uniseminar f&a summary script sample

UNISEMINAR

Theory

Practice

Exams

Extras

Sem

inar

Introduction

Finance & Accounting Academic Year 2012/2013, Block 1

Uniseminar – Finance & Accounting Introduction

Welcome to Uniseminar!

IInnttrroodduuccttiioonn

Uniseminar offers EExxaamm PPrreeppaarraattiioonn SSeemmiinnaarrss,, SSuummmmaarryy SSccrriippttss aanndd

LLeeaarrnniinngg CCaarrddss for students of the Maastricht University. It is our goal to

optimally prepare you for your exams and to make your own exam preparation as

efficient as possible. In order to achieve this goal, we have developed a system of

seminars in combination with an extensive summary script, which is proven for

several years by now.

In university it is often the case that there is a lot of material available for a

course and that the importance of this material is hard to evaluate. Since we, as

students, have made this experience as well, you are provided with a Uniseminar

Summary Script of the corresponding course. This folder contains all exam-‐

relevant material and it gives you a good summary of all course topics. The

content of the folder is created by experienced Master or PhD students, who have

taught this course already several times. As a consequence, it is possible for you

to concentrate on the actual exam preparation, rather than spending hours

searching and printing the right material.

At the end of week 7 of your block, normally during the weekend, our EExxaamm

PPrreeppaarraattiioonn SSeemmiinnaarrss take place. These seminars are taught by above-‐

average students, who have already mastered their studies at the Maastricht

University and have a great deal of experience in tutoring. Since they have studied

and taught at the Maastricht University they know exactly where potential

problems may lie and are therefore able to optimally teach you the whole theory

of the course and practice perfectly tailored examples with you. Furthermore you

can bring in your own questions during the seminar and discuss individual

problems during the breaks.

You are able to pick up your SSuummmmaarryy SSccrriipptt aanndd LLeeaarrnniinngg CCaarrddss in

advance of the Seminar in order to already start preparing so that you can

discover your own difficulties early enough. Later in the Seminar you will then

know what your weaknesses are and be able to pay special attention to these

Introduction Uniseminar – Finance & Accounting

sections or ask questions about it. Our Summary Script and Learning Cards are

updated every year according to the current course’s content and we are always

trying to optimize the folder as much as possible.

AAbboouutt UUss

Uniseminar was founded 5 years ago by two students at the University of

St.Gallen in order to make Exam Preparation more efficient and coherent. Since

2005 we have expanded our vision and are now offering seminars and material

for an efficient exam preparation in Switzerland, the Netherlands, Italy and

Germany.

Thanks to this longstanding experience, we were able to build up a team of highly

qualified tutors and editors and are therefore able to guarantee high quality of

exam preparation.

The team of Uniseminar is grown strongly over the years and comprehends

several mathematicians, statisticians and economists, who all bring a great

didactical experience. All tutors of Uniseminar have been teaching their field for

years and know exactly what is important in order to optimally prepare and pass

the exam.

Theory

Practice

Exams

Extras

Sem

inar

T

Theory


Theory Uniseminar – Finance & Accounting

TThheeoorryy

The Theory Script summarizes the whole theory of the course in a simple and

understandable way. Concepts are explained with the help of demonstrative

examples. It is structured according to the seven weeks of the course and is one of

the most important parts of your exam preparation. Although practice is very

important, it is even more crucial to understand the basic concepts of the course

in order to be able to calculate and understand all different kinds of exercises and

exam questions.

TTaabbllee ooff CCoonntteennttss

FFiinnaannccee 11

1 Capital Markets – Risk & Return 1

2 Capital Structure 11

3 Payout Policy 24

4 Capital Budgeting and Valuation 34

5 Options 41

AAccccoouunnttiinngg 5577

1 Organizations 57

2 Financial Statements 61

3 Transaction Analysis 67

4 Accrual Accounting 71

5 Short-‐Term/Trading Investments 73

6 Receivables 75

7 Inventory & Cost of Goods Sold 81

8 Plant Assets and Intangibles 88

9 Current Liabilities 92

10 The Cash Flow Statement 97

11 Financial Statement Analysis 103

Uniseminar – Finance & Accounting Theory - Finance

1

Finance

1 Capital Markets – Risk & Return

The fundamental principle regarding investments of any kind (stocks, bonds,

options, etc.) is that investors are risk averse and thus demand a risk premium for

bearing risk. Consequently, the basic capital market model (CAPM) establishes a

positive relationship between risk and return. As the risk increases, the

associated premium that investors demand increases, which in turn raises the

required return on the investment.

1.1 Risk – Common vs. Independent Risk

In order to understand how the risk of an individual security differs from the risk

of a portfolio composed of different securities, one needs to understand that there

are two types of risk:

• Common risk: risk that is perfectly correlated (such as an earthquake

affecting all houses in an entire city at the same time)

• Independent risks: risks that do not share correlation (such as the risk of

burglary affecting one house without affecting all other houses at the same

time)

Diversification entails the averaging out of independent risks in a large portfolio

and will be defined more extensively below when applied to securities.

Over a given time period, the risk of holding a stock is that the dividends plus the

final stock price will be higher or lower than expected, which makes the realized

return risky. Stock prices fluctuate due to two types of risk:

• firm-specific risk – risk due to firm-specific news. Risk that does not affect

the whole market, but only one firm or a small number of firms. It is also

called idiosyncratic, unsystematic, unique or diversifiable risk.

• systematic risk – risk due to market-wide news. Risk that affects all

companies to some degree. It is also called undiversifiable or market-risk.

