Why should you approach every problem by drawing a timeline?
Timelines identify events in a transaction or investment which might otherwise be easily overlooked.
True or False:
Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the cost of a project or investment.
True
Which of the following best describes why the Valuation Principle is a key concept in making financial decisions?
It shows how to make the costs and benefits of a decision comparable, using approaches such as market prices and time value of money, so that we can weigh them properly.
How do the shareholders of most corporations exercise their control of that corporation?
By electing members of a board of directors.
A firm reports that in a certain year it had a net income of $5.5 million, depreciation expenses of $2.8 million, capital expenditures of $2.3 million, and Net Working Capital decreased by $1.5 million. What is the firm's free cash flow for that year?
FCF= Unleveled Net income + Depreciation - CapEx - ΔNCW
Therefore,
$5.5m + $2.8m - $2.3m - (-$1.5m) = $7.5 million
Initial Investment and cash flows
Project A $5 million $2 million per year for four years
Project B $3 million $1 million per year for five years
Project C $2 million $1 million per year for four years
Project D $3 million $1.5 million per year for three years
An investor has a budget of $5 million. He can invest in the projects shown above. If the cost of capital is 6%, what investment or investments should he make?
What is the present value (PV) of an investment that will pay $300 in one year's time, and $300 every year after that, when the interest rate is 4%?
PV= C/r
PV= 7500
True or False
The shares of a private corporations are traded on a stock market
False
Which of the following is NOT a limitation of the payback rule?
A) It is difficult to to calculate
TRUE or FALSE
The present value (PV) of a stream of cash flows is just the sum of the present values of each individual cash flow.
True
A firm has an opportunity to invest $80,000 today that will yield $115,000 in one year. If interest rates are 6%, what is the net present value (NPV) of this investment?
Use financial calculator to calculate NPV
CF> - 80,000 > enter
down arrow> CF0= 115,000> Enter
down arrow > NPV
I= 6> Enter
down arrow> CPT
NVP= $28,491
Since your first birthday, your grandparents have been depositing $2000 into a savings account on every one of your birthdays. THe account pays 4% annually. Immediately after your grandparents make the deposit on your 18th birthday, the amount of money in your savings account will be closest to:
$51,290
You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an investment of $20,000 in new equipment. This equipment will be depreciated straight line over 5 years. If your firms marginal corporate tax rate is 35%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation?
Depreciation tax shield= depreciation expense x tax rate
20,000/5 x .35 = $1,400
Stock markets provide liquidity for a firm's shares.
True
You are scheduled to receive $10,000 in one year. An increase in the discount rate will have what effect of the present value of this cash flow?
It will cause the present value to fall.
True or False
The internal rate of return (IRR) is the interest rate that sets the net present value (NPV) of the cash flows to equal zero.
True
U.S. public companies are required to file their annual financial statement with the U.S. Securities and Exchange Commissions on which form?
10-K
10-Q is quartlery
To compute the future value of a cash flow, you must:
Compound it
Consider the follow cash flows:
End of Year 1: $8,000
End of Year 2: $10,000
End of Year 3: $8,000
Using a discount rate of 6%, which is closest to the present values of these cash flows?
PV = FV/ (1+i)^{n}^{}
8000/(1.06)^1 = 7547.17
10000/(1.06)^2 = 8899.96
8000/(1.06)^3 = 6716.95
Sum= $23,164
True or False
The annual percentage rate indicates the rate of interest, including the effect of any compounding.
False
APR indicates the amount of interest that would be earned in one year without the effects of compounding.
In most corporations, to whom does the chief financial officer report?
The chief executive officer
Which group's interests should a financial manager consider paramount when making a decision?
The stockholders
What is the future value of $60,000 invested today at 12% per year for two years?
use financial calculator
n= 2
pv= -60,000
i/y = 12
pmt=0
FV= $75,264
Which of the following statements regarding annuities is FALSE?
A) The difference between an annuity and perpetuity is that a perpetuity ends after a set number of payments.
B) One has a fixed rate, the other does not
C) An annuity is a stream of N equal cash flows paid at regular intervals.
D) Most car loans, mortgages, and some bonds are annuities.
A and B are False
Jeff has the opportunity to receive a lump-sum payment either now or in the future. Which of the following opportunities is the best, given that the interest rate is 7% per year?
A) 1,950 in ten years
B) 1,000 now
C) 1,450 in five years
D) 1,200 in two years
PV= FV /(1 +i)^{n}
A) 1950 / (1.07)^10 = 991.2813
B) 1000 / (1.07)^0 = 1000
C) 1450 / (1.07)^5 = 1033.829762
D) 1200 / (1.07)^2 =1048.1264
D is the best opportunity^{}
Which of the following best describes the Net Present Value rule?
Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.
You are interested in purchasing a new automobile that costs $70,000. The dealership offers you a special financing rate of 6% APR (0.5% per month) for 48 months. Assuming that you do not make a down payment on the auto and you take the dealer's financing deal, then your monthly car payments would be closest to:
Financial calculator
2nd> I/Y> 12 (for months) >enter
n=48
i/y= 6
pv=70,000
=1644
A convenience store owner is contemplating putting a large neon sign over her store. It would cost $70,000, but is expected to bring an additional $33,000 of cash flow to the store every year for five years. Would this project be worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%?
C) No, since the actual amount of the cash flows over the first two years is less than the initial investment.
True or False
The Law of One Price states that if equivalent good or securities are traded simultaneously in different competitive markets, they will trade for the same price in each market.
True
An agricultural research firm has been planning to sell some farm land that it no longer wants to use. Upon leanring that a highway will be built near the farm within a few years, giving access to the farmland from a nearby city and thus making the land attractive to house developers. Expecting the net present value (NPV) of sale to be greater after the highway is built, the firm decides not to sell at this time. What real option is the firm taking?
ANSWER: Option to delay commitment - the option to time a particular investment.
Option to abandon- An option for an investor to cease making investments in a project. Abandonment options can add value to a project because a firm can drop a project if it turns out to be unsuccessful.
Option to expand- The option to start with limited production and expand only if the project is successful
Option to postpone- NOT LISTED
Real option- the right to make a particular business decision, such as a capital investment.
$400,000 is spent by a manufacturer to determine whether it is possible to create a commercially viable packaging material from oak leaves. How should the $400,000 best be classified?
ANSWER: as a sunk cost - Any unrecoverable cost for which a firm is already liable
fixed overhead expense - THose expenses associated with activities that are not directly attributable to a single business activity but instead affect many different areas of a corporation.
opportunity cost or cost of capital- the best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted; the return the investor forgoes on an alternative investment of equivalent risk and term when the investor takes on a new investment.
Which of the following balance sheet equations is INCORRECT?
A) Assets= Liabilities + Shareholders' Equity
B) Assets - Current Liabilities = Long Term Liabilities
C) Assets-Liabilities= Shareholders' equity
D) Assets- Current Liabilities = Long Term Liabilities + Shareholders' Equity
B is Incorrect
Which of the following would be best considered to be an agency conflict problem in the behavior of following financial managers?
Bill chooses to pursue a risky investment for the company's funds, because his compensation will substantially rise if it succeeds.
Which of the following is not a role of financial institution?
C) Printing money for borrowers
What is the effective annual rate (EAR)?
The interest rate that would produce the same interest with annual compounding as the APR would with the given frequency of compounding.
Which answer choice is closest to the correct amount that must be invested now at 8% interest in order to have $500,000 at the end of 9 years?
PV = FV/(1+i)^{n}
PV= 500,000/ (1+.08)^{9} = 250,124.4369
A large publishing firm specializing in college textbooks wishes to expand into online delivery of its materials. In order to facilitate this, it invests in a number of small start-up companies that deliver college courses online and uses these companies to start diversifying the delivery of its content. Which of the following best describes the role of the publishing firm as described above?
A corporate investor
Simone founded her company using $150,000 of her own money, issuing herself 300,000 shares of stock. An angel investor bought an additional 200,000 shares for $100,000. She now sells another 500,000 shares of stock to a venture capitalist for $3 million. What is the post-money valuation of the company?
Post-money Valuation= Implied Price per Share x New Total Number of Shares
VC 3,000,000/500,000=6
6x1,000,000=$6,000,000
The founder of a company issues 300,000 shares of stock of series A stock for his own $450,000 investment. He then goes through three further rounds of investment, as shown below: Round Price Number of Shares
Series B $2.50 200,000
Series C $2.75 300,000
Series D $2.80 200,000
Which of the following is the percentage of the company owned by the founder of the company?
Owners Shares/Total Shares
300,000/(300,000+200,000+300,000+200,000)=0.30
30%
Which of the following statements is NOT true regarding venture capitalists?
A. They might invest for strategic objectives in addition to the desire for investment returns.
Price($) Number of Shares Bid 6.00 100,000
6.25 200,000
6.50 450,000
6.75 200,000
7.00 350,000
7.25 200,000
7.50 250,000
Harrison Products is selling 1.45 million shares of stock in an auction IPO. At the end of the bidding period they have received the bids shown above. Which of the following is the price at which the shares will be offered?
