FIN FINAL EXAM
what are the two major methods for determining the cost of equity
1. dividend growth model 2. CAPM
break-even analysis
3 types... they decide the quantity that should be sold
Al invested $3,630 in an account that pays 6 percent simple interest. How much money will he have at the end of five years? A) $4,910 B) $5,056 C) $4,719 D) $4,678 E) $5,299
FV = $3,630 + ($3,630)(.06)(5) = 4,719
simple interest case formula
FVn= PV + PV x i x t
when r increases...
NPV will decrease
Dee's made two announcements concerning its common stock today. First, the company announced that the next annual dividend will be $1.58 a share. Secondly, all dividends after that will decrease by 1.15 percent annually. What is the value of this stock at a discount rate of 15.5 percent?
P0 = $1.58/[.155 − (−.0115)] = $9.49
Future Motors is expected to pay an annual dividend next year of $3.10 a share. Dividends are expected to increase by 1.85 percent annually. What is one share of this stock worth at a required rate of return of 15 percent?
P0 = $3.10/(.15 − .0185) =$23.57
How much are you willing to pay for one share of LBM stock if the company just paid an annual dividend of $2.24, the dividends increase by 2.3 percent annually, and you require a return of 14.8 percent?
P0 = [$2.24(1.023)]/(.148 − .023) = $18.33
A firm has net working capital of $560. Long-term debt is $3,970, total assets are $7,390, and fixed assets are $3,910. What is the amount of the total liabilities? A) $2,050 B) $2,920 C) $4,130 D) $7,950 E) $6,890
6890
Sensitivity analysis determines the: A) range of possible outcomes given that most variables are reliable only within a stated range. B) degree to which the net present value reacts to changes in a single variable. C) net present value range that can be realized from a proposed project. D) degree to which a project relies on its initial costs. E) ideal ratio of variable costs to fixed costs for profit maximization.
B) degree to which the net present value reacts to changes in a single variable.
4 ways to compute OCF
Approach 1: OCF = EBIT + Depreciation - Taxes Approach 2: top-down approach OCF = Sales - Costs - Taxes (Works only when there is no interest expense) Approach 3: Bottom-up approach OCF = Net income + Depreciation Approach 4: Tax-Shield approach OCF = (Sales - Costs) (1-T) + T (Depreciation)
Which one of the following is the relationship between the percentage change in operating cash flow and the percentage change in quantity sold? A) Degree of sensitivity B) Degree of operating leverage C) Accounting break-even D) Cash break-even E) Contribution margin
B) Degree of operating leverage
4) Which one of the following applies to the dividend growth model? A) An individual stock has the same value to every investor. B) Even if the dividend amount and growth rate remain constant, the value of a stock can vary. C) Zero-growth stocks have no market value. D) Stocks that pay the same annual dividend will have equal market values. E) The dividend growth rate is inversely related to a stock's market price.
B) Even if the dividend amount and growth rate remain constant, the value of a stock can vary.
When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: A) accepted because the payback period is less than the required time period. B) accepted because the profitability index is greater than 1. C) accepted because the profitability index is negative. D) rejected because the internal rate of return is negative. E) rejected because the net present value is positive.
B) accepted because the profitability index is greater than 1.
Do-Well bonds have a face value of $1,000 and are currently quoted at 86.725 percent of par value $1000. The bonds have coupon rate of 6.5 percent. What is the current yield on these bonds?
Current yield = [.065 ($1,000)]/[.86725 ($1,000)] Current yield = .0749, or 7.49%
Which one of following is the rate at which a stock's price is expected to appreciate? A) Current yield B) Total return C) Dividend yield D) Capital gains yield E) Coupon rate
D) Capital gains yield
Which one of the following represents the level of output where a project produces a rate of return just equal to its requirement? A) Capital break-even B) Cash break-even C) Accounting break-even D) Financial break-even E) Internal break-even
D) Financial break-even
By definition, which one of the following must equal zero at the accounting break-even point? A) Net present value B) Depreciation C) Contribution margin D) Net income E) Operating cash flow
D) Net income
Which one of the following represents the capital gains yield as used in the dividend growth model? A) D1 B) D1/P0 C) P0 D) g E) g/P0
D) g
The Fisher effect primarily emphasizes the effects of ________ on an investor's rate of return. A) default B) market movements C) interest rate changes D) inflation E) the time to maturity
D) inflation
DLQ Inc. bonds mature in 12 years and have a coupon rate of 6 percent. If the market rate of interest increases, then the: A) coupon rate will also increase. B) current yield will decrease. C) yield to maturity will be less than the coupon rate. D) market price of the bond will decrease. E) coupon payment will increase.
D) market price of the bond will decrease.
Two-Stage Growth Model
Estimate cash flows for two different growth stages. Stage 1: dividends grow at above-average rates. Stage 2: dividends grow at the industry average rate.
Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is he using? A) Simulation testing B) Sensitivity analysis C) Break-even analysis D) Rationing analysis E) Scenario analysis
E) Scenario analysis
5) Which one of the following statements is correct? A) Stocks can only be assigned one dividend growth rate. B) Preferred stocks generally have variable growth rates. C) Dividend growth rates must be either zero or positive. D) All stocks can be valued using the dividend discount models. E) Stocks can have negative growth rates.
E) Stocks can have negative growth rates.
You cannot attend the shareholder's meeting for Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called? A) Alternative voting B) Cumulative voting C) Straight voting D) Indenture voting E) Voting by proxy
E) Voting by proxy
Which one of these equations applies to a bond that currently has a market price that exceeds par value? A) Market value < Face value B) Yield to maturity = Current yield C) Market value = Face value D) Current yield > Coupon rate E) Yield to maturity < Coupon rate
E) Yield to maturity < Coupon rate
PC Enterprises wants to commence a new project but is unable to obtain the financing under any circumstances. This firm is facing: A) financial deferral. B) financial allocation. C) capital allocation. D) marginal rationing. E) hard rationing.