Theory - Finance Uniseminar – Finance & Accounting

2

As the names already suggest, firm-specific risk can be diversified away in a

(large) portfolio. Contrary systematic risk can not be diversified in a portfolio,

because it affects all firms that are publicly traded. Whereas investors are not

compensated for holding firm-specific risk, they expect a risk premium for

holding systematic risk. The risk premium is also known as the excess return,

which can be defined as the difference between the average return for the

investment and the average return for Treasury bills, a risk-free investment.

• Diversification - refers to the reduction of firm-specific risk. It is achieved

by investing in a variety of assets with different characteristics. The lower

the correlation between the assets the higher is the diversification

potential (exception: correlation of 1 no diversification at all!). The

example below illustrates the effect that diversification has on firm specific

(unsystematic) risk:

Example:

There are two companies. (1) a car producer (e.g. VW) who´s return (revenue)

and consequently its share price will go down if the prices for steel increase

(higher steel prices = higher production costs).

(2) a steel producer (e.g. AcelorMittal), who´s return (and share price) will

increase as the price for steel increases (i.e. AcelorMirral returns are negatively

correlated with VW´s returns).

Now think about what happens if you invested an equal amount of money in both

companies and the price for steel increases: The share price of VW will decrease

due to higher production costs. However, the decrease in VW´s share price will be

offset by the increase in the price of AcelorMittal. As a result, a portfolio

containing both firms will effectively reduce the firm specific risk that is related

to an increase in the price of steel.

A portfolio that contains only systematic risk (where all unsystematic risk is

diversified) is called an efficient portfolio. A natural candidate for an efficient

portfolio is the market portfolio, which is a portfolio of all stocks and securities


8

Exhibit 1.2.1: Capital Market Line

The CAPM assumes an efficient market portfolio, which means that the market

portfolio does not contain any firm-specific risk. Since investors are only

compensated for systematic risk in terms of risk premia (because firm-specific

risk is diversified away), the appropriate measure of risk to determine a

security’s risk premium is its beta. The beta is a measure of sensitivity of an

asset´s returns to market returns.

Beta

• 𝛽𝑖 = 𝑆𝐷(𝑅𝑖)∗𝐶𝑜𝑟𝑟(𝑅𝑖,𝑅𝑀𝑘𝑡)𝑆𝐷(𝑅𝑀𝑘𝑡)

= 𝐶𝑜𝑣(𝑅𝑖,𝑅𝑀𝑘𝑡)𝑉𝑎𝑟(𝑅𝑀𝑘𝑡)

The slope of the CML is the Sharpe Ratio which is a measure of a securities excess

return per unit of risk (reward-to-variability ratio). Consequently, it serves as a

good measure to compare different investment opportunities.

Sharpe Ratio

• Sharpe Ratioi = 𝑅𝑖 − 𝑟𝑓

𝜎𝑖

Standard deviation (σ)

0 20% 40%30%

Exp

ecte

d R

etu

rn (

%) Market Portfolio

=efficient Portfolio

Capital Market

Line

Efficient frontier

Inefficient frontier

Min. Variance

*Slope: Sharpe Ratio

10%

5%

10%

15%

Volatility due to diversifyable risk

Volatility dueto undiver-sifyable risk

Exxon


9

1.4.2 The security market line

The security market line (SML) shows the required return for each security as a function

of its beta with the market. The security market line relates a securities expected return

to its beta. If all securities are correctly priced they lie exactly on the security market line

(as depicted in Exhibit 1.2.2.1).

Exhibit 1.2.2.1: Security Market Line

If securities are mispriced they do not lie on the security market line. Securities that

yield a lower (higher) return than predicted by the CAPM equation are said to be

overpriced (underpriced) and have a negative (positive) alpha. This is illustrated in

Exhibit 1.2.2.2.

• Overpriced security: given the securities level of risk, it provides a lower return

than it should according to the CAPM equation

• Underpriced security: given the securities level of risk, it provides a lower return

than it should according to the CAPM equation

Beta (β)0 0.2 1.0 1.80.6 1.4 2.2

Exp

ecte

d R

etu

rn (

%) Security

Market Line

*Slope: Risk Premium

IBM

NOK

Edison

Apple

5%

10%

Beta of Nokia

15%

Market Portfolio


24

3 Payout Policy

The decision of a firm, how free cash-flows are paid out to its investors is called

payout policy. As depicted in the figure below, a firm has four options to

distribute cash: (1) retain the cash, using it to undertake new investments and

thereby increasing the future growth potential and thus future cash flows.

(2) Retain cash and increase cash reserves which might be important if the firm

has a large amount of short term liabilities or needs a lot of cash to keep

operations running (e.g. grocery stores need lots of change money). (3)

Repurchase shares thereby changing the capital structure of the company. This is

especially favorable if the company thinks that their shares are currently

undervalued! (4) Pay a dividend to investors thereby increasing investors Return

on Equity (ROE).

Retain Pay Out

Invest in New Projects

Increase Cash

Reserves

Repurchase Shares

Pay Dividends

Free Cash Flow


25

Tim

e3.1 Dividends (No taxes)

A company’s board determines the amount of the firm’s dividend. Below you find

the official procedure for dividend payments.

• declaration date – the date on which the board authorizes/declares the

dividend

• ex-dividend date – buyers of stock on or after this date do not receive the

dividends (two before the record date)

• record date – shareholders recorded on this date receive the dividend

• payable date – the date when the dividend is actually paid out to the

shareholders

In a perfect capital market, when a dividend is paid, the share price drops by

the amount of the dividend when the stock begins to trade ex-dividend (Just

before the stock is traded “cum-dividend” - with the dividend)

3.2 Share repurchases (no taxes)

The firm uses cash to buy shares of its own outstanding stock. In a perfect capital

markets, an open-market share repurchase has no effect on the stock price, and

the stock is the same as the cum-dividend price if a dividend were paid instead.

