Final Exam (Ch. 1-14, 16)
total return (YTM) = return of interest (CY) + capital gain (loss)
How do you calculate the total return (YTM)?
present value of dividends + present value of selling price
How do you find the price today of a stock?
time value of money
basic concept that a dollar today is worth more than a dollar tomorrow
payback
break even analysis that does not take into account the value added from the project or the time value of money; good risk and liquidity measurement
financial breakeven
breakeven measure where NPV = 0, discounted payback period equals life of the project, and IRR = RRR
accounting breakeven
breakeven measure where net income is zero, payback period equals the life of the project, NPV<0, and IRR = 0%
cash breakeven
breakeven measure where the project is never paid back, NPV<0, and IRR = -100%
replacement
capital budgeting project classification; ex: delivery truck breaks down so get a new one
cost reductions
capital budgeting project classification; ex: delivery truck works fine but new model would save on gas money
expansion
capital budgeting project classification; ex: expand to a new region from Midwest to South to Northeast
free cash flow (cash flow from assets)
cash flow that is available to be distributed to all investors, both debt (creditors) and equity (shareholders)
incremental
cash flows that would not occur without the project
unsystematic risk
company risk; union strikes, success or failure of new products
risk premium
the additional compensation/return for investors to assume risk
par value
the amount of the loan; standard is $1,000
side effects
the benefits or costs that are the result of the project having an impact on other products/lines of business
quoted rate
the nominal annual interest rate
periodic rate
the nominal interest rate for one compounding period (years, months, weeks, days)
net present value (NPV)
the present value of the benefits minus the costs in time zero; accept if greater than zero, reject if less than zero; estimates how much value will be added to the firm if the project is implemented; doesn't measure risk
capital budgeting
the process of analyzing additions to fixed assets
effective annual rate (EAR)
the rate if there is only one compounding period per year
expected return
the weighted average of the returns of stocks in a given portfolio
efficient markets
when the prices of the security quickly and fully reflects all the available information; at the equilibrium price and investors cannot beat the market
= present value of benefits/costs
How do you calculate the profitability index (PI)?
risk
"you think you understand something when you don't"
maturity
A Treasury yield curve plots Treasury interest rates relative to _______________.
a
A bond has a market price that exceeds its face value. Which one of these features currently applies to this bond? (a) Yield to maturity less than the coupon rate. (b) Yield to maturity equal to the current yield. (c) Current yield greater than coupon rate. (d) Discount bond. (e) Currently selling at par.
unsystematic
A news flash just appeared that caused about a dozen stocks to suddenly drop in value by 20 percent. What type of risk does this news flash best represent?
upward; long, short
A normal yield curve is ____________ sloping because rates are higher in the ______ run than in the _______ run.
c
A zero coupon bond: (a) Pays interest that is tax deductible to the issuer at the time of payment. (b) Can only be issued by the U.S. Treasury. (c) Has more interest rate risk than a comparable coupon bond. (d) Is sold at a large premium. (e) Provides no taxable income to the bondholder until the bond matures.
decrease, operating
According to the statement of cash flows, an increase in inventory will ____________ the cash flow from ___________ activities.
11.15%
Ackerman Co. has 7 percent coupon bonds on the market with fourteen years left to maturity. The bonds make annual payments. If the bond currently sells for $712.53, what is its YTM? Assume a par value of $1,000.
financial
All equity firms don't have _________________ risk.
c
Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect: (a) All stock values to remain constant. (b) Dividend-paying stocks to increase in price while non-dividend paying stocks remain constant in value. (c) A decrease in all stock values. (d) Dividend-paying stocks to maintain a constant price while non-dividend paying stocks decrease in value. (e) An increase in all stock values.
increases, decreasing
As a bond's time to maturity increases, the bond's sensitivity to interest rate risk _________________ at a ___________________ rate.
yield to maturity > current yield > coupon rate
At discount, what is the relationship between the coupon rate, current yield, and yield to maturity?
coupon rate = current yield = yield to maturity
At par, what is the relationship between the coupon rate, current yield, and yield to maturity?
yield to maturity < current yield < coupon rate
At premium, what is the relationship between the coupon rate, current yield, and yield to maturity?
