corporate finance completed notes

Fundamental of Corporate Finance

Lecture Notes

For

MBA/M.Com/MEF/BS/BBA

Sir M.Faseeh Khan

Sir M.Faseeh Khan-CF(notes) of 46 copyright @TM

Federal Urdu Art and Science Universitye-mail: [email protected]

Corporate Finance – Course Overview_____________________________________________________________Instructor: Sir M.Faseeh Khan e-mail: [email protected]: Corporate Finance Class: BBA/MBA/M.Com Shift: Morning Session: Aug. – Dec. 2010

Purpose: The course is design to assist the students in building a conceptual

framework which with to make prudent financial decision in their jobs, personal financial planning and decision making.

Topics:Chapter #1: Introduction to Corporate Finance

Chapter #2: Long-Term Financial Planning and Growth

Chapter #3: Interest Rates and Bond Valuation

Chapter #4: Introduction to Valuation: The Time Value of Money

Chapter #5: Discounted Cash Flow Valuation

Chapter #6: Stock Valuation

Chapter #7: Net Present Value and Other Investment Criteria

Chapter #8: Project Analysis and Evaluation

Chapter #9: Return, Risk, and the Security Market Line

Chapter #10: Cost of Capital

Chapter #11: Dividends and Dividend Policy

Chapter #12: Short-Term Finance and Planning

Evaluation:

The grading component and Scale:


Final Examination ---------> 60 MarksMid-Term ---------> 20 Marks

Class Test ---------> 20 Marks(each @ 10)

Chapter 1: Introduction to Corporat e Finance

Corporate Finance• Some important questions that are answered using finance

• What long-term investments should the firm take on?• Where will we get the long-term financing to pay for the investment?• How will we manage the everyday financial activities of the firm?

Financial Manager• Financial managers try to answer some or all of these questions• The top financial manager within a firm is usually the Chief Financial Officer

(CFO)• Treasurer – oversees cash management, credit management, capital

expenditures and financial planning• Controller – oversees taxes, cost accounting, financial accounting and data

processing

Financial Management Decisions• Capital budgeting

• What long-term investments or projects should the business take on?• Capital structure

• How should we pay for our assets?• Should we use debt or equity?

• Working capital management• How do we manage the day-to-day finances of the firm?

Forms of Business Organization• Three major forms in the United States

• Sole proprietorship• Partnership

• General• Limited

• Corporation• S-Corp• Limited liability company

Sole Proprietorship• Advantages

• Easiest to start• Least regulated


• Single owner keeps all the profits• Taxed once as personal income

• Disadvantages• Limited to life of owner• Equity capital limited to owner’s personal wealth• Unlimited liability• Difficult to sell ownership interest

Partnership• Advantages

• Two or more owners• More capital available• Relatively easy to start• Income taxed once as personal income

• Disadvantages• Unlimited liability

• General partnership• Limited partnership

• Partnership dissolves when one partner dies or wishes to sell• Difficult to transfer ownership

Corporation• Advantages

• Limited liability• Unlimited life• Separation of ownership and management• Transfer of ownership is easy• Easier to raise capital

• Disadvantages• Separation of ownership and management• Double taxation (income taxed at the corporate rate and then dividends

taxed at the personal rate)

Goal of Financial Management• What should be the goal of a corporation?

• Maximize profit?• Minimize costs?• Maximize market share?• Maximize the current value of the company’s stock?

• Does this mean we should do anything and everything to maximize owner wealth?


Chapter 2: Long-Term Financial Planning and Growth

2: Plowback and dividend payout ratiosYour company has net income of $1,600 for the year. You paid out $400 in dividends to your stockholders.

What is the dividend payout ratio?What is the plowback ratio?What is the dollar increase in retained earnings?

3: Plowback and dividend payout ratiosYour company has net income of $1,600 for the year. You paid out $400 in dividends to your stockholders.

25.

600,1$

400$incomeNet

dividendsCash ratiopayout Dividend

.75

.25-1

ratiopayout dividend - 1 ratioPlowback

$1,200

.75 $1,600

ratioplowback incomeNet earnings retained oAddition t

4: Plowback and dividend payout ratiosThis year your company expects net income of $2,800. You now adhere to a 60% plowback ratio.What is the expected dollar increase in retained earnings?How much do you expect to pay in dividends?What is the dividend payout ratio?

5: Plowback and dividend payout ratios


This year your company expects net income of $2,800. You now adhere to a 60% plowback ratio.

120,1$

680,1$800,2$

earnings retained oAddition t incomeNet paid Dividends

40%

$2,800

$1,120

incomeNet

dividendsCash ratiopayout Dividend

$1,680

.60$2,800

ratioplowback incomeNet earnings retained oAddition t

6: Constant growth planning

Income StatementCurrent ProjectedSales $800 $_______Costs $700 $_______Taxable income $100 $_______Taxes (34%) $ 34 $_______Net income $ 66 $_______

Balance SheetCurrent Projected Current ProjectedAssets $400 $_______ Debt $150 $_______Equity $250 $_______Total $400 $_______ Total $400 $_______You expect your sales, costs and assets to grow by 10% next year. You will not pay any dividends. Can you complete the pro forma statement? Round all amounts to whole dollars.