Open Market Repurchase - A firm announces its intention to buy its own shares in

the open market and then proceeds to do so over time like any other investor.

The time interval is not specified and the firm has no obligation to repurchase the

amount it originally stated.

Tender offer - A firm repurchases shares through a tender offer, offering to buy

shares at a prescpecified price during a short time period (usually 20 days). The

price is usually set at a substantial premium to the current market price. If not

enough shareholders are willing to tender their shares, the offer will be canceled.

A related method is the Dutch auction share repurchase, in which the firm lists

different prices at which it is prepared to buy shares, and shareholders in turn


35

4.1 Calculations of Free Cash flows [FCF & FCFE]

In order to understand the income statement items each of the three valuation

methods is based on, it is essential to understand how the different free cash

flows are computed.

Calculation Free Cash flow to the Firm [FCF] Calculation Free Cash Flow to Equity [FCFE]

𝑺𝒂𝒍𝒆𝒔 𝑺𝒂𝒍𝒆𝒔

− 𝐶𝑂𝐺𝑆 − 𝐶𝑂𝐺𝑆

𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕 𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕

− 𝑆𝐺&𝐴 − 𝑆𝐺&𝐴

− 𝑜𝑡ℎ𝑒𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑜𝑡ℎ𝑒𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠

𝐸𝐵𝐼𝑇𝐷𝐴 𝐸𝐵𝐼𝑇𝐷𝐴

− 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

− 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛

−𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

− 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛

𝑬𝑩𝑰𝑻 (earnings before interest and Tax) 𝑬𝑩𝑰𝑻 (earnings before interest and

Tax)

− 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒

− 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥 [𝐸𝐵𝐼𝑇 ∗ (1 − 𝜏𝐶)] − 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥

EBI (unlevered net income) Net Income

+ 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

− 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒

− 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 − 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

+ 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑁𝑒𝑡 𝐵𝑜𝑟𝑟𝑜𝑤𝑖𝑛𝑔 (𝑑𝑒𝑏𝑡)

𝑭𝑪𝑭 𝑭𝑪𝑭𝑬

The free cash flow to the firm [FCF] takes all payments (cash flows) to all

stakeholders (debt and equity holders) into account. As a result, interest


36

payments are not deducted from EBIT, because interest payments are cash flows

that go to a company´s debt holders. Depreciation is added back because it is not

a real cash expense2. The change in NWC refers to the change between short term

assets and liabilities (NWC=current assets - current liabilities). It shows how

much money the company has for its operation in the short term. If the change in

NWC is positive, the amount is subtracted from EBI/net income, and vice versa.

The free cash flow to equity [FCFE] only takes payments (cash flows) to equity

holders into account. Therefore, interest is deducted from the EBIT as interest

payments are made before shareholders are served. Furthermore, increases in

net borrowings are added back, since this represents additional cash

shareholders can use to pay as dividends or invest in projects. It is simply new

debt that is taken on by the company which can be used for any purpose (if you

take out a loan you can decide what to do with the money so it represents an

increase in the amount you can spend).

4.2 The Weighted Average Cost of Capital (WACC) Method

The WACC method determines the firm value to all stakeholders (equity and debt

holders) of a company. The appropriate cash flows to use are the Free Cash Flow

to the Firm (FCF or FCFF) and the discount rate applicable is the WACC.

Procedure:

Step 1 - Compute the free cash flow (FCF) of the company/investment

Step 2 - Compute the weighted average cost of capital, 𝑟𝑊𝐴𝐶𝐶:

• 𝑟𝑊𝐴𝐶𝐶 = 𝑬𝑬+𝑫

𝒓𝑬 + 𝑫𝑬+𝑫

𝒓𝑫 ∗ (𝟏 − 𝒕𝒄) with 𝑟𝐸 = 𝑟𝑓 + 𝛽(𝑅𝑚𝑘𝑡 − 𝑟𝑓)

𝐸 = 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

2 When machinery is bought this is recorded as "Capital Expenditure" on the balance sheet. Depreciation only serves as the function to spread the cost of such an investment over its useful life. That is, when the machinery is bought, cash actually goes out of the company´s pocket, but the depreciation deductions happen only on paper!


51

5.5 Option Pricing

5.5.1 Binomial Pricing Model

The price of an option depends on the fact if the stock will go up or down in the

next period. From the stock price movements the price of an option can be

calculated. The figure below depicts the basic steps for call and put options. Cu

(Pu) and Cd (Pd) stand for the value of a call (put) option if the price goes up or

down, respectively.

Option Price (for call and for put options):

• ∆= 𝐶𝑢−𝐶𝑑𝑠𝑢−𝑆𝑑

• 𝐵 = 𝐶𝑑−𝑆𝑑∆1+𝑟𝑓

• 𝑂𝑝𝑡𝑖𝑜𝑛 𝑝𝑟𝑖𝑐𝑒 (𝐶 𝑜𝑟 𝑃) = 𝑆∆ + 𝐵

Example: Binomial Option Pricing Model You own a European call option with strike price (K) of €32! The current stock price of the

underlying is €30. During the next period, the stock price can either go up or down by €5.

The risk free interest rate (rf ) is 5%. What is the value of the option today?

• ∆= 𝐶𝑢−𝐶𝑑𝑠𝑢−𝑆𝑑

= 3−035−25

= 0.3

• 𝐵 = 𝐶𝑑−𝑆𝑑∆

1+𝑟𝑓= 0−25∗0.3

1.05 = −7,143

• 𝐶 = 𝑆∆ + 𝐵 = 30 ∗ 0.3 − 7.143 = €1.86

This example is a simplification. Usually there are more than two possible and more than

one period.

