fin 310 final exam

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Chapter 11 example problem Stock Y has a beta of 1.30 and an expected return of 13%. If the risk-free rate is 4.5% and the market risk premium is 7%, is this stock undervalued, correctly priced, or overvalued? Briefly explain or show why.

CAPM indicates that, given Stock Y's level of risk, its expected return should be E[rY] = rF + βY * MRP = .045 + 1.30*(.07) = .1360 or 13.60% Comparing that to actual 13% expected return on Stock Y, the actual expected return is too low given its risk. Stock Y plots below the SML and is overvalued. In other words, its price must decrease now so that its future expected return will increase to 13.60%. Alternatively, compare Stock Y's reward-to-risk ratio to the SML slope. The reward-to-risk ratio for any asset is its risk premium divided by its beta: (E[ri] - rF) / βi For Stock Y, the reward-to-risk ratio for Y = (.13 - .045) / 1.30 = .0654 We know the market has βM =1, so the reward-to-risk ratio for the market is (.07) / 1 = .07 Since all assets must have the same reward-to-risk ratio, the reward-to-risk ratio for Stock Y is too low, which means the stock plots below the SML is overvalued. Its current price must decrease until its reward-to-risk ratio is equal to the market reward-to-risk ratio.

Chapter 12 equations

CAPM: E = rF + βE * RPM he total market value of the firm's financial claims: V = D + Pfd + E WACC= D/V (1- TC) rd+ Pfd/V rPFD+ E/V rE

Chapter 18 example problem Switzerland Franc 0.8729 1.1456 Singapore Dollar 0.6613 1.5122 How many Swiss francs can you get for a Singapore dollar? Show your calculation.

CROSS MULTIPLY The cross rate is (1.1456 Swiss Francs per US$) * (US$0.6613 per Singapore dollar) Or 1 / [(0.8729 US$ per Swiss Franc) * (1.5122 Singapore dollar per US$)] = 0.7576 Swiss Francs per Singapore Dollar

Chapter 12 example problem Estimate the existing weighted average cost of capital using this information for a company with a 35% marginal tax rate - Existing bonds with $300m face outstanding mature in 13 years, with an 8% coupon rate paid semiannually, rated A1 by Moody's, with a current quoted yield of 5% per year, and trading for 128.426% of face value. - 3m preferred shares each pay a $6 annual dividend and have a current market price of $96. - 10m common shares with a current market price of $60. Each paid $3 dividend last year, which is expected to grow at a stable rate of 4% forever. Also, this company's beta is 0.9. The current risk-free rate is 2%, the equity market's risk premium is expected to be 6%. (For this problem, round aggregate capital values to millions of dollars.) The quoted bond yield of 5% could be used to confirm that the bond price is:

B= C/M / Y/M [1- 2/(1+Y/M)^MT]+ face/ ((1+Y/M)^MT= 8/2 / 0.05/2) [1- 1/(1+.05/2) ^2*13] +100/(1+.05/2)^2*13= 128.426 n = 2*13 = 26, i = 5/2 = 2.5, PMT = 8/2 = 4, FV = 100 PV = -128.426 Since the bonds are high investment grade with low default risk, their required return is the yield. The total market value of debt is $300m (128.426%) = $385m Investors' required return on the preferred stock is rPfd = $6 / $96 = 6.25% The current market value of preferred is 3m * $96 = $288m Using the divided discount model, investors' required return on the common shares is rE = D0 (1+g) / P0 + g = 3 (1+.04) / $60 + .04 = 9.2% Using the CAPM, investors' required return on the common shares is: rE = rF + βE * MRP = 2% + 0.9 * 6% = 7.4% Use the average of these to estimate the cost of equity at 8.3% The market value of the common shares is 10m * $60 = $600m The total market value of the firm's financial claims is: V = D + Pfd + E = $385m + $288m + $600m = $1,273m Using all these components, estimate the WACC: WACC = 385/1273*(1-.35)*5% + 288/1273*6.25% + 600/1273 * 8.3% = 6.31%

Chapter 6 example problem Q6. P16D Bond RTY.AF has a 4 percent coupon, makes semiannual payments, currently has 20 years remaining to maturity, and is currently priced at par value. If interest rates suddenly rise by 2 percent to 6 percent, what is the percentage change in the price of Bond RTY.AF? Does it increase or decrease?

Bond RTY.AF has a 4 percent coupon, makes semiannual payments, currently has 20 years remaining to maturity, and is currently priced at par value. If interest rates suddenly rise by 2 percent to 6 percent, what is the percentage change in the price of Bond RTY.AF? Does it increase or decrease?Since the coupons are paid semiannually, the number of payments per year is m=2. Any bond that sells at par has a yield to maturity equal to the coupon rate, so the initial YTM on Bond RTY.AF is the coupon rate of 4%, and its price per $1,000 face value is at par: If the YTM suddenly rises to 6%, solve for the new bond price: n = m*T, i = y/m, PMT = C/m, FV = Facen = 40 i = 3% PMT = $20 FV = $1000 PV = -$768.85 The percentage change in Bond RTY.AF's price is (New price - Original price) / Original price = (768.85 - 1000) / 1000 = -23.1%.Bond RTY.AF will drop in price by a whopping 23.1% if its yield rises by 2%.The reason that this price change would be so large is primarily because of its long maturity, along with its relatively small coupons.

Lisa has $1,000 in cash today. Which one of the following investment options will come closest to doubling her money?

C. 8 percent interest for 9 years

Which of the following statements is FALSE? A. The yield to maturity is a bond's rate of return that is required by the market place. B. When a bond's yield to maturity is less than a bond's coupon rate, the bond is selling at a premium. C. A convertible bond initially sells at a deep discount and pays no interest payments. D. The invoice amount that an investor actually pays to purchase an outstanding bond is not its 'clean' quoted price.

C. A convertible bond initially sells at a deep discount and pays no interest payments

Which of the following statements is FALSE? A. A stock split is an increase in a firm's shares outstanding without any change in owners' equity. B. A reverse split is a stock split under which a firm's number of shares outstanding is reduced. C. A stock buyback refers to the purchase of the firm's shares of stock by the firm's debt holders. D. A stock dividend is a payment in the form of stock made by a firm to its owners, diluting the value of each share outstanding.

C. A stock buyback refers to the purchase of the firm's shares of stock by the firm's debt holders.

Which of the following statements is TRUE?A. All secondary markets are dealer markets. B. All secondary markets are broker markets. C. All stock trades between existing shareholders are secondary market transactions. D. All stock transactions are secondary market transactions.

C. All stock trades between existing shareholders are secondary market transactions.

Which of the following statements is FALSE? A. With simple interest, the interest is not reinvested, so interest is earned each period only on the original principal. B. Both lenders and investors prefer more compounding. C. Amortizing a loan allows for a portion of principal to be paid with the interest each period principal so that the actual payments to interest will increase with each payment. D. Treasury Bills are pure discount loans sold by the US government that repay a fixed amount as one lump sum at some time in the future.

C. Amortizing a loan allows for a portion of principal to be paid with the interest each period principal so that the actual payments to interest will increase with each payment.

Which of the following statements is FALSE about initial public offerings? A. IPOs are often underwritten by a syndicate of investment banks for a 7% spread on average B. IPOs must be registered with the SEC, which costs about 3% in accounting and legal fees C. An IPO's exact price is published in a red-herring two weeks before selling begins D. IPOs are underpriced on average by about 19%

C. An IPO's exact price is published in a red-herring two weeks before selling begins

Managers should act in shareholders' interests because shareholders have ___________ priority in receiving their claims.

C. Bottom

Which of the following statements is TRUE? A. In a sole proprietorship, the owner has limited liability and full control. B. In a partnership, ownership can be transferred quickly, and capital can be raised easily. C. Corporations face double taxation, meaning the corporation pays taxes on income before dividends, while the owners pay personal taxes on dividends and capital gains. D. Intended to improve public disclosures, the Sarbanes-Oxley Act has likely increased the number of small companies going public in the USA.

C. Corporations face double taxation, meaning the corporation pays taxes on income before dividends, while the owners pay personal taxes on dividends and capital gains.

Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected?

C. Default risk premium

Which of the following statements is FALSE? A. While the book value of equity can be negative, the market value of equity cannot be negative. B. Market values are the prices at which assets, liabilities, and equities can be bought or sold for now. C. EBIT is the 'bottom line.' D. Average Tax Rates are less useful for making financial decisions than Marginal Tax Rates.

C. EBIT is the 'bottom line.'

Which of the following statements is TRUE? A. Efficient markets will protect investors from wrong choices if they do not diversify. B. Consistent with efficient markets, stock prices reach equilibrium several times per week. C. Efficient markets react to new information by instantly adjusting the price of a stock to its new fair market value without any delay or overreaction. D. Weak form efficiency implies that all information is reflected in stock prices.

C. Efficient markets react to new information by instantly adjusting the price of a stock to its new fair market value without any delay or overreaction.

Which of the following statements is FALSE? A. Firms seek to manage their cash by keeping no more than is needed on hand, because holding cash has an opportunity cost, namely, the returns that could be earned by investing the money. B. The optimal credit policy for a firm depends on many specific factors, but generally involves trading off the cost of granting credit, such as the carrying costs of receivables and the possibility of non-payment, against the benefits in terms of increased sales. C. In the five Cs of credit, capacity refers to the customer's willingness to meet credit obligations out of operating cash flows. D. In the five Cs of credit, collateral are the assets pledged by the customer for security in case of default.

C. In the five Cs of credit, capacity refers to the customer's willingness to meet credit obligations out of operating cash flows.

Which of the following statements is FALSE? A. The bid price is the price that a dealer is willing to pay for a security and is lower than the ask price. B. Bonds trade less frequently than stocks. C. In the stock market, the secondary market is the market where new securities are originally sold to investors by the issuing company. D. Dividends received by corporations have a 70% to 100% exclusion from taxable income

C. In the stock market, the secondary market is the market where new securities are originally sold to investors by the issuing company.

Which of the following statements is FALSE? A. Increasing long-term debt, or borrowing over the long term, increases cash. B. Decreasing current assets other than cash, such as collecting accounts receivable, is considered a source of cash. C. Increasing current liabilities, such as getting a 90-day loan, will decrease cash. D. Increasing current assets other than cash, such as extending more credit to customers, is considered a use of cash.

C. Increasing current liabilities, such as getting a 90-day loan, will decrease cash.

Which of the following statements is TRUE? A. Opportunity costs are those values that have already been incurred, cannot be recouped, and should not be considered in an investment decision. B. Under hard capital rationing, a business enforces limits on investment budgets because it prefers not to raise financing from the capital markets. C. Managerial real options can be very valuable but difficult to measure, and ignoring them will underestimate a project's true Net Present Value. D. Forecasting risk is more troublesome when NPV estimates are particularly large.

C. Managerial real options can be very valuable but difficult to measure, and ignoring them will underestimate a project's true Net Present Value.

Research conducted on firms' dividend policies over time support which one of the following conclusions?

C. Managers tend to smooth dividends.

If any, which of the following statements is FALSE? A. NPV measures the value created by taking on an investment B. NPV indicates how much a project will improve owner wealth C. NPV is the discounted present value of a project's expected future accounting net income at the required return, subtracting the initial investment D. None of the above statements is false

C. NPV is the discounted present value of a project's expected future accounting net income at the required return, subtracting the initial investment

BNM is comparing different capital structures. Plan A is all equity with 20m (million) shares outstanding. Plan B would result in 14m shares and $150m in debt. Plan C would result in 11m shares and $225m in debt. The interest rate on the debt is 8 percent. Ignoring taxes, compare these plans assuming that expected EBIT is $45m. Of the three plans, the firm will have the highest expected EPS with _____ and the lowest expected EPS with _____.

C. Plan C; Plan A Leverage increases expected EPS and ROE (but increases their riskiness too) Expected EPS(All-equity Plan A) = $45m/20m = $2.25 Expected EPS(Plan B) = [$45m - ($150m × 0.08)/14m = $2.36 Expected EPS(Plan C) = [$45m - ($225m × 0.08)]/11m = $2.45

Which of the following is NOT an advantage to the corporate form of organization?

C. Profits taxed at the corporate level

Which one of the following situations is most apt to create an agency conflict?

C. Rejecting a profitable project to protect employee jobs

Which of the following statements is TRUE? a. European options are options that may be exercised at any time until its expiration date. American options, however, are options that may be exercised only on the expiration date. B. A call option is the right to sell an asset at a fixed price during a particular period of time, while a put option is the right to buy an asset at a fixed price during a particular period of time. C. Stock options traded on exchanges are a zero-sum game, meaning that whatever the buyer of a stock option makes, the writer or seller loses, and vice versa. D. Sometimes an option can be worth less than zero.

C. Stock options traded on exchanges are a zero-sum game, meaning that whatever the buyer of a stock option makes, the writer or seller loses, and vice versa.

Which of the following statements is FALSE? A. Legal bankruptcy occurs when the firm or creditors bring petitions to a federal court for bankruptcy. B. Bankruptcy refers to the legal proceeding for liquidating or reorganizing a business. C. Technical insolvency occurs when a firm has a negative net worth, because the book value of its liabilities are less than the book value of its assets. D. Liquidation is the termination of the firm as a going concern, whereas reorganization is the financial restructuring of a struggling firm to attempt to continue operations as a going concern.

C. Technical insolvency occurs when a firm has a negative net worth, because the book value of its liabilities are less than the book value of its assets.

Which of the following statements is FALSE? A. The book value of equity rarely equals the market value of equity except when the market-to-book ratio is 1.0. B. The book value of equity is the residual difference between assets and liabilities. C. The book value of equity increases when a company pays dividends. D. The ultimate goal of financial managers is to maximize the current market value of the company's existing equity.

C. The book value of equity increases when a company pays dividends.

Cash dividends send which of the following signals to the market?

C. The firm is currently, and expects to continue to be, profitable

Under Munich, a footwear manufacturer, recently announced that they have just designed a new footwear product which includes the latest technology. This news is totally unexpected and viewed as a major advancement in the footwear industry. Which one of the following reactions to this announcement indicates the market for New Labs stock is efficient?

C. The price of Under Munich's stock suddenly increases, and then remains at that price.

Suppose you could buy 1,320 South Korea won or 78 Pakistan rupees last year for $1. Today, $1 will buy you 1,318 won or 80 rupees. Which one of the following occurred over the past year?

C. The rupee depreciated against the dollar.

Fill in the blanks: Standard deviation measures ______ risk, while beta measures ______ risk.

C. Total; market-wide

Which of the following statements is FALSE? A. Since errors of commission are often readily apparent, managers have a tendency to be cautious when evaluating new projects B. Errors of omission can result in lost potential value as much as errors of commission can destroy value C. Type 1 errors occur when managers reject projects whose true NPVs are positive D. Errors in projected cash flows create large forecasting risks when their net present values are particularly small in magnitude.

C. Type 1 errors occur when managers reject projects whose true NPVs are positive

Which of the following statements is TRUE? A. Bankruptcy occurs whenever a firm is unable to meet obligations or reports negative book equity. B. A Chapter 7 bankruptcy allows a firm to reorganize and continue operations as "debtor-in-possession." C. Under bankruptcy, trade creditors have lower priority than secured bank loans. D. Financial distress and bankruptcy costs cause WACC to decrease as leverage increases.C.

C. Under bankruptcy, trade creditors have lower priority than secured bank loans.

When is a firm insolvent from an accounting perspective?

C. When the firm has a negative net worth

Which of the following statements is TRUE?A. Bank loans, private placements to funds and insurance companies, and investment bank transactions are all activities in the secondary markets. B. Like general partners, the owners of a corporation have unlimited liability for business debts. C. While maximizing stockholder wealth is the relevant goal of the corporation, sometimes management goals are pursued at the expense of the stockholders. D. The Sarbanes-Oxley Act of 2002 dramatically streamlined American corporate regulations resulting in billions of dollars in overall savings.

C. While maximizing stockholder wealth is the relevant goal of the corporation, sometimes management goals are pursued at the expense of the stockholders.

Fill in the blanks: Stock prices fall if investors either expect _________ growth rates or require _________ returns.

C. lower, higher

Chapter 11 example problem Stock J has a volatility of 50%, a beta of 0.90, and an expected return of 8%. If the risk-free rate is 2% and the market risk premium is 6%, is this stock undervalued, correctly priced, or overvalued? Briefly explain why.

