Exam 2(ch 10,14,15,16,17,19,23)

Question 1

5 methods for firm valuation

Answer 1

dividend discount model
free cash flow to the firm
free cash flow to equity
adjusted present value
residual income

Question 2

main advantage of forecasting inflation for NPV

Answer 2

Consistency in the calculation for cashflows and the discount rate

Question 3

what makes the discount rate increase

Answer 3

to calculate the inflation and real cost of capital are compounded an increase in these will cause the discount rate to increase

Question 4

operating cash flow calculation

Answer 4

sales
- variable costs
= gross margin
- fixed costs
= operating profit
- taxes
= net profit
+ depreciation
= operating cash flow

Question 5

four main differences in with investments cash flows and without investment cashflows

Answer 5

1. increase in annual depreciation with the investment
2. decrease in annual labor costs with the investment
3. the salvage value
4. the initial investment in year zero with the investment

Question 6

why is project npv not very sensitive to with investment labor costs

Answer 6

labor costs are much lower

Question 7

which two points identify break even unit sales

Answer 7

when revenue crosses total cost
when account profit goes from negative to positive

Question 8

relationship between npv and year 1 and year 2 unit sales

Answer 8

direct, selling more increases cash flow increasing present value

Question 9

is npv more sensitive to year 1 sales or year 2

Answer 9

year 2 because the growth rate is compounded

Question 10

six steps used to forecast financial statements

Answer 10

analyze historical financial statements and look for close to constant percentages of sales

forecast sales

apply avg historical percentage to income statement and balance sheet items

forecast other key items

make balance sheet balance

raise or lower the portion of equity relative to debt

Question 11

list major balance sheet items that are not nearly consistent percentages of sales

Answer 11

COGS
DEPRECIATION
RECIEVABLES
INVENTORY
PPE
SHARES OUTSTANDING
PAYABLES
SHORT TERM INVESTMENTS

Question 12

Relationship between external funds needed and sales growth

Answer 12

positive linear relationship because most items are percentages of sales

Question 13

are contributions, gains and distributions taxed or not

Answer 13

401k: contributions taxed, gains not, distributions taxed
ROTH 401k: contributions taxed, gains tax free, distributions not subject to tax

Question 14

which age demographic will generate more income for ROTH IRA

Answer 14

Young due to current lower rates

Question 15

real human capital

Answer 15

find the NPV of the salary using 1% as the discount rate

Question 16

real financial capital

Answer 16

compound year zeros real financial capital at 1% real risk free rate adding year 1 real savings

Question 17

real total wealth

Answer 17

obtained by summing year 1 real human capital and real financial capital

Question 18

advantages and disadvantages of bsm over bm

Answer 18

advantage: efficient and simple calculation
disadvantage: limited applicability to a narrow range of derivatives

Question 19

why is call price with continuous dividend lower than that without

Answer 19

since stock price decreases when dividend is paid, decreasing profitability

Question 20

what happens to call price when exercise price is decreasing

Answer 20

increases call price because it enhances the liklihood of the stock price exceeding the call price

Question 21

what happens to call price when risk free rate is decreasing

Answer 21

decreases call price because present value of the exercise price increases

Question 22

what happens to call option price when time to maturity decreases

Answer 22

call price will decrease due to decreased profitability and an increased of the exercise price

Question 23

Fully describe what the Chart in Fig. 23.8 indicates about the patterns of implied volatilities of calls and puts, compared to the volatility assumption of the Black-Scholes
model.

Answer 23

Puts tend to exhibit lower implied volatility compared to calls, in
contrast to the volatility assumption of the Black-Scholes model, which assumes constant volatility.