FD

Introduction to Financial Decisions
Welcome to the Introduction Financial Decisions e-lecture series.
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HURIC (Hosei University Research Institute, California).
To view a lecture, choose the chapter you wish to study and simply click the
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This course is an introduction to the underlying theory that drives the tools of
financial decisions-making within a business. It shows how corporate finance
works, the range of issues involved and how to perform financial analysis.
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Financial Decisions Chapter1
Push here to start
Henry Wong
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Introduction
1
Introduction to Financial M
1
Forms of Business Organizat
2
Proprietorships
3
Partnerships
4
Partnerships (continued)
5
Corporations
6
Limited Liability Companies
7
Bases for Comparing Various
8
Number of Owners & Ease of
9
Number of Owners & Ease of
10
Investor Liability
11
Investor Liability (continued)
12
Equity Capital Sources
13
Equity Capital Sources (cont
14
Firm Life & Liquidity of Own
15
Firm Life & Liquidity of Own
16
Taxation
17
Taxation (continued)
18
Corporate and Personal Tax
19
Summary: Sole proprietorshi
20
Summary: Corporation
21
Summary: Hybrid Business En
22
Why We Focus on Corporati
23
Why Corps. Maximize Value
24
Self Test 1.1
25
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Self Test 1.2
27
Self Test 1.2 Answer
28
Self Test 1.3
29
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Financial Goals of the Corpo
31
Self Test 1.4
32
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Self Test 1.5
34
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Self Test 1.6
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Self Test 1.7

Self Test 1.8
Self Test 1.9
Factors that affect stock pri
Is stock price maximization
Stock Prices and Intrinsic Va
Determinants of Intrinsic Val
Self Test 1.10
Self Test 1.11
Self Test 1.12
Self Test 1.13
Self Test 1.14
Some Important Trends
Percentage of Revenue and
Self Test 1.15
Business Ethics
Self Test 1.16
Self Test 1.17
Self Test 1.18
Agency/Fiduciary relationsh
Conflicts Between Managers
Self Test 1.19
Self Test 1.20
Role of Finance in a Typical
Responsibility of the Financia
Self Test 1.21
Self Test 1.22
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Every Job is a Finance Job!

CHAPTER 1 ANSWER SET Intr
Question 1-1
Question 1-1 Answer
Question 1-2
Question 1-2 Answer
Question 1-3
Question 1-3 Answer
Question 1-4
Question 1-4 Answer
Question 1-5
Question 1-5 Answer
Question 1-6
Question 1-6 Answer
Question 1-7
Question 1-7 Answer
Question 1-8
Question 1-8 Answer
Question 1-9
Question 1-9 Answer
Question 1-11
Question 1-11 Answer
Question 1-15
Question 1-16
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captivate
Script
Script
This Page is Menu of L
Welcome to Financial Decisions
and Markets. I am Professor He
And
then
number
2,
we
will
talk
specifically
about corporations
Forms of business
organization.
Proprietorships. First,
There are four

More
on
partnerships.
L
primary types or
forms on
of business
More
partnerships.
Lets compare joint liability with joint and
organizations.
First
is
Finally,
we
end
with
limited
partnerships. Before we were
Next we talk about corporations.
joint
and talking
severa
the
sole
A
corporation
is
a
legal
entity
that
separates
the
personal
assets
Finally
we
end
the
dis
proprietorship,
orare breaching
So, although you
a contract with a customer and
sometimes
called
When
a
person
in
America
starts
a business
for the
first time,
the
C-corporation
1/ in a C-corporation you
can
have
an unlimited
number
of inve
proprietorships.
This
Number
1.
The
number
of
owners
and
the
ease
of
startup.
So,
fo
2/ in an
S-corporation
however,
you can
onlyinfluences
have up tobusines
75 acc
Now,
lets
talk about the
first criteria
of what
S-corporation
is
an
unincorporated
And
then
the
second
thing
that
they
often
think
about
is
investo
However,
compare
that
with a general and
partnership
where you
ha
Now
compare
theL
proprietorship
the
partnerships
with
company
hasmajor
Third:lets
Onethat
of the
reasons why people
choose
one entity
o
only one
Fourth
is owner.
how
the
firm
is going
to important
last and the
liquidity
of thi
Lets
now
talk long
about
the
second
most
criteria,
which
S-corporation
An
S-corporation
is the
same
thing
as a C-corporation,
but inste
Compare
But
you that
are
awith
shareholder
inlike
some
of soda
shopUnder
down
thek
The
thing
goes
for
general
partnerships
as well.
join
Nowifsame
what
is investor
liability
for asort
C-corporation?
Well,
we
C-corporation
the
second
form
of
finally,
the
last
reason
that
affects
business
owners
decisio
And
finally
we
have
what
is
called
a
limited
partnership
and
bas
So
we can
startsources.
to see the
big picture now and see that from an
Equity
capital
business
So
the
nextcompare
question
that
we have to ask ourselves is: which one
organization,
which is
Now
if you
that
Rule
2 is that in
a general
partnership you have partners that are
a partnership,
which
The
next
thing
we
look
Rule
3:
In
limited
partnerships,
the limited partners and the gen
is the same thing as a
For
it
doesnt
really matter, because th
soleC-corporations
proprietorship however,
And
again,
this
is
the
same
thing
that
happens
with S-corporatio
except
it
is
an
Finally, we talk about
unincorporated
LLCLLC
Now,
letswith
compare
that
with
taxation
in a corporation
which
is o
And
finally,
LLC
or or
limited
liability
companies
- again the
owners
business
two
So
the
big
difference
between
C-corporations
and
S-corporation
Lets
give
you
a
littl
more owners. Now,
C-corporationS-corporation
there
are
a couple
of gotten
So
now
that
we
have
the
basis
and the
different
criteria
Now
you kinds
mightof
ask yourself:
what
is double
taxation
and
can yof
different
For
sole
proprietorships
and
partnerships
in
particular,
we
know
So
now we can
summarize
the advantages and disadvantages
of
partnerships
that
you
Number
two
is
it
is
subject
to
very
few
regulations
as
well,
so
thi
1/
it
has
an
unlimited
life;
it
is
an
ongoing
entity.
Finally
we
end
with
summary
of the
hybrid business
entities
an
should
beadvantage,
aware
of. a which
The
third
is very
important,
is that
there
is no
2/
itthe
isthere
very
easy
transfer
ownership
between
shareholders,
an
But
disadvantages
are
these:
LLCs
are
a
relatively
new
phen
First,
is
theto
The
disadvantages
however,
are:
So
you
may
have
to
ask
yourself:
why
do
we
focus
so
much
on
c
And
finally,
one
of
the
most
important
things
about
a
corporatio
So,
with
a corporation,
itraise
iswhy
very
black
and
white
you know
wha
general
partnership,
1/
it
is
more
difficult
to
capital
as
a
proprietorship
or
a
par
The
second
major
reason
we
focus
on
corporations
is
that
c
We
have
asked ourselves
why is it that corporations maximize va
and
we mean
2/
there
is
unlimited
liability
generally
in
the
sole
proprietor
and
Now,
there
areyou
a couple
ofa disadvantages
of
a corporation.
1/
The
limited
liability
notion
evaluation
it lowers the
risk
borne
byorder
invest
because
Igeneral
will
now
ask
tolimited
take
self
and
self
test in
And
then
finally
the
life
nature
of
the
sole
proprietors
an
1/
double
taxation.
One,
you
get
taxed
on
a
corporate
level
afte
2/
Capital
resources
a
firms
value
is
dependent
on
the
growth
everyone
who
isThe
a answer
Welcome
back.
to self-test
question
1.1stock
is represent
.
3/
The
third
notion
of
liquidity
investment
in
the
of
a
cor
partner
orfinally
an owner
1/
The
number
of
owners
and ease
of There
start-up
And
then
some
examples
topeople
think
about
we
are
Lets
compare
with
partnerships.
is awhen
general
partner
2/
Another
economic
reason
why
choose
not
to form
co
And
again,
itliability
is that
for
these
three
reasons:
1/
limited
liability,
2/thin
ca
Self-test
question
1.2
partnership
1.2:
in
this
partnership
2/
Investor
Now,
for
limited
partnerships,
these
are
a
little
bit
different
from
The
basic
point
here
is
that
if
you
are
a
big
company,
it
is
advan
C-corporation
has
unlimited
3/
Ease
of
raising
capital
Self-test
1.2
answer.
1.2Sub
S-co
So
an example
ofliquidity
a corporation
that you can think ofchapter
might be
C
liability,
and
we
will
4/
Firm
life
and
of
the
ownership
Next
we get
to the1.3
corporation.
The C-corporation has one or m

Self-test
question
C-corporation
1.3:
go
on
and
discuss
5/
Taxation
Compare
that
with the
S-corporation,
which
has fewer than
75 o
reasonC-corporation
S-corporation
Self-test
1.3
answer:
Again
the
why corporations
maximiz
1.3
what
unlimited
And
finally,
the
hybrid
entity
is a limited liability company that h
three-fold:
liability
means.
But
Please
a few
minutes
jot
down
your is
answer
this que
We
have
been
talking
a
lotand
about
value
forto
corporati
And
thetake
firms
life
and
liquidity
ofmaximizing
ownership
again
defined
by
1/
Limited
liability
lowers
the risk
borne
by the at
investor
and thu
there
is
the
second
1/
do
firms
have
any
responsibilities
to
society
large?
Again
we
pause
here
to
2/
Capital
argue
a firms
value
really dependant
on only
all the
type
of
partnership
Most
would
that
yes,iscorporations
do. Not
dogrowth
they ha
3/
Liquidity.
Investment
of
stock
in
a
corporation
is
easy
sell,
Self
test
1.24
answer.
which
is
called
the
1.
4
2/ Is stock price maximization good or bad for society in to
genera
limited
partnership,
And
the third
question
to ask
as financial managers wh
Self test
1.5. What
do Self
testourselves
1.5.
and in this
Self
test
1.5
answers.
partnership there is a Self test 1.5
Self testpartner
1.6. Based
general
thatj 1.6.
manages
the
Self test 1.6 answer. 1.6South
partnership, which
has unlimited
liability, but the
investors who are
called limited
partners have limited
liability, and again we
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Self test question 1.7 1.7: Boeing

Self test 1.7 answer. Managements
goal is to make the set of de
1.7
Although
management
can
control
their
decision, they can ultim
Self test question 1.8: 1.8:
Boeing
Now management had nothing to do with
these attacks and yet
Self test 1.8 answer. 1.8
Self test question 1.9 1.9Boeing
Now, we have talked already
about how maximizing value for sh
1/
There
is
the
projected
cash
flows
to the shareholders.
Lets take a moment very
quickly
to differentiate
the difference
2/
The timing
of this
cash
flow
stream
is very
important
because
Tradition
thinking
was
that
current
stock
prices
relies
upon
puba
Perhaps
it
is
better
to
try
to
differentiate
between
stock
prices
FRBAlan
Greenspan
3/
The
riskiness
of
these
cash
flows,
and
this
has
to
do
with
the
So
in
those
situations,
a
new
area
of
finance
called
psychologic
These
actionsearlier,
are generally
motivated
by
personal
or
selfish
rea
As
we
noted
value
in
a
corporation
is
determined
on
And we need not look any

further than what Alan Greenspan,not
th
There
variety
of factors:
Again, are
letsa take
a moment
to reflect on what we have learned.
1/
Managerial
actions
what is
managers
choosebetween
to do and
the de
Self
test question
1.10:
What
the difference
a stock
Self
1.10
answer.
1.10
And test
finally,
the
political1.10
climate. No one could have predicted th
Now,
these
three factors
combined will give
investors different k
Self test
question
1.1 1.11:
9/11
Self test 1.11 answer:

1.11
Self test question 1.121.12:
Self test 1.12 answer: Self test 1.12
Self-test question 1.1 1.13:
Self-test 1.13 answer: 1.13
Self-test question 1.1 1.14:
Self-test 1.14 answer: 1.14
The next topic we are going
to talk about is some important tren
The
second
area
of
an
important
trend that financial managers s
This chart shows the p
Lets take a moment

again
to 1.15
review
some 1.15:
Self test
answer:
of
thethe
concepts
that 1.15
Well,
three
areas
Lets
take
a
moment
an
we
learned.
thathave
are really
driving
Self
test
question
Lets
take
a moment
review the concepts we learned in busin
decision-making
for to
1.15:
what
are
the
Self
test
question
1.16:
How would you define business ethics?
financial
managers
Self test 1.16
answer: 1.16:
1.16
three
trends
that
these
days
are: 1.1
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Self test 1.17
business practices.
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management
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1.19:1.19:
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1.19 answer:
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Self
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1.20
that
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Self
1.21
3/
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the
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to understand that a
huge portion of their
businesses are
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Although we have been

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Home Work
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0
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Introduction
1
CHAPTER 2 Time Value of M
1
A Bird in Hand is Better Th
2
Time lines
3
Drawing time lines: $100 lu
4
Self Test 2.1
5
6
Self Test 2.2
7
8
Future Value (FV)
9
What is the future value (FV)
10
Graphical View of Compound
11
Solving for FV: The arithmet
12
Solving for FV: The calculat
13
Spreadsheet Solution
14
Self Test 2.3
15
16
Self Test 2.4
17
18
Self Test 2.4 Answer (contd
19
Self Test 2.5
20
21
Present Value (PV)
22
What is the present value (P
23
Graphical View of Discounti
24
Solving for PV: The arithmet
25
Solving for PV: The calculat
26
27
Self Test 2.6
28
29
Self Test 2.7
30
31
Self Test 2.8
32
33
Self Test 2.9
34
35
Solving for I: What interest
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Self Test 2.10