CAPM indicates that, given Stock J's level of market risk (volatility is irrelevant since much of it can be diversified away), its expected return should be E[rJ] = rF + βJ * MRP = 2% + 0.90*6% = 7.4% Comparing that to the actual 8% expected return on Stock J, the actual expected return is too high given its risk. Stock J plots above the SML and is undervalued. In other words, its price must increase now so that its future expected return will drop to 7.4%. Alternatively, compare Stock J's reward-to-risk ratio to the SML slope. The reward-to-risk ratio for any asset is its risk premium divided by its beta: (E[ri] - rF) / βi For Stock J, the reward-to-risk ratio for J = (.08 - .02) / 0.90 = .0667 We know the market has βM =1, so the reward-to-risk ratio for the market is (.06) / 1 = .06 Since all assets must have the same reward-to-risk ratio, the reward-to-risk ratio for Stock J is too high, which means the stock plots above the SML and is undervalued. Its current price must increase until its reward-to-risk ratio is equal to the market reward-to-risk ratio.

which of the following statements is false? a. the book value of equity is the residual difference between assets and libiliities b. the book value of equity increase when a company pays dividends c. the ultimate goal of financial managers its ti maximize the current market value of the company existing equity d. the book value of equity rarely equals the market value of equity expect when the market to book ratio is 1.0

b. the book value of equity increases when a company pays dividends all other statements are true

which of the following is TRUE about bonds?

both premium and discount bonds tend to converge to face value maturity

firms that compile finance statements according to GAAP:

can still manipulate their earnings to some degree

which of the following is NOT an effective mean of aligning management goals with shareholders interests?

compensating managers with salaries significantly hiring than their peers.

which one of the following is most apt to align management's priorities with shareholders' interests?

compensating managers with shares of stock that must be held for 3 years before the shares can be sold

rank the stakeholders by priority: suppliers, owners, government, creditors, customers, and employees

customers are first

of the stakeholders, the ___ have the highest priority, while ___ have the lowest priority

customers, shareholders

which of the following will decrease the value of a call?

c. less time to expiration as days pass

which of the following is false?

c. the cost of capital for a project depends primarily on the source of funds all other statements are true

which of the following transactions would NOT take place in a primary finical market

c. when a mutual fund security buys NYSE

Chapter 6 example problem If the following quotes are on September 15, 2012, what is the coupon rate for the JD.VR bonds with $1,000 face values and semiannual payments? Show and/or explain your work. Company (Ticker): Jim Doe (JD.VR) Coupon: ? Maturity: Sep 15, 2038 Last Price: 113.478 Last Yield: 5.29 $ Vol. (000s): 1,195

In dollars, the quoted price is 113.478% * $1,000 = $1,134.78 Find the coupon $C that solves B= CM/ YM [1-1/(1+Y/M)^mt] + face/[1-1/(1+Y/M)^mt] C= (B- face/[1-1/(1+Y/M)^mt)/ [1-1/(1+Y/M)^mt] * (ym)*m= (1,134.78- 1,000/(1+5.29%/2)^2*26)/[1- 1/(1+.0529%/2)^52]* (.0529)*2= $62.50 The coupon rate per face value is c = $62.50 / $1,000 = 6.25% per year, semiannually compoundedOr, n = 2*26, i = 5.29/2, PV = $1,134.78, FV = -$1,000 n = 52, i = 2.645, PV = $1,134.78, FV = -$1,000 to the PMT = -$31.25 per half-yearSo the coupon rate per year, semiannually compounded, is c = $31.25 * 2 / $1,000 = 6.25%Note that since this bond's price is at a premium, its coupon rate exceeds its yield.

Chapter 6 example problem A corporate bond pays 7.50 percent interest. A muni bond pays 5.25 percent interest. You are in the 40 percent income tax bracket. Which bond would give you a higher after-tax return? Discuss briefly.

Income from corporate bond investments is taxable while income from muni bonds is not. Your after-tax yield on the corporate bond is effectively 7.50% * (1 - 0.40) = 4.50%. Your after-tax yield on the muni bond is 5.25%. So, the muni bond gives you a higher after-tax return. An investor with tax rate t would get the same after-tax return from either bond: 7.50% * (1 - t) = 5.25%.t = 1 - 5.25% / 7.50% = 30% Investors with tax rates lower than 30% would earn higher after-tax returns on the corporate bond than on the muni bond.

Chapter 16 equations

Inventory turnover = COGS/Average inventory Inventory period=365 days/Inventory turnover Receivables turnover = Sales/Average receivables Receivables period = 365 days/Receivables turnover The operating cycle is the inventory period plus the receivables period. Payables turnover = COGS/Average payables Payables period = 365 days/Payables turnover The cash cycle is the operating cycle minus the payables period. Cash Cycle = Inventory Period + Receivables Period - Payables Period

Chapter 16 example problem *Pull up the Chart from the Document* Consider the following financial statement information for the Round Company. Calculate its operating and cash cycles. Briefly discuss each of these cycles.

Inventory turnover = COGS/Average inventory = $1200/400 = 3x per yearInventory period = 365 days/Inventory turnover = 365 days/3 = 122 daysReceivables turnover = Sales/Average receivables = $1600/200 = 8x per yearReceivables period = 365 days/Receivables turnover = 365 days/8 = 46 daysThe operating cycle is the inventory period plus the receivables period. Operating cycle = 122 days + 46 days = 168 days (slight rounding error)The time that this firm takes to acquire inventory and sell it is 122 days, and collection takes another 46 days. In total the firm receives cash 168 days after it receives inventory.Payables turnover = COGS/Average payables = $1200/300 = 4x per yearPayables period = 365 days/Payables turnover = 365 days/4 = 91 daysThe firm takes 91 days to pay its bills.The cash cycle is the operating cycle minus the payables period. Cash cycle = 168 days - 91 days = 77 daysThe firm receives cash on average 77 days after it pays its bills.

Chapter 3 example problems This firm has 20 million shares outstanding, which are priced on Nasdaq today (in 2013) at $37 per share. Using the 2013 data only, calculate its (a) current ratio, (b) price-to-earnings ratio, and (c) internal growth rate (assuming it never borrows more). Briefly describe or discuss each

Current Ratio = Current Assets / Current Liabilities= $194m/$319m = .608x or 60.8%Given that Current Assets are below Current Liabilities by a significant amount, red flags are raised about this company's short-term solvency: receipts within the next year could be smaller than anticipated payments in the next year. Yet this company has positive EBIT and has been able to reduce its debt from 2012 to 2013, suggesting that it might have a strong ability to borrow more if needed. EPS = NI / n = $13m / 20m = $0.65 per shareP/E = $37 / $0.65 = 56.9x Given that the historical average PE ratio for the S&P500 is about 17x, this ratio is extremely high and typically indicates a company with high growth prospects. Despite the observation that is assets have declined in 2013, investors might be willing to pay more per dollar of earnings if those earnings are expected to grow substantially in the future. Or perhaps 2013 was a bad year for its earnings, and this company's performance is expected to recover. Profit Margin = NI / Sales = 13 / 842 = 1.54% measures cost control in generating sales.Asset Turnover = Sales / Assets = 842 / 636 = 1.32x measures asset use efficiency. ROA = Net Income / Assets = 13 / 636 = 2.04% measures overall profitability to assets, not owners.ROA = Profit Margin * Asset Turnover = 1.54% * 1.32x = 2.04%That seems a bit low, but could be simply due to the current year's data, as distinct from long-run possibilities. Plowback ratio b = 1 - Payout Ratio = 1 - Dividends/Net Income = 1 - (2/13) = 84.6% Internal growth rate = [ROA*b] / [1 - ROA*b] = [.0204(0.846)] / [1 - 0.0204(0.846)] = 1.76%Growth at a 1.76% rate is sustainable in the long run. Yet that is not consistent with the large PE multiple: the market price indicates that this company's growth is substantially higher than average.

Which one of the following has the highest effective annual rate?

D. 6 percent compounded monthly

Which of the following statements is TRUE? A. The venture capital market is the primary source of financing for established firms with proven profitability. B. Firm commitment underwriting is far less prevalent for large issues than best efforts underwriting, which is likely due to the lower uncertainty of smaller issues. C. The direct and indirect costs of going public can be substantial, and once a firm goes public, it will not be able to easily raise additional capital. D. A Green Shoe provision gives the underwriters the right to purchase additional shares at the offer price to cover overallotments.

D. A Green Shoe provision gives the underwriters the right to purchase additional shares at the offer price to cover overallotments.

Which of the following statements is FALSE? A. The direct fees paid by the issuer to the underwriter syndicate is called the spread, which is the difference between the price the issuer receives and the offer price paid by new shareholders. B. Direct expenses include filing fees, legal fees, and taxes and are costs incurred by the issuer that are not part of the compensation to underwriters. C. For initial public offerings, losses arise when shares are sold below their true value; hence, the underpricing of IPOs is an additional implicit cost to the issuer. D. A delayed registration permits a firm to register an offering under SEC 415 and then issue the securities over a two-year period.

D. A delayed registration permits a firm to register an offering under SEC 415 and then issue the securities over a two-year period.

Which one of the following statements is correct? A. Firms that follow restrictive financial policies can generally avoid short-term debt financing. B. Short-term borrowing is generally more expensive than long-term borrowing. C. Long-term interest rates tend to be more volatile than short-term rates. D. A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

D. A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

If any, which of the following does NOT have the potential to increase the net present value of a proposed investment?

D. All of the above have the potential to increase the NPV of a proposed investment

Other things equal, investors will require higher yields on, and be willing to pay lower prices for, bonds with the following characteristics, except those which:

D. Are convertible into common shares

Which of the following statements is TRUE? A. The key risk for a flexible short-term financing policy is losing credit access. B. A 'fortress' balance sheet generally includes restrictive short-term financial policies. C. A restrictive short-term financing policy has high carrying costs and low shortage costs. D. Borrowing short-term to meet peak needs and maintaining a cash reserve for emergencies is described as a compromise policy for short-term financing.

D. Borrowing short-term to meet peak needs and maintaining a cash reserve for emergencies is described as a compromise policy for short-term financing.

A broker is an agent who

D. Brings buyers and sellers

Which of the following is NOT an effective means of aligning management goals with shareholder interests?

D. Compensating managers with salaries significantly higher than their peers

Which of the following statements is FALSE? A. The cost of debt for bonds is the same as the yield implied by their market quoted prices, except when that promised yield is too high due, for example, to the high default probabilities for junk bonds. B. The cost of preferred stock equals its dividend yield as a percent of the current price, rather than the preferred dividend as a percent of its stated liquidating value, which is usually $100. C. Judgment is typically required when estimating the cost of equity, particularly when a company pays no dividends and when its beta estimate is imprecise. D. Due to its lower priority and greater risk, a firm's cost of equity can sometimes be, and often is, less that its after-tax cost of debt.

D. Due to its lower priority and greater risk, a firm's cost of equity can sometimes be, and often is, less that its after-tax cost of debt.

Which of the following statements is FALSE? A. The preliminary document provided to potential investors for their review of new shares to be issued as they wait for the shares to be cleared for sale is called a red herring B. The legal document that is provided to potential investors and describes a new security offering is called a prospectus. C. The advertisement, commonly found in financial newspapers, that announces a public offering of securities and provides the name of the underwriters is called a tombstone. D. Firms that assists issuers by pricing and selling new securities to the general public are called venture capitalists.

D. Firms that assists issuers by pricing and selling new securities to the general public are called venture capitalists.

Which of the following statements is FALSE? A. Across a longer time period, a single cash flow grows to a larger future value B. For a higher interest rate, a single cash flow has a smaller present value C. If its payments last longer, an annuity has a larger present value D. For a higher interest rate, an annuity has a smaller future value

D. For a higher interest rate, an annuity has a smaller future value

A call provision in a bond...

D. Grants the issuer the option to repurchase the bonds prior to maturity at a pre-specified price.

Which of the following statements is FALSE? A. Financial ratios help compare over time companies of different sizes and industries, and since not all sources calculate them the same way, managers should understand how they are derived. B. Asset utilization ratios describe how efficiently, or intensively, a firm uses its assets to generate sales. C. To a firm's creditors, particularly short-term creditors such as suppliers, the higher the current ratio is, the better. D. Higher margin, turnover, leverage, and dividends all generally allow a firm to grow faster over the long run.

D. Higher margin, turnover, leverage, and dividends all generally allow a firm to grow faster over the long run.

Which of the following statements is FALSE? A. The Gordon Growth Model assumes constant dividend growth and implies that stock prices grow at the same rate. B. A stock's price is the present value of the expected dividends and capital gains. C. Dealers buy and sell securities from their own inventory, while brokers bring buyers and sellers together to complete transactions. D. Holders of preferred stock have greater voting rights in corporate decisions than holders of common stock.

D. Holders of preferred stock have greater voting rights in corporate decisions than holders of common stock.

Which of the following will increase the sustainable rate of growth for a firm?

D. Increasing the target debt-equity ratio

Which of the following statements is FALSE? A. Shortage costs typically decrease with the level of investment in current assets. B. Increasing long-term debt increases cash. C. A 'fortress' balance sheet is typified by flexible policies with higher carrying costs, extra cash, and generous receivables, but creates the risk of a mismatch between short-term assets financed with long-term financial claims like bonds. D. Instability in financial markets has led corporations to choose restrictive short-term financial policies.

D. Instability in financial markets has led corporations to choose restrictive short-term financial policies.

Which of the following statements is TRUE? A. Leverage reduces the expected values of both EBIT and net income. B. Leverage increases expected ROE but decreases expected EPS .C. Leverage decreases the volatility of both ROE and EPS. D. Investors can create their own leverage within their own portfolios.

D. Investors can create their own leverage within their own portfolios.

Which of the following is NOT a justification for IPO underpricing?

D. It benefits the existing shareholders.

Which of the following statements is FALSE? A. Over the long run, investments in small-company stocks have had the largest return but also the most risk, when compared with large-company stocks, bonds, and T-Bills. B. The average return is always greater than the geometric return. C. Investors who hold bonds instead of stocks over long horizons can be rational and relatively averse to risk. D. Like the dividend yield, the capital gains yield can never be negative.

D. Like the dividend yield, the capital gains yield can never be negative.

Which of the following statements is FALSE? A. The average tax rate is the total tax expense divided by the total taxable income. B. The marginal tax rate is the tax rate that applies to the next dollar of taxable income that a firm earns. C. The average tax rate is always less than or equal to, and often considerably less than, the marginal tax rate. D. Managers should use the average tax rate when making decisions regarding new investments and financing choices.

D. Managers should use the average tax rate when making decisions regarding new investments and financing choices.

If any, which of the following statements is FALSE? A. Capital Budgeting is the process of planning and managing a firm's long-term investments where managers identify investments that are worth more than they cost to acquire. B. Capital Structure is the mix of debt and equity maintained by a firm to finance operations, where the firm decides how much to borrow and what the cheapest sources of funds are. C. Working Capital Management is the day-to-day management of finances that determines how much cash and inventory should be kept on hand, whether to sell on credit to customers, and how to obtain short-term financing. D. None of the above statements is false.

D. None of the above statements is false.

Which of the following statements is FALSE? A. Liquidity measures the speed and ease with which assets can be converted to cash without significant loss of value, and 'fortress' balance sheets are especially liquid. B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer to depreciate assets using accelerated over straight line methods for tax purposes. C. The marginal tax rate is the tax rate payable on the next dollar earned and is always higher than the average tax rate. D. Operating Cash Flow is generated from utilizing existing assets after deducting interest expense

D. Operating Cash Flow is generated from utilizing existing assets after deducting interest expense

Newly issued securities are sold to investors in which one of the following markets?

D. Primary

Which of the following statements is FALSE? A. The market value of any asset is what an item is actually worth if sold and must always be a positive value. B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer to depreciate assets using accelerated over straight line methods for tax purposes. C. The marginal tax rate is the tax rate payable on the next dollar earned and, due to deductions and credits, the marginal tax rate is always higher than the average tax rate. D. Priority measures the speed and ease with which assets can be converted to cash without significant loss of value.

D. Priority measures the speed and ease with which assets can be converted to cash without significant loss of value.

Which of the following statements is TRUE? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The APR is always strictly greater than the EAR for compounding more than once per year. C. The APR on a monthly loan is equal to (1 + monthly interest rate)12 - 1. D. The EAR is the best measure of the actual rate you are paying on a loan.

D. The EAR is the best measure of the actual rate you are paying on a loan.

Which of the following statements is FALSE? A. The future value of a single cash flow grows across a longer time period B. The present value of a single cash flow falls with a higher interest rate C. The present value of an annuity grows if the annuity lasts longer D. The future value of an annuity falls with a higher interest rate

D. The future value of an annuity falls with a higher interest rate

Which one of the following statements is TRUE? A. The risk-free rate of return has a risk premium of 1.0. B. The reward for bearing risk is called the standard deviation. C. Risks and expected return are inversely related. D. The higher the expected rate of return, the wider the distribution of returns.

D. The higher the expected rate of return, the wider the distribution of returns.

Which of the following choices is NOT a CORRECT way to complete this sentence: Other things equal, a set of cash flows is more valuable ...

D. The larger the time value that investors require compensation for trading a dollar today for dollars tomorrow

Which of the following statements is TRUE? A. The coupon rate on a previously issued bond represents the rate of return required by today's participants in the market place. B. When a bond's yield to maturity is less than its coupon rate, the bond is selling at a discount. C. The market prices of bonds with higher coupons are more sensitive to changes in market interest rates. D. The market prices of bonds with longer maturities are more sensitive to changes in market interest rates.