E) hard rationing.
Oil Creek Auto has sales of $3,340, net income of $274, net fixed assets of $2,600, and current assets of $920. The firm has $430 in inventory. What is the common-size statement value of net income? a. 12.22 percent b. 44.16 percent c. 16.54 percent d. 8.20 percent
Explanation: 274/3340 = 0.082 = 8.20%
You have a savings account valued at $1,500 today that earns an annual interest rate of 8.7 percent. How much more would this account be worth if you wait to spend the entire balance in 25 years rather than in 20 years?
FV = $1,500(1.087^25) =$12,073.41 FV = $1,500(1.087^20) = $7,955.77 Difference = $12,073.41 − 7,955.77= $4,117.64
What is the future value of $11,600 invested for 17 years at 7.25 percent compounded annually? A) $32,483.60 B) $27,890.87 C) $38,991.07 D) $41,009.13 E) $38,125.20
FV = $11,600(1 + .0725)^17= $38,125.20
perpetuity
infinite series of equal payments
Future Value (FV) definition
later money on a time line
Accounting Break-Even Analysis
sales volume at which NI = 0
current liabilities is also known as...
short term debt
One year ago, JK Mfg. deposited $12,000 in an investment account for the purpose of buying new equipment four years from today. Today, it is adding another $15,000 to this account. The company plans on making a final deposit of $10,000 to the account one year from today. How much cash will be available when the company is ready to buy the equipment assuming an interest rate of 5.5 percent?
FV = $12,000(1.055^5) + $15,000(1.055^4) + $10,000(1.055^3) = $46,008.30
Duane and Thad plan on retiring 27 years from today and plan to have the same amount saved at that time. In preparation for this, Duane is depositing $15,000 today at an annual interest rate of 5.2 percent. How will Thad's deposit amount vary from Duane's if Thad also makes a deposit today but earns an annual interest rate of 6.2 percent?
FV = $15,000(1.052^27) = $58,954.40 PV = $58,954.40/1.062^27 = $11,618.61 Difference = $11,618.61 − 15,000 = −$3,381.39
You will receive $15,000 in two years when you graduate. You plan to invest this at an annual interest rate of 6.5 percent. How much money will you have 8 years from now?
FV = $15,000(1.065^(8 − 2)) = $21,887.13
You just invested $49,000 that you received as an insurance settlement. How much more will this account be worth in 40 years if you earn an average return of 7.6 percent rather than just 7.1 percent?
FV = $49,000(1.076^40) = $917,670.84 FV = $49,000(1.071^40) = $761,684.14 Difference = $917,670.84 − 761,684.14= $155,986.70
Marti's coin collection contains fifty 1948 silver dollars. Her grandparents purchased them at their face value in 1948. These coins have appreciated by 7.6 percent annually. How much will the collection be worth in 2025? A) $13,611.18 B) $18,987.56 C) $14,122.01 D) $11,218.27 E) $14,077.16
FV = $50(1.076^77)= $14,077.16
A charity plans to invest annual payments of $60,000, $70,000, $75,000, and $50,000, respectively, over the next four years. The first payment will be invested one year from today. Assuming the investment earns 5.5 percent annually, how much will the charity have available four years from now?
FV = $60,000(1.055^3) + $70,000(1.055^2) + $75,000(1.055) + $50,000 = $277,491
You hope to buy your dream car five years from now. Today, that car costs $62,500. You expect the price to increase by an average of 2.9 percent per year. How much will your dream car cost by the time you are ready to buy it? A) $73,340.00 B) $68,666.67 C) $72,103.59 D) $66,818.02 E) $69,023.16
FV = $62,500(1.029^5)= $72,103.59
Future Value Formula
FV= PV(1+r)^t
compound interest case formula
FV=PV(1+r)^t
mutually exclusive projects cause...
Initial investments are substantially different (issue of scale) and Timing of cash flows is substantially different. NPV and IRR decision rules differ
dividend growth model formula (DGM)
P0 =D0(1+g)/R-g. =D1/R-g
Dividend Growth Model
P0= (D1/Re-g) Re= (D1/P0) + g (the more useful one)
two stage growth model formula
P0= D1/R-g1 [ 1-(1+g1/1+R)^t ] + Pt/(1+R)^t where... Pt=Dt+1/R-g2 = Dt(1+g2)/R-g2 = D0(1+g2)^t (1+ g2)/ R-g2
AC Electric just paid its annual dividend of $2.42. The firm plans to increase its dividend by 2.5 percent for the next 3 years and then maintain a constant 2 percent rate of dividend growth. The required return is 12.5 percent. What is the current value per share of this stock?
P3 = [$2.42(1.025^3)(1.02)]/(.125 − .02) = $25.32 P0 = [$2.42(1.025)/(.125 − .025)][1 − (1.025/1.125)^3] + $25.32/1.125^3 = $23.82
interest rate definition
the exchange rate between earlier money and later money
Yield to Maturity (YTM)
the rate required in the market on a bond
what effect occurs when the salvage value is different from the book value of the asset?
there is a tax effect
Your firm has total assets of $4,900, fixed assets of $3,200, long-term debt of $2,900, and short-term debt of $1,400. What is the amount of net working capital? A) −$100 B) $300 C) $600 D) $1,700 E) $1,800
300
Goals of Financial Management
1. Maximize the current value of the company's stock (value per share) 2. maximize the market value of the existing owner's equity
A firm has common stock of $6,200, paid-in surplus of $9,100, total liabilities of $8,400, current assets of $5,900, and fixed assets of $21,200. What is the amount of the shareholders' equity? A) $6,900 B) $15,300 C) $18,700 D) $23,700 E) $35,500
18,700
The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following? A) Depreciation tax shield B) Tax due on the current salvage value of that asset C) Current year's operating cash flow D) Change in net working capital E) MACRS depreciation for the current year
Tax due on the current salvage value of that asset
incremental cash flows
The cash flows that should be included in a capital budgeting analysis are those that will only occur (or not occur) if the project is accepted.