CU max(S-K,0)

CD max(S-K,0)

SSU

SD

PU max(K-S,0)

PD max(K-S,0)

Call Option Put Option

SSU

SD

CU max(35-32, 0) = 3

CD max(25-32, 0)= -7 = 0

30

35

25


52

5.5.2 Black-Scholes Model

The Black-Scholes Model is an alternative model that can be used to price options

on non-dividend paying stocks. It is derived from the Binomial option pricing

model and requires five input variables:

(1) 𝑆 = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒

(2) 𝑇 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠

(3) 𝐾 = 𝑒𝑥𝑒𝑟𝑐𝑖𝑠𝑒 𝑝𝑟𝑖𝑐𝑒

(4) 𝑟𝑓 = 𝑡ℎ𝑒 𝑟𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑟𝑎𝑡𝑒 �𝑡𝑜 𝑐𝑜𝑚𝑝𝑢𝑡𝑒 𝑃𝑉(𝐾)�

(5) 𝜎 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑣𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦

The price of a call options is computed as follows:

• 𝐶 = 𝑆 ∗ 𝑁(𝑑1) − 𝑃𝑉(𝐾) ∗ 𝑁(𝑑2) 3| ∆ = 𝑁(𝑑1);

𝐵 = −𝑃𝑉(𝐾) ∗ 𝑁(𝑑2)

𝑑1 = ln[𝑆/𝑃𝑉(𝐾) ]𝜎∗√𝑇

+ 𝜎∗√𝑇2

𝑑2 = 𝑑1 − 𝜎 ∗ √𝑇

The Price of a put option is computed as follows:

• 𝑃 = 𝑃𝑉(𝐾) ∗ [1 − 𝑁(𝑑2)] − 𝑆 ∗ [1 − 𝑁(𝑑1)] 4| ∆ = −[1 −

𝑁(𝑑1)];

𝐵 = 𝑃𝑉(𝐾) ∗ [1 − 𝑁(𝑑2)]

The advantage of the Black-Scholes Option Pricing Model is that the only variable

input is the volatility. All other variables are known. Therefore, it is easy to

implement and much quicker than the procedure of the Binomial Option Pricing

Model.

3 From the Binomial Option Pricing Model it is known that 𝐶 = 𝑆 ∗ ∆ + 𝐵 4 From the Binomial Option Pricing Model it is known that 𝑃 = 𝑆 ∗ ∆ + 𝐵

Uniseminar – Finance & Accounting Theory -‐ Accounting

65

22..55 RReellaattiioonnsshhiipp bbeettwweeeenn FFiinnaanncciiaall SSttaatteemmeennttss

It is of great importance that you understand the processes between the financial

statements. Understanding this will give you a general understanding of the

accounting procedures and make other things way easier:

IInnccoommee SSttaatteemmeenntt BBaallaannccee SShheeeett Asset 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 100,000 Current assets − 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 25,000 Cash & Cash equivalents 40,000 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 75,000 Accounts Receivable 5,000 − 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆,𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 & 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅, 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆

30,000 Inventories 10,000 Total current assets 55,000

𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 45,000 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 5,000 Non-‐current Assets − 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 0 Property, Plant, Equip. 20,000 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 40,000 -‐ Acc. Depreciation 5,000 − 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 5,000 Total Non-‐current Assets 15,000 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 35,000 − 𝑇𝑇𝑇𝑇𝑇𝑇 15,000 TToottaall AAsssseettss 7700,,000000 𝑵𝑵𝑵𝑵𝑵𝑵 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰 20,000 Liabilities SSttaatteemmeenntt ooff CChhaannggeess iinn EEqquuiittyy Current Liabilities

Accounts payable 8,000 𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩 𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆 2,500 Short term borrowing 2,000 + 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 20,000 Total current Liabilities 10,000 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 -‐5,500 𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞 17,000 Non-‐current Liabilities Long-‐term Debt (rD=10%) 50,000 Other L-‐T Liabilities 3,000 CCaasshh FFllooww SSttaatteemmeenntt Total Non-‐current

Liabilities 53,000

𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴. 10,000 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴. 5,000 Shareholders' Equity 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴. 0 Share capital 1,000 𝐍𝐍𝐍𝐍𝐍𝐍 𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐅𝐅𝐅𝐅𝐅𝐅𝐅𝐅 15,000 Retained Earnings 16,000 Cash balance beginning year 25000 Total Sh. Equity 17,000 Cash balance end of the year 40000 TToottaall LLiiaabbiilliittiieess aanndd SShhaarreehhoollddeerrss'' EEqquuiittyy 7700,,000000

55

55

33

33

11

11

66

66

44

22

22

44


77

EExxaammppllee:: AAggiinngg ooff RReecceeiivvaabblleess MMeetthhoodd

You were asked by your manager to set up an allowance account for your company. The Table below depicts the outstanding accounts receivables of your customers.

Customer 1 – 30 Days 31 – 60 Days Over 60 Days

X € 2,000 € 1,000

Y € 500

Z €300

Estimated % of

default

1%

2%

3%

Furthermore, your current allowance account shows the following entries:

AAlllloowwaannccee ffoorr UUnnccooll lleeccttiibbllee ((CCoonnttrraa EExxppeennssee AAccccoouunntt))

Debit Credit OOppeenniinngg

BBaallaannccee

5500

In period P2 one of your customers, Mr. Z defaults.

How do the respective journal entries look like? What are the most important steps you have to consider?

