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Finance 3104 Final Exam ALL
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Key Concepts:
Terms in this set (114)
The long-run goal of the firm is to
Maximize shareholder wealth
Maximize shareholder wealth means
Maximizing market value of the firm's common stock
Advantages of the corporation include
1. Transferability of ownership
2. Ability of the corporation to raise capital
Disadvantages of a partnership are
1. Lack of permanence
2. Unlimited Liability
Expected inflation rate
Inflation rate = (1 + nominal interest rate/1 + real interest rate) -1
Real risk free rate of interest
Real rate of interest = nominal rate - inflation rate
Which is NOT a method by which securities are distributed to final investors
Upset Agreement
What is NOT an advantage of private placements
Interest costs -> they have higher interest costs
Which is NOT a disadvantage of private placements
Speed
What are the two major categories of flotation costs
Underwriters' spread & Issuing Costs
Flotation costs are highest on
Common Stock
Why underdeveloped countries remain underdeveloped
Lack effective financial market systems & lack political stability
Earnings per Share
Net income/number of shares
What are profit margins? What are different types of profit margins
1. Profit margins are profit-to-sales relationship.
2. Gross profit margin, operating profit margin, net profit
The purpose of financial analysis is NOT
1. Restating accounting data in relative terms so comparisons can be made with firms of different sizes and with the same firm over time
2. To identify financial strengths and weaknesses of a company
When would one use a financial ratio
1. To decide whether or not to grant credit terms
2. To evaluate a firm's performance
3. To determine the firms creditworthiness
4. Whether or not to make a loan to a company
5. Whether or not to invest in a company
What differences in accounting practices limit usefulness of financial ratios?
1. Different firms choose different methods to depreciate their fixed assets.
2. Different firms choose different methods to allocate inventory
Why should you be careful when comparing a firm with industry norms?
1. Firms experience seasonal changes in operations
2. Difficult to identify the industry to which your firm belongs
3. Published peer groups or industry averages are approximations
4. Industry average is not always a desirable target ratio or norm
5. Accounting practices differ widely among firms
If you invest $1 at an APR of 16% compounded semiannually, how many years would it take for your investment to grow fivefold $5?
N = ? (20/2 = 10)
I/Y = 12/2
PV = -1
PMT = 0
FV = 5
*divide solution (N) by 2
If you are offered $5350.25 12 years from now in return for an investment of $1000, what annual rate of interest would you earn
N = 12
I/Y = ? (15%)
PV = -1000
PMT = 0
FV = 5350.25
Lisa Simpson wants to have 1.5 million in 30 years by making equal annual end-of-the-year deposits into a tax-deferred account paying 8.5 percent annually. What must her annual deposit be?
N = 30
I/Y= 8.5
PV = 0
PMT = ? (12075.86)
FV = -1500000
Ronan Consulting has just realized an accounting error that has resulted in an unfunded liability of $390000 due in 23 years. The appropriate discount rate is 8%, what is the present value of the liability.
N = 23
I/Y = 8
PV = ? (66422.96)
PMT = 0
FV = -390000
Bowflex television ad says you can get a fitness machine that sells for $1060 for $48.18 a month for 24 months. What APR are you paying on this Bowflex loan?
N = 24
I/Y = ? (.7078*12 = 8.49)
PV = 1060
PMT = -48.18
FV = 0
Dennis Rodman has $5000 debt balance with an APR of 14.5% compounded monthly. Current min. monthly payment is 3% of his debt balance, $150. How many months will it take for Dennis to pay off his credit card if he pays at a minimum payment of $150.
N = ? (43)
I/Y = 14.5/ 12 = 1.2083
PV = 5000
PMT = -150
FV = 0
You've received an offer from a bank for a credit card with a quoted are of 16% compounded quarterly. What is the EAR on the credit card?
EAR = (1 + (APR/compounding periods per year (m)))^m -1
Don Draper has signed a contract that will pay him $40000 for the next 7 years plus $110000 at the end of year 7. If 8% is the appropriate discount rate what is the present value. What is the PV of 110000 at the end of year 7 if discount rate is 8%?
