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# Introduction to Financial Management FIN 3310

Baylor University

GPA 3.78

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This 7 page Class Notes was uploaded by Johathan Hodkiewicz IV on Saturday October 3, 2015. The Class Notes belongs to FIN 3310 at Baylor University taught by Staff in Fall. Since its upload, it has received 18 views. For similar materials see /class/217906/fin-3310-baylor-university in Finance at Baylor University.

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Date Created: 10/03/15

Finance Final Departmental Guide Know Learning objectives from each chapter 0 1ntro 2 Financial Markets and Interest Rates 0 Financial Statements and Cash Flows Evaluating a Firm39s Financial Performance Time Value of Money Meaning and Measurement of Risk and Return Valuation and Characteristics of Bonds Valuation and Characteristics of Stocks Cost of Capital 10 Capital Budgeting Techniques 99 59 11 Cash Flows and Other topics in Capital Budgeting 0000000000 12 Determining the Financial Mix 0 14 Short Term Financial Planning Time value of money I A dollar received today is worth more than a dollar in the future I Since we earn interest on money received today it is better to receive money earlier rather than later I FVnPV1rquott I Future value Present Value 1lnterest ratequottime period Hw problem examples from each chapter Focus on chapter 511 Capital Budgeting Concepts Goal of the firm 0 Create value for the shareholders and maximize shareholder wealth o Create wealth for shareholders by making decisions that will maximize the price of the existing common stock 5 principles of Firm Management Chp 1 and understand them 0 Cashflowis what matters I Accounting profits are not equal to cashflows I Cashflow not profits drive the value of the business I Must determine Incremental Cash Flows when making financial decisions I Incremental Cashflowis the difference between being selected and not 0 Money has a Time Value I A dollar received today is worth more than a dollar in the future I Since we earn interest on money received today it is better to receive money earlier rather than later I FVnPV1rquott I Future value Present Value 1lnterest ratequottime period 0 Risk requires a Reward I We won t take on additional risk unless we expect to be compensated with additional reward or return 0 Market Prices are generally right I Efficient market is a market where the prices of all traded assets StockBonds at any instant in time fully reflect all available information I Stock prices are useful indicators of the value of the firm I There are inefficiencies in the market that may distort prices 0 Conflicts of interest cause agency problems I The separation of management and the ownership of the firm creates an agency problem I Managers may make decisions that are not consistent with the goal of maximizing shareholder wealth 0 Conflict is reduced by annual reports compensation schemes stock option takeovers Compute cost of debt cost of equity preferred stock dividend growth model Capital Asset Pricing Model 0 Cost of Debt The return demanded by the firm s creditors on a new borrowing I Must look at Yields to Maturity in Today s marketplace not today s cost I Firm must pay floatation costs when they sell bonds I Net proceeds per bond received by firm is less than the market price of the bond The Cost of Capital will be higher than the bondholders Reg Rate of Return I Interest is tax deductible Before Tax X 1Tax Rate I Ex Firm has determined a 10 Year bond with a 1000 par value paying a 10 coupon can be sold to investors for 970 0 What is yield to maturity N10 PV 970 PMT 100 FV 1000 YR o 105 o Creditors are telling firm that they are requiring a 105 return However the cost of debt to the firm is higher for flotation costs Assume 5 flotation costs per bond What is the dollar value of the Flotation costs 0 970 x 05 4850 per bond 0 Net Proceeds per bond 970485092150 0 Net Proc Per bond Sales S Flotation costs per bond 0 What is before tax cost of capital o N 10 PV92150 PMT 100 FV1000 lYR I 1135 0 Finally assume a 34 corporate tax rate 0 Before tax on Cost of Capital X 1Tax Rate 0 1135 X 1034 749 Summary a 10 year bond with a 10 coupon a req rate of return of 105 and 5 floatation costs will result in a beforetax cost of capital of 1135 and with a 34 tax rate an aftertax cost of capital of 749 0 Cost of Equity MOST Difficult To Estimate I Req rates cannot be observed I Equity can be built through retention of earnings opp Cost or selling new stock the costs for each are different primarily due to flotation costs with stock I Two cost estimation techniques Div Growth Model Capital Asset Pricing Model I Ex Talbot received a 200 dividend and firm will grow by 10 Stock is currently at 5000 per share what is Req rate of return DD01g D120011 220 2250001 1440 cost of equity through ret earnings Flotation costs are 15 50 X 15 750 5000 75 4250 0 224250 1 1517 cost of equity through stocks 0 Dividend Growth Model I Useful when the growth rate will be at a constant rate indefinitely I Growth rate is less than the investor s req rate of return I a nc paid a dividend of 