MGT 300_Review Test 2
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Date Created: 02/08/15
FI 302012 Exam 3 Study Guide Friday April 10 2015 900 AM CHAPTER 10 List 3 methods to reduce information differences 1 2 3 Covenants contractual agreements for performance Collateral posting bail pledging an asset to the lender Credit rating agencies collect data that identifies better borrowers more reactive than proactive List examples of transaction costs Brokerage Commissions Insurance Inspections Recording and documentation Lending fees Indirect costs opportunity costs forgone rents etc List 3 examples of direct trading costs for stocks 1 2 3 Brokerage commissions round trip cost is very low Bid Ask spread market makers take a small cut Market impact costs large trades will move price against you Define or describe the following terms 1 2 3 4 gt19 Covenants contractual agreements for performance Collateral posting bail pledging an asset to the lender Credit rating agencies collect data that identifies better borrowers more reactive than proactive Liquidity premium A seller offers a liquidity premium through lower prices to induce buyers to hold illiquid assets that are dif cult to sell The friction of illiquidity premiums impedes trading Ontherun Treasury bonds high liquidity Difference in yield is 3 basis points for nearly identical bonds Offthe run Treasury bonds Flight to quality or a run on liquidity 1043 On September 28 2007 taxexempt AAA rated 10year muni bonds traded at a yield of 399 Corporate 10year AAA bonds traded at 570 What was the marginal investor s tax rate Muni 399 raftertax Corporate 570 rbeforetax T Rbefore tax 1after tax 570 1t 399 1t 399570 T 1 399570 30 1042 If your tax rate is 40 what interest rate do you earn in aftertax terms if the pre tax interest rate is 6 Rbefore tax 1after tax 61 4 36 Assume a 100 investment that has a real return of 20 and in ation is 50 Assume taxes are 40 Find the real values with 50 inflation and without in ation 100 1 rnominal 100 12015 180 6 Nominal Return 180 100 80 804 32 6 after tax 180 32 148 6 nominal MUST CONVERT TO REAL VALUE P0 real value C1 1 in ation rate Real with in ation 1481 5 9867 Nominal without in ation 14810 148 CHAPTER 12 List and explain 4 commonly used rates in finance 1 4 IRR or Internal Rate of Return Mathematically determined without a marketbased risk measure Cost of Capital Opportunity cost of capital determined in markets for a given risk level Expected Rate of Return Actual expected return gt minimum required expected return Results in a positive NPV Hurdle Rate Expected rate of return required to accept a project List and explain embedded real options PWN Expansion or contraction Firms can vary project or firm size with economy Acceleration or delay Firms can speed up or slow projects with economy Switching Firms can choose new technology depending on conditions Spinoffs Firms can enter new businesses due to innovation Explain and give examples of the behavioral biases overconfidence relativism compartmentalization 1 Overconfidence We believe that estimates are more accurate than actuality Example Investors fail to consider outside opinion on a bad stock 2 Relativism We consider relative percentage differences when we shouldn t Example Driving around to save 2 cents on a fillup but not driving extra miles to save 100 on a car purchase 3 Compartmentalization We categorize decisions and may not see larger picture Example Unexpected loss prevents investment in a good project List examples of agency biases P P PP P 7 Competition for capital Managers may overstate to gain funding Employment concerns Managers may act to preserve jobs first Perks Managers like perks and may work to increase them Power Managers may protect turf of their departments rather than firm value Hidden slack Managers may hide cash from other divisions Reluctance to take risk Managers may avoid risk even if risky projects have positive NPVs Direct theft Employees may steal company cash or assets List methods to reduce agency problems 1 2 Audits provide better information to owners and upper management Incentives for telling the truth and postaudits of results encourage accurate forecasts 3 Contingent compensation on eXpost evaluation reduces agency con icts 4 Reputation when important to longterm success of manager minimizes chance of bad prospect selection 5 Capital rationing limits manager access to capital to prevent waste 6 Manager selection by good hiring may lower agency costs w better Example 4 NPVwithout C0 C11r 3 592 51211 273 NPVwith 3 592 011 1818 Example 1 ABC buys DEF in a merger to diversify ABC is worth 900M with a beta of 2 and its risk equals 20 DEF is worth 100M with a beta of 1 and has a risk of 20 too A riskfree rate 3 Equity Premium 5 Find cost of capital of the conglomerate CAPM R Rf Brm rf ABC DEF 900 100 1000 RABCDEF 03 BABCDEF05 BABcDEF 2 X 9001000 11001000 2 X 9 1 X 1 19 Example 2 Find the cost of capital and NPV Example 2 Acquisition Example Old rm Beta 050 rt 3 Equity Premium 4 New project Beta 300 Cost 10 Payoff in lyr 11 BOLD 5 BNEW 300 Rf 3 Cost 10 Ep 04 Payoff in 1 year 11 1 CAPM R If R 03 304 15 2 NPV C0 C11r 10 11115 4348 CHAPTER 14 De ne the law of one price 0 Companies with the same attributes should have the same value in a perfect market Why PE PriceEarnings ratios differ 0 Growth rates are different Higher growth usually accompanies higher PE Find PE ratios if growth is 5 and 10 Consider a firm with 15 cost of capital and 100 cash earnings next year Answer 10 and 20 gt1ltUse growth model PV Gf39g g 5 g10 r15 E1C1 PV 1001505 1000 9 PE 1000100 10 PV 1001510 2000 9 PE 2000100 20 Find PVGO values and growth when cost of capital 10 Firm A Firm B Firm C 15 Expected EPS 12 Expected EPS 20 Expected EPS 150 Market Value 150 Market Value 150 Market Value First find NGV g 0 C1rg 1510 150 1210 120 2010 200 Then find PVGO MVNGV 150120 0 150120 30 150200 50 Problem 1435 A firm has earnings of 200 and a priceeamings ratio of 20 What is the implied growth rate if its cost of capital is about 10 E 200 PE 20 9 20E 20200 4000 R 10 PV C1rg 9 4000 2001g 40001g 200 4004000g 200 4000g 400 200 200 g 2004000 05 g5 Problem 1438 A firm with a PE ratio of 10 wants to take over a firm half its size with a PE ratio of 25 What will be the PE ratio of the merged firm Acquiring Firm A Target Firm B E E Company A 10 100 Company B 25 50 APE109P10E 100 10E 9 EA 10010 10 BPE259P25E 5025E9 EB50252 EAB PEAB PABEAB 100 5012 125 Find PE ratios if growth is 5 and 10 Consider a firm with 15 cost of capital and 100 cash earnings next year g 5 g 10 r15 PV C1rg 1001505 1000 PE ratio 1000100 10 PV C1rg 100151 2000 PE ratio 2000100 20
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