Add up highest priced stock until you reach the amount of shares being sold.
Which of the following statements is FALSE?
A. The two advantages of going public are greater liquidity and better access to capital. B. By going public, companies give their private equity investors the ability to diversify.
C. The process of selling stock to the public for the for the second time, and thereafter, is called an initial public offering (IPO).
D. Public companies typically have access to much larger amounts of capital through the public markets.
C. The process of selling stock to the public for the for the second time, and thereafter, is called an initial public offering (IPO).
Valiant Industries has 20 million shares of stock outstanding at a price of $28 per share. The company wishes to raise more money and plans to do so through a rights issue. Every existing stockholder will receive one right for each share of stock held. For every eight rights held by the stockholder, one share can be bought at a price of $28. If all rights are exercised, how much money will be raised in this offer?
Proceeds=Price per share x Number of Shares (share/rights)
$28 x (20,000,000/8)=$70,000,000
(True or False) Bond covenants tend to decrease a bond issuer's borrowing costs.
True
What is a call provision?
An option to the bond issuer to repurchase the bonds at a predetermined price.
A company issues a callable (at par) five-year, 8% coupon bond with annual coupon payments. The bond can be called at par in one year after release or any time after that on a coupon payment date. On release, it has a price of $105 per $100 of face value. Which is closest to the yield to call of this bond when it is released?
PV=C+FV/(1+YTC)
105=$8+$100/(1+YTC)
Trial and Error.... YTC=0.0286
2.86%
Coupon: 0%
Conversion Ratio: 220 shares per $1000 principal amount
Call Date: July 1, 2008
Call Price: Par
Maturity: July 1, 2015
A firm issues the convertible debt shown above. The price of stock in this company on July 1, 2008 is $5.15. If the bonds are called on this date, which of the following is the action most likely to be taken by a holder of bond of face value of $10,000?
Convert the bond and accept shares with a value of $11,330.
The coupon value of a bond is the face value of that bond.
False
How much will the coupon payments be of a 5-year $10,000 bond with a 8.5% coupon rate and semiannual payments?
*Divide rate by 2 because it is semiannual
Bond Value*Rate
10,000*0.0425=$425.00
An investor holds a General Mills bond with a face value of $5000, a coupon rate of 3%, and semiannual payments, that matures on 01/15/2020. How much will the investor receive on 01/15/2020?
*Divide by 2 because its semiannual
Face Value * Rate =
$5000*.0.015=75
75+5000= 5075
A furniture manufacturer issues a bond with a face value of $10,000 and a coupon rate of 2.88% that matures on 07/15/2019. The holder of such a bond receives coupon payments of $144.00 How frequently are coupon payments made in this case?
Semiannually
Which of the following statements is FALSE?
A. Bonds are a securities sold by governments and corporations to raise money from investors today in exchange for promised future payments.
B. Bonds typically make two types of payments to their holders.
C. The time remaining until the repayment date is known as the term of the bond.
D. By convention the coupon rate is expressed as an effective annual rate.
D. By convention the coupon rate is expressed as an effective annual rate.
How are investors in zero-coupon bonds compensated for making such an investment?
Such bonds are purchased at a discount to their face value.
What is the yield to maturity of a one-year, risk-free, zero-coupon bond with a $10,000 face value and a price of $9550 when released?
C. 4.71%
10,000-9,550=450
.0471*9,550=449.80
4.71%
A risk-free, zero-coupon bond with a face value of $1,000 has 6 years to maturity. If the YTM is 5.2%, which of the following would be closest to the price at which this bond will trade?
Solve for PV
N=years
i/y=5.2
PMT=0
FV=1000
$737
What is the yield to maturity of a $5,000 bond with a five year term, a 3.6% coupon rate, and semiannual coupons if this bond is currently trading for a price of $5,054?
Solve for I/Y
n=5
PV=5054
PMT=(.036*5000)=180
FV=5000
3.36%
What must be the price of a $1000 bond with a 5.2% coupon rate, annual coupons, and 20 years to maturity if YTM is 6.5% APR?
Solve for PV
N=20
I/Y=6.5
PMT=(1000*0.52)=52
FV=1000
$856.76
A $1000 bond with a coupon rate of 5.4% paid semiannually has five years to maturity and a yield to maturity of 9.5%. If interest rates rise and the yield to maturity increases to 9.8%, what will happen to the price of the bond?
Falls by $10.47
A company releases a ten-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 3%, what should be the coupon rate offered if the bond is to trade at par?