Cost of Debt
The cost of debt is the required return on our company's debt.
what is the cost of equity
The cost of equity is the return required by equity investors given the risk of the cash flows from the firm.
maturity rate
The date on which an investment becomes due for payment.
Net Present Value
The difference between the market value of a project and its cost
Weighted Average Cost of Capital (WACC)
We can use the individual costs of capital that we have computed to get our "average" cost of capital for the firm. This "average" is the required return on the firm's assets, based on the market's perception of the risk of those assets. The weights are determined by how much of each type of financing is used.
Capital Budgeting
What long-term investments or projects should the business take on?
You purchased an investment that will pay you $8,000, in real dollars, a year for the next three years. Each payment will be received at the end of the period with the first payment occurring one year from today. The nominal discount rate is 8.46 percent and the inflation rate is 3.1 percent. What is the present value of these payments in real dollars?
You need to discount real dollars with the real interest rate. r = 1.0846/1.031 − 1 r = .0520, or 5.20% PV = $8,000{[1 − (1/1.052^3)]/.052} = $21,705
Which one of the following statements is correct? a. Stocks can only be assigned one dividend growth rate. b. Preferred stocks generally have variable growth rates. c. Dividend growth rates must be either zero or positive. d. Stocks can have negative growth rates.
d. Stocks can have negative growth rates.
Your broker is offering 12 percent compounded quarterly on its money market account. If you deposit $7,500 today, how much will you have in your account 15 years from now?
daily interest rate= 12%/4 = 3% number of periods= 4*15 = 60 FV = $7,500[1 + (3%)]^(60)= $44,187.0233
Present Value (PV) definition
earlier money on a time line
You own a bond that pays $64 in interest annually. The face value is $1,000 and the current market price is $1,021.61. The bond matures in 11 years. What is the yield to maturity?
enter into calc... 11=N -1,021.61 =PV 64= PMT 1000= FV CPT I/Y= 6.12
New Homes has a bond issue with a coupon rate of 5.5 percent that matures in 8.5 years. The bonds have a par value of $1,000 and a market price of $1,022. Interest is paid semiannually. What is the yield to maturity?
enter into calc... 17= N -1022= PV 27.50= PMT 1000= FV CPT I/Y= 2.588 YTM= 2(2.588%)= 5.18%
World Travel has 7 percent, semiannual, coupon bonds outstanding with a current market price of $1,023.46, a par value of $1,000, and a yield to maturity of 6.72 percent. How many years is it until these bonds mature?
enter into calc... 6.72/2= I/Y -1.023.46= PV 35= PMT 1000= FV CPT N= 25.02 number of years= 25.02/2= 12.53
when are dividends paid
every period forver
DuPoint Identity (ROE)
expresses return on equity as the product of profit margin, total asset turnover, and equity multiplier
A discount bond's coupon rate is equal to the annual interest divided by the: A) call price. B) current price. C) face value. D) clean price. E) dirty price.
face value
Bert owns a bond that will pay him $45 each year in interest plus $1,000 as a principal payment at maturity. What is the $1,000 called? A) Coupon B) Face value C) Discount D) Yield E) Dirty price
face value
annuity
finite series of equal payments that occur at regular intervals
what does a PI of 1.1 imply
for every $1 of investment, we create an additional $0.10 in value.
You are investing $100 today in a savings account. Which one of the following terms refers to the total value of this investment one year from now? A) Future value B) Present value C) Principal amount D) Discounted value E) Invested principal
future value
Gee-Gee common stock returned a nifty 21.6 percent rate of return last year. The dividend amount was $.25 a share which equated to a dividend yield of 1.01 percent. What was the rate of price appreciation for the year?
g = .216 − 0.0101 = .2059, or 20.59%
cost of preferred stock
generally pays a constant dividend each period.
do NPV and IRR give the same decision or not?
generally, yes
capital structure decisions include determining...
how much debt should be assumed to fund a project
what is an example of woking capital management decision?
how much inventory should be on hand for immediate sale
forecasting risk
how sensitive is our NPV to changes in the cash flow estimates; the more sensitive, the greater the forecasting risk.
when do you accept the project (NPV)
if NPV is positive
when there is forecasting risk it is possible that
incorrect decisions will be made due to erroneous cash flow projections
The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's: A) incremental cash flows. B) internal cash flows. C) external cash flows. D) erosion effects. E) financing cash flows.
incremental
The stand-alone principle advocates that project analysis should be based solely on which one of the following costs? A) Sunk B) Total C) Variable D) Incremental E) Fixed
incremental
The operating cash flow for a project should exclude which one of the following? A) Taxes B) Variable costs C) Fixed costs D) Interest expense E) Depreciation tax shield
interest expense
what does I/Y on the calculator and r in the formula stand for
interest rate/exchange rate/compounding rate/discount rate/rate of return
payback period formula
investment required/annual net cash inflow
Operating Leverage
is the relationship between sales and operating cash flow.
when you see cost savings in the problem that indicates that...
it is a cost cutting problem
strong form efficiency is also called
market efficient capital market
A bond's principal is repaid on the ________ date. A) coupon B) yield C) maturity D) dirty E) clean
maturity
Your grandmother will be gifting you $150 at the end of each month for four years while you attend college. At a discount rate of 3.7 percent, what are these payments worth to you on the day you enter college?
monthly rate = 3.7%/12 = 0.3083% (48) number of periods = 4*12 = 48 PVA = $150({1 − [1/(1 + 0.3083%)^(48) ]}/(0.3083%))= $6,683
Capital Rationing
occurs when a firm or division has limited resources.---more good projects than money
Net Working Capital (NWC) is...
positive when the cash that will be received over the next year exceeds the cash that will be paid out (positive in a healthy firm)
Perpetuity example
preferred stock
par value (face value)
principal amount, repaid at maturity
what type of accounting does capital budgeting rely heavily on?