1. N = 7
I/Y = 8
PV = ? (208254.80)
PMT = -40000
FV = 0
2. N = 7
I/Y = 8
PV = ? (64183.94)
PMT = 0
FV = -110000 --> add the 2 PV together to get total
Lisa wants to have 1.2 million in 55 years by making equal annual deposits paying 7.75 percent annually. What must her annual repost be?
N = 55
I/Y = 7.75
PV = 0
PMT = ? (1558.66)
FV = -1200000
State lottery's million dollar payout provides 2 million to be paid over 19 years in 20 payments of $100000. First $100000 is paid immediately and remaining 19 $100000 accord at the end of the next 19 years. If 11% is the discount rate what is the PV. If 22 is the discount rate what is the PV?
1. N = 20
I/Y = 11
PV = ? (796333.81*1.11 = 883929.42)
PMT = -100000
FV = 0
2. N = 20
I/Y = 22
PV ? (4460266.60*1.22 = 544152.46)
PMT = -100000
FV = 0
Ronnie wants to invest $80 at the end of each week for 7 years into an account that pays 9.6% compounded weekly. This will be used as a down payment. How large will his down payment be 7 years from today?
N = 7*52 = 364
I/Y = 9.6/52 = 0.1846
PV = 0
PMT = -80
FV = ? (41465.98)
Fair rate of return for common stock
req. return = risk free rate + (beta*(req return on portfolio - risk free rate)
What makes a fair rate
Fair rates compensate the investor fro the time value of money and for assuming risk
On a graph how is the beta represented
Slope
Portfolio beta
(% portfolio invested in asset 1
beta for asset 1) + (% portfolio invested in asset 2
beta for asset 2) +... etc.
CAPM
Capital Asset Pricing Model
Risk free rate + [Beta*(Market rate-risk free)]
The expected benefits, or returns of most investments come in the form of cash flows
TRUE
The additional compensation fro assuming greater risk is called
Risk premium
Unsystematic Risk
CEO retires from a firm
Manufacturer loses a product liability suit
Firm announces decrease in earnings forecast
Systematic Risk
Federal Reserve announces it will lower interest rates
Inflation rate increases unexpectedly
Product cost of a firm increase due to rising oil prices
How many different securities must be owned to diversify away unsystematic risk
20
What method is used to measure a firm's market risk
Estimating the beta coefficient of the characteristic line using the regression method
Calculate the value of a bond that will mature in 14 years and has a $1000 FV. Annual coupon interest rate is 11%, investors required rate is 12%
N = 14
I/Y = 12
PV = ?
PMT = 1000*11% = -110
FV = -1000
Hamilton has a bond with a 6% coupon rate. Interest is paid semi-annually, and bond matures in 8 years. Par value is $1000. Required rate is 4%, what is the value of the bond? What is the value if interest is paid annually
1. N = 8*2 = 16
I/Y = 4/2 = 2
PV = ?
PMT = 1000*.06 = -60/2 = -30
FV = -1000
2. N = 8
I/Y = 4
PV = ?
PMT = 1000*.06 = -60
FV = -1000
Assume market price of a 9-year bond is $1000 has a par value of $1000. Annual interest rate 8% paid semi annually. What is the bonds yield to maturity
N = 9*2 = 18
I/Y = ? (4*2 = 8)
PV = -1000
PMT = 1000*.08 = 80/2 = 40
FV = 1000
Current Yield
Annual interest payment/current market price of bond
Debenture
The earning ability of the issuing corporation has a higher impact on the risk of debentures than it does on mortgage bonds
How do investors respond to varying types of risk
Investors will require a higher yield for assuming higher risk
Investors receive a return from a zero or very low coupon bond
From the appreciation of the bonds
"Since the bond pays little or no interest, the issuing company is unable to deduct the amortized interest over the life of the bond."
