Fin 325 Final Review

Chang Liu04/30/2014

Intro to Finance• Business organizational forms

– Sole Proprietorship– Partnership (General/Limited)– Corporation– LLC

• Major financial management decisions– Capital budgeting– Financing/Capital structure– Working capital management

• Goal of financial management– Maximize shareholder value/firm value– Agency problem

• Financial Markets & Intermediaries

Time Value of Money

• Components of interest rate• Interest rate mathematics– PV FV

• Compounding– Equivalent n-period interest rate– APR & EAR

• Solving for r• Solving for n– Rule of 72

Annuities & Perpetuities

• PV of an annuity– PV=CF*(1/r-1/(r(1+r)^n))

• PV of a perpetuity– PV=CF/r

• Two presumptions of PV formulas• FV of an annuity• Solving for CF of an annuity

Real & Nominal Interest Rates

• How to measure inflation?– Consumer Price Index (CPI)

• Real vs Nominal– Fisher equation– Real value of $1– PVreal vs PVnominal

– Matching CF with r• Growing perpetuity– PV=CF/(r-g)

Bond & Bond Valuation• Terminology

– Par value, coupon rate, maturity• Different types of bond

– Coupon bond– Zero coupon bond– Level-payment bond

• Bond rating• Bond pricing

– YTM• Yield Curve/Term structure of interest rates

– Shape of yield curve• Return on bond

Stock & Stock Valuation

• Dividend models– Constant dividends– Growing dividends

• CF available to shareholders– Equity = Firm Value - Debt

• Financial ratios– P/E, P/Sales, M/B

• Return on stock

Financial Statements

• Balance sheet– Managing liquidity and capital structure– BV vs MV

• Income statement• Statement of cash flows– Sources and uses of cash

• Statement of retained earnings• Ratio analysis– Liquidity/asset mgmt/debt mgmt/profitability/market

value

Net Present Value

• What does NPV measure?– ΔFirm value

• How to calculate NPV?– Incremental CFs

• What’s the decision rule?– Positive Accept

• NPV takes account of all future incremental CFs and is independent of financing.

Capital Budgeting

• Incremental CF– Pro forma financial statements– OCF, NWC, CAPEX

• Depreciation tax shield• Taxes from asset sale

ΔRevenue

- ΔCosts

- ΔDepreciation

= ΔEBIT

- ΔTaxes

= ΔEAT

+ ΔDepreciation

- ΔCAPEX

+ ΔAsset Sale

- ΔOpportunity Cost

- ΔNWC

= ΔFCF

Issues with NPV

• Lifespan problem– Common end-year– Equivalent Annual Annuity (EAA)

• Real options– Decision tree

Alternatives to NPV

• Internal Rate of Return– Decision rule– Financing opportunity– Equivalence of IRR & NPV

• Payback period– Decision rule– Limitations

Risk & Return

• Higher risk -> higher (expected) return• 2 types of risk– Systematic -> Non-diversifiable– Unsystematic/Idiosyncratic -> Diversifiable

• Measure of systematic risk– Beta, CAPM

• Diversifying with a portfolio– Portfolio expected return, standard deviation, beta

Cost of Capital

• Beta approach– Equity beta & asset beta

• Weighted Average Cost of Capital– Cost of debt– Cost of equity

Capital Structure

• M&M Propositions I & II– 3 assumptions– The “pie”

• Interest Tax Shield• Modified WACC• Value of unleveraged and leveraged firm

Market Efficiency

• Three forms of market efficiency• Weak-form• Semi-strong form• Strong form