finance exam 2
non-constant growth
-Dividends have supernormal growth for some period of time, then "slow down" and grow steadily thereafter. -OR dividends grow erratically for a period of time, then grow steadily thereafter.
net present value (NPV)
1. the difference between the investments market value and its cost 2. accept NPV>0; reject NPV<0 3. Pros: 1. uses all cash flows 2. adjusts for the time value of money Cons: 1. need appropriate discount rate 2. relatively more difficult to communicate
internal rate of return (IRR)
1. the interest rate that makes NPV equal to 0 2. accept if IRR>I; reject if IRR<I 3. Pros: 1. closely related to NPV rule 2. relatively easier to communicate Cons: 1. may result in multiple answers 2. may result in incorrect decisions
Discounted payback rule
1. the length of time it takes for the sum of the discounted cash flows to equal the initial investment. 2. accept if payback is in less than the specified amount of years 3. pros: 1. adjusts for the time value of money 2. biased towards liquidity cons: 1. ignores cash flow beyond cut off 2. requires an arbitrary cutoff 3. biased against long term projects
Payback rule
1. the length of time it takes to recover our initial investment 2. accept if payback period is less than specified number of yrs. 3. Pros: 1. easy to do 2. biased toward liquidity cons: 1. ignores the time value of money 2. ignores cash flows beyond cutoff 3. requires a arbitrary cutoff 4. biased against long term projects
profitability index
1.present value of an investment's future cash flows divided by its initial cost 2. accept PI>1; reject PI<1 3. pros: 1. closely related to NPV 2. may be useful when investment funds are limited cons: 1. may result in incorrect decision
S&P 500 stock
2,999
Dow Jones stock
26,802
Amortized loan
A loan in which the principal as well as the interest is payable in monthly or other periodic installments over the term of the loan.
what does CF0= in profitability index?
CF0=0
what does CF0= in NPV
CF0=X
Creditors have legal
Debt
Interest is considered a cost of doing business and is tax deductible
Debt
What can lead to financial distress and bankruptcy?
Debt
Which does not have voting rights?
Debt
Dividends are not a liability of the firm & stockholders have no legal recourse if dividends aren't paid
Equity
Dividends are not considered a cost of doing business and are not tax deductible
Equity
The YTM determines the bond's coupon payments
Which of the following statements about the Yield to Maturity (YTM) is NOT true?
perpituity
a level steam of cash flows which continue forever
annuity
a level stream of cash flows for a fixed period of time
government bonds
always use asked price in calculations
annuity due
an annuity for which the cash flows occur at the beginning of the period
constant growth
dividends increase at a fixed rate (g) each period, paid every period forever
zero growth
do not increase in dollar amount, paid every period forever
No
does preferred stock have any voting rights?
The price of of a share of stock is equal to the present value of stocks?
future cash flows
What has 0% default risk but has IR risk?
government bonds
debenture
has no collateral
Corporate bonds
it is percentage of par
Harrelson Company has a coupon bond outstanding that pays coupon interest of $120 per year and has 10 years to maturity. The face value of the bond is $1000. If the yield for similar bonds is currently 14%, what do you know about the market value/price of the bond?
it is selling at a discount
Which of the bonds has the greatest interest rate risk?
lowest coupon and longest time of maturity
Annuities where the payments occur at the end of each time period are called _____________, whereas _____________ refer to annuity streams with payments occurring at the beginning of each time period
ordinary annuities; annuities due
annual percentage rate (APR)
periodic rate (r) times the number of compoundings per year (m).
The price of a bond is equal to the ______ of the bonds future cash flows
present value
Your broker offers you the opportunity to purchase a bond with coupon payments of $90 per year and a face value of $1000. If the yield to maturity on similar bonds is 8%, this bond should:
sell at premium
What to do if the problem is an annuity due?
shift begin!!! shift end!!!
maturity
specific date on which the principal amount of a bond (i.e., the face value) is repaid
coupon rate
the annual coupon divided by the face value of a bond
face value
the principle amount of a bond that is repaid at the end of the term. also called par value
yield to maturity (YTM)
the rate required in the market on the bond. this will be the "r" we use to calculate price and is quoted as an APR. this is not the same as the coupon rate
interest rate risk
the risk of change in the value of a bond because of a change in the interest rate
coupon
the stated interest payment made on a bond
indenture
the written agreement between the corporation and the lender detailing the terms of the debt issue
effective annual rate (EAR)
which takes into account the effect of compound interest.
What firm cannot go bankrupt?
Equity
Which has an ownership interest?
Equity