400 per share last year The stock sells for 6000 per share Analysts have estimated a steady growth of 6 per year indefinitely What is the cost of equity capital for Greater States First solve for D1D0 1g 0 Do last dividend paid in past quarter 0 D0 4 G 06 0 D1 41 06 424 0 Cost of Equity 42460 06 1307 or 1307 0 Capital Asset Pricing Model I Driven by three things 1 Risk Free Rate 2 Systematic Risk by Beta 3 Market Risk Premium Kcs Rf BRmRf Ex Target s stock was 5411 on October Beta on the day was 101 One estimate of market risk is 85 and US treasury bills are paying 375 O o What is cost of equity 0 Kcs 37510185 12335 0 Ex Air stock is selling for 30 and has a beta of 12 Market Risk premium is 8 and risk free rate is 6 Air paid 200 dividend last year and firm is growing at 8 o CAPM o Kcs 6 128 156 0 Dividend Growth 0 D1 20016 216 o 21630 08 152 0 Average the two and get 154 Preferred Stock Perf Stock a type of perpetuity Price the present value of the constant stream of dividends Eq If we know the price per share and the dividend Price per share Divreq rate per share 0 Eq Req Rate per share DivPrice per share Flotation costs change equation Net Proceeds issue price per share minus flotation cost per share so equation become Kps DivNPps No ad39ustment for taxes since preferred stock div is not tax deductible Ex Edison issued preferred stock that pays an annual dividend of 425 per share On Nov 23 2009 the stock closed at 5850 If Edison were to sell an issue of preferred stock with the same characteristics it would incur floatation costs of 235 and the stock would sell for the 23 Nov closing price of 5850 0 What is the cost of preferred stock 0 5850 X 0235 138 flotation cost per share DivNet Proceeds per share 4255850 138 744 Cost of Pref Stock Net Proceeds Issue Price Floatation Costs 000 Cost of Capital Cost of Capital the required return necessary to make a project worthwhile O O O 0 Required Return The minimum rate of return necessary to attract an investor to purchase or hold a security Similarities Both depend on risk Differences Taxes and Transaction or Flotation costs Taxes interest paid by a corporation is tax deductibles When paying taxes a firm lowers its cost of capital Cost of Debt X 1Tax rate I Transaction or Flotation Costs Firms incur costs when issuing stocks and bonds the cost of capital is computed on net proceeds vs actual sales price cost of capital is increased I Ex 20 sale with 5 transaction cost 15 of revenue 0 20 sale price vs 15 net proceeds Capital Asset Price model with cost of equity Elements of CAPM o Diversification Cost of Capital Equations Cost of Preferred Stock Valuation of Bonds 0 Combination of C future expected cashlows nThe time to maturity r the investors req rate of return Valuation of Stocks 0 Shareholders wealth value of the stock Pg 202205 relationship that exist in bond valuations know relationship NPV IRR Concepts on MIRR Relationship between NPV 8 IRR Where NPV0 that is IRR Capital Budget 0 Initial Outlay Purchase Cost Installation Initial Working Capital Sale of Old Asset Tax 0 Annual Cash Flow EBIT TaXes Depreciation 0 Terminal Cash Flow Salvage value amp Refund of NWC amp Current Cash Flow 0 Relationship and Differences between Straight Line and MACRS dep o Weighted Average Cost of Capital Problems 0 Chp 5 Annuities Perpetuities PV of an uneven string 0 Present Value What is the value in today s dollars of a sum of money to be received in the future I PVFV at the end of n X 11rquotn o Annuity a series of equal dollar payments made for a specified number of years I 2 types I Ordinary Annuities cash flows occur at the end of each period I Annuities Due payments occur at the beginning of the period 0 Compound Annuities a type of ordinary annuity which involves depositing or investing an equal sum of money at the end of each year for a certain number of years I Examples savings for car college 0 FV ofannuity PMT X 1rquotn 1r I What Is the future value of 500 a year with payments of 6 interest for 5 years 0 281854 0 Present Value of an Annuity I PV of annuity PMT X1 1rquot nr I We need 10000 for college in 8 years How much must we deposit each year at 6 interest to have the money ready I 101036 o Annuities Due ordinary annuity which all payments are shifted forward by one time period Occurs at the beginning of the period rather than the end 0 Perpetuities annuity that continues forever I PVPPr where PP constant dollar amount provided by the perpetuity I Ex What is the present value of a 500 perpetuity discounted back to the present at 8 o PP500 r 08 0 PV 50008 6250 0 Leverage 0 Impact of Financial Leverage 0 Impact of Operating Leverage 0 Compute degree of FL and CL and what it is 0 Making interest rates comparable months years 0 Effective annual Rate 0 Effective Annual Rate the annual compound rate that produces the same return as the normal or quoted rate when something is compounded on a nonannual basis EAR provide the real rate of return I EAR1 quoted ratemquotm 1 0 Where m the number of compounding periods within a year 0 1 invested at 1 per month will grow to in a year 0 Adjust formulas to account for that

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