D. The market prices of bonds with longer maturities are more sensitive to changes in market interest rates.

Today, Courtney wants to invest an amount less than $5,000 with the goal of receiving $5,000 back some time in the future. Which one of the following statements is correct? A. The period of time she has to wait until she reaches her goal is not affected by the compounding of interest. B. The lower the rate of interest she earns, the shorter the time she will have to wait to reach her goal. C. The length of time she has to wait to reach her goal is directly related to the interest rate she earns. D. The period of time she has to wait decreases as the amount she invests today increases.

D. The period of time she has to wait decreases as the amount she invests today increases.

Which of the following statements is FALSE? A. Interest expense reduces taxable income and net income but not EBIT. B. When a company repurchases its shares using proceeds from new issues of debt, its future expected earnings per share increases. C. 'Homemade leverage' is the use of personal borrowing to adjust the overall amount of financial leverage to which the individual investor is exposed. D. Under M&M assumptions which ignore special benefits and costs of debt, leverage has a substantial impact on total firm value and on WACC.

D. Under M&M assumptions which ignore special benefits and costs of debt, leverage has a substantial impact on total firm value and on WACC.

Portfolio diversification eliminates which of the following?

D. Unsystematic risk

Which of the following statements is FALSE? A. When market yields rise, the price of discount bonds fall further below par or face value. B. When market yields rise, the price of long-term bonds fall by a greater percent than short-term bonds. C. When market yields rise, the price of bonds with small coupons fall by a greater percent than those with large coupons. D. When market yields rise, investors redeem or 'call' the callable bonds they own, forcing the issuer of the bond to pay at least the face value.

D. When market yields rise, investors redeem or 'call' the callable bonds they own, forcing the issuer of the bond to pay at least the face value.

Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic firm-specific risk associated with an individual security?

D. Zero

Firms that compile financial statements according to GAAP:

D. can still manipulate their earnings to some degree

An annuity is worth _______ than a perpetuity, and a constant annuity is worth _______ than a growing annuity. (assuming the normal circumstance where the discount rate exceeds the growth rate and where the growth is positive)

D. less, less

Chapter 7 example problem START is a young start-up company that is plowing its operating cash flows back into the company and investing now to fuel future cash flow growth. Because of that, START does not plan to pay dividends for the next 9 years, but expects to pay its first dividend of $4.00 per share in year 10 and will increase the dividend by 4% per year thereafter. If investors require 12% return on this stock, what is its current share price?

Draw a time line to show that the first dividend arrives in year 10. The growing perpetuity formula calculates the value one period before the first cash flow, or in year 9. Thus the result needs to be discounted an additional 9 years to present. D10 P0= r-g/ (1=r)^9 = = $4.00 .12-.04/(1+.12)^9 = $50/2.773 =$18.03 per share today

Chapter 5 equations

EAR = [1 + (APR / m)]m - 1 PV= PMT/r[1 -1(r+r)^t] PV=PMT/(g-r) ( growing perpetuity) PV=PMT/r ( constant perpetuity)

Chapter 17 equations

EOQ = [(2T × F)/C]1/2

Chapter 24 example problem a) You buy 3 contracts of the July 75 call options. How much will you pay, ignoring commissions? b) In July on the expiration date, VTI's price increases to $75.50 per share. For the July 75 call option, what is the payoff per share of underlying stock? c) Given your position in part (a) and the VTI stock price at expiration of $75.50, how much is your total options position worth? d) On that position, what was the percent return?

Each contract is for 100 shares. Since you will pay the ask price for a market order, the total cost is:Total Cost = 3 contracts * (100 shares per contract) * ($2.00) = $600 b. For calls, Payoff per share = max[ST - K, 0] = max[75.50 - 75, 0] = $0.50 c. Total Payoff = 3 contracts * (100 shares per contract) * $0.50 = $150 Total Profit = Total Payoff - Total Cost = $150 - $600 = -$450, a lossPercent return = -$450 / $600 = -75%. Even though the stock price climbed and the call paid off, its initial cost was larger. d. Total Profit = Total Payoff - Total Cost = $150 - $600 = -$450, a lossPercent return = -$450 / $600 = -75%.

Chapter 6 equations

Expected Inflation = (1 + Nominal) / (1 + Real) - 1 The percentage change in Bond is: (New price - Original price) / Original price B= CM/ YM [1-1/(1+Y/M)^mt] + face/[1-1/(1+Y/M)^mt]

Chapter 18 Equations

FFC per USD/ SFC per USD = 1+ rFC/ 1+r USD FFC per USD/ SFC per USD is also equal to 1+ rFC- FFCperUSD/ SFCperUSD

Chapter 7 equations

FIND

Chapter 10 equations

FIND THEM!!!!

Chapter 8 Equations

FIND THESE ONES

Chapter 4 equations

FV = PV * (1+r)t FV = PV * (1+r/m)mt EAR = [1 + (APR / m)]m - 1 EAR = (1 + APR/m)m T = ln(FV/PV) / ln(1+r) =

Chapter 2 example problem Hammett, Inc., has sales of $19,570, costs of goods sold of $9,460, depreciation expense of $2,130, and interest expense of $1,620. If the tax rate is 35%, what is its net income? What is its operating cash flow? Does that represent cash flowing into or flowing out of the company?

First calculate EBIT = Sales - COGS - SGA - Depreciation = $19,570 - 9,460 - 2,130 = $7,980 Taxable Income subtracts interest expense: $7,980 - 1,620 = $6,360Taxes at 35% of Taxable Income are 35% * 6,360 = $2,226 Net Income = Taxable Income - Taxes = $6,360 - 2, 226 = $4,134 OCF = EBIT + Depreciation - Taxes = $7,980 + 2,130 - 2,226 = $7,884 This positive Operating Cash Flow represents cash flowing into the company from current operations.

Chapter 2 example problem Last year, Drumor, Inc. earned $20.4m. This year it has sales of $81.3m, costs of goods sold of $60.7m, depreciation expense of $18.5m, and interest expense of $4.1m. If the tax rate is 35%, what is its net income? What is its operating cash flow? Does that represent cash flowing into or flowing out of the company?

First calculate EBIT = Sales - COGS - SGA - Depreciation = $81.3 - 60.7 -18.5 = $2.1m Taxable Income subtracts interest expense: $2.1 - 4.1 = -$2.0m Taxes at 35% of Taxable Income are 35% * -2.0 = -$0.7m, which is a refund and fully recoverable immediately because Drumor earned a substantial profit last year. Net Income = Taxable Income - Taxes = -$2.0 - -$0.7 = -$1.3m OCF = EBIT + Depreciation - Taxes = 2.1 + 18.5 - -0.7 = +$21.3m This positive Operating Cash Flow represents cash flowing into the company from current operations. Even though net income is negative, depreciation is non-cash and taxes in this case provided a refund.

You have a buddy who recently opened a Robinhood account to buy and sell stocks. He conducts some research on Ford and Tesla and makes the comment to you "I think I am going to buy Ford because it's share price is only $9.41 compared to Tesla's $245.87 and there's no way that Tesla is 26x more valuable." Can you tell him what's wrong with that statement?

He's wrong because the share price is partly due to how many share's outstanding the company has. For example, Ford has nearly 4 billion shares outstanding, while Tesla only has around 200 million - which results in the vastly different share prices. To determine what the market value of a company is, you should look at the market capitalization.

Chapter 9 example problem Constock is considering a new three-year expansion project that requires an initial fixed asset investment of $24m. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $20m in annual sales, with annual cash costs of $14m (excluding depreciation expense). The marginal tax rate is 35%. In addition, the project requires an initial investment in new working capital of $1m, which will be recovered at the end of the project, and the fixed asset will have a market value of $2m at the end of the project. What is the project's net cash flow in Year 3 at the end of the project?

Operating Cash Flow = (Sales-Costs)(1-T) + Depr*T = (20 - 14)(1-.35) + (24/3)*.35 = $6.7m NWC Recovery = 1mAfter-tax Salvage = SalePrice - T*(SalePrice - Book) = 2 - .35(2 - 0) = 1.3m Total Year 3 net cash flow = 6.7 + 1 + 1.3 = $9.0m

chapter 24 equations

Payoff per share = max[ST - K, 0] Total Profit = Total Payoff - Total Cost Percent return = Total Payoff - Total Cost / Total Cost

Chapter 3 equations

ROE = Net Income / Book Equity ROA = Profit Margin * Asset Turnover Profit Margin = NI / Sales Asset Turnover = Sales / Assets Equity Multiplier = Assets / Book Equity Sustainable growth rate = [ROE*b] / [1 - ROE*b] Asset Turnover = 1 / Capital Intensity Ratio Equity Multiplier = +Leverage Ratio ROE = Profit Margin * Asset Turnover * Equity Multiplier b = Plowback Ratio = (Net Income - Dividends) / Net Income Current Ratio = Current Assets / Current Liabilities Current Ratio = Current Assets / Current Liabilities

Chapter 3 example problem Q3 Using the 2010 data only, calculate the ROE and three components of its DuPont decomposition. Briefly describe, discuss, or interpret each of these 4 in a short sentence or phrase (merely restating the definition of each is not sufficient).

ROE = Net Income / Book Equity = 65 / 1080 = 6.0% measures overall profitability to owners. Profit Margin = NI / Sales = 65 / 500 = 13% measures cost control in generating sales. Asset Turnover = Sales / Assets = 500 / 1710 = 29.2% measures asset use efficiency. Equity Multiplier = Assets / Book Equity = 1710 / 1080 = 1.583 or 1 + Leverage Ratio = 1 + (Total Liabs / Book Equity) = 1 + ((210+420) / 1080) = 1.583 This measures how the capital is levered, which can indicate long-term solvency problems if it is particularly high.

Chapter 6 example problem If the nominal yield on 10-year T-Bonds is 2.44% and the real yield on similar 10-year Treasury Inflation-Protected Securities is 0.79%, what exactly is the expected inflation rate? Show your work.

Rearranging the exact Fisher Effect equationExpected Inflation = (1 + Nominal) / (1 + Real) - 1 = 1.0244 / 1.0079 - 1 = .0164 or 1.64% per year

Chapter 16 example problem q 12 Using this financial statement data, calculate the firm's operating cycle. Briefly discuss or interpret it. *Pull of Statements from Document* b) Net of the time delay that the firm takes to pay for the inventory, how long does the firm require short-term financing for its operating process? Briefly discuss or interpret it.

Inventory turnover = COGS/Average inventory = $270 / (½ * 90 + ½ * 82) = 3.14x per yearInventory period = 365 days/Inventory turnover = 365 days/3.14 = 116 daysReceivables turnover = Sales/Average receivables = $350 / (½ * 30 + ½ * 35) = 10.77x per yearReceivables period = 365 days/Receivables turnover = 365 days/10.77 = 34 daysThe operating cycle is the inventory period plus the receivables period.Operating cycle = 116 days + 34 days = 150 daysThe time that this firm takes to acquire inventory and sell it is 116 days, and collection takes another 34 days. In total the firm receives cash 150 days after it receives inventory. b. Payables turnover = COGS/Average payables = $270 / (½ * 40 + ½ * 42) = 6.59x per yearPayables period = 365 days/Payables turnover = 365 days/6.59 = 55 daysThe firm takes 55 days to pay for its inventory.The cash cycle is the operating cycle minus the payables period.Cash cycle = 150 days - 55 days = 95 daysThe firm receives cash on average 95 days after it pays its bills, and this Cash Cycle is the length of time that the firm requires short-term financing for its operating process.

Chapter 2 example problem The December 31, 2009 balance sheet of Anna's Tennis Shop, Inc., showed current assets of $1,015 and current liabilities of $870. The December 31, 2010 balance sheet showed current assets of $1,230 and current liabilities of $905. What was the company's 2010 change in net working capital? Does that represent cash flowing into or flowing out of the company?

Net Working Capital is current assets less current liabilities NWC = CA - CL = $1,015 - 870 = $145 at the end of 2009 NWC = CA - CL = $1,230 - 905 = $325 at the end of 2010 The change in net working capital is the end of period net working capital minus the beginning of period net working capital :ΔNWC = $325 - 145 = $180 in 2010 This positive change in net working capital represents cash flowing out of the company to invest in current operating assets.

Chapter 2 example problem Rotweiler Obedience School's December 31, 2009 balance sheet showed net fixed assets of $1,725,000 and the December 31, 2010 balance sheet showed net fixed asset of $2,040,000. The company's 2010 income statement showed a depreciation expense of $321,000. What was Rotweiler's net capital spending for 2010? Does that represent cash flowing into or flowing out of the company?

Net capital spending is the increase in fixed assets, plus depreciation. CapEx = ΔNFA + Depreciation = $2,040,000 - 1,725,000 + 321,000 = $636,000 This positive capital expenditure represents cash flowing out of the company to invest for future operations.

Chapter 2 example problem Drumor's current balance sheet showed net fixed assets of $160.4m and its balance sheet last year showed net fixed asset of $174.3m. The company's income statement this year showed a depreciation expense of $18.5m . What was Drumor's net capital spending for the current year? Does that represent cash flowing into or flowing out of the company?

Net capital spending is the increase in fixed assets, plus depreciation. CapEx = ΔNFA + Depreciation = ($160.4m - $174.3) + $18.5m = +$4.6m Net fixed assets fell but by a smaller amount than caused by noncash depreciation. This positive capital expenditure represents cash flowing out of the company to invest for future operations.

Between these two companies, which one would you invest in?

No correct answer here! That's the beauty of the stock market. You take risks with the hope that it pays off. In my opinion (Tate speaking here), I think you should invest in companies that you feel are making a difference in the world - a difference that you believe in. Although you should always support your hypothesis with financial data, to ensure you aren't getting ripped off.

Chapter 9 equations

Operating Cash Flow = (Sales-Costs)(1-T) + Depr*T After-tax Salvage = SalePrice - T*(SalePrice - Book) Cash flow= Current Cash + New Cost + Expenses

Chapter 2 example problem Roscoe's purchased new machinery three years ago for $1.8 million. The machinery can be sold to Stewart's today for $1.2 million. Roscoe's current balance sheet shows net fixed assets of $840,000, current liabilities of $348,000, and net working capital of $144,000. If all the current assets were liquidated today, the company would receive $476,000 cash. What is the book value of the firm's assets today? What is the market value? If these values are not the same, briefly discuss why they differ.

The purchase price of the machinery has been depreciated to $840,000 on the current balance sheet Since NWC = CA - CL, CA = NWC + CL = $144,000 + $348,000 = $492,000 Book value = $840,000 + $492,000 = $1,332,000 Market value = $1,200,000 + $476,000 = $1,676,000 The market value of assets is their current liquidation or sale value, which must always be positive. Market values can be higher or lower than book values, which generally reflect their historical costs.

Chapter 9 example problem MUST KNOW. GOT WRONG ON EXAM Currently Perla sells 200,000 Contractor grade windows per year at $200 each, and 100,000 Architect grade windows per year at $600 each. The company plans to introduce a Builder grade window and expects to sell 120,000 of these windows per year at $500 each. Because these Builder grade windows will be more easily matched with the Contractor grade windows, Perla expects to be able to sell an additional 30,000 Contractor grade windows. However, Perla also expects that the Builder grade windows will compete with and reduce its sales of Architect grade windows by 40,000 units. What is the relevant amount to use as the annual sales figure when evaluating this project? Briefly explain why.

Sales due solely to the new Builder grade product are 120,000 windows * $500 per window = $60 million Due to synergies with the new Builder grade windows, the Contractor grade window sales will increase by 30,000 windows * $200 per window = $6 million gained sales Due to erosion caused by the Builder grade windows, the Architect grade window sales will decrease by 40,000 windows * $600 per window = $24 million lost sales The relevant net sales due to the introduction of the Builder grade windows is therefore:$60 million + $6 million - $24 million = $42 million.

Chapter 7 example problem QWE, Inc., has an outstanding issue of preferred stock that pays a $5.20 dividend every year. If this issue currently sells for $81.25 per share, estimate the return that investors require on it currently using the dividend discount model.

Since dividends on a preferred share do not grow, its required return is simply its dividend amount per year divided by its current price, or$5.20 / $81.25 = 6.4% per year

Chapter 17 example problem Clap Off Manufacturing uses 1,300 switch assemblies per week and then reorders another 1,300. The carrying cost per switch is $5, and the fixed order cost is $575. Calculate its existing Carrying Costs and Restocking Costs per year. Is the company's current inventory policy optimal? If not, what quantity should it order each time and how many orders should it make each year?

The carrying costs are the average inventory times the cost of carrying an individual unit, so:Carrying costs = (1,300/2)($5) = $3,250 per yearThe order costs are the number of orders times the cost of an order, so:Restocking costs = 52($575) = $29,900 per yearThe firm's policy is not optimal, since the carrying costs and the order costs are not equal.The economic order quantity is:EOQ = [(2T × F)/C]1/2 = [2(52)(1,300)($575)/$5]1/2 = 3,943.10The number of orders per year will be the total units sold per year divided by the EOQ, so: Number of orders per year = 52(1,300)/3,943.10 = 17.14 The company should increase the order size from 1,300 to 3,943 and decrease the number of orders per year from 52 to 17.

