FI 302 exam 1

to find compound interest rate

APR/m

Balance Sheet

represents the set of assets owned by the company and all claims against these assets; states what the company owns at a fixed point in time

net income=

revenues-expenses

real interest rate

reward for waiting

nominal rate= (inflation)

rr + h + (rr * h)

nominal rate= (complex)

rr + h + dp + mp

effective annual rate (EAR)

the rate of interest that the financial institution actually pays or that you earn per year; formula= (1 + APR/m)^m-1

What type of loan makes interest payments throughout the life of the loan and then pays the principal and final interest payment at maturity date?

Interest-only loan

EBIT- taxes - int=

NI

change in retained earnings =

Ni- dividends

You've had a successful career and wish to create an endowed annual scholarship in the amount of $9,000 per year. University officials tell you they can earn an annual interest rate of 7.50% on endowed funds. How much money do you need to give today to endow this scholarship for as long as the university is in existence?

PV perp= PMT/r--> 9000/.0750--> $120,000

perpetuity formula

PV= PMT/rate

The Milk Factory Income Statement Accounts for the year ending December 31, 2016: COGS.... $345,000 Interest Exp.... $79,000 Taxes.... $57,100 Revenue.... $836,000 S&A Exp..... $93,000 Depreciation.... $126,000 What is the company EBIT?

Revenue - S&A - Depreciation - Cogs = $272,000

hybrid corporations

S corps, not for profit, for profit

Which of the below is NOT a major component of interest rates? a. default premiums b. inflation premiums c. historical interest rates d. real rate

c. historical interest rates

net income does not equal

cash flow

A ______ has limited liability, is a legal entity, and has the greatest potential to raise capital.

corporation

net working capital=

current assets-current liabilities

Which of the statements below is TRUE? a. the frequency of bankruptcy for a high-tech up-start firm is lower than for a blue-chip firm, so we see higher borrowing rate for start-ups than for mature firms. b. the frequency of bankruptcy for a high-tech up-start firm is higher than for a blue-chip firm, so we see lower borrowing rate for start-ups than for mature firms. c. the frequency of bankruptcy for a high-tech up-start firm is lower than for a blue-chip firm, so we see lower borrowing rate for start-ups than for mature firms. d. the frequency of bankruptcy for a high-tech up-start from is higher than for a blue-chip firm, so we see higher borrowing rate for start-ups than for mature firms.

d. the frequency of bankruptcy for a high-tech up-start from is higher than for a blue-chip firm, so we see higher borrowing rate for start-ups than for mature firms.

If you borrow $100,000 at an annual rate of 8% for a 10 year period and repay the total amount of principal and interest due of $215,892.50 at the end of the 10 years, what type of loan did you have?

discount loan

an annuity due

equal payments at the BEG of each regular interval; ex. prepayments such as insurance and rent

an ordinary annuity

equal payments at the END of each regular interval; ex. mortgage payments, car loans, bond coupon

The organized financial intermediaries and the forums that promote the cycle of money is a good definition of which of the following main areas of finance?

financial institutions and markets

How do we solve the agent problem?

hire auditors, provide bonus incentives, stock options

Your part supplier gives you 0.75 of a year to pay for parts your ordered today, or offers you a discount if you pay cash at purchase. You have just purchase $68.400 worth of parts from your supplier and the discount is at an annual rate of 8.9%. How much will you pay for the parts if you pay today?

n= 0.75, I= 8.9, PMT= 0, FV= 68,400, PV= ? --> $64, 163

You are considering the purchase of an industrial printer for your business. the salesman states that you can purchase the pinter today for $50,000 or pay nothing today and make monthly installment payments of $704 for 9 years. Your company's current financing rate is 8% annually. What is the PV of the monthly payment plan and which payment option should you choose?

n= 108 (9*12), I= .67 (8/12), PMT= -704, FV= 0, PV= ?--> 54,076.17 Pay whichever one is lower $54,071, so you should choose to pay the full price today

A financial manager...

oversees all the company's financial activities, such as determining the best repayment structure for borrowed funds and that debt is repaid in a timely fashion