pro forma, especially income statements
what does a negative NPV mean
project is expected to decrease value to the firm
Interest rate formula
r= (FV/PV)^1/t - 1
shareholders equity....
represents the residual value of a firm
example of annuity
retirement pension
financial break even analysis
sales volume at which NPV = 0
Cash Break-Even Analysis
sales volume at which OCF = 0
A $1,000 face value bond has a coupon rate of 7 percent, a market price of $989.40, and 10 years left to maturity. Interest is paid semiannually. If the inflation rate is 2.2 percent, what is the yield to maturity when expressed in real terms?
solve for I/Y on calc...= 3.575 • YTM = 2(3.575%) = 7.15% (Note: this is nominal rate) • To find the real rate, use Fisher effect formula: • (1 + R) = (1 + r)(1 + h) • Solve for r = (1+R)/(1+h) -1 = 1.0715/1.022 − 1= 0.484
The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles? A) Underlying value principle B) Stand-alone principle C) Equivalent cost principle D) Salvage principle E) Fundamental principle
stand-alone
straight line depreciation formula
straight line depreciation= (initial cost-salvage)/# years
number of periods formula
t= ln(FV/PV) / ln(1 +r)
Payback Period
the amount of time required for an investment to generate cash flows sufficient to recover its initial cost
coupon rate
the annual coupon divided by the face value of a bond
Probability Index
the benefit per unit cost, based on the time value of money.
what is the cost of debt NOT equivalent to
the coupon rate.
Internal Rate of Return
the discount rate that makes the NPV = zero the discount rate that make the present value of the future cash flows equal to the initial cost.
The bottom-up approach to computing the operating cash flow applies only when: A) both the depreciation expense and the interest expense are equal to zero. B) the interest expense is equal to zero. C) the project is a cost-cutting project. D) no fixed assets are required for a project. E) both taxes and the interest expense are equal to zero.
the interest expense is equal to zero.
soft rationing
the limited resources are temporary, often self- imposed
Fisher effect
the one-for-one adjustment of the nominal interest rate to the inflation rate
Equivalent Annual Cost (EAC)
the present value of a project's costs calculated on an annual basis
what does a 0 NPV mean
the project has cash outflows that equals to its cash inflows in present values
what does a positive NPV mean
the project is expected to add value to the firm
coupon payment
the stated interest payment made on a bond
depreciation tax shield
the tax savings that result from the ability to deduct depreciation
what is the expected return of a portfolio
the weighted average of the expected returns of the respective assets in the portfolio. m
goal of EAC
to choose the most cost-effective possibility
current assets equation
total assets- fixed assets
difference between simple and compound interest cases
whether interests earn interest
an example of a capital budgeting decision is deciding....
whether or not to purchase a new machine for the production line
CFFA table layout
years (0-n) OCF (tax shield approach) NCS (initial cost) change in NWC (net working capital) CFFA (solve for)
The bond market requires a return of 9.8 percent on the 5-year bonds issued by JW Industries. The 9.8 percent is referred to as the: A) coupon rate. B) face rate. C) call rate. D) yield to maturity. E) current yield.
yield to maturity
proxy voting
• Proxy votes are similar to absentee ballots. Proxy fights occur when minority owners are trying to get enough votes to obtain seats on the Board or affect other important issues that are coming up for a vote.
voting rights
• Shareholders have the right to vote for the board of directors and other important issues • Cumulative voting increases the likelihood of minority shareholders getting a seat on the board.
Global Tek plans on increasing its annual dividend by 15 percent a year for the next four years and then decreasing the growth rate to 2.5 percent per year. The company just paid its annual dividend in the amount of $.20 per share. What is the current value of one share of this stock if the required rate of return is 17.4 percent?
P4 = [$.20(1.15^4)(1.025)]/(.174 − .025) = $2.40635 P0 = [$.20(1.15)/(.174 − .15)][1 − (1.15/1.174)^4] + $2.40635/1.174^4 = $2.03
Chapmen Co. wants to sell preferred stock at $55 per share, suppose the required return is 5%, how much should they pay dividend each period? a. 2.75 b. 2.25 c. 3.25 d.3.75
P=C/r so C=P*r = 55*0.05= 2.75
PI formula
PI= PV of cash inflow/ initial cost
You are considering two savings options. Both options offer a rate of return of 7.6 percent. The first option is to save $2,500, $2,500, and $3,000 at the end of each year for the next three years, respectively. The other option is to save one lump sum amount today. You want to have the same balance in your savings account at the end of the three years, regardless of the savings method you select. If you select the lump sum method, how much do you need to save today?
PV = $2,500/1.076 + $2,500/1.076^2 + $3,000/1.076^3 = $7,250.8873
What is the present value of $45,000 to be received 50 years from today if the discount rate is 8 percent? A) $959.46 B) $1,147.07 C) $841.41 D) $1,106.18 E) $1,291.06
PV = $45,000/1.08^50= $959.46
Your father invested a lump sum 28 years ago at 4.05 percent annual interest. Today, he gave you the proceeds of that investment, totalling $48,613.24. How much did your father originally invest? A) $14,929.47 B) $16,500.00 C) $15,994.70 D) $15,500.00 E) $16,099.45
PV = $48,613.24/1.0405^28 = $15,994.70
Perpetuity Formula
PV= C/r
annuity formulas
PV= C[ 1- (1/(1+r)^t)/r ] FV= C[ ((1+r)^t) -1)/r ]
Present Value Formula
PV= FV/ (1+r)^t
Southern Tours is considering acquiring Holiday Vacations. Management believes Holiday Vacations can generate cash flows of $218,000, $224,000, and $238,000 over the next three years, respectively. After that time, they feel the business will be worthless. If the desired rate of return is 14.5 percent, what is the maximum Southern Tours should pay today to acquire Holiday V acations?