Chapter 4 example question Your bank quotes an interest rate of 3.60% APR per year. Using the Rule of 72, approximately how many years must you wait until your investment has doubled? b) You can earn 0.30% per month at your bank. If you deposit $1,000 now, how many months must you wait until your investment has grown to $2,000 exactly?

T * r*100 ≈ 72 T = 72 / (.0360*100) ≈ 20 years b. T = ln(FV/PV) / ln(1+r) = ln($2,000/$1,000) / ln(1+.0030) = 231.4 months Slightly good news: that's actually only 19.3 years.

Chapter 9 example problem MUST KNOW! WAS MISSED ON EXAM Kenny, Inc. is looking at setting up a new manufacturing plant in South Park. The company bought some land seven years ago for $9.8 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. The land would net $7.2 million if it were sold today. The company now wants to build its new manufacturing plant on this land; the plant will cost $22.1 million to build, and the site requires $1.1 million worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project?

The $9.8 million acquisition cost of the land seven years ago is a sunk cost. The $7.2 million current aftertax value of the land is an opportunity cost if the land is used rather than sold off. The $22.1 million cash outlay and $1.1 million grading expenses are the initial fixed asset investments needed to get the project going. Therefore, the proper year zero cash flow to use in evaluating this project is Cash flow = 7.2m + 22.1m + 1.1m = $30.4m

Chapter 5 example problem You want to buy a new hummer for $50,000 and the finance office at the dealership has quoted you a 4.8% APR loan for 5 years to buy the car. What will your monthly payments be? What is the effective annual rate on this loan?

The interest per month is 4.8% / 12 = 0.4%The number of payments are 5 years * 12 = 60 months PV= PMT/r[1 -1(r+r)^t]=$50,000=PMT/.004[1- 1/(1+.004^60), solving for the payment PMT = $938.99. n = 60, i = 4.8 / 12 = .4, PV = $50,000m, FV = 0 PMT = -938.99 or $938.99 payment / month EAR = [1 + (APR / m)]m - 1 = [1 + (.048 / 12)]12 - 1 = 4.91%

Chapter 6 example problem Three years ago, JKL Co. issued bonds with a 20-year maturity then and at a coupon rate of 7.4 percent. The bonds make semiannual payments. If the YTM on these bonds is 8.5 percent, what is the current bond price? Show your work.

The bond's maturity is now 17 years, which is 3 years less than it was at its issue date 3 years ago. Given that the payments are made semiannually, use the semianual coupon, the semiannual yield, and the number of semiannual payments remaining until maturity: Coupon per period = (.074 / 2) * $1,000 = $37 Yield per period = .085 / 2 = .0425 or 4.25% Number of periods = 2 * 17 years = 34 The price of the bond is P = $37 / .0425 * [1 - 1 / (1 + .0425)34] + $1,000 / (1 + .0425)34 P = $659.13 + $242.89 = $902.02T he annuity of 34 future coupons of $37 each are currently worth $659.13. The future $1,000 face value is currently worth $242.89. Together, the total current value of this bond is $902.02. Alternatively, using financial functions:n = 34, i = 4.25, PMT = 37, FV = 1,000 => PV = -902.02 (be sure to switch the sign to a positive price) This bond sells at a discount since its coupon rate is less than the yield that investors currently require to purchase it.

Chapter 12 example problem you got screwed over by this one on exam 2, it is a must know! A large industrial company with a 28% marginal tax rate, is financed with: Debt: 30 million bonds outstanding with $1,000 par value each, 7.8% coupons paid semiannually, 12 years to maturity, high investment grade rating, a quoted yield of 5.5%, and selling for 120% of par. Common stock: 2,000 million shares of common stock selling for $27 per share with a 1.2 beta and 80% volatility. Market: The current risk-free rate is 2% and investors expect a 5% market risk premium. Estimate this company's WACC.

The quoted bond yield of 5.5% could be used to confirm that the bond price is: n = 2*12 = 24, i = 5.5/2 = 2.75, PMT = 7.8/2 = 3.9, FV = 100 to the PV = -120.01 The market values of the company's debt, equity, and total firm value are: D = 30m($1,000)(1.20) = $36b E = 2,000m($27) = $54b V = $36b + $54b = $90b Due to its high investment grade rating, the cost of debt is the 5.5% YTM of the bonds, and the after-tax cost of debt is: rD = (1 - .28)5.5% = 3.96% Using CAPM, the cost of equity is: rE = rF + βE * RPM = 2% + 1.2 * 5% = 8.0% A stock's volatility can be diversified in a portfolio and is not relevant to the return required on equity by diversified investors in the market. WACC = (36b/90b) * 3.96% + (54b/90b) * 8.0% = 6.38%

Chapter 14 example problem Your brokerage account currently holds 200 shares of ABC stock, each worth $28 per share. ABC has announced a dividend of $1 per share with an ex-dividend date of tomorrow. Assuming no taxes, no other costs or benefits of dividends, and no other cash flows in or out of your account other than the dividend, how much will your total portfolio value be worth in your account tomorrow? Briefly explain.

The same amount as today. Today: 200 shares * $28 per share = $5,600Tomorrow: 200 shares * (28 - 1) per share + 200 * $1 cash dividend = $5,600 The stock value will drop by the amount of the dividend, but your account's cash balance will increase by the same amount.

Chapter 14 example problem In a brokerage account, you own 300 shares of HJK stock each worth $45.60 today. A month ago, HJK announced a dividend of $1.20 per share with an ex-dividend date of tomorrow. Assuming no taxes, no other costs or benefits of dividends, and no news or other surprises, how much do you expect the total value of the 300 shares of HJK in your account to be worth tomorrow? Briefly discuss.

The stock value will drop by the amount of the dividend (but your account's cash balance will increase by the same amount.) Today: 300 shares * $45.60 per share = $13,680 Tomorrow: the per share price will drop to $45.60 - $1.20 = $44.40 Your total shares will be worth 300 * ($44.40) per share = $13,320which is a reduction equal to the amount of the dividend 300 * ($1.20) =$360

Chapter 18 example problem Assume that interest rate parity holds. Currency per U.S. $ Canada dollar 1.1284 6-months forward 1.1336 If the 6-month risk-free rate in Canada is 2.1%, what must the 6-month risk-free rate be in the United States? (These rates are NOT annualized per year, but per 6-month period.)

Today, convert US$100 to C$112.84 (and today enter into a forward agreement to lock in the future exchange rate today.) Earn Canadian interest in 6 months: (1+.021) C$112.84 = C$115.21 In 6 months, convert back to US$: C$115.21 / (C$1.1336 / US$1) = US$101.6 So, the 6-month risk-free rate in the United States must be 1.6% (per 6-month period) Alternatively, FFC per USD/ SFC per USD = C$1.1336 US$1/ C$1.1284 US$1= 1.0046 Rearrange this: FFC per USD/ SFC per USD = 1+ rFC/ 1+ rUSD To solve for rUSD =[ (1+ rFC) Divided by (FFC per USD/ SFC per USD)] -1 = {91+0.21) divided by 1.0046]-1=1.6% Approximately, FFC per USD/ SFC per USD is equal to 1+rFC - rUSD = 1 +.021-rUSD And solve for rUSD is equal to 1+rFC- FFC per USD/ SFC per USD = 1+ .021-1.0046= 1.6%

Chapter 3 example problems A firm has adopted a policy whereby it will not seek any additional external financing. Given this, what is the maximum growth rate for the firm if it has net income of $12,100, total equity of $94,000, total assets of $156,000, and a 60 percent dividend payout ratio?

Without additional financing, the firm's growth is limited to its internal growth rate, assuming the Return on Assets and Retention Ratio are constant over time.ROA = $12,100 / $156,000 = 7.76%Retention Ratio or plowback = 1 - Dividend Payout Ratio = 1 - .60 = .40 or 40%Internal growth rate = .0776 * .40 / (1 - [.0776 * .40]) = 3.20%

Chapter 8 example problem To expand your company's production, you are considering installing a new plant at a cost of $1,200 million, which will be depreciated straight line to zero over its four-year life. The following are projections of its net income and free cash flows over these years. a) What is the project's average accounting return (AAR)? If the company uses AAR to make decisions and its preset target rate is 12%, will it take this project? Briefly explain. b) What is the project's Net Present Value if the appropriate cost of capital for this project 12%? Should the company take this project? Briefly explain. c) Without calculating this project's Internal Rate of Return, what can you tell about this project's IRR? Is it higher or lower than the project's cost capital? Briefly explain why.

a. AAR = Average Net Income / Average Book Value = [(104 + 234 + 26 - 26) / 4] / (1200 + 900 + 600 + 300 + 0) / 5] = 84.5 / 600 = 14.1%Since that exceeds the 12% target, the company will take this project if it makes decisions based on AAR alone. (This would be a mistake in this case given the negative NPV shown below.) b. Calculate the NPV by discounting the FCFs at a rate of 12% to show that its NPV = -$7.41mNo, if the company accepted this project, it would destroy $7.41m in value of its investors' capital. Since this project has the typical pattern of one cash outflow followed by only inflows of cash, and since its NPV is negative, the IRR must be less than the cost of capital. The discount rate would have to be reduced to increase its negative NPV up to zero.[Note also, this project's free cash flows add up to +$338m. Hence, using a 0% discount rate, the NPV of the FCFs would be positive. So, this project's IRR is larger than 0%.]

Chapter 13 example problem Yesterday Quinella Inc. had no debt and its equity was worth $500 million. Its equity investors expected 10% returns per year. Today, Quinella announced a financial recapitalization plan to borrow $200 million at a 6% yield and use the entire proceeds to buyback stock. a) If Quinella pays no taxes and there are no other special advantages or disadvantages of debt financing, what will the value of the firm's capital be after it issues the debt? Briefly discuss. b) If Quinella pays no taxes and there are no other special advantages or disadvantages of debt financing, what will the firm's cost of equity be after it issues the debt? Briefly discuss. c) If Quinella's marginal corporate tax rate is 35% but because of deductions, last year Quinella's average effective tax rate was only 28%, and if there are no other special advantages or disadvantages of debt financing, what will the value of the firm's capital be after it issues the debt? Briefly discuss.

a. After debt issue, Quinella's debt will be $200m After the buybacks, Quinella's equity will be $500 - $200 = $300mThe value of Quinella's debt and equity capital will be 200 + 300 = $500m.The value of the firm does not change unless there are special advantages like tax shields or disadvantages to debt, which is the point of Modigliani and Miller's Proposition I. b. Before the leveraged recapitalization, Quinella had no debt, so its weighted average cost of capital is the same as its cost of equity of 10%. Assuming that the expected return on debt is the same as its yield, meaning that Quinella's probability of default is very low, the cost of its debt is rD = 6%. With leverage, equity investors should expect a higher return due to the additional financial risk, which is the point of Modigliani and Miller's Proposition II. rE=rA+(rA-rD)D/E rE = 10% + (10% - 6%) * (200/300) = 12.67% Equity investors expect compensation in returns of 10% for the firm's overall business risk and an additional 2.67% for the firm's new leverage choice. c.After the debt issue, Quinella will be worth the original $500m plus the present value of the tax shield. The estimated present value of the debt tax shields is estimated using the marginal tax rate: TC * Debt =.35 * $200m = $70m So the firm's value will increase to VL = VU + TCD = $500 + $70 = $570m. Debt is worth $200m when it is issued. Equity gains the entire value of the entire tax shield: $500 + $70 tax shield value at announcement - $200 eventual buybacks = $370m

Chapter 13 example problem Yesterday Trifecta Inc. had no debt and its equity was worth $360 million. Today, Trifecta announced a financial recapitalization plan to borrow $100 million and use the entire proceeds to buyback stock. a) If Trifecta pays no taxes and there are no other special advantages or disadvantages of debt financing, what will the value of the firm's capital be after it issues the debt? b) If Trifecta's marginal corporate tax rate is 28% but because of deductions, last year Trifecta's average effective tax rate was only 15%, and if there are no other special advantages or disadvantages of debt financing, what will the value of the firm's capital be after it issues the debt?

a. After the debt issue, Trifecta's debt will be $100m.After the buybacks, Trifecta's equity will be $360 - $100 = $260mThe value of Trifecta's debt and equity capital will be 100 + 260 = $360m.The value of the firm does not change unless there are special advantages like tax shields or disadvantages to debt, which is the point of Modigliani and Miller's Proposition I. b. After the debt issue, Trifecta will be worth the original $360m plus the present value of the tax shield. The estimated present value of the debt tax shields is estimated using the marginal tax rate: TC * Debt =.28 * $100m = $28m So the firm's value will increase to VL = VU + TCD = $360 + $28 = $388m. Debt is worth $100m when it is issued. Equity gains the entire value of the entire tax shield: $360 + $28 tax shield value at announcement - $100 eventual buybacks = $288m

Chapter 2 example problem Caldweiler & Co. owes a total of $21,684 in taxes for this year. The taxable income is $72,000. If the firm earns $100 more in income, it will owe an additional $36 in taxes. a) What will its average tax rate be on income of $72,100? b) What is its marginal tax rate? Briefly compare these tax rates.

a. Average tax rate = ($21,684 + $36) / $72,100 = 30.12% b. Marginal tax rate = $36 / $100 = 36%The marginal tax rate is the tax on the next increment of income and is larger than the average tax rate.

Chapter 8 example problem 15 G Consider the following two mutually exclusive projects: (Italicized data were not provided on the exam.)... which means you mnsut know how to find irr Whichever project you choose, if any, you require 11% return on your investment. a) If you apply the payback criterion, which investment will you choose, if any? Show and briefly explain. b) If you apply the NPV criterion, which investment will you choose? Show and briefly explain. c) The IRR for Project A is 26%. Is the IRR on Project B higher or lower than 26%? If you apply the IRR criterion, which investment will you choose? Briefly show and describe how you can tell. d) Based on these answers, which project will you finally choose? Explain why.

a. Considering only the payback criterion, an investor would choose Project B since it pays back in exactly 2 years, while Project A takes longer and exactly 3 years to pay back its initial investment. b. Calculate the NPVs to show that Project A has a positive and higher NPV and therefore creates positive value and moreso than Project B. Choose project A. c. At a 26.0% required return, the NPV on Project B is still positive at $5.7m. (Also it only has one IRR since its cash flows change signs only once.) So the discount rate that makes Project B's NPV equal to zero is higher. In fact its IRR is 36.1%. According to the IRR criterion, choose Project B since its IRR is higher. d. While Project B pays back faster and has a higher dollar-weighted return (IRR), Project A has a larger NPV and creates more value. Therefore invest in Project A.

Chapter 24 Example problem. The following quote information is for option contracts on Macrosoft stock, which currently sells for $121 per share. a) Suppose you buy 4 contracts of the August 120 call options. How much will you pay, ignoring commissions? b) Suppose that on the expiration date Macrosoft stock's price has increased to $128 per share. For the August 120 call option, what is the payoff per share of underlying stock? Given your position in part (a), how much is your total options investment worth? What was the total profit? What was the percent return?

a. Each contract is for 100 shares, so the total cost is: Total Cost = 4 contracts * (100 shares per contract) * ($10.20) = $4,080 b. For calls, Payoff per share = max[ST - K, 0] = max[128 - 120, 0] = $8 Total Payoff = 4 contracts * (100 shares per contract) * $8 = $3,200 Total Profit = Total Payoff - Total Cost = $3,200 - $4,080 = -$880, a loss Percent return = ($3,200 - $4,080) / $4,080 = -21.6%. Even though the stock price climbed and the call paid off, its initial cost was larger.

Chapter 24 example problem a) You buy 3 contracts of the July 75 call options. How much will you pay, ignoring commissions? b. b) In July on the expiration date, VTI's price increases to $75.50 per share. For the July 75 call option, what is the payoff per share of underlying stock? c) Given your position in part (a) and the VTI stock price at expiration of $75.50, how much is your total options position worth? d. d) On that position, what was the percent return?

a. Each contract is for 100 shares. Since you will pay the ask price for a market order, the total cost is: Total Cost = 3 contracts * (100 shares per contract) * ($2.00) = $600 b. For calls, Payoff per share = max[ST - K, 0] = max[75.50 - 75, 0] = $0.50 c. Total Payoff = 3 contracts * (100 shares per contract) * $0.50 = $150 d. Total Profit = Total Payoff - Total Cost = $150 - $600 = -$450, a lossPercent return = -$450 / $600 = -75%. Even though the stock price climbed and the call paid off, its initial cost was larger.

Chapter 4 Example problem a) You have just made a $5,000 contribution to your individual retirement account. If you make no further contributions, and if the investments in your account return 6% per year every year, what will your account be worth when you retire in 45 years? b) What will your account be worth if you wait 10 years before making that $5,000 contribution? c) What will your account be worth if you wait 10 years before making that $5,000 contribution, and the investments in your account earn 6% per year compounded monthly?

a. FV = PV * (1+r)T = $5,000 * (1 + .06)45 = $68,823 That's likely not enough to retire on—invest more, and more often. b. If you wait 10 years before making the contribution, it will compound for 45 - 10 = 35 years. FV = PV * (1+r)T = $5,000 * (1 + .06)35 = $38,430 Start investing as early as possible. c. The number of months that your investment will compound over 35 years is 35 * 12 = 420 months.The 6% per year compounded monthly is a quote that would return 6% / 12 = 0.5% per month. FV = PV * (1+r)T = $5,000 * (1 + .005)420 = $40,618More frequent compounding will somewhat improve your investments' future value.