A never-ending stream of equal periodic payments, end-of-the-period cash flows is called a....

perpetuity

yield curve

a graphic depiction of the term structure of interest rates

Assets

things of economic value that the company owns; can be physical, financial, or intellectual; also includes cash

objective of the financial manager is...

to increase company cash flow and maximize company stock price

Equity

what owners reserve after liabilities are fulfilled; equity investments in company

You decide to start saving for retirement by depositing $6000 into an account every year for the next 12 years. If the account earns 2.20% return annually, how much more will be in the account 12 years from now if you made the first deposit today as opposed to the end of the year?

$1790

You've had a successful career and wish to create an endowed annual scholarship in the amount of $8,000 per year. University official tell you they can earn an annual interest rate of 4% on endowed funds. How much money for you need to give today to endow this scholarship for as long as the university is in existence?

$200,000

Kim decides early in her career that she wishes to save aggressively for retirement. Kim chooses to put away $6825 of earnings at the end of each year for 20 years. How much money will be in Kim's retirement account in 20 years if her investment earns an annual rate of 8.4%

$326,514

The 17th national bank of Tuscaloosa offers a 3-year line of credit in the amount of $45000. The account carries a 14% APR with quarterly compounding. At the end of 1 year, how much interest have you paid and what is the banks effective annual rate?

$6,639; 14.75%

Samuel's dad is looking to deposit a sum of money immediately into an account that pays an annual interest rate of 9% so that his first-year college tuition costs are provided for. Currently the average tuition cost is $16,000 and is expected to increase by 3% per year (the average inflation rate). Samuel just turned 4 and is expected to start college when he turns 18. How much money will Samuel's dad have to deposit into the account?

$7,242

You are considering the purchase of an industrial printer for your business. The salesman states that you can purchase the printer today for $85,000 or pay nothing today and make monthly installment payment of $1,368 for 7 years. Your company's current financing rate is 7% annually. What is the present value of the monthly payment plan and which payment options should you choose?

$90,639, so you should choose to pay the full price today

If you borrow $23,570 at an annual rate of interest of 6.7% for 6 years, what is the annual payment (prior to maturity) on a fully amortized loan?

($4,328)

corporation

- a separate legal entity owned by stockholders - can enter into contracts, get sued, pay taxes - limited liability - double taxation - heavy government regulation

partnership

- business owned jointly by 2 or more people - agreement spells out % owned - profits only distributed to owners - general partnership also flows through to indviduals

sole proprietorships

- businesses owned and operated by one individual; the most common form of business organization in the United States - person does business under own name - least regulated - owner makes all decisions and all profits - pays and bears all debts

Definition of Finance

- helps people/businesses decided when to buy and sell, and what to buy and sell - broader than just money and investing - the art of science and managing wealth

default premium (dp)

- is the portion of a borrowing rate that compensates the lender for the higher risk associated with varying types of collateral and the probability that a borrower will default. - assets that increase in value over time have a lower dp - high frequency, higher dp

income statement

- measure a company performance over a specific period of time summarizes revenues and expenses - typically prepared quarterly and annually externally; monthly internally - bottom line is net income - statement begins with revenues and subtracts expenses until arriving at earning before interest and taxes (EBIT)

maturity premium (mp)

- represents that portion of the nominal interest rate that compensates the investor for the additional waiting time or lender for additional holding time. - the longer the period the greater the reward

what are rates of return?

- return on your forgone consumption - cumulative, periodic, arithmetic, and geometric

The cycle of money

- the movement of money from lender to borrower and back again - the bank is a financial intermediary or middleman - goal is to make everyone better off

Agency theory and costs

- the process surrounding recognition of principal-agent problems and ways to align the actions of agents with the interests of the principals - costs to create a better relationship

Why does money have time value?

-Inflation, depreciating real assets, investment opportunity -There is a utility cost of forgoing consumption today and you must be compensated for the disutility -the rate of return/ interest rate/ discount rate captures this tradeoff

**The 17th national bank of Tuscaloosa offers a 3 year line credit in the amount of $27,000. the account carries a 6% APR and monthly compounding. At the end of year 1, how much interest have you paid and what is the banks effective annual rate?