PVA = $218,000/1.145 + $224,000/1.145^2 + $238,000/1.145^3 = $519,799.59
You estimate that a project will cost $33,700 and will provide cash inflows of $14,800 in Year 1 and $24,600 in Year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14.2 percent? Why or why not?
PVInflows = $14,800/1.142 + $24,600/1.142^3 = $29,476.93 PI =PV of cash inflow/ initial cost = $29,476.93/$33,700 = .87 Since PI is smaller than 1, reject the project.
total liabilities equation
current liabilities + long term debt
strong form efficiency
current price reflects all information
semi-strong form efficiency
current price reflects all public information.
common size income statements
Compute all line items as a percent of sales
Book Value Formula
BV= Initial cost- accumulated depreciation
EAC formula
EAC= NPV/Annuity factor Annuity factor= (1-1/(1+r)^t)/r
Working Capital Management
How do we manage the day-to-day finances of the firm?
Bond Valuation
PV of coupons + PV of par
Simulation Analysis
changes multiple variables simultaneously
One year ago, you invested $1,750. Today it is worth $1,815.48. What rate of interest did you earn? A) 3.59 percent B) 4.33 percent C) 3.88 percent D) 3.74 percent E) 4.01 percent
$1,815.48 = $1,750(1 + r) = .0374, or 3.74%
You will receive $4,000 at graduation 3 years from now. You plan on investing this money at 5 percent annual interest until you have accumulated $50,000. How many years from today will it be when this occurs?
$50,000 = $4,000(1.05^t) t = 51.77 years Total time = 3 + 51.77= 54.77 years
You're trying to save to buy a new $68,000 sports car. Currently, you have saved $36,840 which is invested at 4.9 percent annual interest. How many years will it be before you purchase the car, assuming the price of the car remains constant? A) 9.67 years B) 17.18 years C) 12.81 years D) 16.91 years E) 10.84 years
$68,000 = $36,840(1.049^t) = 12.81 years
You are in charge of a project that has a degree of operating leverage of 1.06. What will happen to the operating cash flows if the number of units you sell increase by 3.7 percent? A) 3.49 percent decrease B) 4.76 percent decrease C) 3.70 percent decrease D) 3.92 percent increase
% change in OCF = DOL * % change in Q = 1.06 (3.7%)= 3.92% increase
Farm co just paid its annual dividend of $0.32 per share.The dividends are expected to grow at 25 percent annually for the next 4 years and then level off to an annual growth rate of 3 percent indefinitely. Assuming a required return of 15 percent
(1)What is the price of this stock at year 4? P4 = [$.32(1.25)4(1.03)]/(.15 − .03) P4 = $6.71 (2) What is the current price of this stock? P0 = [$.32(1.25)/(.15 − .25)][1 −(1.25/1.15)4] + $6.71/1.154 P0 = $5.42
future value interest factor formula
(1+ r)^t
common-base year
-choose a base year and then express each item relative to the base amount -use this method when comparing performance in different years
Combined Common Size and Base Year
-first form the common-size statements, then form common-base year statements -compare different size companies in different time
Fisher Effect Formula
1 + R = (1 + r) x (1 + h) R= nominal rate r= real rate h= expected inflation rate
Net working capital=
= current assets- current liabilities
total assets=
= total liabilities + shareholders' equity
Inside information has the most value when financial markets are: A) weak form efficient. B) semiweak form efficient. C) semistrong form efficient. D) strong form efficient.
A) weak form efficient.
Which one of the following compounding periods will yield the lowest effective annual rate given a stated future value at Year 5 and an annual percentage rate of 10 percent? A) Annual B) Semi-annual C) Monthly D) Daily E) Continuous
A. Annual
Decision rule for payback period
Accept if the payback period is less than some preset limit
Decision Rule (IRR)
Accept the project if the IRR is greater than the required return
after tax salvage formula
After tax salvage= salvage- T x (salvage- BV) T=tax rate BV= book value
Which one of the following would make a mutually exclusive project unacceptable? A) Cash inflow for net working capital at Time 0 B) Requiring fixed assets that would have no salvage value C) An equivalent annual cost that exceeds that of an alternative project D) Lack of revenue generation E) A depreciation tax shield that exceeds the value of the interest expense
An equivalent annual cost that exceeds that of an alternative project
Brubaker & Goss has received requests for capital investment funds for next year from each of its five divisions. All requests represent positive net present value projects. All projects are independent. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as: A) scenario analysis. B) soft rationing. C) sensitivity analysis. D) hard rationing.
B) soft rationing.
Oil Wells offers 5.65 percent coupon bonds with semiannual payments and a yield to maturity of 6.94 percent. The bonds mature in seven years. What is the market price per bond if the face value is $1,000?
Bond price = $28.25({1 − [1/(1 + .0694/2)^(7)(2)]}/(.0694/2)) + $1,000/(1 + .0694/2)^(7)(2) =$929.42
A 13-year, 6 percent coupon bond pays interest semiannually. The bond has a face value of $1,000. What is the percentage change in the price of this bond if the market yield to maturity rises to 5.7 percent from the current rate of 5.5 percent?
Bond price = $30({1 − [1/(1 + .055/2)^(13)(2)]}/(.055/2)) + $1,000/(1 + .055/2)^(13)(2) = $1,046.01 Bond price = $30({1 − [1/(1 + .057/2)^(13)(2)]}/(.057/2)) + $1,000/(1 +.057/2)^(13)(2) = $1,027.28 % change in price = ($1,027.28 − 1,046.01)/$1,046.01 % change in price = −.0179, or −1.79%
Roadside Markets has 8.45 percent coupon bonds outstanding that mature in 10.5 years. The bonds pay interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 7.2 percent?
Bond price = $42.25({1 − [1/(1 + .072/2)(10.5)(2)]}/(.072/2)) + $1,000/(1 + .072/2)^(10.5)(2) Bond price = $1,091.00
Roadside Markets has 8.45 percent coupon bonds outstanding that mature in 10.5 years. The bonds pay interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 7.2 percent?
