Financial Management FIN 316
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This 5 page Class Notes was uploaded by Flavio Steuber on Tuesday September 8, 2015. The Class Notes belongs to FIN 316 at University of Oregon taught by Staff in Fall. Since its upload, it has received 15 views. For similar materials see /class/187164/fin-316-university-of-oregon in Finance at University of Oregon.
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Date Created: 09/08/15
Review of Topics Covered Final Exam Goal of managers making financial decisions adding or creating value for the owners of the firm most of the course material has dealt with elements of analysis showing how we know whether the choices we make increase or diminish value Present Value and Future Value key concepts Opportunity rate of return knowing why we discount cash flows that don39t occur immediately and how we determine the rate at which future cash flows should be discounted Compounding interval if cash flows occur monthly we need to use a monthly opportunity rate39 more generally match the frequency of cash flow with an interest rate for that same frequency period of time Be able to recognize and use annuities perpetuities both zero growth and constant growth Apply PV or FV techniques to values ofbonds or stocks now how to calculate a rate of return earned on a bond or a stock The Net Present Value NPV Criterion Know how to calculate NPV and why NPV is a better criterion for evaluating financial decisions than any other criteria it tells us whether and how much value our decisions add see Goal above Know features they are mainly weaknesses of other commonly encountered capital budgeting criteria IRR payback etc Relevant incremental cash flows Know what cash flows belong in our decision analysis the ones that will be affected by our decision opportunity costs matter sunk costs don39t39 know how to recognize the difference Know how depreciation taxes and gains or losses affect cash flow Understand how change in net working capital ANWC affects cash flow Special topics in capital budgeting Evaluating alternatives of unequal lives how equivalent annual cost can help Recognizing options or managerial flexibility in investment projects Estimating the value of managerial flexibility see notes below under Review of Topics Covered Third Quiz Topics coveredfor the third andfourth quizzes are shown below so this summaryjumps ahead here to identify important topics or concepts covered since thefourth quiz Weighted average cost of capital WACC the blend of the returns required by investors in the issuing companies securities we can think ofthe debt and equity issued by a company as a portfolio so the portfolio required return is the debt required return X the proportion of debt financing plus the equity required return X the proportion of equity financing NOTE this works when there are no corporate taxes we have to adjust this calculation when we include the effects of corporate taxes see packet p 164 text pp 404407 MM Proposition VL VU no taxes frictionless markets VL VU PV of interest tax shield when there is a corporate income tax Understand how and why a corporate income tax affects firm value the tax diminishes firm value because it means that not all cash flows generated by the firm39s investments go to the firm39s investors Market efficiency competition for information is the key idea underlying the concept of market efficiency Weak semistrong strong forms know what each form implies Know a little about what the evidence shows Review of Topics Covered Third Quiz Net Present Value Discount all cash flows at the market opportunity rate for projects of comparable risk Specifies how much the project adds to or subtracts from current value of the owners39 claim to the 1rm Capital budgeting specifying cash flows Relevant cash flows are cash flows that will change as a conseguence ofthe decision at hand39 this is w y we focus on incremental cash flows Opportunity costs matter they are as real as outofpocket costs Cash flows that won39t change ifwe change our decision on the project are irrelevant to the analysis Effects on taxes matter this is why we include depreciation in our cash flow analysis but if the firm does not have taxable income the depreciation deduction won39t lower taxes Free Cash Flow this is cash flow available to suppliers of capital to the firm creditors and owners It is customary although not necessary to group cash flows into 3 subcategories Cas flow from operations Cash flows for capital investment Cash flows for changes in Net Working Capital Good problems to review from chapter 6 on specifying cash flows 3 4 7 15 23 Internal rate of return the rate or rates that implies a zero net present value for a set of cash flows A criteria that sounds good because it use 39rate of return language39 but several complications andor logical shortcomings make it difficult and unreliable to use see text pp 155159 and packet notes Payback period the time it takes for the sum of future cash flows undiscounted to equal the initial investment lgnores time value of money lgnores all cash flows that occur after the payback period is reached Book rate of return average annual profit over the life of the investment divided by average book value of the project Logical shortcomings profit isn39t the same as cash flow average book value isn39t average investment Profitability index net present value per dollar of investment when funds available for investment are rationed such that not all positive NPV proj ecm can be taken Mutually exclusive projects with unequal lives the 39durability39 problem Equivalent Annual Cost technique how and when to use it Flexibility in capital budgeting Expanded