Chapter 5 example questions a) Given an interest rate of 4.50% per year, what is the value today of a perpetual stream of constant $27 payments that begin next year? b) Given an interest rate of 4.50% per year, what is the value today of a perpetual stream of growing payments that begin at $27 next year and grow thereafter at 3.30% forever? c) Given an interest rate of 4.50% per year, what is the value at year t = 7 of a perpetual stream of constant $27 payments that begin at year t = 20?

a. For a perpetuity where the payments are constant and start in one period, the present value is simply PV=PMT/r = $27/.4050 =$600 b. For a growing perpetuity where the payments start in one period and grow at a constant rate, the present value is PV=PMT/r-g=$27/.4050 - .0330 =2,250 that is 3.75 times the value of the constant perpetuity c. A time line is particularly helpful in this case.The perpetuity formula calculates the value at one period before the perpetuity begins, which is year t = 19 in this case. V19=PMT20/r=$27/0.450=$600 To calculate its value at year t = 7, discount for (19 - 7) = 12 years PMT20 V7= R/ (1+R)^(20-1)-7= = 27 .0450. /. (1+.045)^12 = $600/ (1+.045)^12+$353.80

Chapter 13 example problem Suppose there is no corporate tax. Cayman Corp. has no debt but can borrow at 6%. The firm's WACC is currently 12% .a. What is Cayman's cost of equity? Briefly discuss. b. If the firm converts to 40% debt, what will its cost of equity be? Briefly discuss. c. If the firm converts to 40% debt (as in part b), what will its weighted average cost of capital be? Briefly discuss.

a. For an all-equity financed company with D = 0, rE = rWACC = 12% b. The cost of equity rises with a company's financial leverage. Ignoring taxes and with 40% debt and 60% equity:rE = rA + (rA - rD) * (D/E) = 12% + (12% - 6%)(.40/.60) = 16.0% c. The WACC with 40% debt and ignoring taxes is: rWACC = (D/V) rD + (E/V) rE = .40(6%) + .60(16%) = 12.00% Without special advantages (like tax shields) or disadvantages (like distress costs) to debt financing, a firm's weighted average cost of capital is not affected by leverage.

Chapter 5 example problem a) Given a discount rate of 8% per year, what is the value today of an annual stream of constant payments that begin next year at $2 and end after 30 payments? b) Given a discount rate of 8% per year, what is the value today of an annual stream of growing payments that begin next year at $2 and grow thereafter at 3% forever? c) Given a discount rate of 8% per year, what is the value today of an annual stream of constant payments that begin at year t = 10 at $2 and are constant forever?

a. For an annuity where the payments are constant (g = 0%) and start in one period, the present value is PV=PMT/r[1-(1+g/1=r)^t] = $2/.08[1-(1+.00/1+.08)^30] = $25[1-.009377] = 22.52 b. For a growing perpetuity where the payments start none period and grow at a constant rate, the present value is PV=PMT/r-g = $2/.08-.03 = $40 Growing payments that last forever are worth considerably more. c. A time line is particularly helpful in this case.The perpetuity formula calculates the value at one period before the perpetuity begins, which is year t = 9 in this case. V9 =PMT10/r = $2/.08 =$40 To calculate its value today at year t = 0, discount for 9 years PMT 10 V0=. r. / (1+r)^9 =. $2 .08. / (1+.08)^9 =. $25/ (1+0.8)^9 = $12.51 Delayed payments can sizably reduce the current value.

Chapter 4 example problems You plan to make one $3,000 contribution to an individual retirement account. Assume you will earn a 9% annually compounded return, make no additional contributions, and retire in 35 years. a) What will your account be worth when you retire in 35 years? Show your work. b) What will your account be worth when you retire in 35 years, if you wait for 5 years before making this contribution? Show your work.

a. Future Value in 35 years = $3,000 * (1 + 0.09)35 = $61,242 b. Set up a time line: an amount deposited in 5 years must be compounded 30 years to find its future value.Future value in 35 years = $3,000 * (1 + 0.09)35-5 = $39,803That's more than $21,000 extra. Start saving early!

Chapter 12 example problem Mulligan Corporation has a target capital structure of 30% debt, 10% preferred stock, and 60% common stock. Its cost of debt is 6.80%, its cost of preferred stock is 6.00%, and its cost of equity is 10.40%. Its marginal tax rate is 35%. a) After taxes, is debt financing cheaper or more expensive for Mulligan than financing with either preferred stock or common stock? b) What is Mulligan's weighted average cost of capital? c) What discount rate should Mulligan use when evaluating expansion projects? Briefly explain.

a. Interest is tax deductible (unlike dividends), so the company's after tax cost of debt is (1 - TC) rD = (1 - .35) 6.80% = 4.42%After taxes, debt is cheaper than financing with either preferred or common stock. b. WACC= D/V (1- TC) rd+ Pfd/V rPFD+ E/V rE WACC = .30 (1 - .35) (6.80%) + .10 (6.00%) + .60 * (10.40%) = 8.17% c. Mulligan should use the 8.17% WACC because it represents the cost of capital for existing operations from all financing sources, and expansion projects have similar risks to existing operations.

Chapter 13 Example problem JKL Co. has no debt, and its current cost of capital is 9%. A bank is willing to lend to JKL at 6%. Suppose that JKL borrows at this rate and converts to a debt-equity ratio of 0.5. a) Will JKL's new cost of equity increase, decrease, or remain the same? b) Ignoring taxes and other benefits and costs of debt, what return will JKL's equity investors require at this new debt-equity ratio of 0.5? c) Ignoring taxes and other benefits and costs of debt, what will JKL's new WACC be?

a. Modigliani and Miller's Proposition II confirms that financial leverage will increase a firm's cost of equity. b. When a company is all-equity financed, its cost of equity is the same as its WACC. rE=rA + (rA-rD)D/E = = 9% + (9% - 6%)(0.5) = 10.5% c. WACC does not change if there are no taxes and other benefits and costs to debt, as pointed out by MM Proposition I. For a .5 debt-to-equity ratio, leverage D/(D+E) = .5 / (.5+1) = 1/3. And for TC = 0, WACC= D/V (1-TC)rD+E/VrE(1-0)6%+1/.5+1 10.55=(%

Chapter 2 example problem Q2 A (a) Calculate the operating cash flow for 2010. Briefly discuss or interpret it. (b) Calculate the net capital expenditures for 2010. Briefly discuss or interpret it. (c) Calculate the investment in working capital for 2010. Briefly discuss or interpret it. (d) Calculate the Free Cash Flow From Assets for 2010. Briefly discuss or interpret it.

a. OCF = EBIT + Depreciation - Taxes = 120 + 120 - 35 = 205 The firm's existing assets generated $205m in cash during 2010. b. CapEx = ΔNFA + Depreciation = 1,300 - 1,200 + 120 = 220 The firm invested $220m in additional fixed assets during 2010, which is far more than enough to replenish depreciating capital and even a little larger than the operating cash flow from existing assets. c. ΔNWC = ΔCA - ΔCL = (410-400) - (210-160) = -40 The firm saved or recovered $40m in net working capital during 2010, driven by increasing its accounts payable, possibly by delaying payments to suppliers. d. FCF = (EBIT + Depreciation - Taxes) - CapEx - ΔNWA = 205 - 220 - - 40 = +25 The firm's cash flow generated from existing assets exceeds its investments in additional assets by $25m. That's the amount available to be paid to investors.

Chapter 2 example problem Q52 (a) How much did the firm receive from operating cash flows in 2013? b) Combined, how much did the firm spend in 2013 on new investments in both net working capital and in net capital expenditures? c) Calculate the firm's Free Cash Flows from assets. Briefly discuss or interpret it. AND briefly discuss how it was either paid for or used (hint in this case: if its Free Cash Flows were negative, what balance(s) increased, or if its FCFs were positive, what decreased?)

a. OCF = EBIT + Depreciation - Taxes = 26 + 47 - 7 = 66The firm's existing assets generated $66m in cash during 2013. Revenues exceeded cash costs by $73m, and $7m were paid in cash taxes. b.CapEx = ΔNFA + Depreciation = (442 - 470) + 47 = +19The firm invested $19m in additional fixed assets during 2013. While positive, that amount was insufficient to replenish depreciation, and its net fixed assets, net of depreciation, actually declined. ΔNWA = ΔCA - ΔCL = (194 - 186) - (319 - 284) = -27 The firm recovered $27m in net working capital during 2013, as its current liabilities climbed substantially more than its current assets did. Delaying payments to its suppliers actually reduces the cash that a firm requires for operations. Combined, the firm's 'investment' in capital expenditures and net working capital are +19 - 27 = -$8m, and since that amount is negative, the firm essentially divested in operations overall. c. The firm's operating cash flow from existing assets generated $66m, and combined with its $8m recovered investment in assets for future operations, its Free Cash Flows, available to be paid to investors, amounted to $74m. FCF = OCF - (CapEx + ΔNWA) = 66 - (-8) = +74 Of that amount, $6m was paid in interest on debt and $2m was paid in dividends to equity holders. The remainder $66m reduced the debt balance and/or the common & paid-in equity: The debt balance actually decreased by $54m and the equity balance decreased by $12m. Not only did this firm pay interest to debt holders and dividends to equity holders, this firm paid down its debt balance a lot and even (depending on accounting conventions) bought back some shares.

Chapter 18 Example Problem a) Which currency appreciated relative to the other over the period from December 2007 to September 2011? The British pound or the US dollar? b) If you exchanged $200 in London in September 2011, how many pounds would you receive? c. Today is September 2011. USACO is a US-based company that expects to repatriate ₤10 million in cash flows from a UK-based subsidiary in 6 months, but it is concerned that UK pounds will substantially depreciate over this time period. Explain what kind of risk this is. And explain how USACO could manage this risk. (No calculations are necessary, but they might be helpful.)

a. One UK pound was worth $1.9870 in December 2007, but was only worth $1.5586 in September 2011. The UK pound depreciated relatively to the US dollar. So, the dollar appreciated relative to the pound. Alternatively, one US dollar was worth ₤0.5033 in December 2007 and was worth even more at ₤0.6416 in September 2011. The US dollar appreciated relatively to the UK pound. b. Using the direct quote of $1.5586 per UK pound in September 2011, which is the spot quote for this currency, you would receive, by dividing, $200 / ($1.5586/₤) = ₤128.32 UK pounds. Alternatively, using the indirect quote of ₤0.6416 per US$, you would receive, by multiplying, $200 * (₤0.6416/$) = ₤128.32 UK pounds. c. This exchange rate risk is that foreign currency cash inflows might decrease in local currency (US$) value. While ₤10m UK pounds are worth $15.586m today, USACO will likely not be able to repatriate the ₤10m UK pounds at the current exchange rate, unless by chance the exchange rate in 6 months turns out to be exactly the same. In fact, note that the market expects that the pound will continue to depreciate over these 6 months. To manage that risk, USACO could enter into a forward contract to lock in the $1.5561/₤ forward rate to be sure to convert the ₤10m foreign cash flows into $15.561m in 6 months. If the exchange rate in 6 months turns out to be less than $1.5561/₤, USACO will be better off having locked in the forward rate today. If the exchange rate in 6 months turns out to be higher than $1.5561/₤, as it currently is, USACO would have been better off if it had not entered into a forward contract today. There is no way for USACO to lock in the current exchange rate due to interest rate differentials, which is a key point of Interest Rate Parity.

Chapter 7 example question a) ABC just paid a $0.40 annual dividend expected to grow at 5% forever and its investors require 7.1% return. Estimate the price of ABC's stock using the Gordon Growth Model. (b) Suppose investors suddenly realize that ABC's growth rate is actually only 4%. What will happen to its share price?

a. P0= D0(1+g)/r-g)= D1/r-g = $.40(1+.05)/.071-.05=$20 b. Drop to $13.42 for g = .04, which is a sharp 33% decrease. Share prices can be extremely sensitive to forecasted growth rates.

Chapter 5 example problem Jeffson Inc. just signed a contract to lease office space for 9 years. The appropriate discount rate is 6% per year. Show your work. a) If the annual lease payment is fixed at $3 million and the first payment is made one year from today, what is the current value of these lease payments? b) If the annual lease payment starts at $2 million one year from today and grows every year after by 10% per year, what is the current value of these lease payments? c. If the annual lease payment is fixed at $3 million and the first payment is today, what is the current value of these lease payments?

a. PV= 3M/.06[1- 1/(1+.06)^9] =3M/.06[.4081}=20.4M b. PV=2M/.06-.10[1-(1+.10/1+06)^9] = 2M/-.04[-.3957]=19.8M C. While lessors can provide incentives, like payments in arrears or delayed/growing payments, usually leases are fixed and require payments in advance, like an annuity due. The annuity formula calculates the value of an annuity one period before the first payment. V-1=3M/.06[1- 1/(1+.060^9] = 3M/.06[.4081] =20.4 So compound that forward by one period to today: V0 = $20.4m * (1 + 6%)1 = $21.6m

Chapter 8 example problem MUST KNOW FOR THE EXAM 15b Consider the following independent projects (these are not mutually exclusive) Whichever project you choose, if any, you require a 10% return on your investment. a) Calculate each project's payback, and show your work. If you require projects to pay back within 2 years, which investment(s) will you choose? Briefly why? b) Calculate each project's NPV given that you require 10% return on your investment, and show your work. Which investment(s) will you choose? Briefly why? c) Based on these answers, which project(s) will you finally choose? Briefly why? d) Is the IRR on project A larger or smaller than zero? Is it larger or smaller than the required return? Briefly describe how you can tell?

a. Project A pays back within 2 years: PaybackA = 1 + (160-110)/60 = 1.83 yearsProject B pays back beyond 2 years: PaybackB = 2 + (100-20-50)/80 = 2.38 years Using payback, accept project A and reject project B. b. NPVA = - $2.9NPVB = + $19.6Reject project A since its NPV is negative, but take project B since its NPV is positive. c. These are independent projects, so both, one, or neither could be accepted. You should reject project A and only take project B because project A destroys value and project B creates value. d. The IRR on project A is greater than zero since it does pay back over time, yet it is below the required return since its NPV is negative. (When a project's initial investment is followed by only positive cash flows, the IRR criterion is consistent with NPV.)

Chapter 3 example problem Chess Pawns has a market-to-book ratio of 3.2x, a total asset turnover ratio of 1.2x, a profit margin of 5%, a target retention ratio of 80%, total assets of $120,000, and an equity multiplier of 1.4x. a) What is its sustainable growth rate? b) Could Chess Pawns change its dividend payout policy to achieve a sustainable growth rate of 10%? Explain why or why not?

a. ROE = 5% * 1.2x * 1.4x = 8.4% Sustainable growth rate = [.084 * .80] / [1 - (.084 * .80)] = .072 or 7.2% b. The least that can be paid out of net income is 0% dividends, and thus retain the maximum 100%. With that, the sustainable growth rate = [.084 * 1.00] / [ 1 - (.084 * 1.00)] = .092 or 9.2% Or note that the implied retention ratio to reach 10% growth is b = g / [ROE * (1 + g)] = .10 / [.084 * (1+.10)] = 108% which is not feasible. So, it is not possible for Chess Pawns to reach 10% growth by simply changing its dividend policy. To get to 10% growth, some combination of the following would be required: -Less dividends and, thus, higher retention - Raising cash through additional equity, such as issuing more shares - Higher profit margin Improved asset turnover -Increased leverage

Chapter 10 example problem Historically, long-term Treasury bonds have averaged about 6% return with 10% volatility per year. Currently, long-term Treasury bond yields are about 2%.a) What return should investors expect to earn if they hold long-term Treasury bonds until maturity? Briefly explain. b) Using the historical data as a guide, what range of returns would you expect to see 99 percent of the time for long-term Treasury bonds?

Yields on safe bonds represent the return that investors should expect to earn on bonds in the future. While investors have historically earned 6% on bonds, they should only expect to earn the current 2% yield on these in the future. b. Assuming that returns are normally distributed, the range of returns you would expect to see 99 percent of the time is within three standard deviations of the mean. μ - 3σ ≤ r ≤ μ + 3σ6% - 3*(10%) ≤ r ≤ 6% + 3*(10%) -24% to 36% [Given that yields, and thus future expected returns, are currently only 2%, not 6%, the mean is lower by 4% and the forecasted range should actually be -28% to 32%.]That's a rather wide range for anticipated returns in any given year, particularly given that bonds are considered to be relatively safe investments. Also, 1% of the time (or 1 in 100 years), long-term bond returns are anticipated to be outside of that range!While long-term Treasury bond yields represent safe returns if they are held to maturity, their prices change over time and, hence, their returns fluctuate during the time they are held, which is a risk if they are sold before maturity and/or their coupons are reinvested at then-prevailing market rates.

you have another cousin, damon. he's an eleven-year-old, and he asks a lot of questions at Thanksgiving. a little bit too many, but he's harmless so everybody goes along with it. he hears that you are a business major. he asks you what a balance sheet is - how do you reply?

a balance sheet is a financial statement that lists the book value of a company's assets, liabilities, and equity. the items are listed in descending scale in terms of liquidity, or ease of conversion to cash.