e
Bonds issued by the U.S. government: (a)Generally have higher coupons than comparable bonds issued by a corporation. (b) Are considered to be free of interest rate risk. (c) Pay interest that is exempt from federal income taxes. (d) Are called "munis." (e)Are considered to be free of default risk.
d
Financial risk is: a. Irrelevant to the value of a firm. b. A type of unsystematic risk. c. The risk inherent in a firm's operations. d. Dependent upon a firm's capital structure. e. Inversely related to the cost of equity.
e
For a tax-paying firm, an increase in _____ will cause the cash flow from assets to increase. (a) Production costs (b) Taxes (c) Net capital spending (d) Change in net working capital (e) Depreciation
NPV, IRR
For normal projects, the _______ and the _______ give the same accept/reject decision.
WACC < MIRR < IRR (WACC > MIRR > IRR)
For normal projects, what is the relationship between the MIRR, WACC, and IRR?
loss, gain
For premium bonds, there is a capital _________, and for discount bonds, there is a capital _________.
d
If a firm produces a 13 percent return on assets and also a 13 percent return on equity, then the firm: (a) May have short-term, but not long-term debt (b) Has a debt-equity ratio of 1.0 (c) Has no net working capital (d) Has an equity multiplier of 1.0 (e) Is using its assets as efficiently as possible
fixed dividend that must be paid before common dividends
In what way is preferred stock like a bond?
dividends can be omitted without pushing the company into bankruptcy
In what way is preferred stock like a stock?
6.31%
Kiss the Sky Enterprises has bonds on the market making annual payments, with 7 years to maturity, and selling for $860. At this price, the bonds yield 9.1 percent. What must the coupon rate be on the bonds?
e
Lenders probably have the most interest in which one of the following sets of ratios? (a) Return on equity and price-earnings (b) Return on assets and profit margin (c) Price-earnings and debt-equity (d) Market-to-book and times interest earned (e) Long-term debt and times interest earned
e
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 final payment will be in the amount of $1,060. (b) The bonds will pay 10 interest payments of $60 each. (c) The bonds will initially sell for $1,030 each. (d) The bonds will become discount bonds if the market rate of interest declines. (e) The bonds will sell at a premium if the market rate is 5.5 percent.
a
Shareholder A sold shares of Maplewood Cabinets stock to Shareholder B. The stock is listed on the NYSE. This trade occurred in which one of the following? (a) Secondary, auction market (b) Secondary, dealer market (c) Primary, dealer market (d) Secondary, OTC market (e) Primary, auction market
d
Shareholders' equity: (a) Is referred to as a firm's financial leverage (b) Includes patents, preferred stock, and common stock (c) Is equal to total assets plus total liabilities (d) Represents the residual value of a firm (e) Decreases whenever new shares of stock are issued
$695.76
Staind, Inc., has 6 percent coupon bonds on the market that have 15 years left to maturity. The bonds make annual payments. If the YTM on these bonds is 10 percent, what is the current bond price?
financial distress costs
any and all costs that are higher due to an increased likelihood of bankruptcy
d
The Corner Hardware has succeeded in increasing the amount of goods it sells while holding the amount of inventory on hand at a constant level. Assume that both the cost per unit and the selling price per unit also remained constant. This accomplishment will be reflected in the firm's financial ratios in which one of the following ways? (a) Increase in the fixed asset turnover rate (b) Decrease in the total asset turnover rate (c) Decrease in the net working capital turnover rate (d) Decrease in the day's sales in inventory (e) Decrease in the inventory turnover rate
c
The DuPont identity can be used to help managers answer which of the following questions related to a firm's operations? I. How many sales dollars has the firm generated per each dollar of assets? II. How many dollars of assets has a firm acquired per each dollar in shareholders' equity? III. How much net profit is a firm generating per dollar of sales? IV. Does the firm have the ability to meet its debt obligations in a timely manner? (a) I, II, III, and IV (b) II, III and IV only (c) I, II, and III only (d) II and IV only (e) I and III only
does not, does
The Modigliani-Miller Model says that with no taxes the capital structure of a firm __________ impact the value. With taxes, it says that capital structure __________ impact value.