Self Test 2.11
Solving for N: If sales grow
Self Test 2.12
Self Test 2.13
Drawing time lines: Uneven
What is the PV of this uneve
Solving for PV: Uneven cash
Self Test 2.14
Self Test 2.15
Self Test 2.16
Self Test 2.17
Self Test 2.18
How FV/PV is used in Corpo
Annuities (FVA and PVA)
What is the difference betw
Self Test 2.19
Self Test 2.20
Solving for FVA for car paym
Solving for PVA for car paym
Self Test 2.21
Self Test 2.22
Solving for FVA for apartmen
Solving for PVA for apartmen
38
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Self Test 2.23

Self Test 2.24
Self Test 2.25
Self Test 2.26
Rates of Interest
The Power of Compound Inte
Solving for FV: Savings prob
Solving for FV: Savings proble
Solving for PMT: How much m
Will the FV of a lump sum be
Classifications of interest ra
Classifications of interest ra
Why is it important to consid
Can the effective rate ever b
When is each rate used?
Self Test 2.27
Self Test 2.28
Self Test 2.29
Self Test 2.30
What is the FV of $100 aft
Whats the FV of a 3-year $1
Method 1: Compound each c
Method 2: Financial calculat
Self Test 2.31
Self Test 2.32
Self Test 2.33
Amortization
Loan amortization
Step 1: Find the required a
Step 2: Find the interest pai
Step 3: Find the principal re
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Step 4: Find the ending bala

Constructing an amortization
Illustrating an amortized p
Partial amortization
Calculating annual loan pay
Determining the balloon pa
Self Test 2.34
Self Test 2.34
Summary
CHAPTER 2 Answer Set Time
Problem 2-1
Problem 2-1 Answer
Problem 2-2
Problem 2-2 Answer
Problem 2-5
Problem 2-5 Answer
Problem 2-6
Problem 2-6 Answer
Problem 2-7
Problem 2-7 Answer
Problem 2-8
Problem 2-8 Answer
Problem 2-10
Problem 2-10(a) Answer
Problem 2-10(b) Answer
Problem 2-10(c) Answer
Problem 2-10(d) Answer
Problem 2-10(e) Answer
Problem 2-12
Problem 2-12(a), (b) Answer
Problem 2-12(c), (d) Answer
Problem 2-18
Problem 2-22
Problem 2-22(c), (d) Answer
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captivate
slide/cap14.swf
slide/cap19.swf
slide/cap21.swf
slide/cap27.swf
slide/cap33.swf
slide/cap35.swf
slide/cap37.swf
Script
Script
Welcome back. I am Pro
Henry Wong
A bird in hand is bett 21
When we think about the
These next two examples
Now that weve gone ov
Self test 2.1 answer: T 2.1

Self test question 2.2: 2.2
Self test 2.2 answer: Y 2.23CD14
Now that we understand
So for example, our fi 100

But before we get to th
So now lets use the ar
If you have a financia
We also use Microsoft excel
to figure
out. The first we have
Microsoft
excelthis
Now that weve covered

The easier way to do it
is click on the function button on your to
Self test 2.3 answer: A
2.31
Next
for payment,
we can
ignore or write in a zero, it wont affec
Self test
question 2.4
2.4
Self test 2.4 answer: 2.4

Self test 2.4 answer continues.
Self test We
2.4 are
answer
looking
continues.
for the future valu
Self test question 2.5
Finally, the payment is 2.52,000
going to be zero, for the present value we
Self test 2.5 answer. Self test 2.5 answer.
0$10
Now that weve covered
We start off with the s

This is the graphical v
In order to solve for p
Solving for the present
Lets take a look at spreadsheet
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Now that weve looked

The second way is much
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Self test 2.6 answer: D 2
2.6
Next
for the
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Self test
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Self test 2.3 answer, weSelf
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2.3 answer
for the present value in this
Self test question 2.9 2.9510010

The second part asks us to look at this is the N periods were diff
Again, we are looking for
the PV, click this function and use the
PV
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So far weve talked aboOK$7,6
If we hit okay we see that

the present value of this would be $7,
This time was are solvi RATE
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slide/cap39.swf
slide/cap41.swf
slide/cap43.swf
slide/cap45.swf
slide/cap47.swf
slide/cap51.swf
slide/cap55.swf
slide/cap61.swf
slide/cap70.swf
slide/cap72.swf
slide/cap74.swf
slide/cap76.swf
slide/cap78.swf
slide/cap80.swf
Now lets do a couple

Self 2.10 answer. By using
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Excel excel
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Microsoft
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Self test question 2.152.15
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The sum therefore is $558.07. The simpler way to do it is use th
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all of the basic fundamentals of time
Now that weve talked

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As I mentioned before,
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When we click okay, we
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Self test 2.22 answers. Self test 2.22 answers.
OK
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slide/cap86.swf
slide/cap88.swf
slide/cap112.swf
slide/cap116.swf
slide/cap118.swf
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Self test 2.23 answer 1,095

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Self test 2.24 answer
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So what we have just w
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The first way we can so1
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slide/cap131.swf
Our fourth and final s 4

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Push here to start
Henry Wong
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Introduction
CHAPTER 3 Financial Statem
Basic Accounting Concepts
Basic Accounting Concepts
The annual report (10-K)
Financial Statements Reflect
Example: Kodak -Financial S
Self Test 3.1
Self Test 3.2
Self Test 3.3
Self Test 3.4
Basic Balance Sheet Terms
Basic Balance Sheet Terms
Types of Balance Sheet Asse
Types of Current Assets
Types of Current Liabilities
Types of Long-Term Liabiliti
Off-Balance-Sheet Financing
Allied Corp. Balance sheet:
Allied Corp. Balance sheet:
Self Test 3.5
Self Test 3.6
Self Test 3.7
Self Test 3.8
Basic Income Statement Ter
Allied Corp. Income stateme
Self Test 3.9
1
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
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Self Test 3.10

Self Test 3.11
Self Test 3.12
Self Test 3.13
Statement of Cash Flows: De
Allied Corp. Statement of C
Allied Corp. Statement of C
What can you conclude about
Self Test 3.14
Self Test 3.15
Self Test 3.16
Self Test 3.17
Self Test 3.18
Statement of Retained Earnin
Allied Corp. Statement of Re
Self Test 3.19
Self Test 3.20
Self Test 3.21
Key Measures of Performanc
What effect did the expansio
Did the expansion create add
What was the free cash flow
Self Test 3.22
What is your assessment of t
Does Allied pay its suppliers
Does it appear that Allieds
What if Allieds sales manag
How did Allied finance its e
38
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Would Allied have required e

What happens if Allied depre
Self Test 3.23
Self Test 3.24
Self Test 3.25
Self Test 3.26
Self Test 3.27
Financial Statements Benefi
Financial Statements Limita
Self Test 3.28
Self Test 3.29
Federal Income Tax System
Corporate and Personal Tax
Tax treatment of various use
More tax issues
slide103
Self Test 3.30
Self Test 3.31
Self Test 3.32
Summary
CHAPTER 3 ANSWER SET Finan
Question 3-1
Question 3-1 Answer
Question 3-3
Question 3-3 Answer
Question 3-5
Question 3-5 Answer
Question 3-6
Question 3-6 Answer
Question 3-8
Question 3-8 Answer
Question 3-9
Question 3-9 Answer
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Question 3-12
Question 3-13
Problem 3-1
Problem 3-1 Answer
Problem 3-2
Problem 3-2 Answer
Problem 3-3
Problem 3-3 Answer
Problem 3-5
Problem 3-5 Answer
Problem 3-6
Problem 3-6 Answer
Problem 3-7
Problem 3-7(b) Answer
Problem 3-8
Problem 3-8 Answer
Problem 3-10
Problem 3-10 Answer
Problem 3-11
Problem 3-11 Answer
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captivate
Script
Script
Welcome back to Financ
Henry Wong
Let's start our discussion
off with discussing and explaining som
In
order to
explain
concept
further, think about an example
A couple
other
verythis
imp
These basic accounting
Now that we know and

h GAP
1.
SEC
2.
In this slide, we see 4
Self test 3.1 answer Th

34
3.1
3.1

3.2
4
Self test 3.2 answer.

3.2

1.
2.
3.
Self test 3.3 answer Th

3.3
4
4
4
Self test 3.4 answer Y 3.4 10
Now that we have discus
There are some more ver
Lets look specifically

3
Now lets focus on spec
Now that we have taken
11
1.
Next, lets look at lon 2

2
1
2.
We just finished talkin
Now that we have talked

about some of the components of the
There
ways that we can ask these questions a
Now asare
wemany
go todifferent
the nex
Just a note on depreciation:

There are various ways that corpor
20042005
Self test 3.5 answer Th3.5
3.5
20042005
Self test 3.6 answer Ite100
3.6
Self test 3.7 answer Th3.7
Self test question 3.8 3.8 Allied Corpora
Slide 3 - 31 (02:02:18 3.8
Now that we have looked

at Allied Corporations
balance sheet,
Allied
Corporation
So
lets
start
off
with
the
first
one;
Gross
earnings.
You of
may
som
Now lets continue on
and
look at the other two levels
measu
The
second
important
thing
to
understand
about
gross
earnings
So
just analyzing
to recap again,
there are three levels of Profit that we loo
Before
AlliedAllied
Corporation
Now that we have gone

through
the basic and core concepts of
The
next
line
item
we
have
in
this
income statement is the Othe
Letstop for a moment
Self test answer 3.9. T

3.9
3.9
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Self test answer 3.9. T 3.10

Self test answer 3.10. EPS
3.10
3.11
Self test answer 3.11.
3.11
3.12 .
Self test answer 3.12. EBITEBITDA
3.12
Self test question 3.13.
Which is like3.13
a snapshot of the firms op
EBIT
3.13
Now that weve lookedAllied
at balance sheets
and the income statem
Corporation
So
the
cash
flow
statement
can
be
used
to
if a compa
Now lets look at AlliedAllied
Corporations cashdetermine
flow
statements
for 2
Corporation2005
So
what
we
first
do
is
add
that
portion
back
in
as
a
source
of
cas
Our next part of our ca
But to also balance this
out and to understand where the cash i
So again, what can we Allied Corporation
Self-test question 3.1 3.14
3.14
3.15
3.15
3.16
3.16
3.17
3.17
3.18
Self test answer 3.18. 3
3.18
Now that weve talked
Now we turn to Allied Allied Corporation2005

3.19
3.20
3.20
3.21
3.21
Now that we have reviewed
the four different
financial statemen
Allied
Corporation4
It
is
essentially
the
working
capital
required
and
acquired with in
So lets look specific NOWC
NOWC
Now lets turn our atteAll
Finally, we look at the NOPAT
or the Net Operating Profit After T
NOPAT
For
the
moment,
lets
assume
this corporation is in a 40% tax br
We now take a look at 40
We started off our dis FCF

Self test answer 3.22. Allied
CorporationFCF
3.22
Based on the followingFCF
Allied Corpor
Another interesting qu Allied Corpor
Does it appear that All Allied Corporation
Now lets consider whaAllied Corporation
So after reviewing the 4A
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3000
NOPAT
Would Allied have requi

2005
1000
What happens if Allied
depreciates
its fixed assets over a 7 year
Allied
Corporation10
1/
there
would
be
no
effect
on
the
physical
assets
Lets now take a revie 2000
1/
2/ the fixed assets on the

balance sheet would obviously declin
Self
test
answer
3.23.
When
companys
overallbepos
2/
3.23
evaluating
as
NOWC
3.23
3/ the
net
income
would
decline
wella because
it would
ch
4/
tax
payments
decline
as
well
because
youd
have
Selfthe
test
question
3.2 would
3/
NOWC
1000
3.24
5/
the cash
position
would improve as a result of all this.
4/
Selffinally
test answer
3.24.
3.24
5/
Self test question 3.2 FCF
3.25
NOPAT
3.25
NOPATEBIT1
3.26
FCF
3.26
FCF
Self test answer 3.27. 3.27

We are coming to an en
NOPAT
Having talked about the

3.28
3.29
3.29
We end our discussion
As weve stated earlie

So there are some vario
A couple more tax issue
The following figure o 3.62004

Lets take a moment to
3.30
3.31
3.3.1
3.32
3.32
To summarize, Chapter
33
Well, now we will revi 3
Question 3-1. What 4 fQuestion 3-1.
Question 3-3. Who are
Question 3-3.
Question 3-3 answer. B
Question 3-5. Explain
Question 3-5.
Question 3-6. Financia20051
Question 3-6.
Question 3-6 answer. I
Question 3-8.
Question
3-8.
Differentiate
between
operating cash flow and ne
Question 3-8 answer. O

Question
3-8 answer.
Question 3-9. What's
Question 3-9.
Question 3-9 answer. NOPAT
NOPAT is the profit a
company can generate

if it had no debt and
held only operating
assets. Net income is
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Question 3-12. What dQuestion 3-12.