Chapter 18 Example Problem Show your calculations using this information: U.S. $ EQUIVALENT CURRENCY PER U.S. $ Poland Zloty 0.3033 3.3747 Euro 1.3206 0.7572 Mexican Peso 0.0757 13.2100 Switzerland Franc 0.8827 1.1366 Chilean Peso 0.001734 576.70 a) How many Polish zlotys can you get for $200? b) Which is worth more, a Mexican peso or a Chilean peso? c) How many Swiss francs can you get for a euro?

a. $200 * 3.3747 zlotys / $ = 674.94 Polish zlotys b. One Mexican peso is worth $0.0757 One Chilean peso is worth $0.001734 So, one Mexican peso is worth more than one Chilean peso (and in any currency due to cross rates). c. One euro buys $1.3206 Each US dollar buys 1.1366 Swiss francs So, multiplying (and crossing out the US dollars): ($1.3206 / euro) * (1.1366 Swiss franc / US dollar) = 1.5010 Swiss francs per each euro

Chapter 17 example problem a. Fill in the blanks: The firm's customers have ______ days to pay in order to receive a ________ percent discount. b. What effective annual interest rate does the firm earn when a customer does not take the discount (assuming the customer pays the amount due at the end of the credit period)? Show your calculation.

a. 14 days, 2% discount b. EAR = [1 + (0.02/(1 - 0.02))]365/(42 - 14) - 1 = 30.13%

if any, which of the following statements is FALSE? a. capital budgeting is the process of planning and managing a firm's long-term investments where managers identify investments that are worth more than they cost to acquire. b. capital structure is the mix of debt and equity maintained by a firm to finance operations, where the firm decides how much to borrow and what the cheapest sources of funds are. c. working capital management is the day-to-day management of finances that determines how much cash and inventory should be kept on hand, whether to sell on credit to customers, and how to obtain short-term financing. d. none of the above statements is false.

d. none of the above statements is false.

which of the following statements is FALSE?

managers should use the average tax rate when making decisions regarding new investments and financing choices.

Tesla's earnings per share is negative. Why do you think investors are willing to pay for a company that has negative net income?

people are willing to invest money in a company that is not CURRENTLY making a profit if they believe it will make a profit in the FUTURE. In future chapters, we will talk more about how to value companies - many of which lose money during their early growth phase.

Chapter 13 Equations

rE=rA+(rA-rD)D/E VL = VU + TCD WACC=D/V (1-TC)rD + E/VrE

which of the following statements is true?

time interest earned, also known as the interest coverage ratio, provides a relative measure of how well a firm can service its debt

formulaically, the ONLY difference between an annuity and a perpetuity is the annuity factor

true

if all else were equal, you would rather have a perpetuity than an annuity.

true, perpetuity payments last forever, while annuity payments end at a point.

Chapter 5 example problem (a) In one year, you plan to make your first contribution to your individual retirement account. If you contribute $100 for each of the next 46 years until you retire, what will your account be worth then? Assume you will earn a 6% yearly compounded rate of return. Show your work.

a. The present value of a $100 annuity for 46 years at 6% interest is PV = $100 / .06 * [1 - 1/(1+.06)46] = $1,552.44 Its future value after 46 years is FV = $1,552.44 * (1+.06)46 = $22,651 Suppose that you had contributed $4,600 today without any future contributions, then at a 6% rate compounded annually, its future value would be FV = $4,600 * (1 + .06)46 = $67,116 That's more than 3 times the value of $100 contributions for 46 years. Large early contributions make a sizeable difference. b. The present value of an annuity starting at $100 and growing at 7% for 46 years at 6% interest is PV = $100 / (.06 - .07) * [1 - ((1+.07)/(1+.06))46] = 100 / (-.01) * [-0.54022] = $5,402.24 (two negatives do make a positive) Its future value after 46 years is FV = $5,402.24 * (1+.06)46 = $78,821 Your last contribution in 46 years, 45 years after the first, will grow to PMT = $100 * (1 + .07)45 = $2,100.25 So, if you start with small retirement contributions, plan to make up for them with a high growth rate.

Chapter 10 example problem A stock has had returns of 30%, -36%, and 15% over the past three years. a) What was its historical arithmetic average return? How much would $1 invested in this stock three years ago be worth today (that is, calculate the total return index over these three years)? b) What was the historical volatility for this stock? Show your calculation.The deviations of each of these returns from the 3% mean arithmetic average return are:27%, -39%, and 12%

a. The arithmetic average return is the sum of the returns divided by the number of returns Arithmetic average return = (.30 - .36 + .15) / 3 = .03 = 3% The geometric return is the annualized compounded growth of a dollar invested: Geometric average return = [(1 + .30)(1 - .36)(1 + .15)](1/3) - 1 = -.0146 = -1.46% Remember that the geometric average return is less than the arithmetic average return if the returns have any variation. The total return index after 3 years is (1 - .0146)3 = [(1 + .30)(1 - .36)(1 + .15)] = $0.9568.Even though the arithmetic average return was positive, this stock lost value, and a dollar invested in it is worth less than a dollar today. b. To calculate variance, square each deviation, sum them, and divide by one less than the sample number (27)2 + (-39)2 + (12)2 ] / (3 - 1) = 1,197 To calculate standard deviation, take the square root. Volatility = σ = √1,197 = 34.6% which is a percentage because volatility has the same units as the returns.

Chapter 10 example problem A stock has had returns of 70%, -50%, 14%, and 22% over the past four years. a) What was its historical arithmetic average return? Show your calculation. b) What was the historical volatility for this stock? Show your calculation.The deviations of each of these returns from the 14% mean arithmetic average return are:56%, -64%, 0%, and 8% c) Calculate either the exact or the approximate geometric compound return. Discuss how it compares to the arithmetic average return.

a. The arithmetic average return is the sum of the returns divided by the number of returnsArithmetic average return = (.70 - .50 + .14 + .22) / 4 = .14 = 14% b. The deviations of each of these returns from the 14% mean arithmetic average return are: 56%, -64%, 0%, and 8% To calculate variance, square each deviation, sum them, and divide by one less than the sample number[ (.56)2 + (-.64)2 + (0)2 + (.08)2 ] / (4 - 1) = .2432 To calculate standard deviation, take the square root. Volatility = σ = √.2432 = .493 = 49.3% which is a percentage because volatility has the same units as the returns.[That is about the same volatility as a typical single stock, and it is considerably larger than the volatility of a diversified portfolio of stocks.] c. The total return index of $1 invested in this stock four years ago would today be worth $1 * [(1 + .70)(1 - .50)(1 + .14) (1 + .22)] = $1.1822 The exact geometric average return is the annualized compounded growth of that dollar invested, or Exact geometric average return = [$1.1822](1/4) - 1 = .0427 = 4.27% The approximate average return can be estimated from the arithmetic average and the volatilityGeometric average ≈ arithmetic average - ½ volatility2 = .14 - ½ (.493)2 = .0184 = 1.84% [This approximation would match the exact geometric (or compound) average return if the returns followed a normal distribution, unlike this sample of only 4 observations.]The geometric average return is considerably less than the arithmetic average return. The arithmetic average return represents the return expected in an average year. The geometric average return represents the annualized compound return over a period of many years.

which of the following statements is TRUE?

all stock trades between existing shareholders are secondary market transactions.

your cousin thinks that answer was good, but not great. He wants to know more, so he follows up and asks you what an income statement is - what do you say?

an income statement lists all of the companies revenues, minus all of it's expenses in order to arrive at a net income figure. Revenue comes from sales to your customers, while expenses come from a variety of sources like payroll, product costs, research costs, rent, taxes, etc.

Chapter 11 equations

A portfolio's beta equals the weighted average of the component betas: βP = wA βA + wB βB = .6 (1.2) + .4 (0.8) = 1.04 weighted average of the component volatilities: σP < wA σA + wB σB = .6 (40%) + .4 (50%) = 44% expected return is the weighted average: E[rP] = wA E[rA] + wB E[rB] evel of risk, its expected return should be E[rY] = rF + βY * MRP

Which one of the following statements is true concerning the price-earnings (PE) ratio?

A. A high PE ratio typically indicates that a firm is expected to grow significantly.

Which of the following will increase the value of a call option?

A. An increase in the underlying stock price further above the strike price

Which of the following statements is FALSE? A. Asset-specific risks can be easily diversified with highly correlated assets in a portfolio B. Asset-specific risks can be easily diversified with numerous assets in a portfolio C. Bearing risk is rewarded with higher expected returns D. Only market-wide risks, not asset-specific risks, should earn rewards

A. Asset-specific risks can be easily diversified with highly correlated assets in a portfolio

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

A. Automatically gives preferential treatment in the allocation of funds to its riskiest division

Which one of the following methods of analysis is most similar to computing the return on assets (ROA)?

A. Average accounting return

Which of the following is NOT an example of an option found in financial claims?

A. Bank loans in which a firm is obligated to pay interest and principle over time

Which of the following statements is TRUE? A. By investing in varied and numerous assets, an investor is able to virtually eliminate all asset-specific risks in her portfolio, both easily and cheaply. B. It is possible, but not very easy, for an investor to control market-wide risks in his portfolio, and increases in these market-wide risks are costly because they reduce expected returns. C. The most important characteristic in determining the expected return of a well-diversified portfolio is the total variance risks of the individual assets in the portfolio. D. When a portfolio has a positive investment in every one of its assets, its standard deviation cannot be less than that on every asset in the portfolio.

A. By investing in varied and numerous assets, an investor is able to virtually eliminate all asset-specific risks in her portfolio, both easily and cheaply.

Suppose Miller Inc. is able somehow to reduce its fixed assets without affecting the company's operations, sales, net income, or equity. This reduction will decrease which of the following ratios?

A. Capital intensity ratio

Which of the following refers to a customer's willingness to meet his or her credit obligations?

A. Character

Which one of the following is most apt to align management's priorities with shareholders' interests?

A. Compensating managers with shares of stock that must be held for 3 years before the shares can be sold

Which of the following is an advantage of the corporate form of organization?

A. Corporations can easily raise capital and its ownership can be transferred easily.

All else constant, which one of the following will decrease the cash cycle?

A. Decreasing the credit period granted to a customer

Chapter 3 example problem Based on the information below, calculate the sustainable growth rate for Southern Lights Co. Briefly discuss whether you believe this growth rate is actually sustainable. Profit Margin = 8.4% Capital Intensity Ratio = 0.45 Leverage Ratio = Liabilities / Equity = 0.60 (described in the RWJ text as the Debt-Equity Ratio) Net Income = $95,000 Dividends = $40,000

Asset Turnover = 1 / Capital Intensity Ratio = 1 / 0.45 = 2.22 Equity Multiplier = 1 + Leverage Ratio = 1.60 ROE = Profit Margin * Asset Turnover * Equity Multiplier = (0.084)(1/0.45)(1+0.60) = 29.9% b = Plowback Ratio = (Net Income - Dividends) / Net Income = (95,000 - 40,000) / 95,000 = 0.58or b = 1 - Payout Ratio = 1 - Dividends/Net Income = 1 - (40,000/95,000) = 0.58 Sustainable growth rate = [ROE*b] / [1 - ROE*b] = [0.299(0.58)] / [1 - 0.299(0.58)] = 20.9%Surely, 20.9% growth rate is not sustainable in the long run. The reason why that is unbelievably high is likely because the current 29.9% ROE is exceptional and not likely to continue forever.

Chapter 10 example problem Over the long term, small cap stocks have averaged 16.4% return with 33.0% volatility per year. Using history as a guide, what range of returns would you expect to see 95 percent of the time for small cap stocks?

Assuming that returns are normally distributed, the range of returns you would expect to see 95 percent of the time is within two standard deviations of the mean. μ - 2σ ≤ r ≤ μ + 2σ16.4% - 2(33.0%) ≤ r ≤ 16.4% + 2(33.0%) -49.6% to 82.4% That's an extremely wide range for anticipated returns in any given year,and 5% of the time (or 1 in 20 years), small cap returns are anticipated to be outside of that range!

Which of the following statements is FALSE? A. While the book value of equity can be negative, the market value of equity cannot be negative. B. On the income statement, financial analysts often focus on a company's EBIT, and items above this line depend on the company's long-term financing choices among debt and equity. C. The average tax rate is always less than or equal to, and often considerably less than, the marginal tax rate. D. Managers should use the marginal tax rate when making decisions regarding new investments and financing choices.

B. On the income statement, financial analysts often focus on a company's EBIT, and items above this line depend on the company's long-term financing choices among debt and equity.

Which of the following statements is FALSE? A. A bond's yield represents the annualized return that an investor would earn by holding it to maturity, if it does not default. B. Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease. C. When interest rates increase, then bond prices fall, and moreso the longer their maturity and the smaller their coupons. D. If a bond is held to maturity and it does not default, then the reinvestment rate risk will offset the price risk.

B. Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease.

Which of the following statements is TRUE? A. When yields increase, bonds with shorter maturities tend to decrease in value more than bonds with longer maturities. B. Over time, if yields do not change, the values of premium bonds decrease toward par smoothly. C. A "call provision" allows the bond holder the option to determine when they want the company to buy back the bond. D. Treasury Bonds are pure discount loans sold by the US government as a means to borrow money for less than one year.

B. Over time, if yields do not change, the values of premium bonds decrease toward par smoothly.

Which of the following statements is FALSE? A. The current ratio provides a measure of the short-term solvency of the firm. B. Price-earnings ratio reflects the book value per share per dollar of accounting earnings for a firm. C. Total asset turnover measures how much in sales is generated by each dollar of firm assets. D. Times interest earned, also known as the interest coverage ratio, provides a relative measure of how well the firm's operating earnings can cover current interest obligations.

B. Price-earnings ratio reflects the book value per share per dollar of accounting earnings for a firm.

Hon just bought 800 shares of TYUJ stock, which has been trading for some time on the NYSE. In which market did Hon's purchase occur?

B. Secondary market

Which of the following statements is TRUE? A. Activities that increase cash are called uses of cash, and activities that decrease cash are called sources of cash. B. Sources of cash always involve increasing a liability or equity account, or decreasing an asset account (other than cash); for example, decreasing fixed assets by selling some property, plant, and equipment, is considered a source of cash. C. The accounts payable period is the time between the sale of inventory and the collection of the receivable. D. The operating cycle is the time period between cash disbursement and cash collection.

B. Sources of cash always involve increasing a liability or equity account, or decreasing an asset account (other than cash); for example, decreasing fixed assets by selling some property, plant, and equipment, is considered a source of cash.

Which of the following statements is TRUE? A. Companies are required by law to have their bonds rated by agencies such as Moody's or S&P. B. The Fisher effect is the relationship between nominal returns, real returns, and inflation. C. Investors require higher yields on secured bonds than on unsecured bonds. D. A callable bond can be swapped for a fixed number of shares of stock before maturity at the holder's option.

B. The Fisher effect is the relationship between nominal returns, real returns, and inflation.

Which of the following should not be included in the analysis of a proposed investment?

B. The amount paid 4 years ago for an existing building to be used in the project.

Which of the following statements is FALSE? A. An easy way to compute the value of an annuity due (such as a lease) is to compute the value of a regular annuity, and then compound the result forward one period. B. The annual percentage rate (APR) is the best way to compare two investments with different compounding periods. C. Lenders and investors prefer daily compounding to annual compounding. D. The process of paying off a loan by making regular principal reductions is called amortizing.

B. The annual percentage rate (APR) is the best way to compare two investments with different compounding periods.

Which of the following statements is FALSE? A. Over the long run, investments in small-company stocks have had the largest return but also the most risk, when compared with large-company stocks, bonds, and T-Bills. B. The average return is always less than the geometric return. C. Investors who hold bonds instead of stocks over long horizons can be rational and relatively averse to risk. D. Unlike the capital gains yield, the dividend yield can never be negative.

B. The average return is always less than the geometric return.

Which of the following statements is FALSE? A. The cost of capital is the minimum required return to compensate financial investors. B. The cost of capital for a project depends primarily on the source of funds. C. The cost of equity is the return required by equity investors given the risk of the cash flows from the firm. D. A firm's WACC reflects the average risk of the existing projects undertaken by the firm.

B. The cost of capital for a project depends primarily on the source of funds.

Which of the following statements is FALSE? A. Credit management trades off the carrying the cost of extending credit to buyers against the goal of increasing sales. B. The credit period is typically longer for perishable goods and for buyers with higher credit risk. C. Terms of sale "2/10 net 45" indicates a 2% discount if paid within 10 days, with the total amount due in 45 days if the discount is not taken. D. Banker's acceptances are credit commitments made before delivery, are guaranteed by banks, and are common in international trade.