FALSE
Which of the following is not one of the important features of a bond
Dividend
Which feature determines the cash flows associated with a bond
Coupon interest rate
When the market interest rate rises above the stated interest rate of a bond, the bond
Will sell at discount
Value of Preferred Stock
annual dividend / req. rate of return
Value of Common Stock
Dividend in year 1 / (req. rate of return - growth rate)
Dividends in year 1
D0*(1+g)
"The opportunity cost represents the investor's return on the next-best investment that is foregone should the project under consideration be accepted and thus must equal the investor's required rate of return."
TRUE
When a firm raises funds by issuing a particular type of security, it incurs flotation costs that will _____ the firm's cost of capital
increase
When firms operate in multiple industries for which the risk characteristics and financial structures vary significantly they should
calculate divisional costs of capital for use in evaluating each divisions investment opportunities
Profitability Index
PV of free cash flows / initial investment
N = 7
I/Y = 8
PV = ? (3,644,459)
PMT = -700,000
FV = 0
Then take PV / 1,950,000
It is so difficult to find an exceptionally profitable project because
competition is brisk and will push down prices and profits
The search for new profitable projects is so important because without the flow of new projects and ideas most firms cannot grow and even survive for long
TRUE
If Ford introduces a new auto line, might some of the cash flows from that new car line be diverted from existing product lines
If Ford introduces a new auto line that might compete with the firm's existing product lines, then only the incremental sales the new line brings to the company should be considered in determining the free cash flows in capital-budgeting analysis.
Which of the following is an example of an option to delay a project
The option to wait for one year to open a restaurant
Which of the following is an example of an option to expand a project
The option to increase production if the new product launches successfully.
1. Standing Alone Risk
2. Contribution-to-firm Risk
3. Systematic Risk
1. project's risk ignoring the fact that much of this risk will be diversified away as the project is combined with the firm's other projects
2. the amount of risk that the project contributes to the firm as a whole
3. the risk of the project from the viewpoint of a well-diversified shareholder
"Because much of a project's risk is diversified away within the firm, the project standing alone risk is an appropriate measure of the meaningful level of risk of a capital-budgeting project
FALSE
"Combining operating and financial leverage magnifies variations in earnings per share in response to changes in sales
TRUE
If a firm's operating and financial leverage are such that a 10 percent change in sales revenue produced a 20 percent change in EBIT, and a 10 percent change in EBIT led to a 20 percent change in earnings per share, what percentage change in earnings would you expect should revenues decline by 25 percent?
If sales revenues will decline by 25 percent, what percentage change in earnings would you expect?
-100%
The optimal capital structure refers to a capital structure that
will minimize the composite cost of a firm's capital for raising a given amount of funds.
It is important for managers of corporations to act ethically ___________.
because it is important for a business to be trusted by investors, customer and the public if it is to succeed
The Sarbane-Oxley Act, or SOX, is aimed at controlling insider trading by members of Congress
(FALSE) aimed at improving corporate governance and accountability by members of Congress.
If a CEO names his or her friends an family to the board of directors and then pays them quite a bit above the norm, this would be an example of the _______.
agency problem
Which of the following would be considered to be a primary market transaction?
A new issue of stock by Transport Solar.
A basis point is equal to one one-hundredth of a percentage point
TRUE
The higher the discount rate, the greater the importance of the early cash flows
TRUE
A debenture is an unsecured long-term debt instrument
TRUE
The detailed legal agreement between a bond's issuer and its trustees that describes the bonds, the rights of the bondholders and the issuing firm is called the _____
indenture
Which of the following gives the bond issuer the right to redeem or repurchase a bond issue before its maturity date
Call Provision
If a bond with a $1,000 par value, 20 years to maturity, and a coupon interest rate of 10% was selling for $800, then the yield to maturity on that bond is
greater than 10%
When the required rate of return on a bond is less than the bond's coupon interest rate, the bond
will sell at a premium over par
Trident Capital has a bond with a $1,000 par value, an annual
coupon interest rate of 7%
that is paid semiannually, and a remaining term of 12 years. The annual
market yield on similar bonds is 5%
is 5%*. This bond will sell at a discount from par.
FALSE
The more years to maturity, the more sensitive the price of a bond will be to changes in market interest rates
TRUE
How much the value of a bond changes as a result of interest rate changes depends on both the bond's time to maturity and its pattern of cash flows.