SStteepp 11:: Check the current Allowance Account for its opening balance

AAll lloowwaannccee ffoorr UUnnccooll lleeccttiibbllee ((CCoonnttrraa EExxppeennssee AAccccoouunntt))

Debit Credit OOppeenniinngg

BBaallaannccee

5500


85

77..22 FFIIFFOO aanndd LLIIFFOO iinn PPrraaccttiiccee

What is the impact of iinnccrreeaassiinngg or decreasing unit ccoossttss for the FIFO and LIFO

respectively? As the figure below illustrates, increasing costs (prices) result in

lloowweerr CCOOGGSS uunnddeerr FFIIFFOO and hhiigghheerr CCOOGGSS uunnddeerr LLIIFFOO. Thus, with

increasing prices the FIFO method will provide a higher profit figure (due to

lower COGS), while the LIFO method would result in higher COGS → lower profit

→ lower tax payments! For this reason LIFO is not allowed under IFRS (since

prices generally increase over time → inflation!).

With decreasing costs the FIFO method yields higher COGS and the LIFO yields

lower COGS. Thus, the FIFO (LIFO) yields higher (lower) COGS.

EExxhhiibbiitt 77..22..11:: FiFo and LiFo cost structures for increasing/decreasing prices

LLIIFFOO LLiiqquuiiddaattiioonn -‐ occurs when inventory levels fall below the levels of the

previous year. If the quantities fall below the level of the previous year the

company has to use (even) older inventory prices to compute COGS. Assuming

that due to inflation, prices usually increase, older and consequently lower costs

are shifted into the COGS calculation, which results in higher net income and

higher tax payments. As a result, managers try to avoid LIFO liquidation.

Time

Cost €

FIFO

Time

Cost €

Time

Cost €

Time

Cost €

A) Increasing Cost

B) Decreasing Cost

LIFO

Practice

Exams

Extras

Sem

inar

P

Practice Exercises


Uniseminar – Finance & Accounting Practice

PPrraaccttiiccee EExxeerrcciisseess

This part contains practice exercises to each week and therefore to each chapter

of the theory script. By this, you can deepen your theoretical knowledge with

practical exercises and you can go through the exercises of these topics again,

which you have not understood so well until now. Although you may think that

you already have done enough exercises during the weeks, these exercises are

tailored specifically to your needs and try to teach you the most important topics

of the exam in a practical manner.


FFiinnaannccee 11

Exercises 1

Solutions 16

AAccccoouunnttiinngg 4433

Exercises 43

Solutions 56

Uniseminar – Finance & Accounting Practice -‐ Finance

1

FFiinnaannccee -‐-‐ EExxeerrcciisseess

11 CCaappiittaall MMaarrkkeettss –– RRiisskk && RReettuurrnn

This topic deals with the basic principle of capital markets: the risk-‐return

relationship of securities. The two most important aspects are the CAPM model

and the Security Market Line (SML).

EExxeerrcciissee 11..11

The table below shows the quarterly stock prices of Apple, Inc. (AAPL) and

Microsoft, Inc. (MSFT) during June and July 2011 (Weekly data, closing prices).

Based on these data, calculate

DDaattee AAAAPPLL SS&&PP 550000

24. Jun. 11 317 1272 01. Jul. 11 328 1268 08. Jul. 11 343 1340 15. Jul. 11 356 1343

aa)) the mean weekly return for the two stocks and the market (round to three

digits)

bb)) the variance for the two stocks and the market (round to six digits)

cc)) the standard deviation for the two stocks and the market (round to four

digits)

Furthermore, calculate AAPL´s

dd)) correlation assuming that the covariance of AAPL with the market is

0.000184 and (round to three digits)

ee)) beta

ff)) sharpe ratio (assume a risk free rate of 2.5%)

Practice -‐ Finance Uniseminar – Finance & Accounting

2


aa)) Explain the difference between the Security Market Line (SML) and the

Capital Market Line (CML). In this regard, elaborate on the different axes

labels.

bb)) Explain where the market portfolio is positioned on each line.

cc)) Regarding the CAPM model

ii .. What is the efficient frontier?

iiii .. Explain the difference between Total risk, systematic risk, and

unsystematic risk. How can you measure each risk type?

iiiiii .. What is the CAPM equation? In this regard, explain what kind of return

relationship is represented by this equation? What is meant by market risk

premium? How does it differ from an individual's risk premium?

dd)) Regarding the SML

ii .. What does "alpha" mean and when is a security over-‐ or undervalued?

Explain the phenomenon of mispricing from a risk-‐return perspective.

ii ii .. What does a securities beta imply?


Assume that in 2007 the rate of return on short-‐term government securities

(perceived to be risk-‐free) was about 4.5%. Suppose the expected rate of return

required by the market for a portfolio with a beta of 1 is 11%. According to the

CAPM:

aa)) What is the expected rate of return on the market portfolio? What is the

market risk premium?

bb)) What is the risk premium for a security with a beta of 0.8 and 1.2?

cc)) The rate of return on Skodia's was 16% in the first quarter of 2007 and

currently Skodia has a beta of 1.5. According to the CAPM, is the stock over-‐

or undervalued? Is the alpha positive or negative? Does it lie above or


9

44 CCaappiittaall bbuuddggeettiinngg aanndd vvaalluuaattiioonn


In table a) below you find the modified financial statements of Apple Inc. for the

last three years. Furthermore, some balance sheet items have also been reported

in table b) below. For the following exercise, assume a corporate tax rate of 35%

and a cost of debt of 10%.