marginal
The WACC is the ___________ cost of capital, not the historical cost.
c
The capital structure that maximizes the value of a firm also: a. Maximizes the present value of the tax shield on debt. b. Maximizes the value of the debt. c. Minimizes the cost of capital. d. Maximizes the present value of the bankruptcy costs. e. Minimizes financial distress costs.
annualized
The convention is to report return on an ________________ percentage basis.
sales, OCF
The degree of operating leverage states that for every 1% change in ___________, there is a DOL % change in ___________.
maximize shareholder value
The goal of financial management is to ___________________________________.
higher, lower
The higher the interest rate, the ___________ the future value and the _________ the present value.
smaller
The larger the coupon, the ____________ the price change of a bond.
minimizes
The level of debt that maximizes the value of a firm also _______________ the WACC.
larger
The longer the time to maturity, the ________ the price change of a bond.
equilibrium
The market is in ________________ when the reward to risk equals to the market risk premium.
0, 1
The market's beta equals ____, and the risk-free's beta equals ____.
inverse
There is a _____________ relationship between price and interest rates.
positive, higher
There is a ______________ relationship between risk and return. The higher the risk, the ___________ the return.
true
True or False: All independent projects with positive NPVs should be accepted.
true
True or False: Annuity dues will have both a higher present and future value than ordinary annuities.
true
True or False: Eliminating unsystematic risk is the responsibility of the individual investor.
true
True or False: For non-normal projects, there are multiple IRRs and may give the wrong decision recommendation.
false
True or False: Interest expense is included in relevant cash flows.
true
True or False: Markets tend to respond quickly to new information.
true
True or False: Relevant risk can't be diversified.
false
True or False: Short-run price movements are easy to predict.
positive, negative, positive or negative (depending on life phase; growth would be positive, stable would be negative because paying out dividends)
We would expect cash flows from operating activities to be ______________, cash flows from investing activities to be _______________, and cash flows from financing activities to be __________________.
expectations about future inflation, perceptions about relative riskiness of securities with different maturities (interest rate risk)
What affects the shape of the yield curve?
debt, equity (preferred, common (retained earnings, new issue))
What are the 2 components of capital?
exposure, uncertainty
What are the 2 components of risk?
consequences vs. probabilities, expecting the unexpected, reversibility vs. control
What are the 3 elements of risk according to Peter Bernstein?
1. estimate cost of project 2. expected cash flows 3. estimate risk of the cash flows 4. appropriate cost of capital 5. calculate the present value of benefits and compare to costs 6. give recommendation
What are the 6 steps of capital budgeting?
standardize numbers and facilitate comparisons, evaluate performance and plan for the future, stakeholders able to evaluate financial strength, highlights strengths and weaknesses
What are the benefits to ratio analysis?
real risk free rate, inflation premium, interest rate risk premium, default risk premium, liquidity premium, taxability premium, currency premium
What are the determinants of the interest rate?
economic cycle, industry analysis, management strategy
What are the dynamic forces that affect financial statements?
corporate structure with limited liability, decision makers are rational, rational decision makers are risk averse
What are the key assumptions in corporate finance?
weak, semi-strong, strong
What are the three forms of efficient markets?
discounting, reinvestment, combination
What are the three ways to calculate the MIRR?
build a better business than competitors, use leverage, cheat
What are the three ways to increase value?
target, market, book
What are the three ways to weight capital structure?
real rate of interest, inflation rate
What are the two components of the nominal risk free rate?
dividend yield, capital gains (losses)
What are the two components of total return?
arithmetic, geometric
What are the two methods for annual rates of return?
interest rates, taxes
What external factors influence WACC?
capital structure (debt vs. equity), dividend policy, investment policy
What internal factors influence WACC?
