FIN 316 midterm 1 study guide
FIN 316 midterm 1 study guide FIN 316
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This 4 page Study Guide was uploaded by Theo Friedman on Friday April 24, 2015. The Study Guide belongs to FIN 316 at University of Oregon taught by Albert Sheen in Spring 2015. Since its upload, it has received 654 views. For similar materials see Financial Management in Finance at University of Oregon.
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Date Created: 04/24/15
FIN 316 study guide Midterm 1 Time Value of Money TVM Present Value PV the value of a cost or benefit also called a cash flow in today s money Future Value FV the value of a cash flow at a specified time in the future FV1 the value of a cash flow in 1periodfromnow dollars FVz the value of a cash flow in 2periodfromnow dollars Interest rate r quotexchange rate between earlier mone and later mone also known as quotdiscount II I rate cost of capital or quotrequired return Compounding interest earns interest A perpetuity is a stream of equal cash flows made each period until the end of time FV PV1i 1 An annuity is a stream of equal cash flows made for a fixed number of periods PV Z Wu 1 i Converting rates to different time periods A of shorter in the longer 1 r longer period r shorter eriod Annual Percentage Rate APR How much interest earned in a year without compounding Not usually the actual interest rate paid But rates are often quoted this way Effective Annual Rate EAR also called Annual Percentage Yield APY How much actual interest is earned in a year This is the annual r we ve been using Nominal Interest Rate r growth in actual Inflation Rate i growth in prices ReaI Interest Rate r growth in purchasing power of your cash Bond vocab Par ValueFace value Principal amount to be paid at maturity The big final payment Maturity Date Final repayment date of the bond Bond Price How much you need to pay to get the bond today Coupon Rate Percentage of par value that is paid every year Coupon Amount Coupon rate X Par Value of coupon payments per year Coupon Amount Coupon Rate Face Value of times coupon is paid in 1 year Bond Pricing Zero coupon bonds Sometimes bonds come Without coupons There is only one cash ow the repayment of parface value at maturity These are even easier to price Zero coupon bonds are also called discount bonds because they must sell at a discount to par value Yield to Maturity YTM or iust yield The discount rate that sets the present value of the bond payments equal to the current price of the bond In other words finding this is like solving for our trusty r It s always quoted like an APR annual terms with no compounding lf YTM coupon rate then the bond s price will be the same as its parface value If YTM gt coupon rate then bond price lt par value If YTM lt coupon rate then bond price gt par value price for the bond 1 YTM ln Face Value Price Yield to Maturity of a ZeroCoupon Bond We can graph the implied discount rates of zerocoupon bonds as a function of their time to maturity This is called the yield curve sometimes called term structure Rising yield curve Could mean investors think interest rates Will rise in the future Also could mean it s just riskier to invest longer so you get more return for buying longer term bonds Declining inverted yield curve very rare Means interest rates are expected to be lower in the future than they are today When interest rates go up bond prices go down and vice versa All else equal longer maturity bonds are more affected by interest rate changes All else equal bonds with lower coupons are more affected by interest rate changes Bond Ratings 0 High Grade Moody s Aaa and SampP AAA capacity to pay is extremely strong Moody s Aa and SampP AA capacity to pay is very strong Medium Grade Moody s A and SampP A capacity to pay is strong but more susceptible to changes in circumstances Moody s Baa and SampP BBB capacity to pay is adequate adverse conditions will have more impact on the rm s ability to pay If NPV gt 0 do it If NPV lt 0 don t do it 1 Estimate expected incremental cash flows 2 Estimate the initial cash flow cost required to undertake the investment 3 Estimate the correct discount rate r for those cash flows Based on the rates of return offered by equivalent risk investments in the capital market learn this later 4 Add up PV of all cash flows positive and negative to get NPV Expected value If a cash flow is uncertain to get the expected value Expected value probability of outcome 1 outcome 1 probability of outcome 2 outcome 2 The IRR is the particular rate of return that makes the NPV of an investment zero C1 C2 CN 0NPVCO 1 2 N 1IRR 1IRR 1IRR f IRR gt interest raterequired return do it If IRR lt interest raterequired return don t do it IRR is similar to NPV but has a few shortcomings 1 IRR ignores scale of project 9 important when comparing across projects 2 Might get multiple IRR solutions if CFs flip sign Payback Period Rule 3 Select a payback cutoff number of years 4 Accept the project if cash coming in exceeds the initial cash going out before the cutoff number of years Free cash flow Cash ows freely available to all providers of capital bondholders and stockholders Difference between a rm s future cash ows with the project and without how much incremental does this add or subtract Cash ows that exist whether or not a project is undertaken are irrelevant sunk costs Free Cash Flow Sales COGS SGampA RampD other op expenses DampA l tax rate DampA capital expenditure change in Net Working Capital AR Inventory AP salvage value or net after tax proceeds from asset sales Net Working Capital Inv AR AP How depreciation works When you buy a longlived asset you don t record the whole cost as an expense on the income statement Instead in straightline depreciation divide the asset s cost by the years of useful life as determined by IRS
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