IInnccoommee SSttaatteemmeenntt AAppppllee IInncc.. ((iinn ´́000000)) 2010 2009 2008

Sales − 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶

65,000 32,000

43,000 25,500

32,000 21,000

𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 −𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 & 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 −𝑅𝑅&𝐷𝐷 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸

33,000 2,000 5,500

17,500 4,000 1,500

11,000 3,000 1,000

𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 & 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴

25,500 3,500

12,000 1,000

7,000 0

𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 2222,,000000 1111,,000000 77,,000000

TTaabbllee aa))

BBaallaannccee SShheeeett IItteemmss

2010 2009 2008 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 20,000 10,000 0 Change in NWC +2,000 −500 +1500 Capital Expenditures 7,000 3,000 3,500

TTaabbllee bb))

aa)) Calculate the Free Cash Flow to the Firm in 2010

bb)) Calculate the Free Cash Flow to Equity in 2009 and the increase in net

borrowing for 2010


22

22 CCaappiittaall SSttrruuccttuurree,, MMooddiigglliiaannii aanndd MMiill lleerr

SSoolluuttiioonn ttoo EExxeerrcciissee 22..11

aa)) Modigliani and Miller Proposition I: In perfect capital markets, the total

value of a firm iiss equal to the market value of the total cash flows generated by its

assets and iiss nnoott affected by its choice of capital structure.

bb)) In perfect capital markets, homemade leverage iiss not a good example that

a firm's choice of capital structure does not affect its overall value.

cc)) (iii) A firm´s financing decision ccaannnnoott alter the cash flows generated by

its investments. Investors can alter their portfolio individually and thus replicate

any capital structure choice themselves.

dd)) SSoommeettiimmeess. It is only called leveraged recapitalization if the issuance of

new leverage is used to repurchase shares. It can also be financed, by using excess

cash of a company's cash reserves..

ee)) In perfect capital markets, an increase in a firms leverage (everything else

constant) iinnccrreeaasseess its cost of levered equity.. Leverage increases the riskiness

of a firm's cash flow to its equity holders as they only have a residual claim on a

firm`s assets (due to the seniority of debt).

ff)) In perfect capital markets, the cost of equity eeqquuaallss the cost of unlevered

equity only when the firm does not has any leverage. Because the unlevered cost

of capital is the cost of capital of a hypothetical all equity (completely unlevered)

firm, the unlevered cost of capital has to be the same as the cost of equity of a

completely unlevered firm.


23

gg)) FFiirree ssaallee ooff aasssseettss is an indirect cost of bankruptcy.

hh)) When a firm faces financial distress it mmaayy file for chapter 7 or 11 of the

U.S. bankruptcy code. Chapter 7 ll iiqquuiiddaattiioonn involves appointing a ttrruusstteeee to

oversee the ll iiqquuiiddaattiioonn of a firm's assets. Chapter 11 rreeoorrggaanniizzaattiioonn allows

for rreessttrruuccttuurriinngg of firm´s assets and eennaabblleess a firm to keep its operations

running.

ii)) Due to the high costs associated with financial distress, firm´s facing

financial distress ccaann directly negotiate with their creditors and thus avoid the

high costs of filing for bankruptcy; this is called a workout.

jj)) Another approach that minimizes the ddiirreecctt costs associated with

bankruptcy is called prepackaged bankruptcy. In this process a firm facing

bankruptcy, first develops a reorganization plan to which all creditors agree and

then files for CChhaapptteerr 1111 of the U.S. Bankruptcy Act.

kk)) FFaallssee.. It is the present value of agency-‐ and distress costs that is

subtracted, not just the costs themselves!


aa)) You were given a debt-‐to-‐equity ratio of 40%. First, let´s clarify the

different nomenclatures of different capital ratios:

= Debt-‐to-‐equity ratio

= = Debt-‐to-‐value ratio

= = Equity-‐to-‐value ratio


34


a) In order to perform a WACC analysis, the following steps must be

completed:

Step 1: Calculate the Free Cash Flow to the Firm

Step 2: Calculate the debt-‐to-‐value ratio (or alternatively the debt-‐to equity ratio)

Step 3: Calculate the cost of equity using the CAPM model.

Step 4: Calculate the 𝑟𝑟

Step 5: Discount the FCF at the 𝑟𝑟

The procedure is illustrated below.

Step 1: FCF

WWeeiigghhtteedd AAvveerraaggee MMeetthhoodd 2012 2013 2014 2015 2016 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 10 15 15 25 30 − 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑡𝑡𝑡𝑡𝑡𝑡 (30%) + 3 4.5 4.5 7.5 9 𝐸𝐸𝐸𝐸𝐸𝐸 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 ∗ 1− 𝜏𝜏 − 7 10.5 10.5 17.5 21 + 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 0 10 10 10 5 −𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 35 0 0 0 0 − 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑁𝑁𝑁𝑁𝑁𝑁 0 0 0 0 0 FCF (42) 20.5 20.5 27.5 26

Step 2: Debt-‐to-‐value ratio

Next, the cash flows need to be discounted at the WACC in order to determine the

NPV of the project. For that purpose the debt-‐to-‐value ratio needs to be

estimated. From the introduction it is known that the company has 500 million in

equity and 330 million in debt plus an additional 30 million in cash and cash

equivalents. Its nneett ddeebbtt can therefore be calculated as:

330 − 30 = 𝟑𝟑𝟑𝟑𝟑𝟑 𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎.

As a result the ddeebbtt-‐-‐ttoo-‐-‐vvaalluuee rraattiioo is equal to = 0.375.

Uniseminar – Finance & Accounting Practice -‐ Accounting

45

22 FFiinnaanncciiaall SSttaatteemmeennttss

EExxeerrcciissee 22

Complete the financial statements below. Hint: Start with the Income Statement

(hint: you will need some Balance Sheet items to complete this statement).