1) Find EAR: (1 + (APR/m))^(m)-1--> (1 + (.06/12))^(12) - 1--> 6.17% 2) interest rate after 1 year is--> 27000(.0617)= 1448 $1,448, 6.17%

Suppose you buy a home and borrow $197,000 using a 30 year mortgage with an annual interest rate of 5.10% compounded monthly. You recall your FI 302 professor talking about how increasing your monthly payment can save you both time and money. You decided to pay 10% more each month than what the bank suggests your payment should be. Given this, in how many years will you pay off the loan?

1) determine what your monthly payment should be: n= 360 (30*12), I= .425 (5.10/12), FV= 0, PV= 197,000, PMT= ?--> 1,069.61 2) increase PMT by 10%: 1176.57 3) enter new payment into annuity and solve for n: n= ?, I= .425, PV= 197,000, PMT= -1176.57, FV=0--> n= 293.19 3) divide by months--> 293.19/12= 24.5 24.5

You would like to buy a car but you must complete a 4 year commitment to the peace corps before you can drive the new car. The current price of the car you want to buy is $19,000 and the dealer expects the price of a similar new car to be $23,750 in 4 years. If you can earn an annual interest rate of 10% on your money, should you buy the car now or wait until you return? why?

1) find the PV of the price of the car in 4 years--> n=4, I= 10, PMT= 0, FV= 23,750, PV= ?--> 16221.57 2) find the FV of the price now in 4 years if you invested it--> n= 4, I= 10, PMT= 0, FV= ?, PV= 19000--> 27,817.90 You can invest the money now and make more than the price of the car in 4 years *If the price in x years is less than the current price, you should wait to buy the car.* Buy when you return, because you could earn more money investing the price of the car today

Samuels dad is looking to deposit a sum of money immediately into an account that pays an annual interest rate of 9% so that his first-year college tuition costs are provided for. Currently, the average college tuition cost is $12,000 and is expected to increase by 3% per year (the average inflation rate). Samuel just turned 3 and is expected to start college at age 18. How much money will Samuel's dad have to deposit into the account?

1) find the cost of Samuels tuition in the future: n= 15, I= 3 (inflation), PV= 12000, PMT= 0, FV= ?--> 18,695.61 2) Find the deposit needed today (PV) to meet the future cost above: n= 15, I= 9 (interest rate), PV= ?, PMT= 0, FV= 18695.61 --> PV= 5132.65 $5,133

Which of the following investments has a larger Future Value: A $100 investment earning 10% per year for 5 years or a $100 investment earning 5% per year for 10 Years?

1) n= 5, I= 10, PV= 100, PMT=0, FV= ? 2) n= 10, I= 5, PV= 100, PMT= 0, FV= ? An investment of $100 at 5% per year for 10 years because it has an FV of $162.89

why does net income not equal cash flow?

1. accrual accounting 2. noncash expenses 3. interest expense

3 categories of financial management

1. capital budgeting--> planning, comparing, and selecting projects; What business should we be in over the long term? 2. capital structure--> means by which a company finances its business activities; Where do we raise the money to conduct our business activities? 3. working capital management--> process of day to day operating needs; How will we manage our day to day needs?

5 principal balance sheet accounts

1. cash account--> current asset; cash and equivalents 2. working capital account--> current assets and liabilities of a company 3. long term capital assets accounts--> capital investments (shelf life > 1 yr) PPE, buildings, machinery, etc. 4. long term capital liabilities accounts--> capitals debts longer than 1 yr; NP, AP, BP 5. ownership accounts--> equity; remaining value after liabilities satisfied

4 financial areas

1. corporate finance--> borrowing funds to support the expansion of products or plants 2. investments--> buying and selling of real and financial assets 3. financial institutions and forums--> organized intermediaries that support the cycle of money; stock market, banks, etc. 4. international finance--> deals with multinational aspect of finance activities

When you borrow money, there are three different ways to repay...

