent. a. What was the arithmetic average return on Crash-n-Burn's stock over this five-year period? b. What was the variance of Crash-n-Burn's returns over this period? The standard deviation? 1) =(7+(-13)+21+34+15)/5=12.8% 2) =(((7-12.8)^2+(-13-12.8)^2+(21-12.8)^2+(34-12.8)^2+(15-12.8)^2))/(5-1)=305.2 (the 5 is number of returns) (variance)>>> Then square root it =17.47% (standard deviation) 3)(17.47)^2= .03052

Future value interest factor of annuity (FVIFA)

[(1+r)^n - 1)/r]

Sole Proprietorship

a business owned by one individual. Usually used for small businesses.

A portfolio is

a group of assets and we often hold assets in groups. Simple examples of these are the S&P 500 and the Dow Jones. These are groups of stocks that people pay particular attention to. Therefore, we need to look at portfolio risk and return.

Bylaws

a set of rules on how the corporation regulates itself.

Lump sum present value and future value

a single cash payment either today or a number of periods from today

Present and future value of annuities

a stream of constant cash flows for a fixed number of periods ex: car payment

Present and future value of an annuity due

a stream of constant cash flows for a fixed number of periods, where the payments start today

annuities

a stream of equal cash payments for a fixed number of periods that start one period from now ex: home and auto loans which are monthly

If you hire a real estate company to sell your house, you are most apt to encounter which one of the following?

agency problem

The conflict of interest between an agent and a principal is called a(n)

agency problem

auction markets

all transactions take place under one roof and brokers Ex: New York Stock exchange building

An organization must prepare ___________________ and bylaws when forming a corporation

articles of incorporation

How to maximize a firm's value

by maximizing frequency and magnitude of cash flow to the firm

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

The equation of the SML which defines the relationship between the expected return and beta is the:

capital asset pricing model.

What type of investments should the firm make?

capital budgeting

The mixture of debt and equity maintained by a firm

capital structure

It would be useful to understand how the _________ of the risk premium on a risky asset is determined

size

It would be useful to understand how the __________ of the premium on a risky asset is determined

size

Suppose a stock had an initial price of $70 per share, paid a dividend of $2.30 per share during the year, and had an ending share price of $82. Compute the percentage total return. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Total return %

ch 12 # 1 The return of any asset is the increase in price, plus any dividends or cash flows, all divided by the initial price. The return of this stock is: R = ($82 - 70 + 2.30) / $70 R = .2043, or 20.43%

Consider the following information: Rate of Return If State Occurs State of Probability of Economy State of Economy Stock A Stock B Recession .19 .08 − .19 Normal .56 .11 .10 Boom .25 .16 .27 Calculate the expected return for each stock. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Expected return Stock A % Stock B % Calculate the standard deviation for each stock. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Standard deviation Stock A % Stock B %

ch 13 #4 The expected return of an asset is the sum of each return times the probability of that return occurring. So, the expected return of each stock asset is: E(RA) = .19(.08) + .56(.11) + .25(.16) E(RA) = .1168, or 11.68% E(RB) = .19(−.19) + .56(.10) + .25(.27) E(RB) = .0874, or 8.74% To calculate the standard deviation, we first need to calculate the variance. To find the variance, we find the squared deviations from the expected return. We then multiply each possible squared deviation by its probability, then add all of these up. The result is the variance. So, the variance and standard deviation of each stock is: σA2 =.19(.08 − .1168)2 + .56(.11 − .1168)2 + .25(.16 − .1168)2 σA2 = .00075 σA = (.00075)1/2 σA = .0274, or 2.74% σB2 =.19(−.19 − .0874)2 + .56(.10 − .0874)2 + .25(.27 − .0874)2 σB2 = .02305 σB = (.02305)1/2 σB = .1518, or 15.18%