IInnccoommee SSttaatteemmeenntt BBaallaannccee SShheeeett 22001122 22001111 Assets Revenue 100,000 Current assets − 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 25,000 Cash & Cash equivalents 25,000 Gross profit 75,000 Accounts Receivable 5,000 12,000 − 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆,𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 & 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺

30,000 Inventories 8,000 Total current assets 55,000 45,000

EBITDA − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 Non-‐current Assets − 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 0 Property, Plant, Equip. 30,000 EBIT -‐ Acc. Depreciation 10,000 − 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒

Total Non-‐current Assets 15,000

Pretax Income − 𝑇𝑇𝑇𝑇𝑇𝑇 15,000 TToottaall AAsssseettss 𝐍𝐍𝐍𝐍𝐍𝐍 𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈 Liabilities SSttaatteemmeenntt ooff CChhaannggeess iinn EEqquuiittyy

Current Liabilities Accounts payable 8,000 5,000

𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩 𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆 2,500 Short-‐Term borrowing 2,000 1,000 + 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 Total current Liabilities 10,000 6,000 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 -‐5,500 𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞 Long-‐Term Liabilities Long-‐term Debt

(rD=10%) 50,000 55,000

Other L-‐T Liabilities 3,000 1,500 CCaasshh FFllooww SSttaatteemmeenntt Total Non-‐current

Liabilities 53,000 56,500

𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝐴𝐴𝐴𝐴𝐴𝐴 10,000 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 5,000 Shareholders' Equity 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐴𝐴𝐴𝐴𝐴𝐴 0 Share capital 1,000 1,000 𝐍𝐍𝐍𝐍𝐍𝐍 𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐅𝐅𝐅𝐅𝐅𝐅𝐅𝐅 Retained Earnings 1,500 Cash beginning year 25000 Total Sh. Equity 2,500 Cash end year TToottaall LLiiaabbiilliittiieess aanndd SShhaarreehhoollddeerrss'' EEqquuiittyy 7700,,000000 6655,,000000

Extras

Sem

inar

E Exams

Extras

Sem

inar

Exams


Exams Uniseminar – Finance & Accounting

EExxaammss

You should start early with the calculation of exams, because you need to get a

general feeling of how the exams are built up. You will soon discover how the

exams are constructed and that there are general tendencies, which repeat from

exam to exam. In this part you will find old exams of the Maastricht University, as

well as two practice exams constructed by Uniseminar. During the seminar you

will then receive a third practice exam.


PPrraaccttiiccee EExxaamm 11 ((iinnccll .. ssoolluuttiioonnss)) 11

PPrraaccttiiccee EExxaamm 22 ((iinnccll .. ssoolluuttiioonnss)) 2255

OOlldd EExxaammss 3399

09/10 Resit

08/09 First Sit

Trial Exam

Uniseminar – Finance & Accounting Practice Exam 1

1

PPrraaccttiiccee EExxaamm 11

FFiinnaannccee

1. Bondholders are always served before shareholders are served. Therefore,

shareholders are said to have a residual claim on the assets of a company.

2. For a levered company (<100% debt financing), the cost-‐of-‐debt is always

smaller than the weighted average cost of capital and the cost-‐of-‐equity is

always larger than the weighted average cost of capital.

[Question 3 & 4]

Assume that the risk free rate in 2011 is 5% and the return on SchnitzelStock´s

share is 15.5%. Furthermore, the variance of the stock during 2011 has been

calculated as 0.2345. The covariance with the market is 0.00323 and the markets

standard deviation during 2011 was 11.55%.

3. The Sharpe Ratio of SchnitzelStock is larger than 1.75.

4. The correlation of SchnitzelStock with the market is smaller than 0.5.

5. In the world of Modigliani and Miller absent taxes, dividends do determine

share prices but a firm´s choice of dividend policy does not.

6. Assume that WirelessCab Inc. has a cost-‐of-‐equity of 12%, a cost-‐of-‐debt of

5%, and a debt-‐to-‐value ratio of 30%. Given that it is subject to a 35%

corporate tax rate, its unlevered cost of equity must be smaller than 11%.

Practice Exam 1 Uniseminar – Finance & Accounting

2

7. Tradeoff theory predicts that the value of a levered firm can be expressed as

the sum of its unlevered value, the value of the interest tax shield less any

cost of financial distress.

[Questions 8 & 9]

Assume that the company McBurger has a beta of 1.2 and the risk premium of the

market is 4% and the risk free interest rate is 3%. Furthermore, it currently has a

debt-‐to-‐equity ratio of 40%. McBurger´s cost-‐of-‐debt of 6% and a corporate tax

rate of 35%.

8. Given the information above, McBurger´s cost of equity is equal to 7.8%.

9. Given the information above McBurger´s weighted average cost of capital is

larger than 7.00%.

10. Given that a firm faces financial distress, it may not choose to invest in

positive NPV projects because most of the benefits will go to debt holders.

This problem is referred to as the underinvestment problem.

11. Assume that in 2011 the company WatchTube Inc. faced a corporate tax rate

of 38%, and tax on interest income and capital gains tax were 20% and

22%, respectively. As a result, the effective tax advantage of debt is equal to

39.55%

12. By minimizing the WACC one can determine the optimal capital structure

for a company.

Uniseminar – Finance & Accounting Practice Exam 1

3

13. In a world of Modigliani and Miller with corporate tax a firm’s WACC

decreases as the debt-‐to-‐value ratio increases.

14. All investors who hold shares on the ex-‐dividend date are entitled to receive

the dividend payment that was declared in the preceding declaration date.

15. In an open market repurchase a firm exactly states how many shares it

intends to buy back. As soon as the number is announced the firm has to

purchase back the declared number of stocks, since otherwise non-‐

tendering shareholders would be harmed.

16. Management entrenchment theory states that managers' tend to take on

excessive leverage to fund operations that benefit themselves but not the

company.

