Corp. Fin 1 Final Flashcards
In deciding what to do with extra cash, a firm should only undertake a project if…
expected return of the project is greater than a comparable project of the same risk
A firm that uses a constant hurtle rate for all projects is likely to make what mistakes in its capital budgeting?
Reject positive NPV project that has less rate than the firm’s. Accept negative NPV project that has higher rate than the SML.
For a conglomerate firm like GE, the cost of equity for a new project should be estimated from the CAPM using?
Using the betas from projects of similar risk.
How do you calculate Return on Equity?
Rf + Beta * (Rm - Rf)
What is the firm’s actual trade-off when they choose capital structure?
benefit of the debt tax shield rise linearly
costs of financial distress rise at an increasing rate
What is the goal of a financial manager?
Maximize the value of a stock.
What are the disadvantages of corporation structure?
Double taxation, more complicated process
Ultimate control of the corporation rests with who?
All of the power rests with shareholders who delegate control to representatives.
What is the M and M’s Capital Structure Irrelevance Theorem?
Capital structure does not affect the cash flows, therefore no impact to value, and capital structure is irrelevant. Managers should concentrate on capital budgeting
For a highly diversified and varied portfolio, the portfolio variance is approximately equal to…
Average of the Covariance
Historical status of security returns?
Lowest – Inflation, T Bills, Govt Bonds, Corporate Bonds,
Large Company Stocks, Small-Company Stocks – Highest
How do we calculate the risk of cash flow?
Single asset - variance, stdev
Portfolio - beta
When a firm estimates discount rate by applying CAPM to the cost of equity this means…
the risk is the same as the company’s, and the project is financed only with equity, not debt
How do you calculate beta?
Covariance / Variance of market
How do you calculate covariance?
correlationst.dev1st.dev2
How do you calculate variance?
st.dev^2
How do you calculate Price-Earnings Ratio?
Price / Earnings Per Share
How do you calculate Earnings Per Share?
Net Income / Shares Outstanding
How do you calculate OCF?
EBIT + Depreciation - Taxes
How do you calculate the price of a perpetuity stock?
P = D1 / (r-g)
How do you calculate price based on Dividend?
P = D/Required Return
Which one of the following statements correctly describes the time value of money?
Time and present value are inversely related. As time increases the present value decreases.
When we have two projects with different cash flows, which has the higher NPV and PV?
The earlier the cash flows, the better
Why do we lever/unlever beta?
Matching operational and financial risks
Semi-annual coupon bond with 30 years to maturity. The bond was issued 5 years ago. (Time to maturity is now 25 years). Given coupon rate and Face Value. What is the value of the coupon? The one every six months.
Take coupon rate X Face Value / 2 times per year
A coupon bond may be valued by calculating the PV as — and the FV as —.
Level annuity, single amount.
Which of the following is not required to calculate the value of a coupon bond?
Risk-free rate.
How do you de-lever?
Beta assets = Beta comparable / (1 + (1 - tax rate)* Debt/Equity)
(Total Equity/(Total Debt + Total Equity))*Beta
How do you lever?
Beta equity = Beta Asset * (1 + Debt/Equity)
What is the signalling theory of Dividends?
Company is planning for a rough future. Acting in the short-term rather than the long-term
What is financial risk?
Financial risk is dependent of the amount of debt in the capital structure
What is systematic risk in a fully diversified portfolio?
Unavoidable risk
How do you calculate the risk of cash flows?
Standard deviation of a single asset
Beta of the portfolio
What is the pecking order?
Retained earning
Straight debt
Convertible debt
Equity
What is the homemade dividend policy?
When someone does not want to pay taxes on dividends, so you reinvest dividends or buy back stocks to create your own dividend. Purchase stock at lower price, then sell high. To corporate managers, it is the firm’s decision regarding whether to retain earnings or distribute earnings to investors.
What is the Tax Clientele theory?
Some investors like dividends, some do not
What is the goal of a dividend paying company?
Stable dividends
What is financial risk?
Proportional to the amount of risk in the company’s capital structure
What type of decision: How much should the company invest and in what specific assets?
Capital-Budgeting Policy
What type of decision: How should the company finance its investments?
Capital-Structure Policy
What type of decision: How should the company distribute cash to shareholders?
Dividend Policy
The market portfolio of common stocks is 20.4%, treasury bills are 5.3%, inflation rate is 2.5%? What is the MRP?
15.1%; Portfolio of common stock - Treasury Bills. You don’t need the inflation rate
The correlation between two stocks can be…
All of the above. It is between -1 and 1. It can be positive and negative.
Returns on Kiwi stock of a standard deviation of .2 and the market has a standard deviation of .16. Kiwi’s correlation is .4. What is Kiwi’s beta?
Beta = Cov / Var of Market (st. dev ^2)
(.4 * .2 * .16) / .16^2
How do you find covariance if you know correlation?
Correlation * st. dev1 * st. dev2
In which region do we find positive NPV projects?
Above SML. A and C
Hurtle is 17.1% If we use this fixed rate, in which rate will we reject positive NPV projects.
Above SML but below hurtle rate. C
How do you calculate capital structure?
Find the value of each component (shares X price, face value X price)
Add them all together
Find percentage of each component
How do you calculate after-tax cost of debt for each issue?
Calculate YTM
After tax = YTM * (1-Tax)
4.94% & 3.90%
How do you calculate YTM in excel?
RATE function
Be careful of semi-annual
How do you calculate the CAPM, cost of debt?
=Rf + MRP * beta, 11.03%
How do you calculate the cost of preferred stock?
Dividend Rate*Book Value/Market Price
How to you calculate WACC using stocks and bonds?
Weight X Cost of stock + Weight X After-Tax Cost of Bond (1- tax rate) (shouldn’t get a high number)
What type of stocks should the firm accept using IRR and Return on Market?
IRR > Return on Market
When asked whether you should accept the opportunity with Beta & IRR, what should you look for?
CAPM < IRR
How do you calculate Cost of Equity using betas?
RF + Beta * MRP
How do you calculate WACC using equity and debt?
Cost of Equity * Weight of Equity + Cost of Debt * Weight of Debt * (1 - tax rate)
How do we find NPV?
Find PV and subtract investment
How do we find Cash Flow PV?
Cash Flow / Rate
How do you calculate the price in year zero of a stock with dividend of 15 starting in year five?
Find the price of the stock in year 4 (Div in year 5/Required Return)
-PV function
How do you calculate the price of stock with a dividend growing at 20% until year 3 where it will grow at 3% in perpetuity?
Find the dividend growth at year 4.
Dividend Yr 4/Required Return - Perpetuity rate
Add results together
NPV of all dividends using Required Rate of Return
What is a Capital Structure decision?
Decision to issue stock
What is a net working capital decision?
How much cash to keep on hand
What is a capital budgeting decision?
to open a new store or not
How do you calculate cash flow from assets?
OCF - Net Capital Spending - Change in New Working Capital
How much would you be willing to pay for this bond today?
Payment * PVAF + Face Value
How do you calculate EBIT?
Revenue - Cost - Depreciation
How do you calculate Net Income?
Revenue - Cost - Depreciation - Interest - Taxes
The interest tax shield is a key reason why…
The net cost of debt to a firm is generally less than the cost of equity
What is the NPV property of value additivity?
NPV (CF1 + CF2) = NPV(CF1) + NPV(CF2)
What is the cheapest form of funding?
Retained earnings