Income StatementCurrent Projected


Sales $800 $880Costs $700 $770Taxable income $100 $110Taxes (34%) $ 34 $ 37Net income $ 66 $ 73

Balance SheetCurrent Projected Current Projected

Assets $400 $440 Debt $150 $117 Equity $250 $323Total $400 $440 Total $400 $440

The computations are shown on the next slide.


$323

$73 $250

incomenet Projected equity Current equity Projected

$440

assets Total equity sliabilitie Total

$117

$323 - $440

equity - equity) sliabilitie (Total Debt

$440 $400(1.10) Assets

)($37 $34(1.10) Taxes

$770 $700(1.10) Costs

$880 $800(1.10) Sales

rounded

9: Percentage of sales planningThe assets and current liabilities of Jennings, Inc. vary in direct proportion to the increase in sales. The current sales are $2,000 and you expect them to increase by 20% next year. Net income is projected at 5% of sales. The firm is not planning on issuing any more common stock nor paying any dividends.

Using this information, can you compile the pro forma balance sheet shown on the next slide?


10: Percentage of sales planningCurrent % of sales ProjectedCash $ 120 _____% $_______Accounts receivable $ 500 _____% $_______Inventory $ 840 _____% $_______Fixed assets $2,600 _____% $_______Total assets $4,060 _____% $_______

Accounts payable $ 600 _____% $_______Long-term debt $ 700 _____% $_______Common stock and paid in surplus $1,000 _____% $_______Retained earnings $1,760 _____% $_______Total liabilities and equity $4,060 _____% $_______

Refer to the prior slide for information pertaining to this problem.Enter n/a where the % of sales does not apply.

11: Percentage of sales planning Current % of sales Projected

Cash $ 120 6% $ 144Accounts receivable $ 500 25% $ 600Inventory $ 840 42% $1,008Fixed assets $2,600 130% $3,120Total assets $4,060 203% $4,872

Accounts payable $ 600 30% $ 720Long-term debt $ 700 n/a $1,272Common stock and paid in surplus $1,000 n/a $1,000Retained earnings $1,760 n/a $1,880Total liabilities and equity $4,060 n/a $4,872

12: Percentage of sales planning

%3030.$2,000$600

payable Accounts

%20303.2$2,000$4,060

assets Total

%13030.1$2,000$2,600

assets Fixed

%4242.$2,000$840

Inventory

%2525.$2,000$500

receivable Accounts

%606.$2,000$120

Cash


$720 $2,400.30 payable Accounts

$3,120 $2,4001.30 assets Fixed

$1,008 $2,400.42 Inventory

$600 $2,400.25 receivable Accounts

$144 $2,400.06 Cash

$2,400 1.20$2,000 Sales

13: Percentage of sales planning

$4,872 assets Total equity owners' and sliabilitie Total

$1,880 $2,400).05 ( $1,760 earnings Retained

$1,000 $0 $1,000 stock Common

Total liabilities and owners’ equity $4,872Accounts payable -$ 720Common stock and paid in surplus -$1,000Retained earnings -$1,880Long-term debt $1,272

14: External financing needYou project your sales will increase by $3,000 next year. Net income is 10% of sales and accounts payable is 25% of sales. The capital intensity ratio is 2.5. No dividends are anticipated.

How much external financing is needed to fund this growth?

Try to solve this problem without looking at the hints on the next slide.

15: External financing needYou project your sales will increase by $3,000 next year. Net income is 10% of sales and accounts payable is 25% of sales. The capital intensity ratio is 2.5. No dividends are anticipated.How much external financing is needed to fund this growth?


Hints:Step 1: Compute the increase in total assetsStep 2: Compute the increase in accounts payableStep 3: Compute the increase in retained earningsStep 4: Compute the additional long-term debt and equity financing that is needed

16: External financing need

Step 1

$7,500

2.5$3,000

ratiointensity CapitalSales assets Total

Step 2

$750

$3,000.25

Sales.25 payable Accounts

Step 3

$300

$3,000.10

0 -sales).10 (

paid Dividends - incomeNet earnings retained oAddition t

Step 4

$6,450

$300 - $750 - $7,500

earnings retained toAdditions - payable Accounts - assets Total need financing External

17: Pro forma with external financingYour firm currently has long-term debt of $4,400, common stock and paid in surplus of $10,000 and retained earnings of $4,600. The capital intensity ratio is 2.2 and the tax rate is 35%. Costs are 72% of sales and accounts payable are 30% of sales. Sales currently are $10,000 and are expected to increase by 10% next year. The dividend payout ratio is 20%. Long-term debt will be used to fund 40% of the external funding need.


Chapter 3: Interest Rates and Bond Valuation

2: Coupon paymentA bond has a 7% coupon and pays interest semi-annually.

What is the amount of each interest payment if the face value of a bond is $1,000?

3: Coupon payment

35$270$

2000,1$07.

yearper paymentsinterest ofNumber amount Face rate Coupon

payment Interest

4: Bond priceA bond has a 9% coupon rate, matures in 12 years and pays interest semi-annually. The face value is $1,000.

What is the current price of this bond if the market rate of return is 8.3%?

5: Bond price

55.052,1$

8577.376$6965.675$

8577.376$)015477.1545($

)2

083.1(

000,1$

2

083.

)2

083.1/(11

2

000,1$09.

)r1(

F

r

)r1/(11CPV

212

212

t

t

7: Time to maturityA bond is currently selling at a price of $977.03. The face value is $1,000 and the coupon rate is 8%. Interest is paid semi-annually.