B. The credit period is typically longer for perishable goods and for buyers with higher credit risk.

Which of the following statements is FALSE? A. The internal rate of return is defined as the discount rate which results in a zero net present value for the project. B. The primary advantage to payback analysis is that it biases companies to invest in long-term projects that require large current expenditures on research and development. C. The average accounting return ignores cash flows is most similar to computing the return on assets (ROA). D. The profitability index reflects the value created per dollar invested.

B. The primary advantage to payback analysis is that it biases companies to invest in long-term projects that require large current expenditures on research and development.

Which of the following statements is FALSE? A. The impacts of estimation errors and forecasting risks are small when NPVs are large and positive. B. Under intense competition, positive NPV projects are as common as negative NPV projects. C. Scenario analysis helps determine the reasonable range of expectations for a project's outcome. D. Sensitivity analysis helps identify the variable within a project that presents the greatest forecasting risk.

B. Under intense competition, positive NPV projects are as common as negative NPV projects.

Sensitivity analysis:

B. helps identify the variable within a project that presents the greatest forecasting risk.

If the financial markets are semi-strong form efficient, then:

B. only individuals with private information have a marketplace advantage.

Operating cash flow is defined as:

B. the cash that a firm generates from its normal business activities using its existing assets.

Which of the following statements is FALSE? A. Market capitalization is the number of shares outstanding times the market price. B. A company with a .05x interest coverage ratio would be at less risk of missing payments on interest than a company with a 4.9x interest coverage ratio. C. The DuPont Identity is an expression that breaks the return on equity into three parts that measure operating efficiency, asset use efficiency, and financial leverage. D. Sometimes book equity can become negative, and when that happens, positive ROE is not a good sign.

B. A company with a .05x interest coverage ratio would be at less risk of missing payments on interest than a company with a 4.9x interest coverage ratio.

Which of the following statements is FALSE? A. The cost to a firm for capital funding equals the expected return to the providers of those funds B. A firm's cost of capital depends primarily on the source of the funds, not the use C. WACC is affected by market conditions including interest rates, tax rates, and the market risk premium D. A firm's WACC reflects the average risk of the existing projects undertaken by the firm

B. A firm's cost of capital depends primarily on the source of the funds, not the use

Which of the following statements is TRUE? A. The Gordon Growth Model assumes constant dividend growth but implies that stock prices grow at a different rate. B. A stock's price is the present value of its future cash flows, namely, its expected capital gains and dividends. C. Brokers buy and sell securities from their own inventory, while dealers bring buyers and sellers together to complete transactions. D. Holders of common stock have greater voting rights in corporate decisions than holders of preferred stock, but they have less voting rights than creditors of the corporation.

B. A stock's price is the present value of its future cash flows, namely, its expected capital gains and dividends.

Which one of the following most likely represents the greatest political risk for a U.S.-based firm?

B. A. A Koch Industries oil refinery in a port in Venezuela

Which was a source of cash, increasing a firm's cash balance, all else equal?

B. Accounts payable increased by $50 million.

Which of the following statements is FALSE? A. Financial Managers make three basic types of decisions: Capital Budgeting, Capital Structure, and Working Capital Management. B. Capital budgeting is the process of planning and managing a firm's short-term investments. C. The primary goal for corporate managers should be to make good decisions to maximize the market value of the owner's equity. D. Agency conflicts, which sometimes arise when CEOs are overly motivated to seek job security, can be reduced by adjusting managerial compensation.

B. Capital budgeting is the process of planning and managing a firm's short-term investments.

An agent who buys and sells securities from inventory is called a:

B. Dealer

Which one of the following activities is a source of cash?

B. Decreasing accounts receivable

Which of the following statements is FALSE? A. Float equals the difference between the cash balance available at the bank and the cash balance recorded on the firm's books, and float also equals the sum of the disbursement float and the collection float (which is negative). B. Firms prefer to maintain a net collection float, rather than a net disbursement float, because they are receiving more money than they are spending. C. Firms often invest idle cash in money market securities which are short-term, safe, and easily marketable D. The income from investing excess cash in T-Bills is exempt from all state taxes, but the income from investing it in munis is exempt from all federal taxes. B.

B. Firms prefer to maintain a net collection float, rather than a net disbursement float, because they are receiving more money than they are spending.

Which one of the following is most indicative of a flexible short-term financial policy?

B. High ratio of current assets to sales

The average accounting return method of analyzing projects:

B. Is similar to calculating the Return on Assets.

Which of the following statements is FALSE? A. Unlike equity holders, debt holders are not owners B. Lenders can exert control over a company's managers by voting for its board of directors .C. A corporation cannot deduct its payments to preferred shareholders before it pays taxes D. Holders of convertible bonds can force bankruptcy if their coupons are not paid

B. Lenders can exert control over a company's managers by voting for its board of directors

Which of the following statements is FALSE? A. The APR should not be used to compare two investments with different compounding periods. B. Lenders prefer less frequent compounding. C. Treasury Bills are pure discount loans with no coupon payments. D. Typical bullet bonds are interest-only loans where the principal is not amortized.

B. Lenders prefer less frequent compounding.

Suppose a U.S. firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies, and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following?

B. Long-run exposure to exchange rate risk

Chapter 8 example problem MUST KNOW FOR THE EXAM 15c Consider the following mutually exclusive projects: You require 10% return on your investment in either of these projects. a) Calculate each project's NPV. Show your work. Based solely on the NPV criterion, which investment should be chosen? Briefly why? b) The IRR on project A is 15.5%. Is the IRR on project B larger or smaller than 15.5%? Show or describe how you can tell. And based solely on the IRR criterion, which investment should be chosen? c) [Dropped from question] Based on your NPV and IRR analysis, which project(s) will you finally choose? Briefly explain? d) If you are capital constrained and unable to accept all of the positive NPV projects available to you, which project should you rank higher?

A. Discounting the cash flows at 10%, the NPVs areNPVA = + $62.6NPVB = + $19.6Both projects' NPVs are positive, but they are mutually exclusive. So take project A since its NPV is higher. B. Using a 15.5% discount rate on Project B's cash flows, its NPV would be +6.7. Since that is positive, the IRR on project B must be larger than 15.5%, and in fact it is 18.8%.Both IRRs exceed the 10% required return, and since project B has a higher IRR, the IRR criterion would lead to the choice of project B. (Note: this exemplifies the size problem for IRRs: the higher 18.8% IRR is the expected return on project B's investment of only $100, compared to project A's 15.5% expected return on its larger investment of $860. Project A creates more value.) c. These are mutually exclusive projects, so only one or neither, but not both, could be accepted. You should take project A and reject project B because, while both would create value, project A creates more value than project B does. d. The profitability index on project B is higher, primarily since it requires a smaller initial cash outflow. PIA = (62.6 + 860) / 860 = 1.073 PIB = (19.6 + 100) / 100 = 1.196 Rank project B higher, when facing a capital constraint.

Chapter 5 example problem Under which credit terms would you rather borrow? (A) 20% APR compounded annually, or (B) 19% APR compounded daily. Show your work, or describe your reason(s).

A. For compounding frequency m=1, the EAR = APR = 20% B. For compounding frequency m=365, EAR = [1 + (APR / m)]m - 1 = [1 + (.19 / 365)]365 - 1 = 20.9% As a borrower you want the lowest interest possible. Comparing Effective Annual Rates shows that 20% with annual compounding is actually nearly a full percent cheaper than 19% with daily compounding, which only seems cheaper.

Which of the following statements is TRUE? A. If a portfolio has a positive investment in every asset, the standard deviation on the portfolio can be less than that on every asset in the portfolio. B. Labor strikes and part shortages are examples of market-wide systematic risks. C. Market-wide systematic risks can be significantly reduced by diversification. D. Asset-specific unsystematic risks can be substantially reduced with less numerous and less correlated assets in a portfolio.

A. If a portfolio has a positive investment in every asset, the standard deviation on the portfolio can be less than that on every asset in the portfolio.

Which of the following statements is TRUE? A. It is better to use Geometric Return than Average Return to forecast what the stock market over the next 50 years B. The return earned in an average year over a multiyear period is known as the geometric return C. The compound return earned per year over a multiyear period is known as the arithmetic average return D. The average return is always smaller than the geometric return

A. It is better to use Geometric Return than Average Return to forecast what the stock market over the next 50 years

Which of the following statements is FALSE? A. MM Proposition 1, if there are no taxes, states the value of the firm does not depend whatsoever on its capital structure. B. MM Proposition 2, if there are no taxes, explains how the cost of equity decreases as the firm increases its use of debt financing. C. Because interest expense is tax deductible, leverage increases the firm's value by the amount of the present value of the interest tax shield. D. Because interest expense is tax deductible, a firm's WACC decreases as firms rely more heavily on debt financing.

B. MM Proposition 2, if there are no taxes, explains how the cost of equity decreases as the firm increases its use of debt financing.

Which of the following statements is FALSE? A. Like Johnson & Johnson (JNJ), nearly all of the 30 Dow Jones Industrial companies were forced to reduce their dividends per share in 2009 and again in 2010 due to the Great Recession. B. Apple paid its first dividend to common shareholders in 2012, and Berkshire Hathaway has not yet paid dividends to common shareholders. C. The dividend yield on the S&P500 has been approximately 2% in recent decades, and tends to be lower when prices rise. D. Share repurchases have become more common over the past half century, and over the same period, the dividend yield has trended downward.

A. Like Johnson & Johnson (JNJ), nearly all of the 30 Dow Jones Industrial companies were forced to reduce their dividends per share in 2009 and again in 2010 due to the Great Recession.

Which of the following statements is FALSE? A. Like typical large US companies, Apple uses about 60% debt in its capital structure. B. In a Chapter 7 bankruptcy liquidation, employees and trade creditors have lower priority among claimants than senior and secured lenders. C. In a bankruptcy reorganization, middle managers or 'white collar' employees lose their jobs more commonly than production workers or 'blue collar' employees. D. Following a Chapter 11 filing a few years earlier and failed attempts to negotiate concessions with its unions, Hostess again in 2012 filed for bankruptcy with the intent to liquidate its assets.

A. Like typical large US companies, Apple uses about 60% debt in its capital structure

Which of the following statements is FALSE? A. One reason why the Average Accounting Return is a flawed measure in making business decisions is that it is based on cash flows. B. IRR measures the dollar-weighted return on an investment. C. In order to use the Payback Rule as a tool to determine if an investment is acceptable, a manager needs to provide a pre-specified limit of time for recouping investment costs. D. The Profitability Index measures the value created per dollar invested, based on the time value of money.

A. One reason why the Average Accounting Return is a flawed measure in making business decisions is that it is based on cash flows

New Century Products is a company that was founded last year. While the outlook for the company is positive, it currently has negative earnings. If you wanted to measure the progress of this firm, which one of the following ratios would probably be best to monitor given the firm's current situation?

A. Price-sales ratio

Which of the following statements is FALSE? A. Promissory notes are the most common credit instrument. B. The evidence of indebtedness in an open account is the invoice. C. For commercial drafts, the buyer accepts it and commits to payment before delivery. D. Banker's acceptances are commonly used in international trade.

A. Promissory notes are the most common credit instrument.

Given an interest rate of zero percent, the future value of a lump sum invested today will always:

A. Remain constant, regardless of the investment time period.

Which of the following statements is FALSE? A. Sensitivity analysis helps determine the reasonable range of expectations for a project's outcome. B. The impacts of estimation errors and forecasting risks are small when NPVs are large and negative C. Under intense competition, positive NPV projects are rare. D. The error of commission, or Type 1 error NPV estimation, is the risk that a project will be accepted when its true NPV is negative.

A. Sensitivity analysis helps determine the reasonable range of expectations for a project's outcome.

Which of the following statements is CORRECT? A. Shareholder's equity is the residual value of a firm B. Net working capital must be a positive value C. An increase in cash reduces the liquidity of a firm D. Equipment is generally considered a highly liquid asset

A. Shareholder's equity is the residual value of a firm

Which of the following statements is FALSE? A. The effect of compounding is great over short time periods, but then it begins to decline as the horizon grows. B. Moving cash flows to the left on a time line is called discounting, and values are additive at any one point in time. C. Future value refers to the amount of money an investment will grow to over some period of time at some given interest rate. D. To estimate the present value of future cash flows, the discount rate should be adjusted for both the timing or maturity of that cash flow and the inherent risk of that cash flow

A. The effect of compounding is great over short time periods, but then it begins to decline as the horizon grows.

Which of the following statements is TRUE? A. The marginal tax rate for most U.S. corporations prior to 2018 was 35% while the average tax rate actually paid across U.S. corporations had actually been closer to 25% B. A Limited Liability Company (LLC) is legally defined as a person, while a corporation with limited liability is considered a partnership of several persons C. The ability of a corporation to grow can be seriously limited by an inability to raise cash via the primary capital markets for investment. D. According to the theory of the firm, among all stakeholders, the stockholders take the least risk.

A. The marginal tax rate for most U.S. corporations prior to 2018 was 35% while the average tax rate actually paid across U.S. corporations had actually been closer to 25%

Which of the following statements about the corporate form of ownership is FALSE? A. The shareholders are the owners of the firm and hold the top priority claim among all stakeholders. B. The shareholders elect the directors of the corporation, usually in uncontested elections. C. The directors appoint the firm's management, and yet managers usually participate in nominating new candidates for directors. D. Separation of ownership from control can cause agency problems where managers act in their own interests, rather than shareholders' interests.

A. The shareholders are the owners of the firm and hold the top priority claim among all stakeholders.

Which of the following statements is TRUE? A. The value of a call option can never be negative. B. The value of a call decreases as the price of the underlying stock increases. C. The value of a call increases when the volatility of the underlying asset's returns decreases. D. The intrinsic value of a call must be zero on the expiration date.

A. The value of a call option can never be negative.

You own 100 shares of JKL Inc. which has 20,000,000 shares outstanding that currently sell for $40 per share. JKL has previously announced a dividend of $0.80 per share with an ex-dividend date of May 31. Assume there are no taxes or other special advantages or disadvantages of dividends. If you take no action, which of the following statements is TRUE?

A. You should expect the stock price to drop to $39.20 on May 31.

Chapter 13 example problem TransGlobal Co. currently has no debt and its equity is worth $20,000. If its corporate tax rate is 30%, what will the value of the firm be if TransGlobal borrows $6,000 and uses the proceeds to buy up stock?

After the debt issue, TransGlobal will be worth the original $20,000 plus the present value of the tax shield. The estimated present value of the debt tax shields is TC * Debt =.30 * $6,000 = $1,800, so the firm's value will increase to VL = VU + TCD = $20,000 + $1,800 = $21,800.

Chapter 3 example problems The following data are from the most recent market sources and annual financial statements for M Co. and N Co. a) Calculate the Market-to-Book ratio for each company. Briefly translate it or describe in words what it means. b) Calculate the Price-to-Earnings multiple for each company. Briefly translate it or describe in words what it means. c) If these ratios are typical for M and N, which one would investment analysts more likely categorize as a 'growth' company, and which one as a 'value' company? Briefly discuss.

a. Book Value per Share = Book Equity / n = $7,425.0m/222.8m = $33.33 for M Co. and = $3,094.2m/342.0m = $9.05 for N Co. Market-to-Book = P / Book Value per Share = 42.44 / (7,425.0/222.8) = 1.3x for M Co.[Or Market-to-Book = Market Cap / Book Equity = ($42.44*222.8m) / $7,425.0m = 1.3x for M Co.] Market-to-Book = $56.78 / ($3,094.2m/342.0m) = ($56.78*342.0m) / $3,094.2m = 6.3x for N Co.Investors value M Co.'s equity 1.3 times its book value. Investors are willing to pay 6.3 times N Co.'s book value based on the historical cost of the difference between its assets and liabilities. b. EPS = Net Income / n = $722.4m/222.8m = $3.24 for M Co. = $312.8m/342.0m = $0.91 for N Co. PE = P / EPS = $42.44 / ($722.4m/222.8m) = 13.1x for M Co. = $56.78 / ($312.8m/342.0m) = 62.1x for N Co. Or PE = Market Cap / Net Income = ($42.44*222.8m) / $722.4m= 13.1x for M Co.= ($56.78*342.0m) / $312.8m = 62.1x for N Co. Investors value M Co.'s shares at 13.1 times its earnings. Investors are willing to pay 62.1 times their proportionate ownership in N Co.'s net income. c. 'Value' companies typically have low Market-to-Book ratios and low PE multiples, like M Co. Investors place a high price on 'growth' companies, when compared to their current earnings or existing book values, believing that these have high future growth prospects, like N Co.