Question 3-13. How doe

Question 3-13.
Question
B
3-13 answer.
Problem 3-1. Little Boo
Problem 3-1.
Little Books
Problem 3-1 answer. Wh
Problem
3-1Inc$3million
answer.
$3millionEBIT
Problem 3-2. Pearson Brothers
Problem recently
3-2.
reported an EBITDA of 7
Pearson
Brothers$7.5millionEBITDA
Problem 3-2 answer. InProblem 3-2 answer.
Problem 3-3. Kendo Cor

Problem 3-3.
Kendo Corners
Inc.$3.1million
Problem 3-3 answer. We
Problem
3-3 answer.
$3.1million$500,
Problem 3-5. Balance Sheet.
Which
the following actions are
Problem
3-5. of
B/
It
buys
new
plant
and
equipment
at
a cost of 3 million. C/ It r
Problem 3-5 answer. St
Problem 3-5 answer.
BD
Problem 3-6. Statemen
Problem 3-6. .
Problem 3-6 answer. Th
Problem
answer.
Computer3-6
World
Inc.$22.5m
Problem 3-7. WC Cyclin

Problem 3-7.
Cycling2004$55,000
Problem 3-7 A answer.WC
Problem
From
the3-7
statement
A answer.
of cash flows, the ch
Problem 3-7B Answer.
Problem
T
3-7B Answer.
Problem 3-8. The Clave
Problem 3-8.
The
Claven
Problem
3-8Corporation
answer.
EBID$750,000$200,000
Problem 3-10. Baillie Corporations
Problem 3-10.
income statement, dollars an
Baillie
Corporations
Problem 3-10 answer. Problem
A/
3-10 answer.
Problem 3-11. HermanA/NOPATEBIT1
Problem
I
3-11.
Herman
Industries
W
3-11 answer.
Henry Wong3
GAP
GAP
2,000
4
Ko
4
3.121
2
3.1
22
10K
3.2
4
3.2
4
2.
3. 4.
3.3
3.3
3.4 4
3.4 10QSEC
1
3
1
11
1
22
1
20051
20042
3.5
3.5
20055,760782
3.6
1003
1
3.6
3.7
200200300300
3.7
3.8 Allied Corporation 1231630

2004
3.8
d6.6320054.92
CorporationAllied Corporation
1
oration2
Allied
Corporation
2005
3.9
3.9
4
3.10
3.10
EPS
3.11
3.11
3.12 .
EBITDA
3.12
EBIT
3.13
3.13
ied Corporation
Net
Cash Burn
Allied
Corporation20053
d CorporationNo. 1
3.14
3.14
3.15
3.15
3.16
3.16
3.17
3.17
3.18
3
3.18
ied Corporation200520042400
3.19
3.19
3.20
3.20
3.21
3.21
ied Corporation4
OWC20042005Allied
CorporationNOWC
Allied Corporation20042005
OPATEBID
4060
FCFAllied Corporation2005
3.22
Allied
CorporationFCF7000FCF
3.22
orationNOPAT
Allied Corporation
Allied Corporation
oration107
3.23
3.23
NOWCNOWC
3.24
3.24
3.25
3.25
EBIT1-NOPAT
3.26
3.26
3.27
NOPATNOPAT300010
3.28
3.28
3.29
3.29
2004
3.30
3.30
3.31
3.3.1
3.32
3.32
33
-1.
-1 answer.
-3.
-3 answer.
-5.
-5 answer.
20051231
-6.
GAAP
-6 answer.
GAAP
-8.
-8 answer.
-9.
-9 answer.
NOPAT
-12.
3
-12 answer.
-13.
-13 answer.
1.
s1Inc$3millionEBIT$6million40%
answer.
$3millionEBIT$6million40%
2.
others$7.5millionEBITDA$1.8million$2million40%
2 answer.
$7.5millionEBITDA$1.8million$2m
3.
ners
Inc.$3.1million$500,000
3 answer.
.1million$500,0000
5.
5 answer.
A/$2million
A
6. .
6 answer.
World
Inc.$22.5million$278.9million$212.3
$278.9million$21
7.
72004$55,0002005$25,000
A answer.
7B Answer.
8.
8CorporationEBIT$750,000$200,000100
answer.
0,000$200,00010040%
10.
porations92$20billion
10 answer.
EBIT1EBIT$4billion0.6NOPAT$2.4billion
11.
dustries92CEO$2.5milli
11 answer.
$12.6million$2.5million
GAP
110K
SEC3
2,0001010
Kodak Corporation20051231
12
1231

1GM
1
21
GM
2
1
Dell
22004
12004
200420052.006.36
120041
2004460,00
300100200
2004220050.33
200200300
2004200575,000
A
19
20054.92
Allied
Corporation1231
4.91
on0405
200529

EPS
EBITDA
Net
Cash Burn
3
Allied Corporation
20
No. 116400No. 2
2400200516000110
NOWC
porationNOWCNOWC
EBIDNOPA
13100602005NOPAT785
20
Allied Corporation2005FCFFCFE
FCFNO
20042005NOPAT2
26076
NOPATAllied Corporation
2
Allied Corporation
NOWC
FCF
300010004000FCF
2
1510003040
20051231
NOPAT
$3million$3m
40%
A$1.8million$2million40%
$3.1mil
A/$2millionB/$3millionC/D/
C
$212.3million
million$212.3million$22.5million$89.
$250,000$170,000A/
$25,000
A
040%
$20billion$2billionBaillie$1.3
NOPAT$2.4billion$1.5billion
CEO$2.5million55%
EBT140%
GM
10K
SEC310Q10
Quarterly
10
2004
11231
www.sec.gov
GM
1
1
1
GM
2
1
20042005
20042005
20042005
2004200
13.23200517.23
2004460,0002005460,000
0.33
300300100200
5,0002,870
B
Allied
Corporation1231630
4.9112
040534602
29
EBITDA
Net Cash Build
Allied
Corporation
200571200
No. 282600No. 3
11002005
NOWC
NOPAT
NOPAT2005NOPATAllied Corporation13000
2005NOPAT78502004NOPAT11400
2005Allied Corporation1600017000
FCFEBIT
FCFNOPAT
20042005NOWC
Allied Corporation
3060
Allied CorporationAllied Corporation
71200
FCF
304015001800385
12
NOPAT
$3million$3million 40%$2million
$1.8million1.8m
$3.1million$500,0000
D/
$89.1million
$170,000A/B/$25,000
$25,000$55,000$30,000
A$50,000
EBIT$750,0000$750,000
$1.3A/NOPATB/C/
$1.5billion$3billion$4.5billionN
55%D&A10%40%
$1.67million$4.17million0.4
IBM CorporationIBM
10K10KSEC
10 Quarterly
2,000
Kodak2005
w.sec.gov10K10Q
IBMIBM
(WIP)
13
Dell
3045
11
1.455.24
200420051.364.90
7.232
2005
200
20
GM12
602Allied
Corporation
2004200535900
2929
EBIT
33
3
No. 35000
3300
2005NOWC72063200
on200591300NOWC94000
ation1300040
1700020054320
NOPATFCF
20042005Allied Corp
60
71200
4000
GM Motor CompanyGM
5103190035
510100015
20051231
$3million 130.6
1.8million0.6$3million$3million
$3.6million
$25,000$100,000$10,000
000
$750,00040%$300,000$450,000
C/D/
NOPAD$2.4billion$3billion
40%$2.5million
0.4$600,0001.1

IBMWalmartCostcoIBM
GM
10K
12
10
3045
413
4
IBM
DellD
3045
Dell
2005
200415200529
EBIT
1212
2
20043.4420059.44
200535900520002005
EBITDA
3Allied Corporation
4370043700
FCF
6320013
94000185000
2020041700
2005Allied CorporationFCF
FC
Allied
Corporation2005
200010004000
CompanyGM3576
035
151,800
2005123120051120051231
NOPAT
30.6$5million$5million$6milli
$3million$1.8 million$1.2million
$10,000
$450,000$450,000$200,000
3billion$5.4billion
$4.8million$4.1million$660,000
GAP
IBM30
10
McDonalds
Corporation
2
102,000200
income payables account

133126303930
Dell
WIP
29200529
4410
2COGSAllied
Corpo
200415
EBITDA)

Allied Corporation
2004200537900
43700
524004890091300
NOPAT
ionFCF1300040
FCF
00520042005
400020001000FCF1000
GM
15105
0035
20051231
GAAP
$6million$1million
2million
$250,000
$10,000$25,000$100,
$450,000$200,000$650,000EBIT
NOPAD$2.4billion$1.3billion
00$800,0001.1$880,000EBITD

IBM
10
2
McDonalds
1,8002,000
2005
393041
2929
1010
Allied
Corporation042805
200415200529
)2005EBITDA1400Allied Corpor
200516000
3790020042005
41100
91300200520042004
NOPATNOPAT2005
4017000
$3million$2millionEBID
0$170,000$30,000
$100,000$50,000$115,000
EBITEBIT$7
$1.3billion$1.1billion
000EBITDA$4.826million$880,000
IBM
1010
McDonalds
2
2,0001,800
Kodak
30
112
30
20042.00
3
29
20041.4620052.63
04280525
Allied Corporation2004EBITDA2900
16000
2004200535400
110082600
FCF
200484200
20057900NOPAT11700383
200512200449100
12
millionEBID$5millionEBITDA
$50,000
$115,000
EBIT$750,000140%0.6$200,000
$6.9$12.68
nalds
241
Kodak2005

3045
21

3045
6.376.37
20044.82200516.5
DA2900
826003
17003830200413300
NOWC2005FCF74400

35
EBITDA$7.5millionEBIT$5million2.5million
$200,000$650,000
$12.68million0.55EBITDA$5.7million10.55$
7
.5
510
2004
FCF
200413300
FCF74400
3576
2.5million
100%
0.55$12.7million
3
3
101010%
on50005000
FCFFCF
33
10%5
290019000EBIT20

5,700,0600720
55
EBIT200513100
2004200528100
720
20042005
5000
20042005
poration30
EBITEBIT
200557200
ration4300200513600Allied Corporation
5572002005
Allied Corporation
16400
00
EBITEBT2004EBT5900
2004EBT590020051700

EBIT
200414700EB

bottom line measurement
200414700EBT5900EBT
EBT20048800
88002005EBT267001
1700
16000

Push here to start
Henry Wong
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Home Work
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0
0
0
0
0
0
0
0
0
0
0
0
0
0
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Introduction
1
CHAPTER 4 Analysis of Finan
1
Why are ratios useful?
2
Trend analysis
3
Allied Corp. Balance Sheet: A
4
Allied Corp. Balance sheet: L
5
Income statement ($ in milli
6
Other data
7
Comparative Ratios and B
8
Self Test 4.1
9
10
Self Test 4.2
11
12
Self Test 4.3
13
14
What are the five major cate
15
Calculate Allieds forecasted
16
Comments on liquidity ratios
17
Self Test 4.4
18
19
Self Test 4.5
20
21
Self Test 4.6
22
23
Self Test 4.7
24
25
Self Test 4.8
26
27
What is the inventory turnove
28
Comments on Inventory Tur
29
DSO is the average number of
30
Appraisal of DSO
31
Fixed assets and total assets
32
Evaluating the FA turnover a
33
Self Test 4.9
34
35
Self Test 4.10
36
37
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Self Test 4.11

Self Test 4.12
Calculate the debt ratio and
How do the debt management
Self Test 4.13
Self Test 4.14
Self Test 4.15
Self Test 4.16
Self Test 4.17
Self Test 4.18
Self Test 4.19
Profitability ratios: Profit
Appraising profitability with
Profitability ratios: Return
Appraising profitability with
Effects of debt on ROA and
Problems with ROE
Self Test 4.20
Self Test 4.21
Self Test 4.22
Self Test 4.23
Self Test 4.24
Self Test 4.24 Answer (cont.)
Calculate the Price/Earnings
Calculate the Price/Earnings
Analyzing the market value r
Self Test 4.25
Self Test 4.26
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
0
0
0
0
0
0
0
0
0
0
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0
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0
0

Self Test 4.27
Self Test 4.28
An example: The effects of i
Reducing accounts receivabl
Effect of reducing receivabl
Potential uses of freed up c
Potential problems and limita
More issues regarding ratios
Self Test 4.29
Self Test 4.30
Qualitative factors to be co
Self Test 4.31
Summary
CHAPTER 4 Answer Set Analys
Question 4-1
Question 4-1 Answer
Question 4-10
Problem 4-1
Problem 4-1 Answer
Problem 4-2
Problem 4-2 Answer
Problem 4-4
Problem 4-4 Answer
Problem 4-5
Problem 4-5 Answer
Problem 4-8
Problem 4-8 Answer
Problem 4-9
Problem 4-9 Answer
Problem 4-13
Problem 4-13 Answer
Problem 4-20
Problem 4-20 Answer
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120

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captivate
Script
Script
Welcome back to Financi
Henry Wong
We first start off with
Again the first thing w
As you may recall from3
Chapter3, Allied Corporation underwent
But
at
this
point
in
time
we
dontsheet
have for
enough
to eq
m
We next look at AlliedsAllied
balance
their information
liabilities and
Corporation
In
section
in our equities we can see the answer. On th
As the
we next
look at
the top
Allied Corporation
As we look at the top Allied Co

Self test answer 4.1. A
4.1
4.2
4.2
4.3
4.3
Now that we have reviewed
the balance sheet and income state
In terms of liquidity ratios

the first ratio we'd like to calculate is c
You
can
see
that
for
Allied
the current assets again were 2.7 bill
So we are doing two thi
Lets take a moment to
4.4
4.5
4.5
4.6
4.6
4.7
Self test answer 4.7. I
4.7
4.8
Self test answer 4.8. W5
4.8
Our next four financial
4
So after reviewing the
Our next financial rat DSODSO
Now that weve taken aDSO
The next two financial
Now that we have calcul

4
Self test 4.9 answer: T 4.9
Self test question 4.1 4.10DSO
Self test 4.10 answer: 4.10DSO
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Our next two ratios de
So how does the debt m

Self test question 4.1 4.195EBIT5
Our next four financial 4
Now well look at the
The final two profitab
When we compare the
re
So to sum up the effect
Some additional proble
Now lets take a moment