1. discount loan--> principal and interest paid at once on maturity date; use formula FV= PV * (1 + r)^n 2. interest only loan--> interest paid yearly and principal paid on maturity date; find interest P * rate 3. amortized loans--> principal and interest amortized over life of loan; use PMT function

what do sole proprietorships and partnerships have in common?

1. unlimited liability of the owners 2. limited life of the business 3. potential difficulty in transferring ownership of business

A furniture store has a sofa on sale for $1500 with the payment due one year from today. the store is willing to discount the price at an annual rate of 6.8% if you pay today. What is the amount if you pay today?

1500 * .062= 102; 1500-102= $1,398

Suppose you buy a home and borrow $139,000 using a 30 years mortgage with an annual interest rate of 4.20% (compounded monthly). You recall your FI 302 professor talking about how increasing your monthly payment can save you both time and money. You decided to pay 10% more each month than what the book suggests your payment should be. Given this, in how many years will you pay off the loan?

25.1

Kelvin has $2500 but needs $5000 to purchase a new golf cart. If he can invest his money at a rate of 12% per year, approximately how many years will it take the money in his account to grow to $5000? Use the rules of 72 to determine your answer. Note: The golf carts price may have changed by the time his account reaches the value of $5000

72/12--> 6 years

Financial markets can be classified by which of the following?

All of the above can be classifications of financial markets; maturity of the financial asset, type of asset traded, and owner of the financial asset

What type of loan requires both principal and interest payments as you go by making equal payments each period?

Amortized loan

What is the Accounting Identity?

Assets= Liabilities + Owners Equity

You would like to buy a car but must complete a 2 year commitment to the Peace Corp before you can drive the new car. The current price of the car you want to buy is $25,000 and the dealer expects the price of a similar new care to be $31,250 in 2 years. If you can earn an annual interest rate of 5% on your money, should you buy the car now or wait until you return? Why?

Buy now, because the annual price increase of the car is higher than your interest rate

____________ is the area of finance concerned with activities such as borrowing funds to finance projects such as plant expansions or new product launches.

Corporate finance

annual percentage rate (APR)

Cost of borrowing money on an annual basis

EBIT + depreciation - taxes=

EBIT

revenue - operating expenses=

EBIT

You decide to start saving for retirement by depositing $6000 into an account every year for the next 17 years. If the account earns 2.50% return annually, how much more will been the account 17 years from now if you made the first deposit today as opposed to the end of the year?

END: n= 17, I=2.50, PV= 0, PMT= 6000, FV=? --> FV= 125,188.38 BEG: n=17, I= 2.50, PV= 0, PMT= 6000, FV=? --> FV= 128,318.09 Difference= 3,129.71

T/F: Reducing principal at a faster pace increases the overall interest paid on a loan

F

Elizabeth is seeking to expand her rare coin collection. Each year, rare coins increase in price at a 3% rate. She believes that if she invests her money for one year, she should be able to buy 26 coins for what 25 coins would cost today. What is her real interest rate or reward for waiting?

FV= 26, PV= 25, n=1, PMT=0, I= ?--> 4%

You make a $24 million investment grow to $62.8 in 10 years (annual compounding). Which statement about the rate of return is most accurate?

Holding period return: W end - W beg / W beg --> 62.8-24/24 = 1.61666 or 161.6% geometric average: Nth root of W end/ W beg - 1--> 10th root of 62.8/24 -1 --> 10% the geometric average annual rate of return is 10.1%

T/F: Monthly interest on a loan is equal to the beginning balance times the periodic interest rate.

T

T/F: Reducing principal at a faster pace reduces the overall interest paid on the loan

T

T/F: The more frequent the payment, the lower the Toal interest expense over the life of the loan, even though the effective rate is higher

T

Congratulations, you've just won the $2,800,000 state lottery! The lottery commission offers you the choice of $127,000 per year for 25 years or a one-time, lump-sum payment of $1,456,000. If your intentions are to save all of the lottery winnings (regardless of annual cash flow or lump-sum) for retirement in an account that earns 14% annually, which payment option would you choose>

Take the lump-sum payment now because the PV of the annuity is less than the lump sum payment

What is an agency issue?

