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Date Created: 09/12/15
TEST 1 LECTURE 1 INTRODUCTION TO FINANCE OBJECTIVES 1 Identify three traditional areas of nance 2 Describe ve guiding principles of nance 3 Compare and contrast different forms of business organizations 4 Describe the role of the nancial manager 5 De ne debt and equity 6 Compare and contrast debt and equity Introduction to Finance 300 nance gradsyear Traditional areas of nance fall into three main categories 1 Money to banking bring borrowers and lenders together real estate small business loans commercial loans Federal Reserve system 2 Investments managing stocksbonds for clients Valuing stocksbondscompanies 9 Analyst Investment Banking 3 Financial Management nance of the rm Financial management refers to the operation of the rm Typical issues facing a nancial manager are A What projects should rm invest in 7New product 7New store 7Expand Business 7 Replace Equipment 7Hire employees 7Buy another company B How do I nance project 7Raise the capital 7Finance as cheaply as possible C Daily decisions of the rm 7Inventory 7Product Mix 7 Cash Balance 7 Exchange rates 7 Hedging Guiding Principles of Finance 1 Maximize wealth 2 Time Value of Money 3 Risk vs Retum 4 Leverage 5 Diversification Maximization of wealth is the creation of as much wealth as possible with the available resources Do all rms maximize wealth Of course not iNonprofrts max social wealth not dollars iChickFilA operates 67 days Time value of money is the opportunity cost of tying up funds in projects stocks or other assets Investors give up consumption today when they invest They want to be compensated They want to be compensated based on risks What is opportunity cost What you give up when you make a decision The expected return versus risk trade off is the concept that greater risk should be rewarded with a higher return What is risk Risk is the chance that our outcome differs from what we expect Examples Low risks vs High risks Low risks mutual funds CD s Bonds High Risks individual stocks small companies trading on margin borrowing money you don t have Greater the risk the greater the reward at the same time you have huge liabilities Leverage is the concept of how much debt a firm issues for its projects We will discuss its importance on Wednesday How much debt do we use Why would a stockholder be concerned about leverage Greater amount of debt greater amount of leverage greater interest paid greater risk for shareholder Diversification is the idea of removing risk from a portfolio of stocks or other investments Don t put all your eggs in one basket Examples Enron all employee retirement money was in Enron stock employee retirement was tied to employee perfonnance 3 Basic Forms of Business Organizations 1 Sole Proprietorship 2 Partnership 3 Corporation where most of us will end up working Roughly 80 percent of all businesses in US are sole proprietorships Roughly 90 percent of all business is conducted by corporations SOLE PROPRIETORSHIP An unincorporated business owned by one individual Three advantages of a sole proprietorship 1 Single taxation 2 Easy to formdissolve 3 Make your own decisions own boss Three disadvantages of a sole proprietorship 1 Unlimited liability 2 Life of the business 3 Dif cult to raise capital PARTNERSHIP Two or more persons associate to conduct a noncorporate business Two basic forms of partnership general and limited Two advantages of a partnership 1 SAME AS SOLE PROPRIETORSHIP 2 SAME AS SOLE PROPRIETORSHIP Four disadvantages to a partnership 1 SAME AS SOLE PROPRIETORSHIP 2 SAME AS SOLE PROPRIETORSHIP 3 SAME AS SOLE PROPRIETORSHIP 4 Partnership issues decisionmaking selling the business etc CORPORATION A legal entity created by a state and it is separate and distinct from its owners and managers Three major advantages to a corporation 1 Limited liability only lose what you invest 2 Easy to raise funds 3 Unlimited life Two disadvantages to a corporation 1 Double taxation 2 Subject to more regulation 3 Agency Issues employees don t have the same goals as the owners Why might the value of a business be maximized as a corporation instead of the other business forms 1 Easier to raise capital 2 Limited liability lower return on investments HOW DO FIRM S RAISE CAPITAL DEBT An agreement contract between borrowers and a lender to repay principal with interest FINA 3000 FINANCIAL MANAGEMENT SPRING 2011 TEST 3 March 28 2011 Instructions 1 Please ll in your LAST name your 810 number and your 3 digit test number on your scantron 2 You have 75 minutes to complete this test All work must be finished when time is called 3 The UGA Honor Code will be strictly followed during this test Violations