Self test 4.21 answer: 4.21BEP
Self test answer 4.22: 4.22
Self test 4.23 questio 4.23
Self test 4.24 questio 4.24210
Self test 4.24 answer 4.24
Our next three ratios l 3
As we look at the trendPERPSR MBR
Again to sum up each of

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Push here to start
Henry Wong
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Introduction
1
CHAPTER 5 Financial Markets
1
The Capital Allocation Proce
2
How is capital transferred
3
Self Test 5.1
4
5
Self Test 5.2
6
7
What is a market?
8
Types of financial markets
9
The importance of financial
10
What are derivatives? How ca
11
Self Test 5.3
12
13
Self Test 5.4
14
15
Self Test 5.5
16
17
Self Test 5.6
18
19
Self Test 5.7
20
21
Self Test 5.8
22
23
Types of financial institution
24
Self Test 5.9
25
26
Self Test 5.10
27
28
Self Test 5.11
29
30
Physical location stock exch
31
Self Test 5.12
32
33
Self Test 5.13
34
35
Stock Market Transactions
36
What is an IPO?
37
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Self Test 5.14

Self Test 5.15
Self Test 5.16
Historical stock market per
Where can you find a stock
Self Test 5.17
Self Test 5.18
What is the Efficient Market
Weak-form efficiency
Semistrong-form efficiency
Strong-form efficiency
Conclusions about market ef
Implications of market effici
Implications of market effici
Self Test 5.19
Self Test 5.20
Self Test 5.21
Self Test 5.22
Summary
CHAPTER 5 ANSWER SET Finan
Question 5-1
Question 5-1 Answer
Question 5-2
Question 5-2 Answer
Question 5-3
Question 5-3 Answer
Question 5-4
Question 5-4 Answer
Question 5-5
Question 5-5 Answer
Question 5-7
Question 5-7 Answer
Question 5-8
Question 5-8 Answer
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Question 5-9 Answer
Question 5-10
Question 5-11
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captivate
Script
Script
Chapter 5. Welcome back
5Henry W
Lets start talking about
the capital allocation process. Like any
This
what
of capital. These are individuals an
Now,ishow
is we
thiscall suppliers
capital
Self testtransferred
question 5.1
between the buyers 5.1:
Self
test 5.1
answer:
The
three different ways that capital is tran
5.1
of capital
and
the
2/
an
investment
banking
house which serves as a middle man b
sellers
capital? 5.2
Self testofquestion
And
finally,
3/
financial5.2:
intermediaries help the capital allocatio
Well,
in
the
grocery
Self
test
5.2
answer:
E 5.2
These
are
the
three
that the capital allocation process is a
store example,
its ways
Now
that
we
have
talked
pretty easy - you go

into the
grocery
Now
lets
talk about the
different types of financial markets that
store,
you
look
for
Now that we know what
financial markets are, why are they even
apples,
you
go stock
to thefinancial
The
New
York
exchange,
for example,
is athe
primary
exampl
1/
Well-functioning
markets
facilitate
flow of
capita
Another
important
trend
produce
section,
take
Now
secondary
markets
are
the
markets
in
which
existing
2/ Well-functioning markets promote economic growth. alread
the
apples
andatake
Next,
we
the
difference
between spot financial
and futures
m
Now
lets
take
momen
Third
anddifferentiate
finally,
economies
with well-functioning
mark
New
York
them
to
the
cash
Self test 5.3 answer Ph5.3
5.3
register
Futures and
markets, however,
are markets in which
participants agr
Self test question

purchase
them. 5.4 5.4
Well,
in lets
the
Finally,
differentiate
the difference between
private and pu
Self test
5.4financial
answer
(p 5.4
markets, its
a little
Whereas
in
the
public
markets,
they
have
got
standardized
cont
Self
test question
bit more
complex.5.5 5.5
Self test
answer
P 5.5
There
are5.5
really
three
ways
that
capital
is
Self test 5.6 Differen
5.6
transferred between
Self
test
5.6
answer
P
buyers and sellers of 5.6 2
Self testThe
question
5.7 5.7
capital.
first way
is
a
direct
transfer.
Self test 5.7 answer A 5.7
This is where there is
Self
test transaction
question 5.8 5.8
a direct
Self test 5.8
between
oneanswer
party, A 5.8
who
could
be
the discus
Now that we have
buyer, and the other
Now
party,lets
whoreview
is the the t
seller
of capital,
in I 5.9
Self test
5.9 answer
5.9
Merrill LynchM
order
to question
access the
Self test
5.105.10
correct capital. So in
Self
test
5.10
answer
P
5.10
the grocery store
example,
this would
Self test question

5.1 5.11
be
a
direct
transfer.
Self test 5.11 answer

The second way that 5.11
Next
we lookmarket
specifica
the financial
allows
capitalagain
to bethe
Lets review
transferred
is
through
a middleman, or what 5.12

Self
test question
5.1 5.13 -
is
called
an
investment
banking
Self test 5.13
answer D5.13
house. This
Here
are a couple
more
middleman
basically
Another
very
common
sto
allows
and
helps
Apple
computers
buyers who are
looking for capital to

2
purchase the right
capital for the right
source. So imagine
yourself again
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Push here to start
Henry Wong
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Introduction
1
CHAPTER 7 Bonds and Their
1
What is a bond?
2
Bond markets
3
Self Test 7.1
4
5
Self Test 7.2
6
7
Self Test 7.3
8
9
Self Test 7.4
10
11
Key Features of a Bond
12
Effect of a call provision
13
What is a sinking fund?
14
Other types (features) of bo
15
Self Test 7.5
16
17
Self Test 7.6
18
19
The value of financial assets
20
What is the value of a 10-y
21
Using a financial calculator
22
23
The same company also has 1
24
25
The same company also has 1
26
27
An example: Increasing infla
28
29
An example: Decreasing infl
30
31
Self Test 7.7
32
33
Self Test 7.8
34
35
Self Test 7.9
36
37
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Changes in Bond Value over

Bond values over time
What is the YTM on a 10-yea
Using a financial calculator
Find YTM, if the bond price
Definitions
An example: Current and ca
Calculating capital gains yie
Self Test 7.10
Semiannual bonds
What is the value of a 10-y
Would you prefer to buy a 1
If the proper price for this
Self Test 7.11
Self Test 7.12
A 10-year, 10% semiannual co
Yield to Call
If you bought these callable
When is a call more likely to
Self Test 7.13
Self Test 7.14
What is interest rate (or price
Illustrating interest rate risk
What is reinvestment rate ris
Reinvestment rate risk exam
Conclusions about interest r
Self Test 7.15
Self Test 7.16
Default risk
Types of bonds
Evaluating default risk: Bond
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Other factors affecting defaul
Self Test 7.17
Self Test 7.18
Self Test 7.19
Self Test 7.20
Bankruptcy
Chapter 11 Bankruptcy
Priority of claims in liquidati
Reorganization
Self Test 7.21
Summary
CHAPTER 7 Answer Set Bonds
Problem 7-5
Problem 7-5(b) Answer (cont
Problem 7-6
Problem 7-6 Answer
Problem 7-6 Answer (cont.)
Problem 7-7
Problem 7-7 Answer
Problem 7-8
Problem 7-8 Answer
Problem 7-9
Problem 7-9 Answer
Problem 7-10
Problem 7-10 Answer
Problem 7-11
Problem 7-11 Answer
Problem 7-12
Problem 7-12 Answer
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captivate
Script
Script
Welcome back. Im Pro
Henry Wong
First question we must
ask ourselves is, What exactly is a bond
Now lets talk a little
1) First off there is the 1)
Treasury
bond. These are bonds, or IOUs
Now
lets
take a
moment
to review
thehave
topics
weve many
just covered
2) The
second
type
of bond
which we
covered
times
2)
2
3) The next
of bond
is called
municipal bond or a muni b
Self-test
7.1type
answer.
Self-test
7.1aanswer.
Self-test
question
7.1.
4)
The last
kind
bond
is
called
the foreign
bond.
These
b
Self-test
7.1.
A
long-term
debtofinstrument
in question
which
a borrower
agrees
toare
mak
3)
Self-test
7.2.
Self-test
7.2.
What is aquestion
bond? Please
explainquestion
and go to
the next slide when y
4)
What
are
the
four
main
types
of
bonds?
Please
list
them
now
an
Self-test 7.2 answer. Self-test

7.2 answer.
The
four
main
types
of
bonds
include
Treasury
4
Self-test question 7.3 Self-test
question
7.3 bonds, corporate
Why
are US
not7.3
completely
Self-test
7.3 Treasury
answer. bonds
Self-test
answer. riskless? Please tak
Treasury
bonds are
riskless
in the
default7.4.
sense of the word, bec
Self-test question
7.4.
Self-test
question
In
addition
to
default
risk,
what
key
risk
do

7.4 answer. investors in foreign b
Besides
default
risk in
investors face also currency risk
Now lets
talk about
sogeneral,
Another key feature of
You may also sometimes
Finally, some other fea

Self-test question 7.5. Self-test
question 7.5.
Define
putable
bonds,
income
bonds,
convertible bonds and ind

Putable
allow
holderquestion
to basically
Self-test bonds
question
7.6.the
Self-test
7.6.sell back or put bac
How
is
the
rate
on
an
index
bond
determined?
Please take a mo

7.6 answer.
The
an
indexed bond is based upon the inflation
Nowinterest
that we rate
haveon
a basi
slide/cap7-23.swf
slide/cap7-25.swf
slide/cap7-27.swf
slide/cap7-29.swf
slide/cap7-31.swf
slide/cap7-33.swf
slide/cap7-35.swf
So now lets take a sp

We can also use a fina
We can also use Microso
Microsoft Excel
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Now lets take a look 1
Again we can use our sMicrosoft Excel
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We again can take a lo N10
Excel
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We can also use our MiMicrosoft Exc

of the topics that weve just covered.
We can also use our MiMicrosoft Exc
Self-test question 7.7. Self-test question 7.7.
Self-test
question
7.8.inSelf-test
question
A bond that
matures
8 years has
a par 7.8.
value of $1000, an ann
8$1,000
A
12 years has a par value of $1000, an an
Bybond
usingthat
ourmatures
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Microsoft Exc
Self-test question 7.9. Self-test question 7.9.
Which
of7.9
theanswer.
previous bonds
is 7.9
a discount
Self-test
Self-test
answer.bond and which is a p
The discount bond is the
bond that matures in 8 years and has a
8
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slide/cap7-42.swf
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slide/cap7-49.swf
slide/cap7-52.swf
slide/cap7-55.swf
slide/cap7-58.swf
slide/cap7-61.swf
slide/cap7-68.swf
This next chart shows u

So again, to summarize
what happens to the bond values over ti
Now lets take a look a109%
1) At maturity, the value
of
any bond must equal its par value.
1)
Again
a couple
2) Alsotheres
if the rate
of debt
(or the going rate or the yield-to matur
3)
any2)
discount
bond
would increase over time
WeAlso
canthe
alsovalue
solveofthis
Microsoft
Excel
4)
And
the
value
of
a
par
value
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stays
flat at $1000 through
3)
We can also find the b

4) $1
Again, when we use our
Microsoft Excel
You might also ask your
Lets work on an examp
Now lets calculate the

to review some of the topics that wev

Self-test
question
7.10.
Self-test
question
7.10.
By
using
Microsoft
Excel
we would
simply
clickannual
on the coupon
function
Microsoft
Excel
Up
until
this
time, weve
only
been
discussing
Halley
Enterprises
bonds
currently
sell
for
$975.
They
have abo
7
Halley Enterprise$975
So our first example deals
with
a
question
about
what
the
value
1) We have to multiply 13%
the
years by 2, so that the number of per
1)
By
usingwe
a spreadsheet
2)
Also
divide
the
nominal
rate
2, soby
that
the multiplied
periodic rate
1) We know we have to1)
multiply
thebyyears
2 and
by
2)
2
2
3)
And
then
we
divide
the
annual
coupon
by
2
as
well.
if the
Next
question
is,
Wou
2) We divide the nominal rate of 13% by 2, which wouldSo

now
eq
3) 13%
2)
3)
And then
divide the annual coupon by 2, wh
Another
takefinally
on thewe
sawould
So just to summarize, if1
we
look at the different calculator inputs
3)
By using Microsoft ExcMicrosoft Excel

Thus, when we input these
numbers in our calculator we find th


Self-test
question
7.11.
question
Converting
the annual Self-test
coupon bond
to a7.11.
semi-annual coupon b
12
Self-test
Self-test
question
7.12.
Describequestion
how the 7.12.
annual
payment
bond
valuation
formula is cha
Harwell
Corporations
bonds have
a answer.
20-year maturity, an 8% sem
Harwell
Corporation20
Self-test
7.12
answer.
Self-test
7.12
1) We must multiply the
years
by 2, thus N is multiplied 2.
2N
Again
looking
for1)
the
present
value
bond
we clic
2)
also have
to discu
divide
the
nominal
rateofbythis
2 so
the so
interest
p
So We
far were
weve
been
WTM
2)
3)
And
finally,
we
need
to
divide
the
annual
coupon
by
2,
which
Now lets take a look Excel
3) 12
A
couple
points
on is
Thus
our of
new
formula
the value of the bond equals the coupo
Now lets compare the
So when is a call more


Self-test
question 7.13.
The
yield-to-maturity
isSelf-test
the ratequestion
of return7.13.
an investor would expe
Self-test
question
7.14.
Self-test
question
7.14.
Explain the
difference
between
yield-to-maturity
and yield-to-ca
The Henderson Companys

bonds
currently
Henderson
Company$1,275
Self-test
7.14
answer. sell for $1275. The
First
we need
is calculate our yield-to-maturity so we
Now thing
lets talk
a littleto do
The following graph ill

Now were done talking
So lets take a look a

So what kind of conclus
Self-test question 7.15.Self-test question 7.15.