Bond price = $42.25({1 − [1/(1 + .072/2)^(10.5)(2)]}/(.072/2)) + $1,000/(1 + .072/2)^(10.5)(2) = $1,091.00
Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs and machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision? A) Internal rate of return B) Net present value C) Equivalent annual cost D) Depreciation tax shield E) Bottom-up operating cash flow
C) Equivalent annual cost
The DuPont identity can be used to help managers answer which of the following questions related to a company's operations? I. How many sales dollars are being generated per each dollar of assets? II. How many dollars of assets have been acquired per each dollar in shareholders' equity? III. How much net profit is being generating per dollar of sales? IV. Does the company have the ability to meet its debt obligations in a timely manner? A) I and III only B) II and IV only C) I, II, and III only D) II, III and IV only E) I, II, III, and IV
C) I, II, and III only
Which one of the following statements related to the internal rate of return (IRR) is correct? A) The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects. B) A project with an IRR equal to the required return would reduce the value of a firm if accepted. C) The IRR is equal to the required return when the net present value is equal to zero. D) Projects should not be accepted if the IRR exceeds the required return.
C) The IRR is equal to the required return when the net present value is equal to zero.
Round Dot Inns is preparing a bond offering with a coupon rate of 6 percent, paid semiannually, and a face value of $1,000. The bonds will mature in 10 years and will be sold at par. Given this, which one of the following statements is correct? A) The bonds will become discount bonds if the market rate of interest declines. B) The bonds will pay 10 interest payments of $60 each. C) The bonds will sell at a premium if the market rate is 5.5 percent. D) The bonds will initially sell for $1,030 each. E) The final payment will be in the amount of $1,060.
C) The bonds will sell at a premium if the market rate is 5.5 percent.
All else constant, a bond will sell at ________ when the coupon rate is ________ the yield to maturity. A) a premium; less than B) a premium; equal to C) a discount; less than D) a discount; higher than E) par; less than
C) a discount; less than
capital structure weights weight
WE = E/V = percent financed with equity• WD = D/V = percent financed with debt• Wp = P/V = percent financed with preferred stocks
Sam just opened a savings account paying 3.5 percent interest, compounded annually. After four years, the savings account will be worth $5,000. Assume there are no additional deposits or withdrawals. Given this, Sam: A) will earn the same amount of interest each year for four years. B) will earn simple interest on his savings every year for four years. C) could have deposited less money today and still had $5,000 in four years if the account paid a higher rate of interest. D) has an account currently valued at $5,000. E) could earn more interest on this account if the interest earnings were withdrawn annually.
C) could have deposited less money today and still had $5,000 in four years if the account paid a higher rate of interest.
Forecasting risk is defined as the possibility that: A) some proposed projects will be rejected. B) some proposed projects will be temporarily delayed. C) incorrect decisions will be made due to erroneous cash flow projections. D) some projects will be mutually exclusive. E) tax rates could change over the life of a project.
C) incorrect decisions will be made due to erroneous cash flow projections.
Your goal is to have $1 million in your retirement savings on the day you retire. To fund this goal, you will make one lump sum deposit today. If you plan to retire ________ rather than ________ and earn a ________ rate of interest, then you can deposit a smaller lump sum today. A) sooner; later; low B) sooner; later; high C) later; sooner; high D) later; sooner; low E) today; later; high
C) later; sooner; high
The expected rate of return on a stock portfolio is a weighted average where the weights are based on the: A) number of shares owned of each stock. B) market price per share of each stock. C) market value of the investment in each stock. D) original amount invested in each stock.
C) market value of the investment in each stock.
The annual dividend yield is computed by dividing ________ annual dividend by the current stock price. A) this year's B) last year's C) next year's D) the past 5-year average E) the next 5-year average
C) next year's
According to the Rule of 72, you can do which one of the following? A) Approximately double your money in five years at 7.24 percent interest B) Double your money in 7.2 years at 8 percent interest C) Approximately double your money in 11 years at 6.55 percent interest D) Triple your money in 7.2 years at 7.2 percent interest E) Approximately triple your money in 7.2 years at 10 percent interest
C. r = 72/11 r = 6.55%
EAC decision rule
Choose the possibility with the lowest EAC
Which one of the following standardizes items on the income statement and balance sheet relative to their values as of a chosen point in time? A) Statement of standardization B) Statement of cash flows C) Common-base year statement D) Common-size statement E) Base reconciliation statement
Common- base year statement
8) Oil Creek Auto has sales of $3,340, net income of $274, net fixed assets of $2,600, and current assets of $920. The firm has $430 in inventory. What is the common-size statement value of inventory?
Common-size inventory = $430/($2,600 + 920) Common-size inventory = .1222, or 12.22%
Uptown Promotions has three divisions. As part of the planning process, the CFO requested that each division submit its capital budgeting proposals for next year. These proposals represent positive net present value projects that fall within the long-range plans of the firm. The requests from the divisions are $4.2 million, $3.1 million, and $6.8 million. For the firm as a whole, management has limited spending to $10 million for new projects next year even though the firm could afford additional investments. This is an example of: A) scenario analysis. B) sensitivity analysis. C) an operating leverage application. D) soft rationing. E) hard rationing.
D) soft rationing.
Simulation analysis is based on assigning a ________ and analyzing the results. A) narrow range of values to a single variable B) narrow range of values to multiple variables simultaneously C) wide range of values to a single variable D) wide range of values to multiple variables simultaneously E) single value to each of the variables
D) wide range of values to multiple variables simultaneously
When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under the condition known as: A) best-case sensitivity analysis. B) worst-case sensitivity analysis. C) best-case scenario analysis. D) worst-case scenario analysis. E) base-case scenario analysis.
D) worst-case scenario analysis.