17. In a world of Modigliani and Miller without taxes, a firm that lowers its

dividend for one period does not risk that its share price will drop.

18. The free cash flow hypothesis predicts that if managers have excess cash on

hand they tend to waste it for their own benefit. As a result, dividend

payments for instance, are highly valued by shareholders as it reduces

excess cash management can waste.

19. The free cash flow to equity can be calculated by taking the free cash flow to

the firm and subtracting after tax interest expense and adding net

borrowing.

Extras

Sem

inar

E

Extras


Extras Uniseminar – Finance & Accounting

EExxttrraass

In general, the Extras part will supply you with several extras that will be very

helpful for your exam preparation. In the script of this course, you will find a

formula sheet as well as a glossary. You should try to learn as many as possible

definitions of the glossary, because it is easy to gain many points with this. Note:

The formula sheet we included here does not contain all formulas, which you will

need for the exam, as some formulas only make sense in the context of a

procedure and therefore are only included in the Theory part.


FFoorrmmuullaass 11

Finance 1

Accounting 5

GGlloossssaarryy 77

Uniseminar – Finance & Accounting Formula Sheet

1

FFoorrmmuullaa SShheeeett

FFiinnaannccee

11 CCaappiittaall MMaarrkkeettss –– RRiisskk && RReettuurrnn

FFoorr SSttoocckkss

VVaarriiaannccee::

𝑉𝑉𝑉𝑉𝑉𝑉 𝑅𝑅 = 𝑝𝑝 ∗ 𝑅𝑅 − 𝐸𝐸 𝑅𝑅

SSttaannddaarrdd DDeevviiaattiioonn (Volatility):

𝑆𝑆𝑆𝑆 𝑅𝑅 = 𝑉𝑉𝑉𝑉𝑉𝑉 𝑅𝑅

FFoorr PPoorrttffoolliiooss::

CCoovvaarriiaannccee::

𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅 = (𝑅𝑅 . − 𝑅𝑅 ) ∗ (𝑅𝑅 , − 𝑅𝑅 )

(T = number of return observations, R = return, 𝑅𝑅= expected return)

CCoorrrreellaattiioonn::

𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅 = ,

∗ → 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅 ∗ 𝑆𝑆𝑆𝑆 𝑅𝑅 ∗ 𝑆𝑆𝑆𝑆 𝑅𝑅 =

𝐶𝐶𝑜𝑜𝑜𝑜 𝑅𝑅 ,𝑅𝑅

VVaarriiaannccee::

𝑉𝑉𝑉𝑉𝑉𝑉 𝑅𝑅 = ∑𝑥𝑥 ∗ 𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅

(𝑥𝑥 = weight, amount of j held in the portfolio)

Uniseminar – Finance & Accounting Glossary

7

GGlloossssaarryy

AAccccoouunntt ppaayyaabbllee – A liability backed by the general reputation and credit

standing of the debtor

aabbaannddoonnmmeenntt ooppttiioonn – An option for an investor to cease making investments

in a project. Abandonment options can add value to a project because a firm can

drop a project if it turns out to be unsuccessful.

aabbssoolluuttee rreettuurrnn – see cash multiple

aacccceelleerraatteedd ddeepprreecciiaattiioonn mmeetthhoodd – A depreciation method that writes off a

relatively larger amount of the asset's cost nearer the start of its useful life than

the straight-‐line method does.

aaccccoouunntt – The record of the changes that have occurred in a particular asset,

liability or stockholders' equity during a period. The basic summary device of

accounting.

aaccccoouunntt ffoorrmmaatt – A balance-‐sheet format that lists assets on the left and

liabilities and stockholders' equity on the right.

aaccccoouunnttiinngg – The information system that measures business activities,

processes that information into reports and financial statements and

communicates the results to decision makers

aaccccoouunnttiinngg eeqquuaattiioonn – The most basic tool of accounting: Assets = Liabilities

+ Owners' Equity

Glossary Uniseminar – Finance & Accounting

8

aaccccoouunnttss rreecceeiivvaabbllee ttuurrnnoovveerr – Measures a company's ability to collect cash

from credit customers. To compute accounts receivable turnover, divide net

credit sales by average net accounts receivable.

aaccccoouunnttss rreecceeiivvaabbllee ttuurrnnoovveerr – Net sales divided by average net accounts

receivable.

aaccccrruuaall – An expense or revenue that occurs before the business pays or

receives cash. An accrual is the opposite of a deferral.

aaccccrruuaall aaccccoouunnttiinngg -‐ Accounting that records the impact of a business event as

it occurs, regardless of whether the transaction affected cash.

aaccccrruueedd eexxppeennssee – An expense incurred but not yet paid in cash.

aaccccrruueedd eexxppeennssee – An expense incurred but not yet paid in cash. Also called

accrued liability.

aaccccrruueedd ll iiaabbiill iittyy – A liability for an expense that has not yet been paid by the

company.

aaccccrruueedd ll iiaabbiill iittyy – An liability for an expense that has not yet been paid. Also

called accrued expense.

aaccccrruueedd rreevveennuuee – A revenue that has been earned but not yet received in cash.

aaccccuummuullaatteedd ddeepprreecciiaattiioonn – The cumulative sum of all depreciation expense

from the date of acquiring a plant asset.

Sem

inar

S

Seminar


Seminar Uniseminar – Finance & Accounting

SSeemmiinnaarr

In the following we have provided you with some notepaper so that you can take

notes during the seminar. Furthermore you will receive a third practice exam

during the seminar, which you can file in here. In case you have not subscribed

for the Finance & Accounting seminar yet, you can do so on our website -‐

www.uniseminar.nl -‐ at any time.

Uniseminar – Quantitative Methods I Notes

uniseminar f&a summary script sample

Documents