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Principles of Finance

by: Jamie Frami

Principles of Finance FIN 3403

Jamie Frami
GPA 3.72

Scott Besley

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Scott Besley
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This 4 page Class Notes was uploaded by Jamie Frami on Wednesday September 23, 2015. The Class Notes belongs to FIN 3403 at University of South Florida taught by Scott Besley in Fall. Since its upload, it has received 78 views. For similar materials see /class/212612/fin-3403-university-of-south-florida in Finance at University of South Florida.

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Date Created: 09/23/15
Principles of Finance Review Sheet Exam 3 The exam will include multiple choice questions and problems If you have worked and understand the endofchapter problems that were assigned you should be able to work the problems on the exam You should understand the topical areas given in the following listithe concept questions will be primarily based on these topics Cost of Capital 0 Understand the concept of weighted average cost of capital WACC7that is the de nition the computation and the use Remember that the WACC is simply the average cost of all the funds used to nance the rm s assets based on the proportion of each type of funds used thus it is the minimum rate of return the rm needs to earn when investing those funds 0 Be able to compute each of the component costs of capital Why is the cost of debt adjusted for taxes whereas the costs of equity whether preferred stock or common equity are not Understand why there is a cost associated with retained earnings Why is the cost of retained earnings always less than the cost of issuing new external equity 0 Understand what makes the WACC changeithat is understand what break points are Be able to compute break points What is one break point that a rm always faces Think about retained earnings 0 How is the WACC used to make capital budgeting decisions Capital Structure 0 What do we mean when we say that a rm s capital structure contains 40 percent debt How much equity must there be What does it mean to operate at the optimal capital structure 0 How do such factors as business risk nancial exibility and risk tax position and managerial attitude affect the capital structure of a rm 0 Understand how a nancial manager tries to determine the optimal capital structure for his or her rm For example how can EBITEPS analysis and EPS indifference analysis help the nancial manager with such analyses 0 In reality is there an optimal capital structure If a rm currently is nanced with equity only it is an all equity rm how would you expect its cost of capital to change as its capital structure is changed to included greater and greater proportions of debt Adding some debt to a rm s capital structure is bene cialithat is WACC decreasesidue to its tax deductibility But when does adding more debt become detrimentalithat is WACC increases 0 How can the concept of leverage be used to help a nancial manager make decisions about the capital structure of the rm Be able to compute the degree of operating leverage the degree of nancial leverage and the degree of total leverage and understand what the resulting numbers mean 0 According to the tradeoff theory of capital structure what is the best way to nance a rm optimal capital structure Why Does the signaling theory propose the same capital structure would be optimal Why 0 Why do the capital structures of rms vary so much among rms in different industries and in different countries 0 Can decisions about the capital structure of a rm affect its capital budgeting decisions How Dividend Policy 0 What does it mean to have an optimal dividend policy 0 Understand how the concepts of information content signaling the clientele effect and the free cash ow hypothesis affect dividend policy decisions 0 What dividend policies are followed in practice All else equal which dividend policy probably results in the highest value for a rm s stock if managers and investors have the same symmetrical information Which policy probably results in the highest value if managers and investors have asymmetrical information Why 0 What are the important dates associated with paying dividends Why are the holderofrecord date and the ex dividend date important to stockholders o How do such factors as restrictions in debt agreements capital budgeting opportunities availability of alternative sources of nancing and concern for the rm s cost of capital affect dividend policy decisions 0 What are stock splits and stock dividends and what economic impact do they have How do stock splits and stock dividends affect a rm s balance sheet Financial Planning and Control 0 Understand the general process that must be followed to construct pro forma nancial statements What does AFN mean and why is it important in the construction of pro formas Why does the process of constructing pro forrnas have to be repetitive What are some factors that affect or might complicate the process 0 Understand the concepts of operating breakeven and nancial breakeven Why is it important to conduct O breakeven analyses Be able to compute breakeven points Understand the concept of leverage What is operating leverage Financial leverage What information does the degree of leverage whether operating nancial or total provide Be able to compute the degree of operating leverage the degree of nancial leverage and the degree of total leverage Why is the US taX system considered to be a progressive taX system Principles of Finance Review Sheet Exam 2 The exam will include multiple choice questions and problems If you have worked and understand the endofchapter problems that were assigned you should be able to work the problems on the exam You should understand the topical areas given in the following listithe concept questions will be primarily based on these topics Valuation Concepts 0 Understand the basic concept of valuation In simple terms the value of any asset is the present value of the future cash ows the asset is expected to generate 0 Be able to compute the value and the yield to maturity of a bond 0 Understand what the yield to maturity YTM of a bond represents 0 Understand the relationship between YTM and the coupon rate and the market value of a bond For example when the market rate or YTM is greater than the coupon rate a bond sells at a discountithat is its price is less than its par value Why What part of the YTM is attributed to the current yield and what part is attributed to capital gains 0 Understand how bond prices change over time even if market interest rates remain constant We know that the value of a bond must equal its face value at maturity assuming no bankruptcy so the value of a bond must move from its current price to its maturity value as time passes all else equal 0 Be able to compute the value of a stock when there is 1 no growth 2 constant growth and 3 nonconstant growth 0 Understand the components that make up the required return