For each of the following, compute the future value: (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Present Value Years Interest Rate Future Value $ 1,900 12 12 % $ 8,052 6 10 69,355 13 11 176,796 7 7

ch 5 #1 FV = PV(1 + r)t FV = $1,900(1.12)12 = $7,402.35 FV = $8,052(1.10)6 = $14,264.61 FV = $69,355(1.11)13 = $269,324.90 FV = $176,796(1.07)7 = $283,895.74

Your coin collection contains 42 1952 silver dollars. If your grandparents purchased them for their face value when they were new, how much will your collection be worth when you retire in 2052, assuming they appreciate at an annual rate of 5.9 percent? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Future value $

ch 5 #10 To find the FV of a lump sum, we use: FV = PV(1 + r)t FV = $42(1.059)100 FV = $12,967.17

In 1895, the first Putting Green Championship was held. The winner's prize money was $170. In 2014, the winner's check was $1,390,000. What was the percentage increase per year in the winner's check over this period? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Increase per year % If the winner's prize increases at the same rate, what will it be in 2046? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) Winner's prize in 2046 $

ch 5 #11 To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = ($1,390,000 / $170)1/119 - 1 r = .0786, or 7.86% To find the FV of the first prize in 2046, we use: FV = PV(1 + r)t FV = $1,390,000(1.0786)32 FV = $15,672,322.36

Which one of the following is a correct ranking of securities based on their volatility over the period of 1926 - 2013? Rank from highest to lowest.

small company stocks, long-term corporate bonds, large company stocks (INCORRECT)

A coin that was featured in a famous novel sold at auction in 2014 for $3,685,500. The coin had a face value of $15 when it was issued in 1790 and had previously been sold for $390,000 in 1974. At what annual rate did the coin appreciate from its first minting to the 1974 sale? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Rate of return % What annual rate did the 1974 buyer earn on his purchase? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Rate of return % At what annual rate did the coin appreciate from its first minting to the 2014 sale? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Rate of return %

ch 5 #12 The time line from minting to the first sale is: To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = ($390,000 / $15)1/184 - 1 r = .0568, or 5.68% The time line from the first sale to the second sale is: To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = ($3,685,500 / $390,000)1/40 - 1 r = .0578, or 5.78% The time line from minting to the second sale is: To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = ($3,685,500 / $15)1/224 - 1 r = .0570, or 5.70%

In March 2012, Daniela Motor Financing (DMF), offered some securities for sale to the public. Under the terms of the deal, DMF promised to repay the owner of one of these securities $800 in March 2047, but investors would receive nothing until then. Investors paid DMF $400 for each of these securities; so they gave up $400 in March 2012, for the promise of a $800 payment 35 years later. a. Assuming that you purchased the bond for $400, what rate of return would you earn if you held the bond for 35 years until it matured with a value $800? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Rate of return n/r incorrect % b. Suppose under the terms of the bond you could redeem the bond in 2022. DMF agreed to pay an annual interest rate of 1.2 percent until that date. How much would the bond be worth at that time? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) Bond value $n/r incorrect c. In 2022, instead of cashing in the bond for its then current value, you decide to hold the bond until it matures in 2047. What annual rate of return will you earn over the last 25 years? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Rate of return n/r incorrect %

ch 5 #13 To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = (FV / PV)1/t - 1 r = ($800 / $400)1/35 - 1 r = .0200, or 2.00% Using the FV formula, we get: FV = PV(1 +r)t FV = $400(1 + .012)10 FV = $450.68 Using the FV formula and solving for the interest rate, we get: r = (FV / PV)1/t - 1 r = ($800 / $450.68)1/25 - 1 r = .0232, or 2.32%

You are planning to make monthly deposits of $470 into a retirement account that pays 9 percent interest compounded monthly. If your first deposit will be made one month from now, how large will your retirement account be in 35 years? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Future value $

ch 6 # 11 The equation to find the FVA is: FVA = C{[(1 + r)t − 1] / r} FVA = $470[{[1 + (.09 / 12)]420 - 1} / (.09 / 12)] FVA = $1,382,638.70