If a bond sells at par the only return investors will earn is from the coupons that the bond pays
Therefore, the bond's coupon rate will exactly equal its yield to maturity
3%
Which of the following statements is true?
D. A rise in interest rates causes bond prices to fall.
The credit spread of a bond increases if it is perceived that the probability of the issuer defaulting increases.
True
Bonds with a high risk of default typically can’t offer high yields.
False
Consolidated Mining pays a dividend of $4.25 per share and is expected to pay this amount indefinitely. If Consolidated's equity cost of capital is 11%, which of the following would be expected to be closest to Consolidated's stock price?
A.$29.98
B.$31.11
C.$35.22
D.$38.64
4.25*0.11=38.6363
$38.64
A stock is bought for $20.00 and sold for $26.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction?
Capital Gain Yield= (P1-P0)/P0
(26-20)/20=0.30
30.00%
Von Bora Corporation (VBC) is expected to pay a $3.00 dividend a year from now. If you expect VBC's dividend to grow by 7% per year forever and VBC's equity cost of capital is 15%, then the value of a share of VBS stock is closest to:
P=D1/(r-g)
3.00/(.15-.07)
3.00/0.08=$37.50
Luther Industries has a dividend yield of 2.5% and a cost of equity capital of 12%. Luther Industries' dividends are expected to grow at a constant rate indefinitely. The growth rate of Luther's dividends are closest to:
g=rE - DIV1/P0
12-2.5=9.5
A portfolio consists of three securities: 200 shares of Yahoo (YHOO), 200 Shares of General Motors (GM), and 50 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $60, the price of GM is $30, and the price of SPY is $150, calculate the portfolio weight of YHOO and GM.
YHOO (200*$60) 12,000
GM (200*$30) 6,000
SPY (50*$150) 7,500
12,000/(12,000+6,000+7,500)=47.1%
6,000/25,500=23.5%
The beta of the market portfolio is:
1
(True or False) The Capital Asset Pricing Model (CAPM) says that the excess return on a stock is equal to the risk free rate plus the stock’s beta times the market risk premium.
False
Your estimate of the market risk premium is 8%. The risk-free rate of return is 3.5% and General Electric has a beta of 1.3. According to the Capital Asset Pricing Model (CAPM), what is its expected return?
Expected Return= Risk-free Rate + (Beta x Mark Risk Premium)
.035 + (1.3*0.08)=0.139
13.9%
A portfolio comprises Coke (beta of 1.1) and Consolidated Edison (beta of 0.80). The amount invested in Coke is $20,000 and in Consolidated Edison is $10,000. What is the beta of the portfolio?
(1.1*0.666666)+(0.80*0.333333)
.7333333+.2666666=.999999
1.00
The Capital Asset Pricing Model asserts that the ________ return is equal to the risk-free rate plus a risk premium for systematic risk.
Expected Return
The founders and owners of a private company have funded it through the following rounds of investment: Round Source Price Number of Shares
Series A Self $1.00 300,000
Series B Angel $1.00 300,000
Series C Venture Capital $1.25 400,000
The owners decide to take the company public through an IPO, issuing 2 million new shares. Assuming that they successfully complete the IPO, the net income for the next year is estimated to be $6 million. The IPO price per share will be set using average price-earning rations for similar businesses of 25.0 (25:1). What will be the IPO price per share?
Value of Firm=Total Earning x P/E Ratio
6 million x 25 = 150 million
Value of Firm/Total Number of Shares= Price per share
150 million/ 3 million= 50 million
The price of each share is 50 million
Outstanding debt of Southern Atlantic Railways trades with a yield to maturity of 16.0%. The (marginal) tax rate of Southern Atlantic is 30%. What is the effective cost of debt of Southern Atlantic?
After-tax Cost of Debt= 0.16 x (1-0.30)= 11.2
11.2%
Preferred stock of Pan Euro Airways has a par value of $100, pays a dividend of 5% each year and trades at a price of $80. What is the cost of preferred equity (preferred stock capital) for Pan Euro?
(0.05*100)/80= 0.0625
6.25%
A firm has a capital structure with $60 million in equity and $40 million of debt. The firm's cost of equity capital is 15% and the firm's pretax cost of debt is 10%. The marginal tax rate of the firm is 40%. What is the weighted average cost of capital of the firm?
11.4%
Modern Manufacturing, Inc. has inventory days of 31, accounts receivable days of 36, and accounts payable days of 17. What is the cash conversion cycle?
50
Firms typically would prefer a cash conversion cycle.
Negative
(True or False) A firm that is financed with all equity is considered to be unlevered.