How many years is it until this bond matures if the market rate of return is 8.4%?


8: Time to maturity

9: Yield to maturityA 6% bond pays interest annually and matures in 14 years. The face value is $1,000 and the current market price is $896.30.

What is the yield to maturity?

11: Current yieldAn 8%, semi-annual coupon bond has a $1,000 face value and matures in 8 years.

What is the current yield on this bond if the yield to maturity is 7.8%?

12: Current yield

74.011,1$

18967.542$54920.469$

18967.542$)73873.1140($

)2

078.1(

000,1$

2

078.

)2

078.1/(11

2

000,1$08.

)r1(

F

r

)r1/(11CPV

28

28

t

t

%91.7

07907.

$1,011.74

$80

74.011,1$

000,1$08.

priceCurrent

interest Annual yield Current


%91.7

07907.

$1,011.74

$80

priceCurrent

interest Annual yield Current

14: Holding period yieldYou bought a bond exactly one year ago for $1,004.50. Today, you sold the bond at a price of $987.40. The bond paid interest semi-annually at a coupon rate of 6%.

What is your holding period yield on this bond?

15: Holding period yield

16: Interest rate riskYou own two bonds. Both bonds have a 6% coupon and pay interest semi-annually. Both have a face value of $1,000. Bond A matures in two years while bond B matures in 10 years.

What is the price of each bond at a market rate of 6%? What happens if the rate increases to 7%.

19: Interest rate riskYou own two bonds. Both bonds mature in 5 years, have a $1,000 face value and pay interest annually. Bond X has an 8% coupon rate while bond Y has a 3% coupon rate.

What is the price of each bond if the market rate of return is 7%? What happens to the price of each bond if the market rate falls to 6%?


Chapter 4: The Time Value of Money

2: Simple versus compound interestFirst United Bank pays 4% simple interest on their savings accounts. Second Federal Bank pays 4% interest compounded annually on their savings accounts.

If you invest $1,000 in each bank, how much will you have in your accounts after twenty years?

Why are the balances different?

3: Simple versus compound interest

First United BankSecond Federal BankDifference

12.191,2$

1.04$1,000

r)(1PVFV20

tt

12.391$800,1$12.191,2$

800,1$800$000,1$

800$2040$

40$04.000,1$

4: Future valueYou invest $3,000 in the stock market today.

How much will your account be worth forty years from now if you earn a 9% rate of return?

5: Future value


26.228,94$

40942.31000,3$

09.1000,3$

140

tt rPVFV

7: Present valueYou want to have $7,500 three years from now to buy a car. You can earn 6% on your savings.

How much money must you deposit today to have the $7,500 in three years?

8: Present value

14.297,6$191016.1

500,7$

06.1

500,7$

1

3

tt

r

FVPV

10: Interest rate for a single periodLast year your investments were worth $369,289. Today they are worth $401,382. No deposits or withdrawals were made during the year.

What rate of return did you earn on your investments this year?

%6905.8

086905.

1086905.1

1289,369$382,401$

11

r

r

r

r

rPVFV tt


Chapter 5: Discounted Cash Flow Valuation

3: Financial reviewIf you invest $100 today for one year at a 10% rate of return, how much money will you have one year from now?

You are spending $100 by investing it. You input that as a negative value using the “±” key. You are receiving $110 back at the end of one year. That is the positive value.

Positives and negatives are used to denote the direction of the cash flow. Generally you use a positive value to indicate a cash inflow and a negative value to indicate a cash outflow. All dollar amounts in this type of problem are, in actuality, positive values.

5: Ordinary annuity present valueYou will receive $12,000 a year for the next ten years from a trust fund your grandmother is establishing.

What is this gift worth today at a 9% discount rate?

6: Ordinary annuity present value

89.011,77$

4176578.6000,12$

09.

5775892.000,12$

09.

)09.1/(11000,12$

1/11 C APV

10

r

r t


8: Annuity due present valueYou are buying some land from your parents today. You agree to pay them $5,000 a year for six years. The first payment is due today.

What is the actual selling price of the land if your parents are only charging you 3% interest?

9: Annuity due present value

54.898,27$

03.14171914.5000,5$

03.103.

.162515743 000,5$

)03.1(03.

03.1/11000,5$

11/11

C PVA

6

Due

rr

r t

10: Annuity due present value

11: Ordinary annuity future valueYou are planning on investing $3,500 in the stock market every year for your retirement. You will make your first investment at the end of this year. The average rate of return you expect to earn is 7%.

How much money do you expect to have when you retire forty years from now?

12: Ordinary annuity future value

89.722,698$

63511.199500,3$

07.

1)07.1(500,3$

1)1( AFV

40

r

r C

t


14: Annuity due future valueYour parents are giving you $3,000 at the beginning of each year for four years. You are saving this money and earning a 2.5% rate of return on your savings.

How much money will you have at the end of the four years?

15: Annuity due future value

99.768,12$

025.11525156.4000,3$

)025.1(025.

1)025.1(000,3$

)1(11

AFV

4

rr

r) ( C

t

17: Annuity – annual paymentsYou plan on retiring at age 60 and then living another 25 years. Your goal is to have $500,000 in your retirement savings on the day you retire and spend it all by the time you die. During your retirement, you expect to earn 5% on your savings.

How much money can you withdraw from your savings each year during your retirement if you withdraw the funds on the last day of each year?