Geometric averages are_____ than arithmetic averages

smaller

A _______________ is someone other than an owner or a creditor who potentially has a claim of the cash flows of a firm.

stakeholder

For each of the following, compute the present value (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.): Present Value Years Interest Rate Future value $ 12 6 % $ 14,451 3 12 41,557 28 13 876,073 30 10 540,164

ch 5 #2 To find the PV of a lump sum, we use: PV = FV / (1 + r)t PV = $14,451 / (1.06)12 = $7,181.70 PV = $41,557 / (1.12)3 = $29,579.45 PV = $876,073 / (1.13)28 = $28,598.54 PV = $540,164 / (1.10)30 = $30,956.02

Solve for the unknown interest rate in each of the following (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.): Present Value Years Interest Rate Future Value $ 300 4 % $ 380 420 18 1,394 45,000 19 237,520 44,261 25 703,627

ch 5 #3 We can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1 / t - 1 FV = $380 = $300(1 + r)4 r = ($380 / $300)1/4 - 1 r = .0609, or 6.09% FV = $1,394 = $420(1 + r)18 r = ($1,394 / $420)1/18 - 1 r = .0689, or 6.89% FV = $237,520 = $45,000(1 + r)19 r = ($237,520 / $45,000)1/19 - 1 r = .0915, or 9.15% FV = $703,627 = $44,261(1 + r)25 r = ($703,627 / $44,261)1/25 - 1 r = .1170, or 11.70%

Solve for the unknown number of years in each of the following (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.): Present Value Years Interest Rate Future Value $ 500 8 % $ 1,075 750 12 1,836 17,800 18 294,671 20,900 14 320,610

ch 5 #4 We can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for t, we get: t = ln(FV / PV) / ln(1 + r) FV = $1,075 = $500(1.08)t t = ln($1,075 / $500) / ln(1.08) t = 9.95 years FV = $1,836 = $750(1.12)t t = ln($1,836 / $750) / ln(1.12) t = 7.90 years FV = $294,671 = $17,800(1.18)t t = ln($294,671 / $17,800) / ln(1.18) t = 16.96 years FV = $320,610 = $20,900(1.14)t t = ln($320,610 / $20,900) / ln(1.14) t = 20.84 years

At 5.5 percent interest, how long does it take to double your money? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Length of time years At 5.5 percent interest, how long does it take to quadruple it? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Length of time years

ch 5 #6 To find the length of time for money to double, triple, etc., the present value and future value are irrelevant as long as the future value is twice the present value for doubling, three times as large for tripling, etc. We can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for t, we get: t = ln(FV / PV) / ln(1 + r) The length of time to double your money is: FV = $2 = $1(1.055)t t = ln(2) / ln(1.055) t = 12.95 years The length of time to quadruple your money is: FV = $4 = $1(1.055)t t = ln(4) / ln(1.055) t = 25.89 years

Assume that in January 2013, the average house price in a particular area was $287,400. In January 2001, the average price was $204,300. What was the annual increase in selling price? (Do not round intermediate calculations. Enter your answer as a percent rounded answer to 2 decimal places, e.g., 32.16.) Annual increase in selling price %

ch 5 #7 To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = ($287,400 / $204,300)1/12 - 1 r = .0288, or 2.88%

You're trying to save to buy a new $195,000 Ferrari. You have $45,000 today that can be invested at your bank. The bank pays 5.3 percent annual interest on its accounts. How long will it be before you have enough to buy the car? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Number of years

ch 5 #8 To answer this question, we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for t, we get: t = ln(FV / PV) / ln(1 + r) t = ln($195,000 / $45,000) / ln(1.053) t = 28.39 years

You have just received notification that you have won the $2 million first prize in the Centennial Lottery. However, the prize will be awarded on your 100th birthday (assuming you're around to collect), 76 years from now. What is the present value of your windfall if the appropriate discount rate is 8 percent? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Present value $

ch 5 #9 To find the PV of a lump sum, we use: PV = FV / (1 + r)t PV = $2,000,000 / (1.08)76 PV = $5,765.34

