Unit 10 (4) Flashcards
Which of the following would have an effect on the co’s working capital:
- Borrowing money from a bank on a 90 day note
- Declaring a 15% stock dividend
- Calling in a portion of a 20 year bond at par
- Paying a utility bill
Calling in a portion of a 20 year bond at par reduces current assets, but there is no offsetting reduction to liabilities. This causes working capital to decrease. Declaring a stock divvy has no effect on current assets or liabilities because payment is in stock, not cash. The other options have offsetting consequences so its equal
Working capital
Difference between corps current assets and current liabilities
Rule of 72
Divide 72 by the interest rate and it will give you the number of years for the investment to double. Or, if you divide 72 by the number of years, it will give you the % you need for the investment to double.
What is NPV?
When you can buy a bond for less than its present value.
What is the present value of a bond with a coupon of 6% and 12 years to maturity?
Take 72 divided by the coupon of 6. That gives you 12 years to double and since the bond is 12 years to maturity, the present value should be approximately $500 or a quote of 50
If a bonds price is the same as is present value, what is its NPV?
Zero
What is the net present value of a bond with a coupon of 4% and matures in 18 years and a price of 45?
First take 72 divided by the coupon of 4 which is 18. The time till maturity is also 18, so the present value should be 500 or 50 but you can buy it for 450 or 45. The net present value is $50. This bond would be a good buy according to NPV
If a bonds years till maturity is equal to the time it takes for it to double per the rule of 72, what should the bonds estimated price be?
$500. It matures at $1000
A company with a current ratio of .5:1 might
This means that its current liabilities are twice its current assets so it will probably have a hard time paying its bills. This also means negative working capital (current assets - current liabilities)
Working capital
Current assets minus current liabilities or “the amount of money a corporation has available to work with if it liquidates its current assets and pays off all current liabilities”
Debt to equity ratio
Divide long term debt by the total capitalization. The higher the ratio, the more debt is being used by the company
A measurement of investment that takes into account the time value of money is?
- Risk adjusted rate of return
- Internal rate of return
- Holding period return
- Real rate of return
Internal rate of return compounds returns and takes into account the time value of money.
Internal rate of return uses the
Time value of money
Real rate of return considers the
Inflation rate
Risk adjusted return
Another way of saying the sharpe ratio
The future value of an invested dollar is dependent on
The rate of return it earns and the time period over which it is invested. Future value of a dollar reflects the interest rate it earns over time.
Which of the following is a discounted cash flow technique?
- Net present value
- Holding period return
- Internal rate of return
Net present value and internal rate of return use discounted cash flow.
Holding period of return
Total of the income cash flows and capital growth earned by an investment during the time it is held. It does not take into account the time value of money
XYZ Corp has a beta of 1, and ABC has a beta of 1.4. XYZs return is 12% and ABCs is 14.8%. What is ABCs alpha?
Beta of 1 = 12% and ABCs beta is 1.4, so 1.4 x 12 = 16.8 minus the return of 14.8 so the alpha is -2%
Using the net present value method, a potential investment should be undertaken if the present value of all cash inflows minus the present value of all cash outflows (which equals the net present value) is
Positive. If the NPV of a proposed investment is positive it should be undertaken
An investors required rate of return is 6% and the internal rate of return of the investment offered is 5.75%. The NPV is:
Negative. Any time an investments internal rate of return is less than the required rate, the NPV is negative
NPV is expressed as?
A dollar amount
An investor wished to compute the mean return of her portfolio, she is going to
Find the arithmetic mean. Unless something else is specified, whenever mean is mentioned, it is always the arithmetic mean, the simple average.
The difference between present value and net present value represents
The initial cash outlay. When computing the net present value, we remember that the word net means something must be subtracted. The number subtracted is the initial cost of the investment
Future value
FV = PV * (1 + r) * n. R = rate and N = number of years
Internal rate of return
The discount rate that makes the NPV of an investment equal to zero. Think of it as the r in the present and future value computations
Internal rate of return
The method for computing long term returns that takes into account the time value of money
The yield to maturity of a bond reflects its
Internal rate of return
Which is more important, NPV or IRR?
NPV is generally considered more important than IRR
What is the NPV of an investment when the IRR equals the discount rate (required rate of return)?
Zero. In an efficient market, bonds should be priced so their NPV is zero.
Which is expressed as a percentage, IRR or NPV?
IRR is always a percent, NPV is always a dollar amount
A bond has a present value of $1,136.78 and is being offered for $1,100. What is its NPV?
$36.78 - since it has a positive NPV it’s a good investment.
If an investment can be expected to return 8%, using the rule of 72, what is the present value needed to have 50k for a child’s education in 18 years?
Dividing 72 by the expected return shows the number of years it will take for the deposit to double. 72 divided by 8 is 9 years. Over an 18 year period, there are 2 doublings. So, divide 50k by 4 and get $12,500
An investment of 2k made 10yrs ago is now worth 8k. Using the rule of 72, the approximate rate of compounded return is?
You need to know how many years it takes to double. Look at how many times the investment has doubled. This investment has quadrupled in 10 years. So, we know that it doubles in 5 years. Using the rule of 72, we divide 72/5 and get 14.4
If you’re asked a question using the rule of 72, you need to figure out how many years it takes for an investment to double
So, if you see a starting amount that has quadrupled in 10 years, you know it doubles in 5 years, so divide 72 by 5, or divide 72 by 10 and double the answer
Risk measurement tools include all of the following except:
- Sharpe ratio
- Standard deviation
- Beta
- Future value
Future value measures the time value of money, not risk.
Your required rate of return is 6%. The internal rate of return of the investment offered is 5.75% the NPV is?
Negative. Any time the IRR is less than the required rate of return, the NPV is negative.
If they give you a question about NPV and the answer choices have percents you know
That those answers aren’t options because NPV is a dollar amount and IRR is a percent