What if you withdraw the money on the first day of each year?

18: Annuity – annual payments

(rounded) $35,476.23C

86$35,476.22C14.0939446

$500,000C

14.0939446C000,500$

05.

05.1/11C000,500$

1/11 C APV

25

r

r t


88.786,33$05.1

2286.476,35$

r1

CCAD

20: Annuity – monthly paymentsYou currently owe $3,780 on your credit card. You are not charging any more on the account. The interest rate is 1.5% per month.

How much do you have to pay each month if you want to have this bill paid off within two years?

21: Annuity – monthly payments

$188.71 C20.0304

$3,780C

20.0304C780,3$

.015

.300456C780,3$

015.

015.1/11C780,3$

1/11 C APV

)122(

r

r t

22: Annuity – monthly payments

23: Annuity – quarterly paymentsYour company recently borrowed $12,000 to buy some office equipment. The financing terms call for eight equal quarterly payments. The interest rate is 10%.

What is the amount of each quarterly payment?

24: Annuity – quarterly payments


$1,673.61 C7.170136

$12,000 C

7.170136C000,12$

025.

1792534. C $12,000

4/10.

410.

1/11

C $12,000

1/11 C APV

8

r

r t

Chapter 6: Stock Valuation

2: Zero growth stockRainbow Rentals pays a constant annual dividend of $1.00 per share on their common stock.

How much are you willing to pay for one share of this stock if you want to earn a 9% rate of return?

3: Zero growth stock

11.11$09.

00.1$r

DP0

4: Zero growth stockBits ‘n Pieces pays a constant annual dividend of $.50 a share. The market price of the stock is $5.41 today.

What is the rate of return on this stock?



%24.9r

09242.r

50$.r41.5$r

50$.41.5$

r

DP0

6: Zero growth stockThe common stock of Kathy’s Antiques, Etc. is priced at $12.50 a share. The stock provides a 10% rate of return. The company pays a constant dividend.

What is the amount of the annual dividend?


25.1$D10.

D50.12$

r

DP0

8: Constant growth stockJLE, Inc. just paid their annual dividend of $1.10 a share. JLE’s policy is to increase the dividend by 2% annually.

How much are you willing to pay today for a share of this stock if you require an 11% rate of return?

9: Constant growth stock


47.12$

46667.12$09.

122.1$02.11.

)02.1(10.1$

gr

)g1(D

gr

DP 01

0

10: Constant growth stockSLG, Inc. announced today that they will be increasing their annual dividend to $1.60 per share next year. After that, they expect to increase the dividend by 3% annually. You want to buy shares of stock in this company but can not afford to do so for another two years. At that time, you will buy shares if you can earn a 12% rate of return.

How much will you be willing to pay for one share of this stock two years from today?


86.18$09.

69744.1$03.12.

)03.1(60.1$

gr

)g1(D

gr

DP

gr

DP

2

213

2

1tt

12: Constant growth stockAlex’s Ventures, Inc. stock has a 13% rate of return and a current market price of $16.18. The company pays annual dividends. The last dividend paid was $1.40 per share.

What is the growth rate of this stock?



%00.4g

04001.g

7034$.g58.17$

g40.1$40.1$g18.16$1034.2$

g13.

)g1(40.1$18.16$

gr

)g1(D

gr

DP 01

0

14: Constant growth stockC and F Fabrics is going to pay an annual dividend of $1.36 per share next week. The dividends have been increasing by 2% annually and this trend is expected to continue. The stock is selling for $15.11 per share.

What is the market rate of return on this stock?


%00.11

1100.r

6622.1$r11.15$

36.1$3022$.r11.15$02.r

36.1$11.15$

gr

DP 1

0

16: Constant growth stockThe Thomas Co. is in a declining industry and has just announced that they will be reducing their annual dividend by 2% annually from now on. The last dividend they paid was $1.60. The market rate of return on this stock is 6%.


What is the market price of one share of Thomas Co. stock?


60.19$P

568.1$P08.

)02.(06.

)]02.(1[60.1$P

gr

)g1(D

gr

DP

0

0

0

010

18: Irregular growth stockIsaac’s Shoes just announced that they will commence paying annual dividends next year. The plan is to pay $.50, $.75 and $1.00 per share over the next three years, respectively. After that the company plans on increasing the dividend by 2.5% annually. The market rate of return on this stock is 12.5%.

What should the market price of this stock be?19: Irregular growth stock

25.10$10.

025.1$025.125.

)025.1(00.1$

gr

)g1(D

gr

DP 34

3

94.8$

93826.8$

90123.7$59259$.44444$.

)125.1(

25.10$00.1$

)125.1(

75$.

)125.1(

50$.P

3210

20: Irregular growth stock


Nu-Tek, Inc. just paid their annual dividend of $1.20 per share. The company has stated that dividends will increase by 20% a year for the next two years. After that, the dividends will increase by 4% annually.

What is one share of this stock worth today if the required return is 14%?

21: Irregular growth stock

728.1$)20.1(20.1$D

44.1$)20.1(20.1$D2

2

1

9712.17$10.79712.1$

04.14.

)04.1(728.1$

gr)g1(D

gr

DP 23

2

42.16$

42105.16$

15789.15$26316.1$

)14.1(

9712.17$728.1$

)14.1(

44.1$P

210

Chapter 7: Net Present Value and Other Investment Criteria

2: Net present valueYou are considering a project which requires an initial investment of $24,000. The project will produce cash inflows of $8,000, $9,800, $7,600 and $6,900 over the next four years, respectively.