NPV (always gives correct accept/reject)
What is the best decision making method criteria?
units produced/sold
What is the critical variable?
depreciation
What is the primary noncash charge?
intrinsic value of the organization
What is the value of stocks?
dividend yield, capital gains; R = (D/P) + g
What two components make up the total return? How do you calculate?
maximize, long, zero(low)
When interest rates are expected to decrease, you want to ____________ the price increase by buying _______ term and _______ coupon bonds.
minimize, short, high
When interest rates are expected to increase, you want to ____________ the price decline by buying _______ term and _______ coupon bonds.
rises, less, greater, premium
When interest rates fall, price _________. The yield to maturity is __________ than the coupon; therefore, price is _________ than par and the bond sells at ____________.
falls, greater, less, discount
When interest rates rise, price _________. The yield to maturity is __________ than the coupon; therefore, price is _________ than par and the bond sells at ____________.
aren't, are, are (most of the time)
When it comes to incremental cash flows, sunk costs _________ included, opportunity costs __________ included, and side effects _________ included.
ability to generate cash flows
Where does a firm's market value come from?
PPE
Which balance sheet category has nonconstant growth?
b
Which bond would you generally expect to have the highest yield? (a) Risk-free Treasury bond (b) Long-term, taxable junk bond (c) Short-term, inflation-adjusted bond (d) Non-taxable, highly-liquid bond (e) Long-term, high-quality, tax-free bond
debt
Which is more expensive? Debt or Equity?
a, d
Which of the following are examples of diversifiable risk? a. Earthquake damages an entire town. b. Federal government imposes a $100 fee on all business entities c. Employment taxes increase nationally. d. Toymakers are required to improve their safety standards.
c
Which of the following can be used to compute the return on equity? I. Profit margin × Return on assets II. Return on assets × Equity multiplier III. Profit margin × Total asset turnover × Debt-equity ratio IV. Net income / Total assets (a) I, II, and III only (b) I, II, III, and IV (c) II only (d) II and III only (e) II and IV only
b
Which one of the following best illustrates that the management of a firm is adhering to the goal of financial management? (a) Increase in the number of shares outstanding (b) Increase in the market value per share (c) Decrease in the net working capital (d) Increase in the amount of the quarterly dividend (e) Decrease in the per unit production costs
a
Which one of the following is a source of cash for a non-tax-paying firm? (a) Increase in common stock (b) Increase in depreciation (c) Decrease in accounts payable (d) Increase in inventory (e) Increase in accounts receivable
e
Which one of the following is included in a firm's market value but yet is excluded from the firm's accounting value? (a) Equipment owned by the firm. (b) Real estate investment. (c) An item held by the firm for future sale. (d) Money due from a customer. (e) Good reputation of the company.
c
Which one of the following is the financial statement that shows the accounting value of a firm's equity as of a particular date? (a) Dividend statement (b) Creditor's statement (c) Balance sheet (d) Income statement (e) Statement of cash flows
a
Which one of the following relationships applies to a par value bond? (a) Coupon rate = current yield = yield-to-maturity. (b) Yield to maturity > current yield > coupon rate. (c) Coupon rate < yield to maturity < current yield. (d) Coupon rate > current yield > yield to maturity. (e) Coupon rate > yield-to-maturity > current yield.
a
Which one of the following statements concerning net working capital is correct? (a) Net working capital increases when inventory is sold for cash at a profit. (b) Net working capital is a part of the operating cash flow. (c) Firms with equal amounts of net working capital are also equally liquid. (d) The lower the value of net working capital is, the greater is the ability of a firm to meet its current obligations. (e) An increase in net working capital must also increase current assets.
c
Which one of the following statements related to an income statement is correct? (a) Depreciation does not affect taxes since it is a non-cash expense. (b) Net income is distributed to dividends and paid-in surplus. (c) Taxes reduce both net income and operating cash flow. (d) Interest expense increases the amount of tax due. (e) Interest expense is included in operating cash flow.
c
Which one of the following terms is defined as the management of a firm's long-term investments? (a) Agency cost analysis (b) Working capital management (c) Capital budgeting (d) Financial allocation (e) Capital structure
d
Which one of the following transactions occurs in the primary market? (a) Gift of 100 shares of stock to a charitable organization. (b) Gift of 200 shares of stock by a mother to her daughter. (c) IBM's purchase of GE stock from a dealer. (d) A purchase of newly issued stock from ATamp;T. (e) Purchase of 500 shares of GE stock from a current shareholder.