DOL formula
DOL = 1 + (FC / OCF) % change in OCF = DOL * % change in Q
depreciation tax shield formula
Depreciation tax shield= DxT D=depreciation expense T= tax rate
Home Services common stock offers an expected total return of 14.56 percent. The last annual dividend was $2.27 a share. Dividends increase at a constant 2.1 percent per year. What is the dividend yield?
Dividend yield = .1456 − .021 = .1246, or 12.46%
capital structure weights notation
E = market value of equity = # of outstanding shares times price per share D = market value of debt = # of outstanding bonds times bond price P = market value of preferred stocks = # of outstanding preferred stocks times price per share V = market value of the firm = D + E
Wayco Industrial Supply has a pretax cost of debt of 8.3 percent, a cost of equity of 14.7 percent, and a cost of preferred stock of 8.9 percent. The firm has 165,000 shares of common stock outstanding at a market price of $33 a share. There are 15,000 shares of preferred stock outstanding at a market price of $43 a share. The bond issue has a face value of $750,000 and a market quote of 101. The company's tax rate is 21 percent. What is the weighted average cost of capital?
E =165,000($33= 5,445,000 P =15,000($43)= 645,000 D =1.01($750,000)= 757,500 V = $5,445,000 + 645,000 + 757,500 = $6,847,500 WACC = ($5,445,000/$6,847,500)(.147) + ($645,000/$6,847,500)(.089) +($757,500/$6,847,500)(.083)(1 − .21) WACC = .1325, or 13.25%
Which one of the following will produce the lowest present value interest factor? A) 6 percent interest for 5 years B) 6 percent interest for 8 years C) 6 percent interest for 10 years D) 8 percent interest for 5 years E) 8 percent interest for 10 years
E) 8 percent interest for 10 years
Assume both the discount and tax rates are positive values. At the financial break-even point, the: A) payback period equals the project's life. B) NPV is negative. C) OCF is zero. D) contribution margin per unit equals the fixed costs per unit. E) IRR equals the required return.
E) IRR equals the required return.
By definition, which one of the following must equal zero at the cash break-even point? A) Net present value B) Internal rate of return C) Contribution margin D) Net income E) Operating cash flow
E) Operating cash flow
Kelley's Baskets makes handmade baskets and is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project? A) Storing supplies in the same space currently used for materials storage B) Utilizing the basket manager to oversee wreath production C) Hiring additional employees to handle the increased workload should the firm accept the wreath project D) Researching the market to determine if wreath sales might be profitable before deciding to proceed E) Planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt
Hiring additional employees to handle the increased workload should the firm accept the wreath project
Capital Structure
How should we pay for our assets? Should we use debt or equity?
Probability index decision rule
If PI is greater than 1, accept the project
relationship between coupon and yield
If YTM = coupon rate, then par value = bond price If YTM > coupon rate, then par value > bond price If YTM < coupon rate, then par value < bond price
when do you use EAC
If the possibilities have different economic lives
straight line depreciation
Method that allocates an equal portion of the depreciable cost of plant asset (cost minus salvage) to each accounting period in its useful life.
Decline Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 13 years to maturity that is quoted at 105.2 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually. What is the aftertax cost of debt if the tax rate is 21 percent?
N=13*2=26, PMT=0.06*1000/2=30, PV=-1052, PV=1000, CPT I/Y=2.7185% (remember this rate is only for 6 months) So annual rate: r =2.7285% * 2= 5.437% RD Aftertax = 5.437%(1 − .21)= 4.30%
when the initial cost increases...
NPV will decrease
NPV formula
NPV= PV- initial cost where PV= (CF1/(1+ r)^1) + (CF2/(1+ r)^2) + (CF3/(1+ r)^3)
Your firm has total assets of $4,700, fixed assets of $3,000, long-term debt of $2,700, and short-term debt of $1,000. What is the amount of net working capital? a.$500 b.$700 c.$600 d.$1,700
NWC=current assets - current debt = (4700-3000) - 1000 = 700
Project X has cash flows of $8,500, $8,000, $7,500, and $7,000 for Years 1 to 4, respectively. Project Y has cash flows of $7,000, $7,500, $8,000, and $8,500 for Years 1 to 4, respectively. Which one of the following statements is true concerning these two projects given a positive discount rate? (No calculations needed) a. Both projects have the same value at Time 0. b. Both projects have the same future value at the end of Year 4. c. Project X has both a higher present and a higher future value than Project Y. d. Project Y has a higher present value than Project X.
Project X has both a higher present and a higher future value than Project Y.
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over its 10-year life. The project produces items that sell for $1,000 each, with variable costs of $700 per unit. Fixed costs are $350,000 per year. What is the accounting break-even quantity, operating cash flow at accounting break-even, and DOL at that output level? Ignore tax.
Q = (FC + D) / (P - V) = ($350,000 + $100,000) / ($1,000 - $700) = 1,500 units OCF = ( S - VC - FC - D) + D = (1,500 × $1,000 - 1,500 × $700 - $350,000 - $100,000) + $100,000 = $100,000 DOL = 1 + (FC / OCF) = 1 + ($350,000 / 100,000) = 4.5
The common stock of Dayton Repair sells for $47.92 a share. The stock is expected to pay $2.28 per share next year when the annual dividend is distributed. The company increases its dividends by 1.65 percent annually. What is the market rate of return on this stock?
R = $2.28/$47.92 + .0165 = .0641, or 6.41%
Street Corporation's common stock has a beta of 1.33. The risk-free rate is 3.4 percent and the expected return on the market is 10.97 percent. What is the cost of equity?
RE = .034 + 1.33(.1097 − .034) = .1347, or 13.47%
Taylor's Men's Wear has a debt-equity ratio of 48 percent, sales of $829,000, net income of $47,300, and total debt of $206,300. What is the return on equity?