What is the net present value of this project if the required rate of return is 12%?

Should this project be accepted?

3: Net present value

96.749$

07.385,4$53.409,5$50.812,7$86.142,7$000,24$

)12.1(

900,6$

)12.1(

600,7$

)12.1(

800,9$

)12.1(

000,8$000,24$NPV

4321

4: Net present value


CF0 = -$24,000CO1 = $ 8,000 FO1 = 1CO2 = $ 9,800 FO2 = 1CO3 = $ 7,600 FO3 = 1CO4 = $ 6,900 FO4 = 1I = 12%NPV CPT$749.96

5: PaybackA project has an initial cost of $199,000. The project produces cash inflows of $46,000, $54,000, $57,500, $38,900 and $46,500 over the next five years, respectively.

What is the payback period for this project?

Should the project be accepted if the required payback period is 3 years?

6: PaybackYear Cash flow Cumulative cash flow 1 $46,000 $ 46,000 2 $54,000 $100,000 3 $57,500 $157,500 4 $38,900 $196,400 5 $46,500 $242,900

years 06.40559.4500,46$

600,2$

500,46$

400,196$000,199$4Payback

7: Discounted paybackA project has an initial cost of $200,000 and produces cash inflows of $86,000, $93,600, $42,000 and $38,000 over the next four years, respectively.

What is the discounted payback period if the discount rate is 10%?

Should this project be accepted if the required discounted payback period is 3 years?

8: Discounted paybackYear Discounted Cumulative discounted cash flow cash flow 1 $86,000/(1+.10)1 = $78,181.82 $ 78,181.82 2 $93,600/(1+.10)2 = $77,355.37 $155,537.19 3 $42,000/(1+.10)3 = $31,555.22 $187,092.41 4 $38,000/(1+.10)4 = $25,954.51 $213,046.92


years 50.34973.351.954,25$

59.907,12$

51.954,25$

1)$187,092.4 - ($200,000 3 payback Discounted

9: Average accounting returnA project has an initial cost of $134,000 for equipment. This equipment will be depreciated using straight line depreciation to a zero book value over the four year life of the project. The project is expected to produce annual net income of $4,700, $5,100, $5,800 and $6,500 over the four years, respectively.

What is the average accounting return (AAR)?

Should this project be accepted if the required AAR is 8%?

10: Average accounting return

%25.8

08246.

000,67$

525,5$2

0$000,134$4

500,6$800,5$100,5$700,4$

book value Average

incomenet AverageAAR

11: Internal rate of returnYou are considering a project with an initial cost of $48,500. The project has a five year life and produces cash inflows of $9,800, $12,200, $12,850, $13,200 and $13,600 over the five years, respectively.

What is the internal rate of return on this project?

Should this project be accepted if the required rate of return is 8%?

12: Internal rate of return

CF0 = -$48,500CO1 = $ 9,800 FO1 = 1CO2 = $12,200 FO2 = 1CO3 = $12,850 FO3 = 1CO4 = $13,200 FO4 = 1CO5 = $13,600 FO5 = 1IRR CPT8.14%


Chapter 8: Project Analysis and Evaluation

2: Scenario analysisWilson’s Woods is considering a project which involves producing inexpensive golf clubs for teenagers. The company expects to sell these clubs for $100 a set, plus or minus 2%. The sales manager estimates that 20,000 sets can be sold, plus or minus 5%.

What is the expected amount of sales under the worst case scenario?

3: Scenario analysis

000,862,1$

98$19,000

.02)(1$100.05)- (1 20,000 scenario casefor worst Sales

4: Scenario analysisBob’s Custom Wheels is considering designing and selling customized steering wheels for hot rods. The projected fixed costs of this project are $18,000. Variable costs are estimated at $54.90 per wheel. The cost estimates are considered accurate within a plus or minus range of 5%. The depreciation expense is $8,000 per year. Bob’s expects to sell


1,500 wheels, plus or minus 3%. The sales price is estimated at $139.00, plus or minus 5%.

What is the projected earnings before interest and taxes under the best case scenario?

5: Scenario analysisNote: Totals are rounded to whole dollars.

Sales = 1,500 (1 + .03) $139.00 (1 + .05) = $225,493Variable cost = 1,500 (1 + .03) $54.90 (1 - .05) = $ 80,579Fixed cost = $18,000 (1 - .05) = $ 17,100Depreciation = $8,000 = $ 8,000 EBIT

= $119,814

6: Sensitivity analysisKettle Corn and Chips is considering selling snack foods at sporting events. The company has developed the following estimates:

Sales 25,000 units ± 10%Variable cost $.59 per unit ± 5%Fixed cost $7,500 ± 2%Selling price $1.25 per unit ± 5%Depreciation $1,000

What is the earnings before interest and taxes for a sensitivity analysis using a variable cost of $.60 per unit?

7: Sensitivity analysisNote: Totals are rounded to whole dollars.

Sales = 25,000 $1.25 = $31,250Variable cost = 25,000 $.60 = $15,000Fixed cost = $7,500 = $ 7,500Depreciation = $1,000 = $ 1,000 EBIT

= $ 7,750

8: Sensitivity analysisThe Sweet Shoppe is considering opening a kiosk and selling homemade cookies on the waterfront during tourist season. The company has developed these estimates:

Sales 6,000 cookies ± 20%Variable costs $.69 per cookie ± 4%Fixed costs $500 ± 3%Sales price $1.10 ± 5%Depreciation $800Tax rate 34%

What is the operating cash flow for a sensitivity analysis using a sales quantity of 6,500 cookies?


