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zFundamentals of Corporate Finance > Midterm II + Final > Flashcards

Midterm II + Final Flashcards

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1
Q

What is an annuity due?

A

annuity where payments occur at the BEGINNING of each period

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2
Q

What happens to future value (FV) with other things being equal if present value (PV) goes up?

A

future value (FV) goes up

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3
Q

What happens to future value (FV) with all other things being equal if interest rate (r) goes up?

A

future value (FV) goes up

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4
Q

What happens to future value (FV) with all other things being equal if time period (t) goes up?

A

future value (FV) goes up

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5
Q

From the formula FV = PV (1+r)^t, what does (1+r)^t stand for?

A

(1+r)^t is the compounding factor or the Future Value Interest Factor (FVIF)

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6
Q

What is simple interest?

A

Interest earned only on the original principal invested.

SI = PV * r * t

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7
Q

What is compound interest?

A

Interest earned on both the initial principal and the interest reinvested from prior periods.
CI = TI - SI

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8
Q

How do you calculate Total Interest (TI)?

A

TI = Future Value (FV) - Present Value (PV)

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9
Q

What is interest on interest?

A

Interest earned on the reinvestment of previous interest payments.

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10
Q

What is the primary goal of management?

A

to maximize the value of a firm’s stock.

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11
Q

What is perpetuity?

A

An annuity in which the cash flows continue forever.

PV = Cash amount (C)/ Interest rate (r)

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12
Q

In real life, bonds pay every ____ months.

A

6

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13
Q

What is a discount bond?

A

When the bond sells for less than face value.

Pb < FV

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14
Q

What is a premium bond?

A

When the bond sells for more than face value.

Pb > FV

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15
Q

What happens to the price of the bond (Pb) if interest rate (r) goes up? and vice versa?

A

If interest rate (r) goes up, price of the bond (Pb) goes down.
If interest rate (r) goes down, price of the bond (Pb) goes up.

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16
Q

What causes interest rate risk to go up?

A
  1. If Maturity (t) goes up

2. If Coupon rate (CR) goes down

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17
Q

What is a debenture?

A

an unsecure debt, usually with a maturity of 10 years or more

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18
Q

What is a note?

A

an unsecure debt, usually with a maturity under 10 years

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19
Q

What are government bonds?

A

The federal government borrows money by selling treasury notes and treasury bonds. (DON’T PAY STATE TAX & NO DEFAULT RISK)

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20
Q

What are municipal bonds?

A

State and local governments also borrow money by selling municipal notes and bonds. (DON’T PAY FEDERAL INCOME TAX, BUT VARYING DEGREES of DEFAULT RISK)

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21
Q

What is a zero-coupon bond?

A

A bond that makes no coupon payments and is thus initially priced at a deep discount.
Pzero = FV/(1+r)^t

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22
Q

What is a par bond?

A

The bond is equal to the face value is a par bond.

Pb = FV

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23
Q

How do you calculate current yield (CY)?

A

CY = Annual coupon (C)/Price (P)

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24
Q

How do you calculate Coupon rate (CR)?

A

CR = Annual Coupon (C)/Face Value of bond (FV)

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25
Q

What is a level coupon bond?

A

coupon is constant and paid every year.

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26
Q

What are the four bond pricing theorems?

A
  1. Bond prices (Bp) and market interest rates (r) move in opposite directions.
  2. When CR ( > , < , =) market’s required return (r), market value (PV) ( > , < , =) par value (FV).
  3. The price of a long-term bond will change more than that of short-term bond for a given change in market interest rates (r).
  4. The price of a lower-coupon bond will change more than that of a higher-coupon bond for a given change in market interest rates (r).
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27
Q

What is an amortized loan?

A

Which the lender may require the borrower to repay parts of the loan amount over time.

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28
Q

Which is riskier, a high coupon? or a low coupon?

A

low coupon

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29
Q

How do you calculate the annual percentage rate (APR)?

A 
APR = m[(1+EAR)^(1/m) - 1]
APR = ln(1+EAR) if Infinitive
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30
Q

All else constant, a bond will sell at _______ when the yield to maturity is _______ the coupon rate.

A

at discount; higher than

31
Q

What is the nominal rate on an investment?

A

The percentage change in the number of dollars you have.

32
Q

What is the real rate on an investment?

A

The percentage change in how much you can buy with your dollars–in other words, the percentage change in your buying power.

33
Q

What is the formula to calculate the value of a stock?

A 
P = D/(r - g)
D = Dividend payment (per share)
r = required return
g = growth rate
34
Q

How do you calculate dividend yield and capital gains yield?

A 
r = (D/P) + g
(D/P) = dividend yield 
D = dividend payment (per share)
P = price of the stock
g = growth rate (capital gains yield)
35
Q

When does a dividend become a liability of the firm?

A

Until a dividend has been declared by the Board.

36
Q

A firm cannot go bankrupt for ____________ dividends.