include receiving or providing assistance to fellow students during the test 4 Select the answer that best answers the question Questions 111 are 5 points each Use the following information for questions 13 Dawg Incorporated recently purchased a new assembly line for 100000 The assembly line will be depreciated using a 7year MACRS schedule see back page Dawg also incurred a cost of 10000 for installation and delivery of the assembly line Depreciation begins in YEAR 1 and ASSUME A 40 TAX RATE What is the year 0 cash ow for this purchase 100000 1 a b 103712 c 104000 d 108000 e 110000 2 What is the cash ow created by the depreciation of this purchase in year 1 a 5716 b 6288 c 8574 d 14290 e 15719 3 Suppose the firm will sell this assembly line for 50000 three years from today What is the cash ow from selling the assembly line a b c d e 30000 48862 49241 50759 55137 Use the following information for questions 46 Dawg Incorporated will use working capital to help support their new project The NWC needs for the project are shown below 905792 nap0er What is the cash ow from NWC at year 0 1200 2000 1200 2000 What is the cash ow from NWC at year 1 12000 10000 12000 10000 20000 6 What is the cash flow from NWC at year 4 combine the investment in NWC and reclaimed NWC into one cash flow a b 20000 c 20000 d 1 2000 e 1 2000 7 What is a free cash flow a39 A cash flow that does not cost anything b The cash flow generated for shareholders over a specific time period usually a year c Free cash flow represents the cash that firm has invested over the last year in projects or other activities d Free cash flow is the cash available to all investors in the firm before any payments to investors are made 6 Free cash flow is equivalent to the net income of the firm A firm should abandon a project when When the TCF for any given year is greater than the OCF When payback has been met When the market value of assets is less than the book value of assets When the TCF is greater than the value of continuing When the OCFs begin to decline naporg 9 The term that applies to a new product hurting sales of existing products is called Encroachment Market share Cannibalization Complement Positive side effect 09057 Use the following information for questions 1011 10 What are the incremental earnings for the project in 2010 400 1400 1600 2400 3600 09057 1 What is the free cash flow for the project in 2010 400 l400 1600 2400 3600 OP PSTPH Consider the following information for questions 1217 3 points each Paid In Full a retailer in the discount retail sector currently operates twenty retail outlets in the Panhandle area of Florida There top operating store is in Destin Florida The firm is considering opening an additional store in the neighboring beach community of SanDestin The company already owns the land for the store which currently has an abandoned warehouse on it Last month the marketing department spent 18000 on market research to determine the extent of customer demand for the new store Now Paid In Full must decide whether to build and open the store 12 The original purchase price of the land where the store will be located should be included in the cash flows for the project TRUE B FALSE 13 The cost of demolishing the warehouse and clearing the lot should be included in the incremental cash flows A TRUE B FALSE 14 The potential loss in sales for the Destin store should not be considered as an incremental cash flow to the project B FALSE 15 The 18 000 in market research Should be included as part of the 18 Based on the assumptions above what is the enterprise value of the firm incremental cash flows of the project a39 51940 A TRUE 3 F b 52136 c 52516 16 There are no opportunity costs associated with this decision d 56660 A TRUE B FALSE 6 57406 17 The interest expense for the debt borrowed to pay the construction costs of the new SanDestin store should be included in incremental cash flows A TRUE B FALSE 19 What is the equity value per share of North Avenue based on the assumptions of 18 North Avenue Trade has 130 million in debt and 57 million in cash on their balance sheet North Avenue has 70 million shares outstanding a 41 b 662 Use the following information to answer questions 1820 5 points each c 478 ASSUMPTIONS d 705 Weighted average cost of capital 10 7 16 Tax rate 40 e39 39 NWC as of sales 18 Long term growth rate in FCFs 450 20 A proposed project requires a firm to use some unused office space Recently a small business offered to rent the unused office space for 2000 per month for 60 months The firm has a tax rate of 40 and a cost of capital of 6 APR What is the opportunity cost of doing the project Rent is paid at the beginning of the month 3 47211 b 58242 0 62071 d 62381