9: Sensitivity analysisNote: Totals are rounded to whole dollars.

Sales = 6,500 $1.10 = $7,150Variable cost = 6,500 $.69 = $4,485Fixed cost = $500 = $ 500Depreciation = $800 = $ 800EBIT = $1,365Tax = .34 $1,365 = $ 464Net income = $ 901

OCF = EBIT + Depreciation – Taxes = $1,365 + $800 - $464 = $1,701

10: Sensitivity analysisOCF = [(Sales – Costs) (1 – Tax rate)] + [Depreciation tax rate] = {[6,500 ($1.10 - $.69)] - $500} {1 - .34} + {$800 .34} = $1,428.90 + $272.00 = $1,700.90 = $1,701 (rounded to whole dollars)

11: Total costSandwiches To Go sells 500 sandwiches per day. The company pays $1,200 a month for rent. Other fixed costs are $500 monthly.The variable cost per sandwich is $2.89. Assume a month has 30 days.

What are the monthly total costs incurred by Sandwiches To Go?

12: Total cost Total monthly cost = (500 30 $2.89) + $1,200 + $500

= $43,350 + $1,700= $45,050

13: Average vs. marginal costDaisy’s Flowers raises and sells 36,000 bouquets of fresh cut flowers each year. Total labor cost for the year are $68,000. Total material costs for the year are $28,470. Daisy’s computed that at the current level of production the labor cost per additional unit is $1.40 and the material costs are $2.09.Fixed costs for the year are $50,000. Annual depreciation is $55,000 on the greenhouses and equipment. Ignore taxes.

What is the average total cost per bouquet?


What is the minimum price Daisy’s should charge if they can obtain a one-time special order for an additional 250 bouquets?

14: Average vs. marginal cost

)rounded( 60.5$

36,000

$55,000 $50,000$28,470 $68,000 cost totalverageA

$3.49

$2.09 $1.40 order time-onefor price Minimum

15: Contribution marginJack’s Custom Kars manufactures motorized toy cars for children aged 3 to 6. Jack’s sells these cars for $320 each. The company has fixed monthly expenses of $1,500. The variable cost per car is $212. During an average month, Jack’s sells 20 of these toy cars.

What is the contribution margin per car sold?

Chapter 9: Return, Risk, and the Security Market Line

2: Expected return of individual stockYou own 500 shares of ABC, Inc. This stock has the following expected returns given the various possible states of the economy.

State of Probability of Rate of ReturnEconomy State of Economy if State OccursBoom .20 28%Normal .70 12%Recession .10 -40%

What is your expected return on this stock?

3: Expected return of individual stock


%10

10.

04.084.056.

)40.10(.)12.70(.)28.20(.Er

4: Standard deviation of individual stockA stock has returns of 6.8%, 9.2%, -4.3% and 18.7% over the last four years, respectively.

What is the standard deviation of this stock assuming the returns are normally distributed?

5: Standard deviation of individual stock

076.4

304.4

187.043.092.068.Er

%45.9

0945.

008934.

3

026802.

3

012321.014161.000256.000064.

14

)076.187(.)076.043.()076.092(.)076.068(. 2222

6: Portfolio weightsYou own 50 shares of Stock A and 200 shares of stock B. Stock A sells for $30 a share and stock B sells for $22 a share.

What are the portfolio weights for each stock?

7: Portfolio weights

Stock Number of Price per Total Portfolio Shares Share Value Weight A 50 $30 $1,500 25.4% B 200 $22 $4,400 74.6% Totals $5,900 100.0%

8: Portfolio expected return


You have $3,600 invested in stock A and $5,400 invested in stock B. Stock A has an expected return of 11% and stock B has an expected return of 7%.

What is the expected return of your portfolio?

9: Portfolio expected returnStock Expected Return Amount Invested Portfolio Weight A 11% $3,600 40% B 7% $5,400 60%Totals $9,000 100%

%6.8

086.

042.044.

)07.60(.)11.40(.Er

10: Portfolio expected returnYour portfolio consists of the following stocks:

Stock Expected Return Number of Shares Stock Price A 9% 640 $25 B 14% 250 $40 C 7% 700 $20

What is the expected return on your portfolio?11: Portfolio expected return

Expected Number Price Stock PortfolioStock Return of Shares per Share Value Weight A 9% 640 $25 $16,000 40% B 14% 250 $40 $10,000 25% C 7% 700 $20 $14,000 35% Totals $40,000 100%

%55.9

0955.

0245.035.036.

)07.35(.)14.25(.)09.40(.Er


12: Portfolio expected returnYou have a portfolio with an expected return of 12.94%. Your portfolio consists of stock A and stock B only. Stock A has an expected return of 18% and stock B has an expected return of 7%.

What are the portfolio weights?


%54w

54.w

w11.0594.

w07.07.w18.1294.

]07.)w1[(]18.w[1294.

)Ew()Ew( E

A

A

A

AA

AA

B rBA rAportfolior

1294.1294.

0322.0972.1294.

]07.)54.1[(]18.54[.1294.