You want to buy a new sports coupe for $81,500, and the finance office at the dealership has quoted you an APR of 6.3 percent for a 60 month loan to buy the car. What will your monthly payments be? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Monthly payment $ What is the effective annual rate on this loan? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Effective annual rate %

ch 6 # 10 We first need to find the annuity payment. We have the PVA, the length of the annuity, and the interest rate. Using the PVA equation: PVA = C({1 − [1 / (1 + r)t]} / r) $81,500 = $C[1 − {1 / [1 + (.063 / 12)]60} / (.063 / 12)] Solving for the payment, we get: C = $81,500 / 51.35420 C = $1,587.02 To find the EAR, we use the EAR equation: EAR = [1 + (APR / m)]m − 1 EAR = [1 + (.063 / 12)]12 − 1 EAR = .0649, or 6.49%

Huggins Co. has identified an investment project with the following cash flows. Year Cash Flow 1 $ 750 2 990 3 1,250 4 1,350 If the discount rate is 7 percent, what is the present value of these cash flows? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Present value $ n/r incorrect What is the present value at 18 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Present value $ n/r incorrect What is the present value at 24 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

ch 6 #1 PV = FV / (1 + r)t PV@7% = $750 / 1.07 + $990 / 1.072 + $1,250 / 1.073 + $1,350 / 1.074 = $3,615.92 PV@18% = $750 / 1.18 + $990 / 1.182 + $1,250 / 1.183 + $1,350 / 1.184 = $2,803.70 PV@24% = $750 / 1.24 + $990 / 1.242 + $1,250 / 1.243 + $1,350 / 1.244 = $2,475.32

You want to be a millionaire when you retire in 40 years. How much do you have to save each month if you can earn an annual return of 11.9 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Savings per month $ How much do you have to save each month if you wait 15 years before you begin your deposits? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Savings per month $ How much do you have to save each month if you wait 25 years before you begin your deposits? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Savings per month $

ch 6 #12 Starting today: FVA = C[{[1 + (.119 / 12)]480 - 1} / (.119 / 12)] C = $1,000,000 / 11,399.037 C = $87.73 Starting in 15 years: FVA = C[{[1 + (.119 / 12)]300 - 1} / (.119 / 12)] C = $1,000,000 / 1,845.847 C = $541.76 Starting in 25 years: FVA = C[{[1 + (.119 / 12)]180 - 1} / (.119 / 12)] C = $1,000,000 / 494.865 C = $2,020.75

You're prepared to make monthly payments of $210, beginning at the end of this month, into an account that pays 6.2 percent interest compounded monthly. How many payments will you have made when your account balance reaches $12,000? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Number of payments

ch 6 #13 FVA = $12,000 = $210[{[1 + (.062 / 12)]t - 1} / (.062 / 12)] Solving for t, we get: 1.00517t = 1 + [($12,000) / ($210)](.062 / 12) t = ln 1.29524 / ln 1.00517 t = 50.20 payments

Cannonier, Inc., has identified an investment project with the following cash flows. Year Cash Flow 1 $ 930 2 1,160 3 1,380 4 2,120 If the discount rate is 7 percent, what is the future value of these cash flows in Year 4? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Future value $ What is the future value at a discount rate of 13 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Future value $ What is the future value at a discount rate of 22 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Future value $

ch 6 #3 FV = PV(1 + r)t FV@7% = $930(1.07)3 + $1,160(1.07)2 + $1,380(1.07) + $2,120 = $6,063.97 FV@13% = $930(1.13)3 + $1,160(1.13)2 + $1,380(1.13) + $2,120 = $6,502.50 FV@22% = $930(1.22)3 + $1,160(1.22)2 + $1,380(1.22) + $2,120 = $7,218.88