Differentiate
between
rate risk and reinvestment rate ris
Self-Test Answer
7.15.interest
7.15
Self-Test Question 7.1 7.16

Self-Test Answer 7.16. 7.16
So far we have talked a
When we talk about default
risk, lets think about some of the ty
The two major agencies
Thus they have a senior

secured interest in those fixed assets. D
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00:00
00:00
00:00
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00:00
00:00
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00:00
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Here are some of the factors

affecting default risk and the bond
S
Still other factors could
affect the default risk rating as well. No.
Finally, they look at specific contractual provisions within the bo

No.3 is there any potential

anti-trust or product liability issues w
Now that we are talkin
Let's first start by talking
about Chapter 11 Bankruptcy. If a com
11
In Chapter 7 Liquidatio120
During these 120 days7
the court appoint a trustee to supervise t
So in Chapter 11 on Reorganization
we have to understand the
11
7.217()
Now we have come to 7()
th
Now lets review home7
Problem 7-5, an invest7-5
Problem 7-5A answer, 7-5AL
so problem A , find bond L present value
Problem 7-5B answer continued,
Part B asks us why longer-term
7-5B
Bond S we would simply
change the end period equal to one an
Problem 7-6, an inves 7-6
One year bonds value fluctuate more than the one month ones
Finally
for7-6
12%,
bondat
L7-64C
we would changed to the end period to
Problem
answer,
Problem 7-6 answer con
7-6C,Z
Problem 7-7, an investor
purchases the following bonds, each o
7-7
Problem 7-7 answer, with
the yield to maturity going at 8%, we c
What is the percentage7-78%10
change in price for Singleton
each of the
following
7-86
20
Problem
7-8,
six yearsso the rate of return is approximately 15.03
Problem
7-8
answer,
If
the interest
rates declined
tothe
7%value
then the
prices
7%
of at 10
protectionSingleton
Problem
7-9 answer,
we
know
of the
bond
equals
they
7-815.03%
Despite
a7-9,
15%Hammond
return
on
bonds,year,
investors
are not bonds
likely towill
be
The
percentage
change
for
10% coupon
Problem
cthe
7-9Hammond
7-9
In order
to find
the
value
of the
the 10
bond of $829
we simply input
e
Problem 7-10 answer, 8294-8
solve for yield to maturity which we know
The
value7-10,
of the
bond B
will be $1,104.00
so this time we ch
B"yes"829
Problem
Hooper
p we
7-10Hooper
Printing
B/ The current
yield is 7-10
to
findthe
that
currentcalculator
annual
coupon
paym
Problem
7-11 answer,
using
financial
we solve
the
80.00
The answer to part B isB)
yes
the price offer of $829 the yield to
The
expected
capital
gains
yield
found
thetodifference
However,
this is
theyear
periodic
rate,can
thebe
nominal
yield
maturity
C)
Problem
7-11,
last
7-11
Clarkeas
10
7-11
However again this is the periodic rate and we have to multiply
B)January
120.001,100
C/
A long7-12,
as coupon
payments
are
made,
the
current
yields
will
Problem
It is now
1,the
2006
and
are considerin
Problem
7-12
answer,
7-122006112004
calculating
yield
toyou
maturity
we are
us
C)
7-12
B/ The current yield equals

$100.00, $120.00
divided by 1,100
What
is the yield toinvestors
maturity,
the yield
to the
call,return
if you to
bought
this
B/ Knowledgeable
with
expect
be closer
B)8%
C/ The yield to maturity can be calculated by the current yields
C)
C/ If the bond sold at a discount this would imply that current in
Henry Wong7
12
answer.
estion
estion 7.1.
7.2.
2
answer.
estion 7.3
3 answer.
estion 7.4.
4
answer.
US
estion 7.5.
5 answer.
estion 7.6.
6
answer.
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Microsoft Excel
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Microsoft Excel
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23
estion 7.11.
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present
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13 answer.
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10
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IPO
IPO

Push here to start
Henry Wong
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Home Work
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0
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Introduction
1
CHAPTER 8 Risk and Rates o
1
Todays Lesson: No Pain,
2
Investment Returns
3
Investment returns
4
Selected Realized Returns,
5
Investment Asset Alternative
6
How do the returns of HP an
7
Return: Calculating the expec
8
9
Summary of expected returns
10
Self Test 8.1
11
12
Investment Risk
13
What is investment risk?
14
Selected Realized Returns,
15
Comparing standard deviati
16
Risk: Calculating the standar
17
Standard deviation calculati
18
19
Comments on standard deviat
20
Self Test 8.2
21
22
Self Test 8.3
23
24
Self Test 8.4
25
26
Risk & Return Together
27
Why is the T-bill return ind
28
Comparing risk and return
29
Coefficient of Variation (CV)
30
31
Risk rankings, by coefficient
32
Illustrating the CV as a measu
33
Self Test 8.5
34
35
Self Test 8.6
36
37
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
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Investor attitude towards ris

Self Test 8.7
Portfolio construction: Risk
Calculating portfolio expect
An alternative method for de
Calculating portfolio standa
Comments on portfolio risk
Correlation Between Stocks
General comments about ris
Returns distribution for two
Returns distribution for two
Creating a portfolio: Beginn
Illustrating diversification ef
Breaking down sources of ri
Failure to diversify
Self Test 8.8
Self Test 8.9
Self Test 8.10
CAPM & SML
Capital Asset Pricing Model
Beta
Comments on beta
Calculating betas
Illustrating the calculation o
Can the beta of a security b
Self Test 8.11
Self Test 8.12
Self Test 8.13
Beta coefficients for HP, Gol
Comparing expected return a
The Security Market Line (SM
What is the market risk pre
Calculating required rates of
Expected vs. Required retur
38
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0
0
0
0
0
0
Self Test 8.14

Self Test 8.15
Self Test 8.16
An example: Equally-weighte
Self Test 8.17
Calculating portfolio require
Factors that change the SML
Factors that change the SML
Verifying the CAPM empirica
More thoughts on the CAPM
Self Test 8.18
Summary
CHAPTER 8 Answer Set Risk
Problem 8-1
Problem 8-1 Answer
Problem 8-2
Problem 8-2 Answer
Problem 8-3
Problem 8-3 Answer
Problem 8-4
Problem 8-4 Answer
Problem 8-5
Problem 8-5 Answer
Problem 8-6
Problem 8-6 Answer
Problem 8-7
Problem 8-7 Answer
Problem 8-8
Problem 8-8 Answer
Problem 8-9
Problem 8-9 Answer
Problem 8-10
Problem 8-10 Answer
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captivate
slide/cap8-9.swf
slide/cap8-12.swf
slide/cap8-19.swf
slide/cap8-31.swf
slide/cap8-37.swf
Script
Script
Welcome back. I am Prof
Henry Wong
If you recall from our
We begin our discussio
Investment returns can(()(
Now lets take a look a19262004
about what returns are and what some
The
first one
T-bills and as I explained before, T-bills
So again
howare
do called
the ret
HP
So now back to returns,
our goal here is to calculate the expecte
Ok
but
right
now
we
are
looking
for therates
expected
rate for
of return
So let us try to figure out
the expected
of return
each of
Now that we are done

ca
So, the next thing we do once we are able to get the sum of the
But before going onto
Self-test 8.1 answer. I
Self-test 8.1 answer.
AB
Remember todays lesso
So lets first start of

Here we are again look19262004
Again standard deviatio
So when we talk about
r
So here we are going to
T-bills
So, we can also use our
spreadsheets in order to solve for stand
Now that we have calcul
McDonalds
Next, we look at McDonald's.

McDonald's we would also take th
Now,
because
we have
entered our formulas
incorrectly,
we can
Self test
8.2 answer

8.2

8.3 2
Self test 8.3 answer X 8.3

Now that we have looked
Why is the T-bill retur T-bills

Here we have a chart c
The coefficient of vari CV
In order to find the co-efficient
of variation, all we would need to
So again the coefficien

We can also illustrate
Now lets review the to
Self test 8.5 answer. T 8.5
Self test question 8.6. 8.610%
Self-test 8.6 answer. I Self-test 8.6 answer.
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slide/cap8-43.swf
slide/cap8-46.swf
Now lets take a review

Self test 8.7 answer. I 8.7
So far weve been looki
So in order to calcula
Using Microsoft we canMicrosoft Excel
There is an alternative
Also based on the infor
In this exercise, we are
asked to find the expected rate of return
1/
taking
the
sum
of
each
of these different standard deviations
There are some importa
So what we have been 2

ta
So, more general comme
Here are the returns th1.02

This next example shows
2
So, when we are creatin
This slide basically sh

Now lets break down th
What happens if an inve
Self test 8.8 answer. I 8.8

Self test questions 8.9 8.9
Self test 8.9 answer. I 8.9 1
Lets take a quick moment
just to review what we have just learn
Now
we
have
come
full
circle
to why all this stuff matters, and th
So, what exactly is CAP
CAPM
As I mentioned earlier
Some quick comments
on
Now you might ask yours
Heres an illustration
Can the beta of this se
Self test question 8.1 8.12 :
Self test question 8.138.13 5
The following slide repHPT-bills
Now we come back full
c
Now
that we
talked
about
the
expected
of return,
So before
wehave
go on,
lets
actually
take
a brief rate
moment
to talknow
ab
It
basically
says
that
this
is
what
the
investors
require
as
aover
minim
So
again
the
market
risk
premium
is
the
additional
return
So now lets go ahead
and apply our CAPM equation to each ofth
So
on
top
of
that,
the
market
return
represents
averagerequir
stoc
So
again
doescalculated
this
mean?
meansrates
thatthe
investors
Now
thatwhat
we have
theThis
required
of
return on
eac
We
doatthe
same
calculation
forwe
each
of these 17.4%.
differentThe
varia
If wecan
look
HPs
expected
return,
calculated
w
So
now
that
weve
all of these
required
rates
of retur
Lets
take
a look
at calculated
the
next
example.
For
Standard
&
Poors
ind
HP17.4%
Lets continue on to McDonalds.
McDonalds, if you recall, had
Standard
& the
Poo
Now lets go to the T-Bills.
The expected rate of return and
And then finally gold. Golds
expected rate of return was 1.7% b
McDonaldsMcDo
T-Bills
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3%

to review some of the topics that we h
Self-test 8.14 answer 3%

8.14
Self-test
question
The
expected
rate8.14
of return
has not occurred yet. This is the ret
8.14
Self-test
question
8.15
8.15
Differentiate
among rate
a stocks
expected
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its
K^,
or
the
expected
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must
be
thantake
therequire
How
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Self-test
K
8.15
All of the variables would
typically
be
different
unless
the
stock
A
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beta
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changes
in
the
compositio
Self-test question 8.16
8.16
A
stock has
a beta
of 1.2.
Assume that the risk-free rate is 4.5%
Self-test
8.16
answer.
10.5%
1.2
8.16
As
recall,
capital
asset pricing model, or CAPM is the req
Ouryou
next
slidethe
deals
wi
2
13.5%
to review some of the topics weve jus
Self-test 8.17 answer 3%

Self-test
question
8.178.17
The
betathere
of this
particular
portfolio
the
weight the
of Merrill
8.17
So
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two
ways
in
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can
calculate
portfo
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An investor has a two-stock

portfolio
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invested
in M
The
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required
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portfolio
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usi
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Lynch
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However there is another way that you can do it as well using th
Another factor that co
It should now be apparent

to
you that the CAPM requires a lot o
CAPM
Some
argue
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there
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additional
risk factors as well other
Some more thoughts on
t
Self-test question 8.188.18

Explain
following
Self-testthe
8.18
answer statement:
:
The
standalone
risk of8.18
an individual
project
be
quite
high,o
Through
diversification
one
project
may
havemay
lesslets
of an
impact
Now
weve
finally
reached
the
end
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take
a mo
Please take a moment 8

to answer
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and
go to8,
the next
slide
wh
Now let's review the assignment
for
chapter
eight,
Risk
and
Rate
8
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1
Problem
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Problem
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us what returns investors
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Problem
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Henry Wong
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Introduction
1
CHAPTER 9 Stocks and Their
1
Facts about common stock
2
Preemptive Rights
3
Control of Firm
4
Anti-Takeover Measures
5
Self Test 9.1
6
7
Self Test 9.2
8
9
Intrinsic Value and Stock Pri
10
Different approaches for est
11
Dividend growth model
12
Constant growth stock
13
Future dividends and their p
14
What happens if g > rs?
15
If rRF = 7%, rM = 12%, and b
16
If D0 = $2 and g is a constan
17
What is the stocks intrinsic
18
What is the expected market
19
Self Test 9.3
20
21
Self Test 9.4
22
Self Test 9.4
23
What are the expected dividen
24
Self Test 9.5
25
26
Self Test 9.6
27
28
Self Test 9.7
29
30
Self Test 9.8
31
32
What would the expected pric
33
Self Test 9.9
34
35
Self Test 9.10
36
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Supernormal or Nonconstant
Valuing common stock with
Find expected dividend and ca
Nonconstant growth: What if
Find expected dividend and ca
If the stock price was $2.00
Find expected annual dividen
Self Test 9.11
Self Test 9.12
Corporate Value model
Applying the corporate valu
Issues regarding the corpor
Given the long-run gFCF = 6%
If the firm has $40 million in
Self Test 9.13
Self Test 9.14
Self Test 9.15
Self Test 9.16
Firm multiples method
Firm Multiples (cont.)
Spreadsheet Example
What is market equilibrium?
Market equilibrium
How is market equilibrium e
How are the equilibrium val
Self Test 9.17
Self Test 9.18
Preferred stock
If preferred stock with an an
Summary
CHAPTER 9 Answer Set Stock
Problem 9-1
Problem 9-1 Answer
Problem 9-2
Problem 9-2 Answer
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Problem 9-3 Answer
Problem 9-4
Problem 9-4 Answer
Problem 9-5
Problem 9-5 Answer
Problem 9-6
Problem 9-6 Answer
Problem 9-7
Problem 9-7 Answer
Problem 9-10
Problem 9-10 Answer
Problem 9-11
Problem 9-11 Answer
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captivate
Script
Script
Welcome back. Im Professor
Henry Wong and today we will
be
Henry
Wong
So let's first start o
Another way for a company

to raise money is by issuing or sellin
A very common feature
So we know what the common
features of common stock is. We
So we know what the common

features of common stock is. We
What is a proxy fight then?