NPV Static NPV Value of managerial flexibility see pp 103105106110 in packet Review of Topics Covered Fourth Quiz Risk and Expected Rate of Return R39 ersion investors prefer less risk to more but will bear risk for sufficient compensation eg higher expected return Risk measured by dispersion of returns more dispersion means more risk We use mean returns as our measure of expected return We use standard deviation of return as our measure ofrisk You should be able to calculate a simple mean and standard deviation see text examples packet examples or the instructions for your stock market exercise writeup MeanStandard Deviation Rule see p 129 in packet39 you should know how to apply this not just memorize its definition39 for example you should be able to tell if one asset is preferred according to the meanstandard deviation rule to another Risk Premium Compensation additional expected but uncertain return for bearing risk is all risk compensated distinction between nondiversifiable and diversifiable risk the importance ofusing a portfolio perspective39 what does an asset contribute to a portfolio s characteristics how does covariability measured by covariance or correlation between asses affect portfolio risk39 holding expected return constant what happens to portfolio variability standard deviation as correlation between assets in the portfolio declines the role of the Market Portfolio nondiversifiable risk is sensitivity to overall market performance beta a measure of systematic nondiversifiable risk CAPM and SML what are some sources of unsystematic and systematic risk see p 139 of packet beta as a slope coefficient of a regression line sometimes called a 39characteristic line39 good problems to review from chapter 8 13 14 16 23 beta of a portfolio is a weighted average of the betas of the asses in the portfolio CAPM and capital budgeting use project risk and project required rate of return can use appropriate beta of comparable firm when we cannot directly estimate project beta packet example of Intuit Quotecom and Hyperfeed Technologies Good problems to review from chapter 9 9 12 15 16 Cost of capital and capital structure Business risk and financial risk know the distinction Know why debt financing increases the risk of the rate of return on common stock Adjusting project risk for leverage know the relation between beta of assets and beta of equity The Wall Street Journal Interaetlve Edmon Page 1 of 2 Apru92nnl 5 me nrl Mululeunds uatletl Revew Don39t Play Favorites Seven Reasons to Index ByJONATHAN ELEMENTS Sta Repanex ame Wm srmr mums It s amazlng how rnany people you ean offend by belng rnoffensrve n u t author ofThe 1 dJVlSlVE lssues Rather Iprefer alessrconfrontatlonal approaeh to rnvesung My advree Don t play favontes Adrnrtyou really dont know vvhreh stoeks wlll sparkle andrnstead buy thern all Aslthappens L p d f d Frdelrty anestrnents T Rnwe Prise Assnelates Charles Schwzh TLAACREF and Vanguard Group rum n htun there wth Commumsm publre televrsron and nonaleoholre beer You re out ofyour rnrnd thundered a reeent ermall How rnueh does Vanguard pay you7 dernanded another Wouldn tltbe rnore effrerentto tustputJohn Bogle on yourpayroll7 askedyet another talung a svvrpe at Vanguard s founder The Tt h rdt f 1 Wall StreetJoumal But thls sort of stuffhelps 1n faet lndex funds and slmply rnatehrng the perforrnanee ofthe rnarket average Here s rny lrst ofthe top seven reasons to lndex of defeat erther Whatever the rnarket delrvers that s vvhat you get r Celebrated stockrplckerWan39en Buffett approves Mostrnvestorsbothrnstrtutronal and rndrvrdual eharges rnrnrrnal fees vvrote Mr Buffettrn the 1996 annual report for hls eornpany Berkshire Hat away delrvered by the geat majorlty ofrnvestrnent professronals 4112001 The Wall Street Journal Interactive Edition Page 2 of 2 6 Stress Who needs it Forget about following individual stocks and fretting about star fund managers Instead simply put 75 of your stock portfolio in a fund that tracks the Wilshire 5000 index of most regularly traded stocks and the other 25 in a foreignstock index fund Then sit back and wait for the good times to roll True you might not laugh all the way to the bank But you will probably smile smugly 5 There s no need to waste time checking the mutualfund quotes Was the market up yesterday Your index funds probably were too 6 The meek really do inherit the earth The indexfund investor39s humility costs maybe 03 a year and sometimes less which means you keep almost all of the market s gain Meanwhile your overconfident neighbors rack up huge investment costs as they try to find the next big stock market winner And the harder they try the greater the costs they incur Result These folks fall even further behind the market average 6 Both index funds and actively managed stock funds on average have lost money over the past year But on April 16 yes the 16th this year only the folks who own actively managed funds will be sitting around scratching their heads wondering how their funds could simultaneously lose truckloads of money and still generate massive tax bills for shareholders via capital gains distributions 6 Getting an earful from your colleagues about their latest hot stock pick As the owner of a Wilshire 5000index fund you can nod knowingly and say quotYeah I own that one tooquot Write to Jonathan Clements at W1 URL for this Article http 39 quot wsj L39 irvrCgliJ B 314307686148825djm Hyperlinks in this Article 1 mailtojonathanclementswsjcom Copyright 2001 Dow Jones amp Company Inc All Rights Reserved Printing distribution and use of this material is governed by your Subscription Agreement and copyright laws For information 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