TRUE
If the market price of a bond decreases, then:
yield to maturity increases
If current market interest rates drop, what will happen to the value of any bonds that are outstanding?
it will rise
If current market interest rates rise, what will happen to the value any bonds that are outstanding
it will fall
Tranis Corporation sold an issue of 20-year, $1,000 par value bonds to the public that carry a 10.00% coupon rate, payable semiannually. It is now 10 years later, and the current market rate of interest is 8.00%. If interest rates remain at 8.00% until Tranis' bonds mature, what will happen to the value of the bonds over time?
The bonds will sell at a premium and decline in value until maturity
Which of them is true regarding bonds
- If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds
- If market interest rate is
above
a bond's coupon interest rate, then the bond will sell
below its par value
- The market value of a bond moves in the opposite direction of market interest rates
If you, as an investor, are looking for capital gains, which type of bond should you purchase
Bonds with distant maturity dates when interest rates are expected to decline
A Eurobonds is a bond issued in a country different from the one in whose currency the bond is denominated.
TRUE
As an investor, you expect a larger expected return on common stock than on bonds because
- you have no legal right to receive dividends.
- you bear greater risk.
- in the event of liquidation, you are only entitled to receive any cash that is left after all creditors are paid
Which of the following is an example of systematic or market risk
Risk resulting from a general decline in the stock market.
Which of the following is an example of diversifiable risk
Risk resulting from uncertainty regarding a possible strike against Disney.
The beta of a stock is the slope of
the line of best fit for a plot of the company's returns against the returns of the market portfolio for the same period
Which of the following has a beta of zero
risk-free asset
The security market line (SML) relates risk to return, for a given set of market conditions. If you expect inflation to increase, which of the following would expect to occur all else being held constant?
The SML line would shift up but maintain the same slope
The market risk premium is measured by
Market Return - risk-free asset
The security market line can be graphically represented by a line that connects the risk-free rate and the expected return on the market portfolio.
TRUE
If you invest a sum of money at 8% compounded annually, how long will it take for it to double?
N = ? (9.01)
I/Y = 8
PV = -1
PMT = 0
FV = 2
If you put $1,000 in a savings account that yields an 7% annual rate of interest that is compounded weekly, how much would that be worth in 25 weeks (round to the nearest dollar)
N = 25
I/Y = 7/52
PV = - 1000
PMT = 0
FV = ? (1,034)
What is the present value of $500 received at the beginning of each year for 15 years? (Assume that the first payment is received today. Use a discount rate of 10%
!
($4,180)
Assuming that an amount is compounded for more than one year and is also compounded more than once a year (for example, compounded monthly) the EAR will always be greater than the APR.
TRUE
All else constant, you should be indifferent between receiving $7,500 today or receiving a $600 perpetuity when the discount rate is 8% annually.
FALSE
Why is the acid-test or quick ratio considered to be a more refined measure of liquidity
Inventory is not included in the numerator of the acid-test or quick ratio because inventory is generally the least liquid of the firm's current assets
Acid Test Ratio
(Current assets - inventory) / current liabilities
if liabilities are not given, divide current assets by current ratio
What will happen to the return on equity if the total asset turnover ratio decreases
decrease
Looking at an income statement, sales revenue, minus cost of goods sold and operating expenses, is equal to which of the following
EBIT
Which of the following streams of income is not impacted or affected by how a firm is financed or raises money, that is, whether it uses debt or equity
Operating Income
Which of the following is not included when computing earnings before taxes or EBT
dividends
gross profit margin
sales - COGS(gross margin) / sales
We use which two terms interchangeably
EBIT and Operating Income
the gross profit margin will increase when which of the following decreases
COGS
Any time the profitability index on a project is greater than 1,
A. The NPV will also be positive.
B. the present value of future cash flows will exceed the project's initial outlay.
C. the IRR will be higher than the required rate of return.
If the IRR on a project is exactly equal to the project's required rate of return, then:
the NPV equals zero.
If investors became
more risk averse
e*, the slope of the Security Market Line drop (that is, it would become less steep)
FALSE
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