This is an attempt to gain control of a
Let's take a brief mom
What is a proxy fight then? This is an attempt to gain control of a
Self test question 9.2. 9.2
If you recall from our lecture
on Risk and Return you will remem
So there are different
So thus outside investors,

corporate insiders and analysts use a
Let's first start talki
We start off the dividend

growth model by first discussing a con
So dividends like any TD
Thus the dividend payment

stream is equal to D with the time p
You may ask yourself wh
Let's talk about RS or the

required rate of return on common eq
rs
So now let's apply the dividend
growth model formula and the c
SMLCAPMrs
Using
ourare
SML
or CAPM
equation
we
know that
RS is
equals
thekno
ri
What
we
given
again
is
that
the
dividend
today
$2. We
So what exactly is the
So what would be the e1
There is another way to
figure out the required rate of return on
Now let's take a momen
Dividend yield can be found

by taking the dividend expected in
Self test answer 9.7. W9.71
Self test question 9.8. Write
out and explain the valuation formu
9.8
So far we have been ta
Now let's take a moment

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slide/cap9-64.swf
So far we have been ta

How exactly do we evaluate
common stock with non-constant g
After
that
year,
year
4
is
called
ourcan
stepping
stone
year. Thus
if o
With the following information
we
find the
expected
dividen
4
Again
inalso
a non-constant
growth
what
ifof
the
growth
rate would
eq
23.38
We
out 3
that
at the
end
year
2 its
and we
at
If
wecan
want
tofigure
calculate
the capital
gains
yield
in
the$3.38
first year
Again we can find the 4
14
Thus we can use our stepping
stone year and calculate the expe
What if the stock was expected
to have negative growth such th
So we can also find theD1/(rs-g)
Thus the expected price

on this scenario would equal the D1 di
Let's take a moment to
Now let's go to the se
How do we apply the co
There are some issues

There are some issues
you should understand about the corpor
But remember our calculation
isnt done yet. If the firm has $40
Slide 9-5 (01:01:56)

Let's
review
some
of
th
1
4
So
an example
now or
and
apply
the corporate
value is
me$
Welets
taketake
out the
market
value
debt,
which
we will assume
Self test answer 9.13. 9.13FCF
Thus
anyquestion
free cash9.1
flows that the firm gets in the future it could
Self test
9.14
Selfintest
9.14.
So
thisanswer
case we
have9.14
expected future cash flows in year 1 of n
We come to the third m
3
Now well have a couple
of refreshers on market capitalization.
2
Let's look at a spreadsheet
example of how we can calculate usi
(PER)1
If we want to look at Price

to Earnings or PE ratio we could do it
So what exactly is mark
Next, given the sales and

the net income information for each o
In market equilibrium expected
returns are determined by estim
If
didexactly
that you
could
see that the price jumps considerably a
Sowe
how
is the
m
So how are the equilib
Let's review. Self test 9.17
So how do we calculate
Now weve reached the

9
Now let's review the 9
Problem 9-1, Work Corp
9-1Work11
Problem 9-1 answer, if91-1.50
given to us that the dividend today $1.50
Problem 9-2, Thomas Br
1D1
9-2
Thomas
Brothers
1
We start off with the dividend
payment
in year
one, D1
equals si
are given that the dividend expected a
D21.50
9-211
D2, we take the same formula
which is going to be the dividend
5%
Now the growth rate changes to 5% so in order to calculate the
Finally a dividend payment at year five would equal $1.50 multip
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9-10 Martel
Mining
Problem 9-3, Harrelson

9-3 Harrelson120.0
are given the price currently sells at $2
9-3120.00
Problem 9-4, Heart ente

9-4Heart
Next were expected to
find the requiredenterprises1.2
rate of return on equit
Problem 9-4 answer, the
terminal or horizon day is the day when
9-4
Problem 9-5, Smith Tec
B)
9-5
Smith Technologies
B/ In order to find the terminal

or horizon
or value we would
ha
Problem 9-5 answer, firms
free
cash
flow
is
expected
to
grow at
5%
C)
9-5
C/
The firms
intrinsic
value
is
calculated
Problem
9-6, Feefinders
as
the sum of the pres
9-6
To find the share of stock
we divideFeefinders160.0
equity value or in this case f
5.00rs
are told that the dividend on the prefer
9-65.00
Martel
Problem 9-7, What will15%
9-7
The required rate of the
stock is found by taking the dividend of
Mining
Problem 9-7 answer, ag

9-7
Problem 9-10, Martel mi

i
Problem 9-11, a stock 9-11
i
first we must solve for the current price w
Next, if the stock is it a constant growth rate the constant of divi
Henry Wong9
9.1
9.13
9.22
9.2
2
g
TDD0(1+g)Tg
CAPMrs+
26%
1211
9.3
9.3
9.46%GE
9.46%
2.12
9.5
9.5
9.62
9.6
9.7126%40
9.7112
9.8
9.81rs(
9.9
9.9g
9.10111%
9.105%1111%
413%
6%
3.3834.39
13%4.81%
30%6%
42.122.12
142
6%
D1/(rs-g)21
9.11
9.11
9.12
9.12
FCF
99.99%
(FCF)6%
411
15210320321.20
37694
9.13(FCF)
9.13FCFNOPATEBIT(1-t)
9.14
9.14
9.15
9.15(FCF)
9.16
9.16
3
21PSR
PER)11
(PSR)(PER)
660
9.172
9.172
9.18
9.18
550
Work11.5037%5%
1.50137%5%
D11+7%1.50
Thomas Brothers 10.507%

1.501.0722
110.507%
rs15%
5%1.50131+3
Harrelson120.00116%
120.00116%1
Heart enterprises1.25220%5%
2
1.801+5%1.801.05
Smith Technologies 1500

Feefinders160.005
5.0060.00
100.008%$60.00$80.00
rate
1rs-g
0.50D1.507%
rs-g0.5012%-7
1/35
2
2
gD11D01
D11rsg
T(1+g)T
rs
CAPMSML
26%1
1
111P111
GE5%7%
6%
30.297%1
rs
12405%
rs()g()
g1rsg
11%5%0%
11%5%16%16.67
330%6%
21.312.6
14
4.81%8.19%
30%2
.1213%6%
2125.72
11.88
6%13%
(FCF)
99.99%
FCF)6%(WACC)10%
(WACC)FCF
1
10%
13
CF)
-t)
PSR1PSR
1
PSR)(PER)PSRPE
2660
(CAPM)
7%5%51
15
1.501.501.071.61D1
rs15%1
221.7231.
s15%D1/RS-G1
311.0541.93
6%1
111+
10%
05
rs5%37.80

5%SmithWACC
1.
WACC

5
$60.00$80.00 $100.00$140.004
A8.0060.0013.33%B8.00
(1+)/(rs-g)5.005
12%4
0.5012%-7%10.00
23
1/33
50%75%3/4
D01g2D01
rsgPP^01
T
7%12%7%
121+3
12.12
11221
1132.10
11
D/rs
6.670%111%9.09
6%
330%6%
1D1P0
4.66
8.19%
212336%
330.29
25.727.78%113%
13%6%0.06
13%6%19%
FCF(WACC)
41600
154.542108.2643
37694137.69
11
PER
A,B,C,D,E
PERPSRPSRPER
6601006.64PSR
505
3
1.501.071.84
/RS-G10.5015%7%6.25
41.9351.50131+3

1+20.006%1

hWACC10%Smith5001
1.2511.5021.80
37.80
WACC
1500
5.0060.008.33%
13.33%B8.0080.0010%C8.00100.008%D8.0014
5%rs15%-5%
3
50%
1/33
2D012
11rs-g
(PVDPresent Value of the Dividend)D1+T
7%12%1.2
7%5%1.2
2
13%6%
12rs-g2
32.1030.2930.29
140
13%2
3
6%3
1P012.6054.11
2.602.302.38
8.19%30%
6%
13%
13%7.78%5.22%
6%0.0619%9
%
FCFFCF
2108.26432015.02636%
37.69
PSR
PSR2.7xPER13.3xXYZ100
PSR2.68
555010%
31+35%1.05452
121.201D
1
37.8039.60210%
1500WACC10%5%30

%D8.00140.005.71%
41+410.0
3
50%
75%50%
-g
D1+T
.2rs13%
21+g12.121+g
30.29
22.2513%6%1
6%
401+1.061
2213%
54.114.81%
2.382.654.39
330%
5.22%37%
9.89
6%
FCF(NOPAT)
344
Yahoo Finance
XYZ100500,000100PSR2.7x
522.03
1D11.0620
NPV35.43
30
23.75
10.0047%13.11
1+g222.251+
132.101+1
7%+6%13%
6%
213%15.38
4.393.05
30%
7%6%
6%19%
(EBIT)(1)
201.064121.20
PSR2.7x270PER500,000
1.06206%11.3%11.3%
35.43
1+6%332.38
132.10
%+6%13%
6%5%6%=11%
(EBIT)(1)
4121.2010%6%
500,000PER13.3
11.3%
67%
5%6%=11%11%

7%6%
6%3530
67%
13%22
4.67
6%
398
30500 160.00
212.121.88
4.676%
160.00160.00
.8822.251.7632.38
6%66.5466.54
416.94
32.381.65
66.5413%4
4346.11
54
54.11

Push here to start
Henry Wong
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Introduction
1
CHAPTER 10 The Cost of Cap
1
Todays Lesson: NO FREE
2
What sources of long-term ca
3
Calculating the weighted ave
4
Self Test 10.1
5
6
Self Test 10.2
7
8
Self Test 10.3
9
10
Should our analysis focus on
11
Should our analysis focus on
12
How are the weights determ
13
Component cost of debt
14
Component cost of debt
15
A 15-year, 12% semiannual co
16
Self Test 10.4
17
18
Self Test 10.5
19
20
Self Test 10.6
21
22
Component cost of preferred
23
What is the cost of preferred
24
Is preferred stock more or le
25
Why is the yield on preferre
26
Self Test 10.7
27
28
Self Test 10.8
29
30
Component cost of equity
31
Why is there a cost for retai
32
Two ways to determine the c
33
If the rRF = 7%, RPM = 6%,
34
If D0 = $4.19, P0 = $50, an
35
What is the expected future
36
Can DCF methodology be appl
37
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Self Test 10.9
Self Test 10.10
Self Test 10.11
Self Test 10.12
Self Test 10.13
Why is the cost of retained
If issuing new common stock
Flotation costs
Self Test 10.14
Self Test 10.15
Self Test 10.16
Ignoring flotation costs, wha
Self Test 10.17
Self Test 10.18
Self Test 10.19
Self Test 10.20
What factors influence a c
Self Test 10.21
Self Test 10.22
Self Test 10.23
Should the company use the
Risk and the Cost of Capital
What are the three types of p
How is each type of risk use
Self Test 10.24
Self Test 10.25
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How are risk-adjusted costs o
Finding a divisional cost of c
Calculating a divisional cost
Self Test 10.26
Problem areas in cost of capi
Self Test 10.27
Summary
CHAPTER 10 Answer Set The
Problem 10-1
Problem 10-1 Answer
Problem 10-2
Problem 10-2 Answer
Problem 10-3
Problem 10-3 Answer
Problem 10-4
Problem 10-4 Answer
Problem 10-5
Problem 10-5 Answer
Problem 10-6
Problem 10-6 Answer
Problem 10-7
Problem 10-7 Answer
Problem 10-8
Problem 10-8 Answer
Problem 10-9
Problem 10-9 Answer
Problem 10-10
Problem 10-10 Answer
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captivate
Script
Script
Welcome back. I am Professor
Henry Wong and today weWong
are go
Henry
As
you
know,
in
order
for
corporations
to
make
money
they
need
Before we proceed lets
go and take a quick review of everythin
We
willreally
be discussing
the
ways
and
the
sources
in which the
cor
Weve
learned
two
out
of
the
three
most
important
lesson
The
firstend
question
that 1
we should
ask ourselves
is what
sources
o
3
We
will
our
discussion
by
talking
about
flotation
costs
and
Next weve learned No Pain, No Gain, which in reality meanst
Now
we turnwell
to the
actual
of calculating
the weighte
(
Well
today,
learn
the calculation
thirddebt
and can
final
lesson.
Todays
lesson
1)
Long-term
debt.
Long-term
be
either
a
debt
issuanc
As
you
can
see
the
ws
here
in
this
equation
refer
to
theweve
firms
c
1)
Once
we
are
done
with
this
chapter
and
this
lecture
we
will
hav
Lets
take
a
quick
moment
to
review
some
of
the
topics
ju
3
w
2)
Next there
is preferred
stock.
The company
can issuestock
preferr
Whereas
in
preferred
stock
we
would
take
the
preferred
a
So
it is very
important,
again,
that we focus
in
and
that wein
undera
2)
3)
And
finally,
there
is common
whichtake
we
will
Self-test
10.1
answer
10.1
And
then
for the
common
stock,stock
we would
the focus
commonon
sto
Self-test
question
10.1
The
cost
of
capital
should
be
a
weighted
average
of
the
various
3)
10.1
The
Rs
in
each
of
these
components
refer toas
each
of the differe
Self-test
question
10.2.
10.2.
Why
should
the
cost
of
capital
be
calculated
a
weighted
aver
So,
the
basic
point
here
is that
you
have
spend
moneybut
in orde
Well
get
back
to what
the
(1-T)
means
intojust
a components
second,
let
Identify
the
firms
three
major
capital
structure
and
R
Self-test
10.2
answer.
3
10.2.
So
as
you
can
see,
the
cost
of
long-term
debt
plus
the
cost
ofwh
pr
And
then
finally
we
have
RS
(or
sometimes
referred
to
as
KS)
The
threequestion
components
are the cost
of debt, the cost of preferred
1-T
Self-test
10.3.
3
10.3.
So you might ask yourself,
Why is there a different connotation
()(
Why
might
there
be
two
different
component
costs of common
e
So
each
of
these
different
RS
R-components
or K-components
repr
(
Self-test
10.3
answer
2
10.3
And
then
finally
we
can
tie
all
this
together
and
calculate
the
we
The
two
types
of
cost
of
common
stock
are
the
cost
of
retained
Now lets get back to our