ROE = $47,300/($206,300/.48) ROE = .1101, or 11.01%
A firm has a debt-equity ratio of .62, a total asset turnover of 1.24, and a profit margin of 5.1 percent. The total equity is $489,600. What is the amount of the net income?
ROE = .051(1.24)(1.62) ROE = .1024 NI = .1024 * 489,600 = 50,135.04
Oscar's Dog House has a profit margin of 5.6 percent, a return on assets of 12.5 percent, and an equity multiplier of 1.49. What is the return on equity?
ROE = 12.5%(1.49) ROE = 18.63%
The Dupont identity formula
ROE= NI/TE=PM X TAT X EM ROE= (NI/SALES) (SALES/TA) (TA/TE)
Grill Works has $6 each year for its preferred stock outstanding, and the stock is currently selling for $49 a share. What is the cost of preferred stock?
RP = 6/49RP = .1224, or 12.24%
preferred stock formula
RP =D/P0
CAPM formula
Re= Rf + Be (E(Rm)-Rf)
A common-size income statement is an accounting statement that expresses all of a firm's expenses as a percentage of: A) total assets. B) total equity. C) net income. D) taxable income. E) sales.
Sales
Round Dot Inns is preparing a bond offering with a coupon rate of 6 percent, paid semiannually, and a face value of $1,000. The bonds will mature in 10 years and will be sold at par. Given this, which one of the following statements is correct? a. The bonds will become discount bonds if the market rate of interest declines. b. The bonds will sell at a par if the market rate is 6.5 percent c. The final payment will be in the amount of $1,030. d. The bonds will initially sell for $1,030 each.
The final payment will be in the amount of $1,030.
Degree of Operating Leverage (DOL)
The higher the DOL, the greater the variability in operating cash flow. The higher the fixed costs, the higher the DOL. DOL depends on the sales level you are starting from.
total dollar return formula
Total dollar return= income from investment + capital gain (loss) due to change in price
total percentage return formula
Total percentage return = dividend yield + capital gains yield Dividend yield = income / beginning price Capital gains yield = (ending price - beginning price)/ beginning price
WACC formula
WACC= WeRe + WdRd(1-TC) + WpRp
future value interest factor (FVIF)
a factor multiplied by today's savings to determine how the savings will accumulate over time
total asset turnover (TAT)
a measure of the firm's asset use efficiency - how well does it manage its assets
Equity Multiplier (EM)
a measure of the firm's financial leverage
profit margin (PM)
a measure of the firm's operating efficiency - how well it controls costs
Dividend Growth Model
a model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate
Depreciation
a non-cash expense; consequently, it is only relevant because it affects taxes.
Balance sheet definition
a snapshot of the firm's assets and liabilities at a given point in time
Stand along principle
allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows.
The depreciation tax shield is best defined as the: A) amount of tax that is saved when an asset is purchased. B) tax that is avoided when an asset is sold as salvage. C) amount of tax that is due when an asset is sold. D) amount of tax that is saved because of the depreciation expense. E) amount by which the aftertax depreciation expense lowers net income.
amount of tax that is saved because of the depreciation expense.
base-case scenario
an analysis in which all of the input variables are set at their most likely values
which approach of OCF is the most important
approach 4 Tax-shield
balance sheet identity formula
assets= liabilities + stockholders' equity
A project has cash flows of -$148,400, $42,500, $87,300, and $43,200 for Years 0 to 3, respectively. The required rate of return is 11 percent. Based on the internal rate of return of ________ percent for this project, you should ________ the project. a. 7.91; accept b. 8.03; reject c. 6.67; reject d. 7.91; reject
b. 8.03; reject
Bond Value Formula
bond value= C [ 1- (1/(1+ r)^t)/r ] + FV/(1+r)^t
A project has an initial cash outflow of $42,600 and produces cash inflows of $17,680, $19,920, and $15,670 for Years 1 through 3, respectively. What is the NPV at a discount rate of 12 percent? a. $186.95 b. -$108.19 c. $219.41 d. $229.09
c. $219.41
weak form efficiency
current price reflects all information about the stocks previous prices.
Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Bob also deposited $3,000 this morning at 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Bob will reinvest her interest earnings into her account. Given this, which one of the following statements is true? a. Bob will earn more interest in Year 1 than Andy will. b. Andy will earn more interest in Year 3 than Barb will. c. Bob will earn more interest in Year 2 than Andy. d. After five years, Andy and Bob will both have earned the same amount of interest.
c. Bob will earn more interest in Year 2 than Andy.
Chemical Mines has 5,000 shareholders and is preparing to elect two new board members. You do not own enough shares to personally control the elections but are determined to oust the current leadership. Likewise, no other single shareholder owns sufficient shares to personally control the outcome of the election. Which one of the following is the most likely outcome of this situation given that some shareholders are happy with the existing management? a. Negotiated settlement where each side is granted control over one of the open seats b. Protracted legal battle over control of the board of directors c. Proxy fight for control of the board d. Control of the board decided without your influence
c. Proxy fight for control of the board
Capital structure decisions include determining: a. which one of two projects to accept. b. how to allocate investment funds to multiple projects. c. how much debt should be assumed to fund a project. d. how much inventory will be needed to support a project
c. how much debt should be assumed to fund a project.
hard rationing
capital will never be available for this project Financial distress Pre-existing contractual agreement
nonconventional cash flows cause...
cash flow signs change more than once, NPV and IRR decision rules differ
Sensitivity Analysis
changes one variable
portfolio
collection of assets
Christina invested $3,000 five years ago and earns 2 percent annual interest. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as: A) simplifying. B) compounding. C) aggregating. D) accumulating. E) discounting
compounding
common size balance sheet
compute all accounts as a percent of total assets
what is the cost of debt equivalent to
compute the YTM of a bond
Scenario Analysis
considering different scenario results
Allison just received the semiannual payment of $35 on a bond she owns. Which term refers to this payment? A) Coupon B) Face value C) Discount D) Call premium E) Yield
coupon