earned on a stockithat is dividend yield and capital gains 0 What is the dividend discount model What are some other modelstechniques that investors use to value stock 0 Know the different featurescharacteristics of stock and bonds Risk and Rates of Return 0 What is risk and how do we measure it How does the risk of an investment held in isolation differ from the risk of the same investment held in a portfolio What is portfolio risk How does risk affect rates of return 0 What is expected rate of return and how is it measured What does it mean to have an expected rate of return equal to 20 percent 0 Why do we generally divide total risk into two componentsisystematic risk and unsystematic risk Which component is diversi able 0 Understand the concept of beta and the Capital Asset Pricing Model CAPM Be able to compute expected rates of return using the CAPM 0 Understand how factors like in ation and risk aversion affect rates of return Capital Budgeting Techniques 0 What are the various types of capital budgeting decisions What does it mean for projects to be independent Mutually exclusive 0 Be able to compute the payback period both traditional and discounted net present value NPV and internal rate of return IRR for a capital budgeting project Understand what the result for each computation means For example what does it mean if you nd a project has an IRR equal to 14 percent If NPV gt 0 what is the relationship between the rm s required rate of return and the project s IR and what is the project s discounted payback period relative to its life 0 Understand what an NPV pro le is how it is used and how it is constructed What does the crossover point associated with the NPV pro les of two projects mean How is such information used to make capita budgeting decisions 0 How do capital budgeting decisions differ from general asset valuation Are they based on the same concepts Capital BudgetingiCash Flows and Risk 0 Understand and be able to identify the different cash ows that are relevant for making capital budgeting decisions For example what would be included as part of the initial investment outlay terminal cash ow and so forth How does the identi cation of these cash ows differ if the project is a replacement asset rather than an expansion asset 0 Why should the risk associated with a project be considered when making a capital budgeting decision What incorrect decisions could be made if risk is not considered in capital budgeting analysis 0 Understand how we incorporate risk into capital budgeting decisions What techniques are used Principles of Finance Review Sheet Exam 1 The exam will include multiple choice questions and problems If you have worked and understand the endofchapter problems that were assigned you should be able to work the problems on the exam You should understand the topical areas given in the following listithe concept questions will be primarily based on these topics Overview ofManagerial Finance 0 Why is it important to have some understanding of nance 0 Understand the differences among the alternative forms of business What are the advantages and disadvantages of each In general how is each taxed o What are some of the goals that are pursued by corporations Why should the primary goal of a nancial manager be to try to maximize shareholder wealth 0 Understand what agency relationships are What are some ways shareholders can reduce agency problems 0 Know how businesses in the United State differ in general from businesses in other countries Analysis ofFinancial Statements 0 Understand the general concepts associated with nancial statements and ratio analysis Do not memorize any of the ratios What information does each of the ve categories of ratios mentioned in the text provide to those who interpret the ratios Who uses ratios 0 Why is the Statement of Cash Flows considered an important nancial statement In general what would be a source of cash and what would be a use of cash 0 Know the limitations associated with ratio analysis Why is the interpretation of the ratios considered more important than the computation of the ratios The FinancialMarkets and the Investment Banking Process 0 What is a nancial market Know how the different types of nancial markets mentioned in the lectures and the text differ For example in what type of market would shortterm securities be traded How do the physical stock exchanges differ from the overthecounter market 0 What is a nancial intermediary What are some of the more common nancial intermediaries mentioned in the text and what are the roles of such intermediaries in the nancial markets 0 What is an investment banker What services do investment banking houses provide Time Value ofMoney 0 Understand the concept of the time value of money Remember that the computations we conduct in this section are used to restate dollars received or paid at different time periods into equivalent dollars at one periodifor example the present period We do this so that the dollars are stated in comparable dollars Be able to compute the future value and the present value of 1 a lumpsum amount single payment 2 an annuity 0 whether it is an annuity due or an ordinary annuity and 3 an uneven cash ow stream Be able to compute the same present and future values when compounding occurs more than once a year What is a perpetuity 0 Understand the concept of amortizing a loan and be able to compute the payoff value of a loan after some payments have been made For example consider a 10000 12 percent loan that requires quarterly payments over a veyear period Every three months the payment would be 67216 11 20 r 3 and PV 10000 What would the payoff value of the loan be after three yearsithat is after 12 payments have been made Because there are two years or eight payments of 67216 remaining on the loan we now have an 8period annuity equal to 67216 with interest equal to 3 percent per period The present value ofthis annuity is 471835 11 8 r 3 and PMT 67216 which is the amount that would be due if the borrower wants to repay the loan after three years 0 Understand and be able to compute the effective annual rate EAR rEAR What is the difference between rEAR and 7 The Cost ofMoney o What is the yield on an investment and how is it computed 0 Understand how interest rates are determined in general and what factors affect interest rates For example if two companies are identical except one has a greater chance of defaulting on its debt the company with the higher chance of defaulting on its debt should have to pay a higher interest rate to borrow Why is the interest rate higher What are the basic risks that are included in the risk premium associated with a debt instrument That is what are 0 DRP LP and MRP 0 Understand the term structure of interest rates and the theories that have been developed to help explain the shape of the yield curve What is a yield curve 0 Be able to compute expected interest rates The problems on the exam should be similar to those you were assigned in Chapter 5


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