If you put up $47,000 today in exchange for a 6.75 percent, 14-year annuity, what will the annual cash flow be? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Annual cash flow $

ch 6 #5 PVA = C({1 − [1 / (1 + r)t]} / r) PVA = $47,000 = $C{[1 − (1 / 1.067514)] / .0675} We can now solve this equation for the annuity payment. Doing so, we get: C = $47,000 / 8.878105 C = $5,293.92

The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $24,000 per year forever. If the required return on this investment is 6.3 percent, how much will you pay for the policy? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) Present value $

ch 6 #7 This cash flow is a perpetuity. To find the PV of a perpetuity, we use the equation: PV = C / r PV = $24,000 / .0630 PV = $380,952.38

Find the EAR in each of the following cases (Use 365 days a year. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.): Stated Rate (APR) Number of Times Compounded Effective Rate (EAR) 9.4 % Quarterly % 18.4 Monthly 14.4 Daily 11.4 Infinite

ch 6 #8 For discrete compounding, to find the EAR, we use the equation: EAR = [1 + (APR / m)]m − 1 EAR = [1 + (.094 / 4)]4 − 1 = .0974, or 9.74% EAR = [1 + (.184 / 12)]12 − 1 = .2003, or 20.03% EAR = [1 + (.144 / 365)]365 − 1 = .1549, or 15.49% To find the EAR with continuous compounding, we use the equation: EAR = eq − 1 EAR = e.114 − 1 = .1208, or 12.08%

First National Bank charges 13.6 percent compounded monthly on its business loans. First United Bank charges 13.9 percent compounded semiannually. Calculate the EAR for First National Bank and First United Bank. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) EAR First National % First United % As a potential borrower, which bank would you go to for a new loan? First United Bank

ch 6 #9 For discrete compounding, to find the EAR, we use the equation: EAR = [1 + (APR / m)]m − 1 So, for each bank, the EAR is: First National: EAR = [1 + (.136 / 12)]12 − 1 = .1448, or 14.48% First United: EAR = [1 + (.139 / 2)]2 − 1 = .1438, or 14.38% Notice that the higher APR does not necessarily mean the higher EAR. The number of compounding periods within a year will also affect the EAR.

Assume the total cost of a college education will be $300,000 when your child enters college in 18 years. You presently have $60,000 to invest. What annual rate of interest must you earn on your investment to cover the cost of your child's college education? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Annual rate of interest %

ch5 #5 To answer this question we can use either the FV or the PV formula. Both will give the same answer since they are the inverse of each other. We will use the FV formula, that is: FV = PV(1 + r)t Solving for r, we get: r = (FV / PV)1/t - 1 r = ($300,000 / $60,000)1/18 - 1 r = .0935, or 9.35%

When new securities are added to a portfolio, the total unsystematic risk portion of that portfolio is most likely to _____________.

decrease

What is an important mechanism used by unhappy stockholders to replace current management?

proxy fight

An investment offers $6,200 per year for 20 years, with the first payment occurring one year from now. If the required return is 7 percent, what is the value of the investment? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Present value $ n/r incorrect What would the value be if the payments occurred for 45 years? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Present value $ n/r incorrect What would the value be if the payments occurred for 70 years? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Present value $ n/r incorrect What would the value be if the payments occurred forever? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Present value $ n/r incorrect

ch6 #4 PVA = C({1 − [1 / (1 + r)t]} / r) PVA@20 yrs: PVA = $6,200{[1 − (1 / 1.0720)] / .07} = $65,682.89 PVA@45 yrs: PVA = $6,200{[1 − (1 / 1.0745)] / .07} = $84,354.23 PVA@70 yrs: PVA = $6,200{[1 − (1 / 1.0770)] / .07} = $87,794.41 To find the PV of a perpetuity, we use the equation: PV = C / r PV = $6,200 / .07 = $88,571.43