The owners of the business (principals) want the company managers to act in the owners best interests and maximize current stock price. The managers (agents) are hired to satisfy these requests. A natural conflict arises because the agents cannot maximize their benefits without reducing the wealth of the company. Issue of motivating one party to act in the best interest of another party call the principal agent problem.

Congratulations, you've just won the $1,500,000 state lottery. the lottery commission offers you the choice of $68,000 per year for 25 years or a one-time, lump-sum payment of $645,000 if your intensions are to save all of the lottery winnings (regardless of annual cash flow or lump sum) for retirement in an account that earns 11% annually which payment option should you choose?

You want to make a decision in today's dollars. 1) find the PV of the annuity stream: n= 25, I= 11, PMT= 68000, FV= 0, PV= ?--> 572,678.64 If the PV of the annuity is less than the lumps payment, you choose the lump sum. Take the lump-sim payment now because the present value of the annuity is less than the lump-sum payment.

the rule of 72?

a quick formula for computing how long it will take to double money invested at a given interest rate or what rate it will take to double your money in a given time period

risk free rate

a theoretical interest rate at which an investor is guaranteed to earn the subscribed rate and at which the borrower will never default

liabilities

amounts of money that a company owes to others such as payroll, taxes, and money borrowed through loans and debt

annuity

an annuity is a series of equal cash flows at regular intervals across time

Which of the following is NOT an example of ordinary annuity cash flows? a. mortgage payments due at the end of the period b. Insurance payments due at the start of the period c. Car loans due at the end of the period d. All of the example above are ordinary annuity cash flows

b. Insurance payments due at the start of the period (this would be an annuity due)

In exactly 12 years your student loan bill of $30,400 is due. Today you receive a signing bonus from your employer of $36,480 and choose to deposit some of that bonus such that if the account earns 9.40% per year (compounded annually), the student loan bill is perfectly financed. How much do you deposit?

n= 12, I= 9.40, PV= ?, PMT= 0, FV= 30400--> PV= 10,343

Kim decides early in her career that she wishes to save aggressively for retirement. Kim chooses to put away $8,400 of earnings at the end of each year for 20 years. How much money will be in Kim's retirement account in 20 years if the account earns an annual rate of 8.2%?

n= 20, I= 8.2, PV= 0, PMT= 8400, FV= ?--> FV= $393,023

You have saved up $3,000 this year and are shopping online savings accounts to see where you will deposit your money. You're hoping that in 3 years, the account will have a balance of $4,980. When looking at different online savings accounts, what interest rate do you need to achieve your savings goal assuming you make no other deposits in the account?

n= 3, I= ?, PV= 3000, PMT= 0, FV= -4980--> I= 18.40%

A $1100 deposit today that earns an annual interest rate of 8% is worth how much at the end of 3 years? Assume all interest received at the end of each year is reinvested the next year.

n= 3, I=8, PV= 1100, PMT= 0, FV= ? --> $1,386

If you borrow $14,610 at an annual rate of interest of 8% for 8 years, what is the annual payment (prior to maturity) on a fully amortized loan?

n= 8, I=8, PV= -14610, PMT= ?, FV= 0--> PMT= ($2,542)

You currently have $8000 invested at an annual rate of 15%. How long will it take this investment to grow to a value of $12,000?

n= ?, I= 15, PV= 8000, PMT= 0, FV= -12,000--> n= 2.90

real interest rate=

nominal interest rate - inflation rate

net income is...

not cash flow

Net income + depreciation + interest expense =

operating cash flow

The sale of "new securities, where the financial asset is being traded for the very first time, is said to take place in the ______ market.

primary

nominal rate=

real rate + inflation rate

perpetuity

the longest possible period for an annuity is forever; we call this never-ending stream of cash a perpetuity; ex. government bonds and endowments

nominal rate

the precent change in actual dollars that you receive on your investment