discussion about weighted average co
2
A
first
question
we
should
RK
A second question we 1
s ask ourselves is, Should our analysis
2
Another question you might

find yourself asking is, How are the
You
might
ask
yourself,
Should
wefirst
usecost
accounting
numbers
Now were ready to talk
about our
component
whichoris
1
The second question you
might ask yourself is, Do we use actu
We
must
multiply
the
cost
of debt
by talking
the taxabout
shieldhow
because
inte
2
Now
again,
we will
spend
some
time
manager
a)
interest
that
the company
needs
to
pay
in
terms
of
borrowing
Thus
if
our
before-tax
cost
of
debt
is
10%
then
we
know
that
the
a)
We
canissuance
also figure
out 10%
the
ofisdebt
by figuring
out
yield
b)
the
of bonds
cost
which
a security
transaction
into
thethe
marketp
Again
what
are
flotation
costs?
These
are
the
fees
So
in thisquestion
example10.4.
we have
an outstanding 15-year bond with ao
b)
Self-test
1153.7212
10.4.
In
our
next
slide
we
will
discuss
how
this relates
tothe
therate
yield-to-m
Now
wethe
want
to figure
out
what
the
actual
cost
de
So
there
are
two
different
thethan
corporation
can getof
acc
Why
is
after-tax
cost
ofways
debtthat
rather
the or
before-tax
cost
Self-test
10.4
answer.
10.4
Again,
we
will
talk
more
specifically
about
value
in
bonds
and
ho
So
the
marginal
cost
of
debt
capital
is
whats
important
to
us.
At
The
stockquestion
price depends
upon
after-tax
cash
flows
available
to
Self-test
10.5.
And finally there is this10.5.

1-T,
or
what
we
call
a
tax
shield
that
w
Why
is the
relevant
cost
of debt the interest rate on new debt an
Self-test
10.5
answer
10.5
1-T
The
company
is concerned
with the marginal (or new) cost of de
Self-test
question
10.6.10.6
A
company
has
outstanding
long-term bonds with a face value o
Self-test
10.6
answer.
11%8%
10.6
The
cost
of
debt
would
be
equal
to the
yield-to-maturity
thecob
Now we move on to the2
second cost
component
which isofthe
8%
It
alsodo
thewe
required
rate
ofcost
return
for investors
on that
preferre
Soishow
calculate
the
of preferred
stock?
Well
the co
And
again
our
calculation
here
will
ignore
possible
flotation
cos
Now
you
may
ask
yourself
Why
is
it
that
preferred
stock
is
value
Between debt and preferred
stock, which is the more risky prop
You may find yourself asking,

If preferred stock has a lower cos
a)
because
if they yield
dont
then
theyto
cannot
pay a common
dividen
Now
the question
after-tax
or
returns
an investor
and the after-tax
a)
Self-test
10.7.
10.7.
b) its going to be difficult
to raise additional funds if they do no
Is
taxpreferred
adjustment
made
to the
cost
of control
preferred
or
b)
c) athe
stockholders
may
gain
of stock?
the firmWhy
if they
Self-test
10.7 answer.
10.7
Tax
adjustment
is not
to preferred stock because dividend
c)
Self-test
question
10.8made
10.8
A
companys
stock currently trades at $80 per share,
Self-test
10.8 preferred
answer. 10.8
180
The
cost
of
preferred
stock
We have now come to
th can be solved by using this formula:
You
ask yourself,
Themay
dividend
per share
divided by the actual price per share.
(
1)(1
So now there are two ways
in which we will determine the cost o
2
So
thus,
the
cost
of
preferred
equals
ayou
$6pricing
dividend
per sh
The
first
way
you
have
already
learned
and
shouldmodel.
understa
In our first approach we
used stock
the
capital
asset
If
1
Thecan
other
way
is these
using1
a discounted
cash
flowequation.
model technique
80
We
just
plug
figures
in
to
the
CAPM
We
kno
Based on the discounted
cash
flow
approach
we
were
given
the
CAPM
Before we compare the2

two lets talk about the growth rate very
So
that
the dividend
per
share
today
atatime
is $4.19
inmore
this
following
example
we
have
firm0thats
been earning
014.19
One
problem
with
1
And
thatthe
thebasic
price
today
at
time
0
is
$50
thing to understand
between
using
all
of these dif
050
the cash flows are expected
to grow at a constant growth rate
5%
Whats the cost of this retained earnings based on the DCF app
We can plug this back DCF
into our basic DCF equation and see that
Now well combine this with our capital asset pricing model num
DCF
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Now that we have emplo

2
Self-test 10.9 answer. 10.9

Self-test
question
10.9.10.9.
Theres
an
opportunity
cost for the firm if it holds the retained e
Self-test
10.10.
10.10.
Why mustquestion
a cost be
assigned
to retained earnings? Please take
What
two
approaches
are
used to estimate the cost of common
Self-test 10.10 answer.
10.10
The
two approaches
that
we have discussed in this lecture are:
Self-test
question 10.11.
2
10.11.
Based
on10.11
what answer.
you already
know about capital asset pricing mo
Self-test
10.11
1) the capital
asset pricing
model, and
There
always
going
to
be
controversy
in estimating the risk-fre
1)
2) the is
discounted
cash
flow
method
Self-test
question
10.12.
10.12.
Which
of
the
two
components
of
the
discounted
cash flow form
Self-test
10.12
answer.2)
2
10.12
1)
Do we
use
long-term
or short-term
treasury
bills?
Under
the
capital
asset
pricing
model
we
simply
take
our
requir
The
growth
rategoing
is 10.13.
more
difficult
to estimate
because
it
involves
1)
2)
Second,
its
tocash
be
difficult
to estimate
thethe
beta
because
Self-test
question
10-47
(01:10:58)
Under
the
discounted
flow
method,
we
take
expected
3)
And finally
theres
difficulty
in the
estimating
the
proper market r
Suppose
you are
an analyst
with
following
information:
2)
2
Self-test
10,13
answer.
10,13
(1
3)
Using
the weve
CAPMtalked
approach
wethe
seecosts
that of
theretained
risk freeearnings
rate equals
5
10.13.
Now
about
we n
CAPM
Thethat
risk
rate equals
5.5%
Using
the free
discounted
cash
flow
approach
we
see
that
the
cost
o
The
average
flotation
cost
for
issuing
stock
in
a
marketplace
is
a
So,
The
market
risk premium
equals 6%
the
difference
aga
ABeta
is
0.8
few notes on actual f
The dividend expected
a year from now is $1
5.5%
Now
moment
toisreview
Thelets
pricetake
per ashare
today
$25 some of the topics weve jus
6%
Self-test
The growth
rate
equals
6%
10.14 answer.10.14
0.8
Self-test
question
10.14.
By
adjusting
the cost
of10.14.
equity
to include flotation costs, the new
Self-test
question
10.15.
10.15.
Explain
briefly
one
approach
thatusing
can be
to approach,
adjust for flota
What
is
the
firms
cost
of
11
equity
theused
CAPM
and
Would
firms
that
had many
good investment
opportunities
be
lik
Self-test
10.15
answer.
10.15
125
Firms
with
many more
good investment opportunities would typ
Self-test
question
10.16.
10.16.
6%
A
firm has
common
stock
with these following data:
Self-test
10.16
answer.
10.16
We
can
adjust
our
discounted
cash
flow
model
approach
by
Now
weveexpected
examined
of the
three
different
costjust
comp
CAPMDCF
(1)
3
Thethat
dividend
a each
year from
now
is $1.50
10.17.
11.50
The price
today is
$30
Self-test
question
10.17.
1)
The
weighted
average
cost
of capital
typically
alsoweve
calledjus
a
Self-test
Thelets
growth
is 5%1)
Now
takerate
aanswer.
moment
to review
someisof
the topics
10.17
30
10.17
2)
Now
the
second
very
important
thing
about
the
weighted
ave
We
The
flotation
costweighted
equals
4%
()
5%
know
that the
average cost of capital equals the w
2)
2
Self-test
question
10.18.
10.18.
These
are
the
two
most
important
4%
things
tocapital
remember
for how
Is
short-term
debt
already
included
in is
the
used
If the firm10.18
must answer.
issue new
stock, what
its
cost
ofstructure
financing,
orim
i
Self-test
10.18
2
Generally
short-term
debt
is
already
part
of
the
overall
debt
use
Self-test question 10.19.
10.19.
Why
does
the
WACC,
at
every amount of capital raised, represen
Self-test 10.19 answer.10.19
WACC
Each
newquestion
dollar raised
will consist of some debt, some common
Self-test
10.20.
10.20.
A
firm
has
the
following
data:
:
The
weighted
average
cost ofabout
capital
can
be found
by multiplyin
Now
that
were
done talking
the
weighted
average
cost3%
o
()
It has
a target
capital
structure of approximately
46% debt,
The
first
one
is
market
conditions.
These
are
things
that
the
ma
46%3%51
Thelets
tax rate
40%
Now
takeequals
a moment
to review some of the topics weve jus
1
Self-test
The cost
of
debt
is
7%
40%
10.21 answer.10.21
Both
The tax
cost
of preferred
stock
is 7.5%,
andof the firms control and
Self-test
question
10.21.
7%
rates
and10.21.
interest
rates
are out
Self-test
10.22.
10.22.
The cost
of retained
earnings
11.5%.
What
twoquestion
factors
that
affect
theiscosts
of capital are generally be
7.5%
What
are10.22
the three
factors
under the firms control that can affe
2
Self-test
answer.
10.22
Assume
the
firm will
not
11.5%
beaffect
issuing
stock.
is thisare:
firm
The
three
factors
that
can
thenew
firms
costWhat
of capital
Self-test
question
10.23.
10.23.
Suppose
interest
rates
in the economy increase. How would suc
Self-test
10.23
answer.
10.23
1)
its capital
structure
If
interest
rates
increase,
the
cost
of debt wouldhurdle
increase
as(or
welw
1)
2) its that
dividend
payout
ratio
Now
we have
calculated
the corporations
rate
(
(
3)
capital
decisions to accept more or less
2)
To altering
illustrateitsthis
poinbudgeting
1) a high-risk WACC
3)
1)
So
when
wererisk
looking
atWACC
the different project risks, there are re
2) an
average
WACC
2)
WACC
3)
low-risk
WACC
So ahow
are each
of thes
1) the standalone risk
3)
WACC
1)
Self-test
question
10.24.
10.24.
2)
the
corporate
risk
So
therefore,
talking
about
a project with
low risk,
would be
Why
is
the
cost
of
capital
sometimes
referred
to asthey
the hurdle
ra
2)
3) the market
Self-test
10.24risk
answer.
10.24
In
capitalquestion
budgeting
decisions,
the returns on the project must j
3)
Self-test
10.25.
10.25.
The
standalone
risk
involves
a
quantitative,
mayberisks?
a qualitative
How should firms evaluate
projects with different
Please
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Different
projects
different risks. The projects WACC shou
So far weve
been have
talk
WA
Lets take an example by
finding a divisional cost of capital for a
So this is how we woul