14: Portfolio expected returnState of Probability of Rate of ReturnEconomy State of Economy if State OccursBoom .15 18%Normal .60 11%Recession .25 2%

What is the expected return on this portfolio?



%8.9

098.

005.066.027.

)02.25(.)11.60(.)18.15(.Er

16: Portfolio expected returnState of Probability of Rate of Return if State OccursEconomy State of Economy Stock A Stock B Stock C Boom

.20 17% 13% 40%Normal .50 8% 6% 13%Recession .30 -12% -5% -50%

Your portfolio consists of 50% stock A, 40% stock B and 10% stock C.

What is the expected return on your portfolio?

Chapter 10: Cost of Capital

2: Cost of equityIsabelle Thomas and Son, Inc. just paid the annual dividend on their common stock in the amount of $1.20 per share. The company expects to maintain a constant 3% rate of growth in their dividend payments. Currently, the stock is selling for $20.40 a share.

What is the cost of equity for Isabelle Thomas and Son, Inc.?


3: Cost of equity

%06.9

0906.

03.0606.

03.40.20$

)03.1(20.1$

gP

)g1(D

gP

DR

0

0

0

1E

4: Cost of equityThe Curtis Plane Co. has paid $1.10, $.90, $.83 and $.75 in annual dividends over the past four years, starting with the latest year first. This year the company is paying a dividend of $1.22 a share.

What is the average growth rate of the dividends?

5: Cost of equity$1.22 ($1.22 - $1.10) ¸ $1.10 = .10909

$1.10 ($1.10 - $.90) ¸ $.90 = .22222

$ .90 ($.90 - $.83) ¸ $.83 = .08434

$ .83 ($.83 - $.75) ¸ $.75 = .10667

$ .75 --- ---

Total .52232

%06.1313058.4

.52232 rategrowth Average

6: Cost of equityThe stock of Neal & Co. has a beta of 1.40. The risk-free rate of return is 3.5% and the risk premium is 8%.

What is the expected rate of return on Neal & Co. stock?

7: Cost of equity


%7.14

147.

112.035.

08.4.1035.

)RR(RR fmEfE

8: Cost of preferredThe 7% preferred stock of Anderson, Inc. is selling for $72.92.

What is the cost of preferred stock?

9: Cost of preferred

%60.9

0960.92.72$

00.7$92.72$

100$07.

P

DR

0P

10: Cost of debtThe bonds of TA, Inc. have a face value of $1,000 per bond, mature in 13 years, and pay 8% interest annually. These bonds currently sell for $969.08.

What is the pre-tax cost of debt?

12: Cost of debtFour years ago, JE, Inc. issued twenty-year bonds that have a face value of $1,000 per bond and pay interest semi-annually. These bonds currently sell for $1,012.30 and have a 9% coupon.

What is the pre-tax cost of debt?

Chapter 11: Dividends and Dividend Policy

2: Ex-dividend dateThe Marla James Co. declared a dividend of $1.50 a share to holders of record on Thursday, July 19. The dividend is payable on July 31. Suzie purchased 100 shares of Marla James stock on Tuesday, July 17. Jim purchased 100 shares of Marla James stock on Monday, July 16.

How much did Suzie receive in dividends on July 31?


How much did Jim receive in dividends on July 31?

3: Ex-dividend dateSuzie will receive $0 on July 31 because she bought the stock on the ex-dividend date.

Jim will receive $1.50 a share for a total of $150 on July 31 because he bought the stock cum dividend.

4: Homemade dividendsYou own 100 shares of Big Boys Burgers. The company will pay a $.50 per share dividend this year and a final liquidating dividend of $42 per share next year. The required return on this stock is 14%. Ignore taxes.

What is the current market value of one share of this stock?

What will your homemade dividend per share be next year if you do not want any dividend this year?

5: Homemade dividends

76.32$

7562.32$

3176.32$4386$.1.14

42$

1.14

$.50 uemarket val Current

21

$42.57

$42 $.57

$421.14)$.50( 2year for dividend Homemade

6: Residual dividendFood, Etc. has after-tax earnings of $1,300 for the year. The company maintains a debt/equity ratio of .60 and has a residual dividend policy. $1,500 is needed for new investments.

What is the amount of new borrowing?

What amount, if any, is paid out in dividends?

7: Residual dividend


WeightD = .6 37.5%E = 1.0 62.5%V = 1.6 100.0%

Equity 50.937$625.500,1$

Debt 50.562$375.500,1$

50.362$

50.937$300,1$Dividend

8: Cash dividend vs. Share repurchase

Net income = $750Market value = Book value

Current $1,000 cash Dividend

$1,000 sharerepurchase

Excess cash $1,000

Other assets $9,000

Equity $10,000

# of outstanding shares 5,000

Earnings per share $.15

Stock price $2.00

Dividend per share $0

Stockholder value per share

$2.00


shareper Dividend priceStock shareper valuerStockholde

shares goutstandin ofNumber

paid Dividend shareper Dividend


)book value uemarket val Assumes :(NoteEquity price Stock


incomeNet shareper Earnings



shares 5002$

000,1$

shareper priceStock

repurchase ofamount Dollar drepurchase shares of Number


Net income = $750 Current $1,000 cash Dividend

$1,000 sharerepurchase

Excess cash $1,000 $0 $0

Other assets $9,000 $9,000 $9,000

Equity $10,000 $9,000 $9,000

# of outstanding shares 5,000 5,000 4,500

Earnings per share $.15 $.15 $.1667

Stock price $2.00 $1.80 $2.00

Dividend per share $0 $.20 $0

Stockholder value per share

$2.00 $2.00 $2.00

12: Small stock dividend Current 10% (small)