b
Which type of business organization has all the respective rights and privileges of a legal person? (a) Limited partnership (b) Corporation (c) Limited liability company (d) General partnership (e) Sole proprietorship
stockholders
Who has voting rights? Stockholder or creditors?
low cost of financing (tax deductible), leverage, ROE increases
Why do companies use debt?
managers use it as a decision making tool, able to determine if the company has enough cash to fund new projects
Why do firm's budget?
inflation (purchasing power loss), opportunity costs, deferred spending
Why is it that a dollar today is worth more than a dollar tomorrow?
because they have no maturity date
Why is the secondary market critical for stocks?
capital asset pricing model (CAPM)
a stock's required expected rate of return is equal to the risk-free rate (nominal) plus a risk premium that reflects the relevant risk of the stock after diversification
semi-strong
You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____________ form efficient.
c
You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur? (a) Long-term; high coupon. (b) Short-term; low coupon. (c) Long-term; zero coupon. (d) Short-term; high coupon. (e) Long-term; low coupon.
liquidity
ability of a company to make required payments
creditors
__________ have legal recourse if interest and principal are not paid because it is a contractual agreement.
financial ratios
___________ _________ turn data into information.
financial statements
___________ ____________ give us past information that we use to predict the future.
relevant
___________ risk is the only risk that is compensated for with higher return for a higher risk.
interest, dividend, opportunity cost
_____________ is the cost of debt. __________ is the cost of preferred stock. _____________ ______ is the cost of common stock/equity.
relevant
_______________ risk is the risk of the portfolio of stocks, not per stock.
diversification
______________________ lowers but does not eliminate risk.
weighted average cost of capital (WACC)
cost of raising money for capital budgeting projects; hurdle rate that we use to compare the IRR to for recommending projects; discount rate for calculating the NPV
opportunity costs
costs of alternative uses; costs of what is given up when a project is accepted
sunk costs
costs that have already been incurred regardless of whether or not the project is accepted
post audit
evaluating the project after implementation; ongoing decision making, improve future decisions, provide accountability for decisions already made
percent of sales forecasting method
financial statement method for projecting future statements and determining the external funds needed (EFN) to make the balance sheet balance
income statement
financial statement that provides us with a flow of data for a period of time
balance sheet
financial statement that provides us with a snapshot of a point in time; able to evaluate liquidity, debt vs. equity, and book vs. market value of a firm
strong form
form of efficient market; all information (public and private) is reflected in the stock price; NOT efficient
semi-strong form
form of efficient market; all publicly available information is reflected in stock price; evidence supports but requires some investors to believe they can beat the market
weak form
form of efficient market; says that markets are efficient
simulation
hundreds to thousands of scenarios
sensitivity analysis
identifies the most significant variables by changing one variable and leaving all others constant
scenario analysis
identifying multiple variations in variables
fully amortized loan
loan type in which you make the same payment at the same time interval; portion goes to pay debt and initial purchase (ex: car or house)
systematic risk
market risk; inflation, GDP growth, interest rates, macroeconomics
sustainable growth rate
maximum rate while maintaining capital structure (no new equity issued; constant debt to equity ratio)
internal growth rate
maximum rate without external funding needed
constant dividend growth model
model that assumes that dividends are a good proxy of cash flows; dividends are discounted at a minimum required rate of return and the growth rate is a constant percentage
perpetuity
no time period; just receive payments forever (can't solve for future value)
bond
not an ownership interest but rather long-term debt
stock
ownership interest in a company; have voting rights; receive residual dividends
internal rate of return (IRR)
rate of return when the NPV=0; rate that results when present value of benefits=costs at time zero; accept when greater than r, reject if less than r
modified internal rate of return (MIRR)
rate that adjusts for the multiple IRRs and the reinvestment rate assumption; accept if greater than r, reject if less than r
annuity due
receive payments at the beginning of the period
ordinary annuity
receive payments at the end of the period
operating leverage
relationship between sales and operating cash flow
business risk
risk that is associated with the operations of a business; ex: demand variability, sales price variability, input cost variability, operating leverage
financial risk
risk that is associated with the use of debt
risk averse
says that investors dislike risk and need to receive extra return to encourage extra risk