A

not declaring

37
Q

Why are dividend payments not tax deductible?

A

Because dividend payments are not considered a business expense.

38
Q

The taxation of dividends received by individuals depends on the _________.

A

holding period

39
Q

Dividends received by corporations have a minimum ___% exclusion from taxable income.

A

70

40
Q

What are features of preferred stock?

A

Preferred stock generally does not carry voting rights.

41
Q

What are features of preferred dividends?

A
  1. Stated dividend that must be paid before dividends can be paid to common stockholders.
  2. Dividends are not a liability of the firm and preferred dividends can be deferred indefinitely.
  3. Most preferred dividends are cumulative - any missed preferred dividends have to be paid before common dividends can be paid.
42
Q

How do you calculate the profitability index (PI)?

A

PI = Present Value of all Cash Flows (from discounted payback method)/ Initial Cost

43
Q

How do you calculate the payback period (PB)?

A

PB = (# of Years to recover cost - 1) + [(Cost - Total amount recovered before last year)/Cash flow in last year]

44
Q

If the NPV > 0, IRR > r (cost of capital), PI (Profitability Index) > 1, should the firm accept the project?

A

Yes

45
Q

If the NPV < 0, IRR < r (cost of capital), PI (Profitability Index) < 1, should the firm accept the project?

A

No

46
Q

If the NPV = 0, IRR = r (cost of capital), PI (Profitability Index) = 1, should the firm accept the project?

A

It would be OK.

47
Q

Under what condition would there be NO conflict between IRR and NPV?

A

When r (required return) > cross-over rate

48
Q

What is payback?

A

The length of time to return the original investment or the time it takes to break even in an accounting sense.

49
Q

What are the advantages of the payback method?

A
  1. Ease of calculation
  2. Liquidity indicator
  3. Risk indicator
50
Q

What are the disadvantages of the payback period?

A
  1. Ignores returns beyond payback period.

2. Ignores time value of money

51
Q

What are the factors affecting required return (r)?

A
  1. Default risk premium - remember bond ratings
  2. Taxability premium - remember municipal vs. taxable
  3. Liquidity premium - bonds that have more frequent trading will generally have lower required returns
  4. Anything that affects the risk of cash flows to the bondholders, will affect the required returns.
52
Q

What is the term structure of interest rates?

A

Term structure is the relationship between time to maturity and yields, all else equal
- It is important to recognize that we pull out the effect of default risk, different coupons, etc.

53
Q

Net working capital is defined as:

A

Current assets - current liabilities

54
Q

What is a liquid asset?

A

One which can be quickly converted into cash without significant loss in value.

55
Q

Noncash items refer to:

A

Expenses charged against revenues that do not directly affect cash flow.

56
Q

What is cash flow from assets?

A

The net total cash flow of a firm which is available for distribution to the firm’s creditors and stockholders.

57
Q

Cash flow from assets is also known as the firm’s:

A

free cash flow

58
Q

What is shareholder’s equity?

A

represents the residual value of a firm

59
Q

The sources and uses of cash over a stated period of time are reflected on the:

A

statement of cash flows

60
Q

A decrease in accounts payable ______ net working capital, all else constant.

A

increases

61
Q

As discount rate is increased, IRR ________ while NPV __________.

A

remains constant, decreases

62
Q

Decreasing the time to maturity ___________ the price of a discount bond, all else constant.

A

increases

63
Q

If a bond has a market price > face value, then it is a ___________ price and has a yield-to-maturity that is __________ than the coupon rate.

A

premium, less

64
Q

When analyzing a capital budgeting project, a financial manager should consider the following:

A
  1. project start-up costs
  2. timing of all projected cash flows
  3. dependability of future cash flows
  4. dollar amount of each projected cash flow
65
Q

The decision to issues additional shares of stock is an example of?

A

capital structure decision

66
Q

The sustainable growth rate of a firm is best described as the:

A

maximum growth rate achievable excluding any external equity financing while maintaining a constant debt-equity ratio.

67
Q

An increase in _____________ will increase a firm’s quick ratio without affecting its cash ratio.

A

accounts receivable

68
Q

All else equal, a ___________ in total assets will increase the internal rate of growth.

A

decrease

69
Q

What is the Fisher Effect?

A 
(1+R) = (1+r)(1+h)
R = nominal rate
r = real rate
h = expected inflation rate
(i.e., R = r + h for APPROXIMATION)
70
Q

What is a bond indenture?

A

A 3 party contract between the bond issuer, the bondholders, and the trustee. The trustee is hired to protect the bondholder’s interests.

71
Q

What is the real rate of interest?

A

change in purchasing power

72
Q

What is the nominal rate of interest?

A

quoted rate of interest, change in purchasing power and inflation
R = real rate (r) + inflation rate (h)

73
Q

What is an ordinary annuity?

A

annuity where payments occur at the END of each period (90% of the time)

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