Chapter 24 example problem a) For the $65 strike call options with 7 months to expiration, what is the Intrinsic Value (on a per share basis, like the option price quotes)? Are they currently in-the-money or out-of-the-money? b) Suppose you buy 5 contracts of the $65 strike call options with 7 months to expiration. How much will you pay, ignoring commissions? c) In 7 months when this call option expires, how much will you profit if the ETF share price is the same as its current price? Is that a gain or a loss on the call option contracts?

a. Call Intrinsic Value = max[S - K, 0] = max[$70.28 - $65, 0] = $5.28 These call options are in-the-money currently with a positive intrinsic value. (Note: the corresponding put options are out-of-the-money with Put Intrinsic Value = max[K - S, 0] = max[65-70.28, 0] = $0) b. Each contract is for 100 shares, and market orders buy at the best ask price or $8.00 for the December $65 strike calls. Total Cost = 5 contracts * (100 shares per contract) * ($8.00) = $4,000 c. At the call's expiration date T in 7 months, the VTI share price remains at ST = $70.28. This call's Payoff per share is max[ST - K, 0] = max[70.28 - 65, 0] = $5.28 Total Payoff = 5 contracts * (100 shares per contract) * $5.28 = $2,640 Total Profit = Total Payoff - Total Cost = $2,640 - $4,000 = -$1,360, a loss (Note the percent return is ($2,640 - $4,000) / $4,000 = -34%) An option's value decays as time passes and as its payoff become more certain, ie, less risky or volatile

Chapter 24 example problems a) For the $65 strike call options with 7 months to expiration, what is the Intrinsic Value (on a per share basis, like the option price quotes)? Are they currently in-the-money or out-of-the-money? b) Suppose you buy 5 contracts of the $65 strike call options with 7 months to expiration. How much will you pay, ignoring commissions? c) In 7 months when this call option expires, how much will you profit if the ETF share price is the same as its current price? Is that a gain or a loss on the call option contracts?a

a. Call Intrinsic Value = max[S - K, 0] = max[$70.28 - $65, 0] = $5.28These call options are in-the-money currently with a positive intrinsic value.(Note: the corresponding put options are out-of-the-money with Put Intrinsic Value = max[K - S, 0] = max[65-70.28, 0] = $0) b. Each contract is for 100 shares, and market orders buy at the best ask price or $8.00 for the December $65 strike calls. Total Cost = 5 contracts * (100 shares per contract) * ($8.00) = $4,000 c. At the call's expiration date T in 7 months, the VTI share price remains at ST = $70.28.This call's Payoff per share is max[ST - K, 0] = max[70.28 - 65, 0] = $5.28Total Payoff = 5 contracts * (100 shares per contract) * $5.28 = $2,640Total Profit = Total Payoff - Total Cost = $2,640 - $4,000 = -$1,360, a loss (Note the percent return is ($2,640 - $4,000) / $4,000 = -34%) An option's value decays as time passes and as its payoff become more certain, ie, less risky or volatile

Chapter 10 example problem A stock has had returns of -18%, 25%, and 11% over the past three years. (a) What was its historical arithmetic average return? And what was its geometric return? (b) What was the historical volatility for this stock? Show your calculation.

a. The arithmetic average return is the sum of the returns divided by the number of returns Arithmetic average return = (-.18 + .25 + .11) / 3 = .06 = 6% The geometric return is the annualized compounded growth of a dollar invested: Geometric average return = [(1 - .18)(1 + .25)(1 + .11)](1/3) - 1 = .044 = 4.4% Remember that the geometric average return is less than the arithmetic average return if the returns have any variation. b. The deviations of each of these returns from the 6% mean arithmetic average return are:-24%, 19%, and 5% To calculate variance, square each deviation, sum them, and divide by one less than the sample numbe r[(-24)2 + (19)2 + (5)2 ] / (3 - 1) = 481 To calculate standard deviation, take the square root. Volatility = σ = √529 = 21.9% which is a percentage because volatility has the same units as the returns.

Chapter 8 example question 24F Consider the following cash flows (in $ millions) for a project: For this project, you require an 8 percent return on your investment.(a) Calculate the payback. If a company requires all projects to pay back within 4 years, will it invest in this project? Briefly explain. (b) Calculate the NPV. Interpret it. (c) Calculate the profitability index. If you apply the profitability index criterion, will you make this investment if funds are available? Briefly discuss.

a. Technically yes, since it pays back between years 1 and 2 and exactly in 1 + (500-240)/300 = 1.87 years. Yet given the negative cash flow at the end, all of its pay back is erased—the sum of the future cash flows equals the initial investment in this case. b. Discounting the cash flows at 8%, the NPV is -40.6. Do not take this investment because it would destroy $40.6 million in value. c. PI = -40.6 / 500 + 1 = .919The profitability index is less than one. Do not take this project even if funds are available.

Chapter 4 example problem (a) You have just made a $4,600 contribution to your individual retirement account. Assume you earn a 0.5% monthly rate of return and you make no additional contributions. What will your account be worth when you retire in 46 years? Show your work. (b) What is the Effective Annual Rate of return? Is it higher or lower than the APR? Show your work.

a. The APR is 0.5% * 12 = 6% per year, but compounded monthly. Be consistent with the rate and time.For a 0.5% monthly rate and 46*12 = 552 months FV = PV * (1 + r)T = $4,600 * (1 + .005)552 = $72,181 For a 6% APR per year and 46 years, with 12 compounding periods per year FV = PV * (1 + r/m)mT = $4,600 * (1 + .06/12)12*46 = $72,181 b. EAR = (1 + APR/m)m = (1 + .06/12)12 - 1 = 6.17% per yearThat's higher than the 6% APR.To check, confirm provides the same future value for 46 years FV = PV * (1 + r)T = $4,600 * (1 + .0617)46 = $72,251 (Even slight rounding errors or differences in rates make notable differences when compounded over long time periods)

Chapter 17 example problem You order 500 items for $20 each, and the supplier's terms are 2/10, net 40. a. What is the last day you can pay before the account is overdue? And if you pay on that day, how much must you pay? b) What is the last day you can pay to receive the discount? And if you pay by that day, how much must you pay? c) What is the implicit Effective Annual Rate that you incur if you wait and pay on the final due date and do not take the discount?

a. The account will be overdue if you pay after 40 days. By the 40th day, you must remit 500 items * $20 each = $10,000 total. b. The supplier offers a 2% * $10,000 = $200 discount if you pay by the 10th day.If you pay on the 10th day, you should remit $10,000 - $200 = $10,000 * (1 - .02) = $9,800 c. The interest rate per period of (40 - 10) = 30 days on a $9,800 loan with $200 'interest' is 200/9800 = .02/(1-.02) = 2.0408% The number of periods per year is 365/30 = 12.167These are all equivalent ways to calculate the Effective Annual Rate:EAR = [1 + .020408]12.167 - 1 = [1 + .02/(1 - .02)]365/30 - 1 = [10,000/9,800]365/30 - 1 = 27.86% When buyers do not take the discount and pay early, suppliers often have reason to worry about their ability to pay at all.

Chapter 3 example problem Just this past year, the KC Bakeries had depreciation expense of $89m, taxes paid of $216m, and an operating cash flow of $785m. A partial listing of its balance sheet accounts is as follows: a) What was its Free Cash Flow? Discuss it and its components. b) How did this company's Current Ratio change over the year? Discuss one type of stakeholder which might be particularly interested this change, and whether they are relieved or concerned?

a. The firm's existing assets generated $785m in operating cash flow last year. CapEx = ΔNFA + Depreciation = (7,034 - 6,878) + 89 = +$245m The firm invested $245m in additional fixed assets during 2013, which was $156m above and beyond its depreciation. ΔNWA = ΔCA - ΔCL = (1,385 - 1,417) - (915 - 873) = -$74m The firm recovered $74m in net working capital, since its current assets actually fell, while its current liabilities climbed, and both reduced the cash that the firm required for operations. Combined, the firm's operating investments in capital expenditures and net working capital totaled 245 + (-74) = $171m. FCF = OCF - (CapEx + ΔNWA) = 785 - 171 = +$614m The firm's operating cash flow from existing assets exceeded its in operating investments in additional assets by $614m, which is the amount available to be paid to investors. b. Beginning: 1,417/873 = 1.62x Ending: 1,385/915 = 1.51x Current Ratio = CA/CL Reductions in the Current Ratio mean improved operating capital usage, creating higher Free Cash Flows, to the advantage of residual claimants like equity. Other stakeholders with higher priority may be concerned by this drop in the Current Ratio: the company's short-term solvency has been reduced, and customers with warranties, wage earners, suppliers, and short-term lenders may become increasingly concerned.

Chapter 10 example problem Q72, pull up the chart Suppose these are statistics from total annual returns over many years in the past. Today the Wall Street Journal reports that the yield on 1-year Treasury Bills is currently 0.4% and the yield on 20-year Treasury Bonds is currently 3%. Otherwise, assume that future returns will be similar to past returns and follow a Normal distribution. a) If you invest $1,000 in 20-year Treasury Bonds today, about how much will your investment be worth in 20 years? Show and discuss. b) If you invest in small-company stocks, what percent return would you expect in 1 year? c) If you invest in small-company stocks, what range of returns would you expect to observe in any given year about 68% of the time? d) If you invest in large-company stocks, what annualized percent return would you expect to earn compounded over a long time period like 40 years?

a. The history is not particularly relevant for known safe future returns, like current Treasury yields. Using today's 3% yield on 20-year T-Bonds, $1,000 invested today will be worth in 20 years :FV = $1,000 * (1+.03)20 = $1,806 (The only risk, assuming that government bonds are truly safe and will not default, is whether the interim coupons received will be reinvested at a lower subsequent return than today's 3% T-Bond yield.) b. The historical average (arithmetic mean) return was 16%, and that is the best estimate for short horizons. c. For returns which follow a Normal distribution, the range will be within one standard deviation of the mean with 68% probability, or for the small-company stock data, between 16% - 1*(30%) = -14% and 16% + 1*(30%) = +46% That's a large range of returns for any given year In addition, for ½(1 - 68%) = 16% of the time or about one in six years, returns would be lower than -14% On the up side, for the other 16% of the time or about one in six years, returns would be higher than 46% d. The geometric average return is the best estimate for annual returns earned over long-term horizons. Geometric average ≈ arithmetic average - ½ volatility2 (which is exact for Normally distributed returns)= 12% - ½ * (.20)2 = 10% annualized return After 40 years, $1,000 invested in large-company stocks would be worth about $1,000 * (1+10%)40 = $45,259 [Do NOT compound the arithmetic average when returns are risky: that would suggest over twice the value at $1,000 * (1+12%)40 = $93,051]

Chapter 16 example problem MERT has a 9 day receivables period, a 30 day payables period, and a 55 day inventory period. MERT just announced that it would stretch out its bill payments to 45 days, in order to "control costs and optimize cash flow." The increased payables period will be in effect for all of the company's suppliers. a) Exactly, what impact did this change in payables policy have on MERT's operating cycle? Its cash cycle? b) Describe how this policy change will impact the operating cycles for MERT's suppliers? Their cash cycles? c) MERT lengthened its payables period to "control costs and optimize cash flow." Describe specific benefits, emphasizing items from the income statement and/or balance sheet, which will benefit MERT from this change?

a. There is no impact on the company's Operating Cycle = Inventory Period + Receivables Period = 55 + 9 = 64 daysThe policy change lengthened its payables period, thereby shortening its cash cycle by 15 days from: Cash Cycle = Inventory Period + Receivables Period - Payables Period = 55 + 9 - 30 = 34 daysto: Cash Cycle = Inventory Period + Receivables Period - Payables Period = 55 + 9 - 45 = 19 days b. The suppliers' receivables periods increased, thereby increasing both their operating and cash cycles. If MERT is only one of many customers for a particular supplier, then that supplier's operating and cash cycles will increase a little. If MERT is the only customer for a particular supplier, then that supplier's operating and cash cycles will each increase by 15 days. c. The company will need less financing because it is essentially borrowing more from its suppliers. Either the company can use less short-term, and perhaps long-term, debt from traditional sources, so it will save on interest expense. Eventually, however, the suppliers may respond with higher prices or more stringent terms of sale.

Chapter 4 example question On March 28, 2008, 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 $100,000 on March 28, 2028, but investors would receive nothing until then. Investors paid DMF $22,364 for each of these securities. a) Based on the $22,364 price, what rate was DMF paying to borrow money? b) Suppose that, on March 28, 2018, this security's price is $40,128. If an investor had purchased it for $22,364 at the offering and sold it on this day, what annual rate of return would she have earned? Discuss how this compares to the rate DMF paid to borrow money.

a. Using the FV formula and solving for the interest rate:r = (FV / PV)1/t - 1r = ($100,000 / $22,364)1/20 - 1r = 0.0778 or 7.78% per yearDMF is effectively promising a 7.78% return per year to investors if they hold the security to maturity and if DMF does not default. b. Using the FV formula and solving for the interest rate: r = (FV / PV)1/t - 1 r = ($40,128 / $22,364)1/10 - 1 r = 0.0602 or 6.02% per year An investor's realized return may be either higher or lower than rate promised by a company, depending on the price she bought and/or sold it. She realized a lower return than the rate promised by the company because the market price in 2018 depends on the rate required by other investors at that time. If those other investors in the market pay $40,128 in 2018 and hold this security until maturity in 2028, those investors would realize this return: r = (FV / PV)1/t - 1 r = ($100,000 / $40,128)1/10 - 1 r = 0.0956 or 9.56%

Chapter 11 example problem Assume these are your forecasts for the returns on 2 stocks: Expected Return Volatility Market Beta Stock A. 8.0% 40% 1.2 Stock B 6.0% 50% 0.8 Your portfolio is (unwisely) invested entirely in these stocks, with $3m in stock A and $2m in stock B. a) What is the expected return on your portfolio? b) Is the volatility of your portfolio higher than, lower than, or equal to 44%? c) Is the beta of your portfolio higher than, lower than, or equal to the average market risk?

a. Your total portfolio is worth 3 + 2 = $5m, and the weights on these stocks in your portfolio are:wA = $3m / $5m = .6 and wB = $2m / $5m = .4 Your portfolio's expected return is the weighted average: E[rP] = wA E[rA] + wB E[rB] = .6 (8.0%) + .4 (6.0%) = 7.2% b. When the weights are all positive and the stocks not perfectly correlated, then volatility risk is diversified and the portfolio's volatility is strictly less than the weighted average of the component volatilities: σP < wA σA + wB σB = .6 (40%) + .4 (50%) = 44% To calculate the portfolio's volatility, the correlation between stocks A and B would be required. c. A portfolio's beta equals the weighted average of the component betas: βP = wA βA + wB βB = .6 (1.2) + .4 (0.8) = 1.04 The portfolio is weighted more toward the stock with more than average market risk, sufficiently so that the portfolio's beta is more than 1. Hence, the portfolio has more than average market risk.

Chapter 5 practice problem Jo is 67 years old, has just retired and will receive her first pension check of $24,000 in exactly one year. The pension payments will thereafter grow with inflation, which she believes will be 2% per year, for the remaining years of her life. The effective rate she could earn on CDs across various maturities from at her bank is 3% per year. (Label your answers in either dollars or millions of dollars.) a) If Jo expects to live forever, how much would you estimate is the current value of these pension payments to Jo? b) Jo's financial advisor points out that realistically she is not likely to live beyond 30 years. Given that, how much would you estimate is the current value of these pension payments to Jo? c) Jim has the same pension plan as Jo except that Jim is 62 years old and will not retire for another 5 years: One year after retirement he will receive his first pension check of $24,000 which will grow thereafter at 2% for 30 years. Given that, how much would you estimate is the current value of these pension payments to Jim?

a. a perpetuity, growing for ever at 2% PV=PMT/(g-r) PV=$24,000/03.-0.2 b. PV= PMT/r[1 -1(r+r)^t] PV=$24,000/03.-0.2[1-(1+.02/1+.03)^30]=$608,983 or $0.609m That is about one-fourth of the perpetuity value, and it is still a rather high estimate the pension's current value since Jo's life expectancy is likely significantly less than 30 years. c. PV=$24,000/03.-0.2[1-(1+.02/1+.03)^30]/(1+03)^5=$608,983/ (1.03)^5= 525, 314 or 0.525m Jim's pension is worth quite a bit less because his payments will be the same amount but delayed 5 years, starting at year 6 rather than at year 1. The value of the annuity is $608,983 in year 5 (which is one period before the first annuity payment). To convert that to today's present value, discount for 5 years.

Chapter 4 example question A U.S. bank quotes 4.2% per year compounded monthly on deposits. a) If you invest $20,000, how much will your investment be worth in 5 years? b) What is the APR? What is the EAR?

a. r = 4.2% per year, or 4.2/12 = 0.35% per monthTime 0 5 years, or 5*12 = 60 months$10,000 FV For r =0.35% per period and t =60 periods: FV = PV * (1+r)t = $20,000 * (1 + .0035)60 = $24,665 For r = 4.2% per year, t = 5 years, and m = 12 periods per year FV = PV * (1+r/m)mt = $20,000 * (1 + .042/12)12*5 = $24,665 b. The Annual Percentage Rate is the rate required to be quoted by law, which is 4.2% per year.The Effective Annual Rate is the rate which would be earned if it were compounded once a year.EAR = [1 + (APR / m)]m - 1 = [1 + (.042 / 12)]12 - 1 = 4.28% per year.

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