stock dividend

Common stock $5,000

Capital in excess of par $20,000

Retained earnings $10,000

Total equity $35,000

# of outstanding shares 5,000

Par value $1

Book value per share $7.00

Market value per share $10.00

Total market value $50,000

13: Small stock dividend

500 5,000.10

goutstandin Sharespercentage Dividend issued be toshares ofNumber


$500

500$1

shares ofNumber valuearPstock common in Change

$4,500

500$1) - ($10

shares ofNumber Par value) - lue(Market va par of excessin capitalin hangeC

$5,000-

500$101-

shares ofNumber shareper ueMarket val1- earnings retainedin Change

14: Small stock dividend

36.6$

500,5

000,35$


equity Total shareper valueBook

09.9$

500,5

000,50$


uemarket val Total shareper ueMarket val

Chapter 12: Short-Term Finance and Planning

2: Sources and uses of cashAccount Beginning

BalanceEnding Balance

Sourceof Cash

Use of Cash

Cash 444 460 U

Accounts receivable 996 980

Inventory 1,387 1,405

Fixed assets 4,813 5,209

Accounts payable 1,042 1,234


Note payable 250 500

Long-term debt 1,500 1,200

Common stock 2,900 3,000 S

Retained earnings 1,948 2,120

3: Sources and uses of cashAccount Beginning

BalanceEnding Balance

Sourceof Cash

Use of Cash

Cash 444 460 U

Accounts receivable 996 980 S

Inventory 1,387 1,405 U

Fixed assets 4,813 5,209 U

Accounts payable 1,042 1,234 S

Note payable 250 500 S

Long-term debt 1,500 1,200 U

Common stock 2,900 3,000 S

Retained earnings 1,948 2,120 S

4: Operating and cash cyclesGiven the information in the table, compute the operating and cash cycles.Average accounts receivable $ 2,080

Average inventory 2,400

Average accounts payable 1,135

Sales 15,600

Cost of goods sold 9,761

5: Operating and cash cycles

5.7

080,2$

600,15$

receivable accounts Average

sales Credit turnover sReceivable


days 7.487.5

days 365

turnoversReceivable

days 365 period ceivablesRe


0671.4

400,2$

761,9$

inventory Average

sold goods ofCost turnover Inventory

days 7.890671.4365

turnoverInventory days 365

period Inventory


6.8

135,1$

761,9$

payable accounts Average

sold goods ofost C turnover Payables


days 4.428.6

days 365

turnoverPayables

days 365 period ayablesP


days 138.4

48.7 89.7

period sReceivable periodInventory cycle Operating

days 96

42.4-138.4

period Payables - cycle Operating cycle Cash

9: Receivables scheduleThe receivables period is 60 days. Assume that each month has 30 days.Can you complete this table? Q1 Q2 Q3 Q4

Beginning receivables 290

Sales 300 270 360 420

Cash collections

Ending receivables

10: Receivables schedule Q1 Q2 Q3 Q4

Beginning receivables 290 200 180 240

Sales 300 270 360 420

Cash collections 390 290 300 380


Ending receivables 200 180 240 280

$280 )60/90($420 sreceivable ending Q4

$380 )30/90($420 )60/90($360 scollection Q4

$300 )30/90($360 )60/90($270 scollection Q3

$290 )30/90($270 )60/90($300 scollection Q2

$390 30/90(300) $290 scollection 1Q

11: Payables schedule Q1 Q2 Q3 Q4

Sales 300 270 360 420

Beginning payables 90

Purchases

Payments 171

Ending payables

Sales for Q1 of the following year are $310.Purchases are equal to 60% of the next quarter sales.The payables period is 45 days.Assume that each month has 30 days.12: Payables schedule Q1 Q2 Q3 Q4

Sales 300 270 360 420

Beginning payables 90 81 108 126

Purchases 162 216 252 186

Payments 171 189 234 219

Ending payables 81 108 126 93

Q1 payments = $90 + 45/90($162) = $171Q2 payments = 45/90($162)+ 45/90($216) = $189Q3 payments = 45/90($216) + 45/90($252) = $234Q4 payments = 45/90($252) + 45/90($186) = $219Q1 purchases = .6($270) = $162Q2 purchases = .6($360) = $216Q3 purchases = .6($420) = $252Q4 purchases = .6($310) = $186


Sales for Q1 next year = $31013: Disbursements schedule Q1 Q2 Q3 Q4

Payment of accounts 171 189 234 219

Wages, taxes, other expenses 70 85 90 110

Capital expenditures 80 35

Long-term financing expenses 12 12 12 12

Total cash disbursements

14: Disbursements schedule Q1 Q2 Q3 Q4

Payment of accounts 171 189 234 219

Wages, taxes, other expenses 70 85 90 110

Capital expenditures 80 35

Long-term financing expenses 12 12 12 12

Total cash disbursements 253 366 371 341

<<< The End >>>


corporate finance completed notes

Documents

produces cash inflows

constant growth stocksir

capital intensity ratio

dividend payout ratio

marla james stock

constant annual dividend

pays interest semi

interest rate riskyou