If you deposit $5,300 at the end of each of the next 20 years into an account paying 10.8 percent interest, how much money will you have in the account in 20 years? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Future value $ How much will you have if you make deposits for 40 years? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Future value $

ch6 #6 Here we need to find the FVA. The equation to find the FVA is: FVA = C{[(1 + r)t − 1] / r} FVA for 20 years = $5,300[(1.108020 − 1) / .1080] FVA for 20 years = $332,560.16 FVA for 40 years = $5,300[(1.108040 − 1) / .1080] FVA for 40 years = $2,918,779.91

Who is responsible for accurate financial reporting of the firm's activities?

controller

The government taxes:

corporate earnings and shareholders dividends

The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the:

cost of capital

Dealer markets

dealers buy and sell for their own accounts and make money on each transaction by buying at the bid and selling at the ask

As long as P < 1

diversification leads to less risk i.e. lower variance of the return on the portfolio.

Some of the cash flows generated by a firm goes back to the financial markets in the form of ______________ and ___________

dividends and debt payments

FV

future value of some amount of money at some future date future value of some amount of money at some future date

The average compound return earned per year over a multi-year period is called the _____ average return.

geometric

the future value of the annuity due is _______ than the future value of the regular annuity

greater

If the variance of a portfolio increases, then the portfolio standard deviation will _________

increase

As cash flow _______, the demand for the stock ________

increase, increase

Which one of the following is an example of systematic risk?

inflation unexpectedly increases by 1.5 percent in the U.S.

r

interest rate or discount rate

Risk

is best measured by how the individual stock return correlates with the market return. To look at this we use the CAPM: Capital Asset Pricing Model - CAPM Relates the return on an individual stock to the Excess Return on the market.

A corporation is a distinct ____________ entity

legal

An investment will have a negative NPV when its expected return is _________________ ________________ what the financial markets offer for the same risk

less than

Businesses are motivated to organize as corporations because stockholders in a corporation have ________________ liability for corporate debts

limited

capital budgeting is concerned with planning and managing a firm's:

long- term investments

Which one of the following categories of securities had the highest average return for the period 1926 - 2013?

long-term corporate bonds (INCORRECT)

You own a portfolio that has $2,650 invested in Stock A and $4,450 invested in Stock B. If the expected returns on these stocks are 8 percent and 11 percent, respectively, what is the expected return on the portfolio?

look in notes Ch 13

Since ownership in a corp. can be dispersed over a huge number of stockholders, it can be argued that __________ effectively controls the firm

management

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

market value of the investment in each stock.

The goal of a for-profit business is to ___________ existing owners' equity.

maximize

Which one of the following correctly describes the dividend yield?

next year's annual dividend divided by today's stock price

Limited Partnership

one or more general partners run the business and have unlimited liability, but the limited partner is liable only for the amount contributed.

Institutions instead of individuals

own the largest percentage of outstanding corporate stock

A limited liability company is taxed like a _____________ and its owners have ______________ liability

partnership; limited

The security market line (SML) shows that the relationship between a security's expected return and its beta is ________.

positive

Partnership

when two or more persons associate to conduct a non-corporate business.

primary markets

where NEWLY issued securities and loans are traded

secondary markets

where PREVIOUSLY issued secures are traded

Present value of a perpetuity

which is a stream of constant cash flows per period forever

Sole Proprietorship disadvantages

• Difficult to obtain large sums of capital • Proprietor has unlimited personal liability for the business's debts, i.e., can get personal assets • Life of the business is limited to the life of the owner

Sole Proprietorship advanatages

• Easily and inexpensively formed • Subject to few government regulations • Business avoids corporate income taxes, which are higher than personal

Managers may want to deviate from maximizing shareholder wealth such as:

• Increase firm size to increase his power and receive higher pay • Buy expensive offices, company cars and jets • Have luxurious expense accounts

How directors are to be elected

➢ All in one year ➢ Staggered - 1/3 or ¼ each year, usually for a three-year term