They have a target capital
structure of approximately 40% deb
10.26.
40%60%
Self-test
question
The cost
of debt 10.26.
is 12%
Should
divisions
within
the
same firm all use the firms composi
12%
The risk-free
is 7%
Self-test
10.26rate
answer.
10.26
Now
The
risk premium
on
the
market
isdiscussion
6%
For
calculating
division
WACCs,
you
make subjective
7%
were
reaching
the
end
of our
on the adjustmen
cost of cap
WACC
The beta of this specific
division
of
our
estimate
is 1.7
6%
letsrate
takeisa40%
moment to review some of the topics weve jus
Now
1)The
Fortax
privately
owned
firms,
we dont really have any publicly a
1.7
1)
10
problems as you ca
Self-test
10.27
answer.
10.27
2)
There
are
a
whole
bunch
of
measurement
Self-test
question
10.27.
How
would
we
calculate
40%
the
cost
of capital
capital
for different
this
division?
Problems
include
as
just
discussed
privately
owned
firms
no
2)
10.27.
3)
We
need
toreached
adjust these
of
for
types
We
have
now
th
10
Identify
some
problem
areascosts
in the
cost of capital
analysis.
Dooft
4)
And finally,
capital structure
rates. The process of actually ca
3)
Chapter
10 homework.
4)
Problem 10-1. The Haus
10-1Hauser
Problem 10 -1 answer.10-1
T
Problem 10 -2. Tuny In10-2 Tuny Industries 1
Problem 10- 2 answer.10-247.50
Problem 10-3. Percy Mo
10-3Percy Motors
Problem 10-3 answer. 10-340%
We are given that the debt structure is 40
Problem 10-4, Javits a 10-4 Javits and Sons
So we can simply plug this information into our RS formula whic
Problem 10- 4 answer,10-430.00
we are given that the price today is $30.
Problem 10-5, Midwest10-5
estimates its WACC atWACC10.5%
10.5% the compa
We can simply use our formula whereMidwest

the cost of common equit
Problem 10- 5 answer.10-5A,B,C,D,
Project
A,
B,
C,
D
and
E
would be accept
10%
A1000
We have project A which will be a $1 million investment with the
B/ we are10-6,
asked
if we
were
to
issue
new
common
stock
in
the
m
Problem
the
earnings,
dividends
and
common
stock
price
1
10-6
Carpeto
technologies
Inc.
Project C with the 11.3%
which is greater
than
that a WACC
of 1
Problem 10-6 answer, 10-6DCF
using the DCF approach we know that th
DCF
Using the DCF approach, what is its cost of common equity? If t
Problem 10-7. The Eve10-7
CAPM
B/ If we use the CAPM approach we EverneckD1
can figure that the cost of c
Since
we 10-8.
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have equal
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Problem
Pa
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we can find the
costPaints
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we know that
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asked
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Problem
thetoPatric
This would equal $2.1410-9Patrick
given the information and the growth ra
In order to solve this
C/ The cost of new equity again go to our original DCF approach

Now we can
that number
into
our
overall
WACC
equation
Problem
10- plug
10, Close
Outfitters
Inc,
think
that
its optimal
capita
10-10
Close
Outfitters
Inc.
$4
million
of
debt.
The
CFO
estimates
that
a
proposed
expansio
Again it should
a10-10
lot
of intuitive
to you because
if we used
Problem
10-10 make
answer.
If the
project requires
approximately
5.9
Needing $2.36 million in debt the firm could get by raising debt
Henry Wong10
321
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Push here to start
Henry Wong
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Introduction
CHAPTER 11 The Basics of C
Todays Lesson: Not all ide
What is capital budgeting?
Steps to capital budgeting
Self Test 11.1
Self Test 11.2
Self Test 11.3
What is the payback period?
Calculating Payback
Calculating payback
Strengths and weaknesses o
Discounted payback period
Self Test 11.4
Self Test 11.5
Self Test 11.5 Answer (cont.)
Net Present Value (NPV)
What is Project Ls NPV if r
Solving for NPV: Financial ca
Rationale for the NPV metho
Self Test 11.6
Self Test 11.7
Internal Rate of Return (IRR)
Rationale for the IRR metho
How is a projects IRR simil
IRR Acceptance Criteria
Self Test 11.8
1
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
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Self Test 11.9
NPV Profiles
Drawing NPV profiles
Comparing the NPV and IRR
Reasons why NPV profiles cr
Reinvestment rate assumpti
Self Test 11.10
Self Test 11.11
Self Test 11.12
Self Test 11.13
Since managers prefer the I
Calculating MIRR
Why use MIRR versus IRR?
Self Test 11.14
Self Test 11.15
Self Test 11.16
Summary
CHAPTER 11 Answer Set The
Problem 11-1
Problem 11-1 Answer
Problem 11-2
Problem 11-2 Answer
Problem 11-3
Problem 11-3 Answer
Problem 11-4
Problem 11-4 Answer
Problem 11-5
Problem 11-5 Answer
Problem 11-6
Problem 11-6(b), (c) Answer
Problem 11-7
Problem 11-7(a) Answer (con
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Problem 11-12
Problem 11-13
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captivate
slide/cap11-26.swf
slide/cap11-31.swf
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Script
Script
Welcome back to Financ
Henry Wong
As you recall, we have 3
We start off in this le
There are really five steps
to capital budgeting:
5
First off though, let
1) We must estimate the
cash
flows of the potential project or th
1)
Another
question
we hav
1
2) We need
to assess
the
riskiness of those cash flows.
2)
3) Welets
need
to determine
thereview
appropriate
cost
capital
which,
Now
take
a moment
to
some of
theoftopics
weve
jus
4)
And
then
we
find
the
net
present
value
or
the
internal
rate
of
3)
Self-test 11.1 answer. 11.1

5)
Then
finally
we
accept
if
the
net
present
value
is
greater
than
Self-test
question
11.1.
4)
There
arequestion
really three
between security valuation and
11.1.
Self-test
11.2similarities
3
How is capital
budgeting
similar to security11.2
valuation and how is
5)
What
are
some
of the
ways
that firms
generate
capital
projects ay
Again
when
were
talking
about
the
steps
of
capital
budgeting,
Self-test
11.2
answer.
11.2
1) First off in both security valuation and capital

budgeting
we h
Management
can
seek
to
develop
new
projects
simply
2) Also inquestion
both of these
we
have to discount
both cash through
flows at si
Self-test
11.3.1)
11.3.
3)
And finally
our
investment
decision
is always the
in both
Whats
the
difference
between
an independent
andsame
a mutually
e
2)
Self-test
11.3
answer.
11.3
3)
Independent
projects
are
if the cash flows of one another are un
Now
off wit
Therelets
are start
a couple
of key
differences, though, that you should b
In terms of calculating
In this example there a2

Here are some strengths
and weaknesses of using the payback p
So one of the weaknesses

that we have just talked about is that
1
1) It provides an indication
of a projects risk and liquidity pretty
1)
Self-test
question
11.4.
2)
Its very
easy0to11.4.
calculate
and understand as you can see. We
1)$-100
at
time
Discuss
some
of the2)
benefits
of using the payback method an
0100
Self-test
11.4
answer.
1)
2)$9.09
after year
1 the11.4
Do
people
follow
payback
method
rigidly
in a typical
capi
The
weaknesses
though
are:
1)
The
benefits
include
it provides
indication
of a projec
19.09
$49.59
after year
2 Self-test
Self-test
question
11.5.
questionan
11.5.
2)that
1)
2)
So the
net-net
is we
only
use
this
as aflows
benchmark, we dont u
Self-test
And
finally
in :
year
3.
Project
P11.5
has$60.11
aanswer.
cost
of
$1000
and
cash
Self-test
249.59
$1,000
11.5
answer. of $300 per year fo
2)
1) It ignores
the
time value
of money
Self-test
360.11
Project
Ps
payback
calculation
can
be
as
follows.
Wepresent
see thatvat
2)
Wewe
dont
discount
any
of these
cash
flows
back
to
Self-test
11.5
answer
continued.
11.5
answer
continued.
Now
take
the
cumulative
cash
flows
of these
present
values
1)
3)
It
also
ignores
cash
flows
occurring
after
the
payback
period,
We
can
also
use
the
discounted
payback
calculation
to
calculat
We will now move on to
2)
AsInathe
thirdlets
we line
we
start
out
with
spending
$100project L. W
review,
figure
out
the
net
present
value
in net-net
intoday
real
3)
life,
financial
managers
willfor
the us
payb
So
negative
Then
we $1000
areas
able
to make
$9.09
after year
1use
giving
an
back
$1000
Remember,
$261
afterwe
year
1add
we
can
solve
And
then
can
back
3100
in
another
$49.59
after
year
2
and
in
yearafter
timeyear
0 we
cash flows of negative $100,
1$261
$227
2 have
The
And
finally
break
some
time
in year 3 because we hav
following
the
s even
19.09
Excel
year
timewe
1iswe
cash
flows
of $10,
in
$197
after
year
3 have
2$227
0$100
Lets
in
year
time
2 we$572
have
cash
$60,4.
again
review
the
at
249.59
So
And
then
the flows
endofofof
year
thus,
thefinally
discounted
payback
the
long-term
is really the sa
3$197
Now
and
finally
in
year
time
3
we
have
cash
flows
$80.
1$10
lets review some
of60.11
the topics weve
justof
covered.
2$60
$572 of each of these cash flows

If
we take11.6
the answer.
cumulative
calculation
Self-test
Self-test
11.6present
answer.value we get negativ
If
we
discount
each
of
these
to
the
Self-test
question
11.6.
3$80
Self-test
question
11.6.
NPV
(or
net
present
value)
is
the
primary
capital budgeting crite
Self-test
question
11.7.Self-test
question
Why is the
net present
value regarded
as11.7.
being the primary capi
What
are
the
net
present
values
of
projects

11.7 answer.SS and LL if both ha
This
thehave
spreadsheet
solution. As you can see we first want to
So fariswe
covered
The following is the sp Microsoft excel

Now lets again talk ab
Another very important1
Let us now review the a
Lets take a quick moment
and review the topics weve covered
Self-test question 11.8.Self-test question 11.8.

In what sense is the IRR
on a project related to the yield-to-matu
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slide/cap11-40.swf
slide/cap11-62.swf

The
yield-to-maturity
on
a bondquestion
and the IRR
on a project are exa
Self-test
question 11.9.
Self-test
11.9.
The
cash11.9
flowsanswer.
below for
projects
SSanswer.
and LL are shown. What ar
Self-test
Self-test
11.9
This
theweve
spreadsheet
solution. We will use the spreadsheet th
Now is
that
covered
If we plot the followin

Again, when we compare
the net present value and IRR method
So, really there are a couple

of reasons why the net present valu
1) If the projects are independent

then the two methods are alw
1)
So
that reallyifbegs
th
2) Size
However,
projects
are
mutually
exclusive,
then up
if the
we
1)
or scalethe
differences.
The
smaller
projects frees
funds
2)
1)
Self-test
11.10.
Self-test
question
11.10.
2) Timingquestion
differences.
The project
with the
faster payback provi
Do
the net
present
value
and internal
rate of return criteria lead
2)
Self-test
11.10
answer.
Self-test
11.10 answer.
If
the products
are11.11.
independent,
then the11.11.
two methods are goin
Self-test
question
Self-test question
What
is the
crossover
and how
does
it interact with the cos
Self-test
11.11
answer.rate
Self-test
11.11
answer.
The
crossover
rate
is
the
cost
of
capital
at
which the net present
Self-test question 11.12.

Self-test
question 11.12.
What
two11.12
characteristics
can lead
to conflicts
Self-test
answer.Self-test
11.12
answer. between the net p
Two
concepts
in particular.
First
one is size
or scale matters th
1
Self-test
question
11.13.
Self-test
question
11.13.
What
reinvestment
rate
assumptions
built into the net prese
Self-test
11.13 answer.
Self-test
11.13are
answer.
The
net
present
value
again
assumes
that
the cash flow is reinve
So,
the good
main access
problem
IRR
a) with
toth
external
capital,
or
a)
b)
no access
to external
capital?
So with
in order
to calculat
b)
Now that weve learned
why the MIRR is a more accurate measu
3
Please take a moment MIRRIRR
to think about this and go to the next slid
of the topics that weve just covered.
1) The modified internal

of return correctly assumes that th
1) rate
Self-test
11.14
answer.
Self-test
11.14
answer. and the modifie
2)
Managers
like
the
rate
of
return
comparisons
Self-test
question
11.14.
Self-test
question
11.14.
The
MIRR
assumes
that
the
reinvestment
is at the opportunity c
2)
MIRR
Self-test
question
11.15.
Self-test
questionthe
11.15.
What is the
primary
difference
between
MIRR and the IRR?
MIRRIRR
However,
we have
to have
caveat
here.
is not
eas
What
advantages
does
the aMIRR
have
overThe
theMIRR
regular
IRR?as Ple
IRRMIRR
Self-test
11.15
answer.
Self-test
11.15
answer.
Managers
like the 11.16.
rate MIRRIRR
of returnquestion
comparisons
and MIRR is better
Self-test question
Self-test
11.16.
Projects
S
and
LL
have
the
following
cash
flows
SLL
Self-test 11.16 answer.Self-test
11.16 answer. below and their
We
startreached
off trying
to figure out the internal rate of return for
Nowfirst
weve
the
11
Chapter 11 answer set.LL
11
Problem 11-1, Project 11-1K52,125

us
Problem 11-2, Refer pr11-211-1

us
Problem 11-3, please r11-311-1
u
s
Problem 11-5 answer, 11-5K
w
Problem 11-6, your division
is considering two projects that the
11-6
Problem 11-6A answer.11-6A
Project B has -$20 million today, 10 million a year from now, the
Problem 11-6 B & C answer.
A)
11-6B,C
A/ Using a financial calculator,
we can enter the following the d
Problem 11-7, a firm wA
B)B
11-7WACC14%
B/ Using that the data for project A we can enter the cash flows
B/ Project
B we answer.
can do11-7A
this same calculations by looking at the
Problem
11-7A
At
a WACC
of 10%
the A
net
Problem
11-7A
answer
c present value of B is greater than the
11-7A
Project A we can calculate
the cash flows of -$6,000 upfront an
For the MIRR we would solve for future value of each cash flow a
00:00
00:00
00:00
00:00
00:00
00:00
00:00
Problem 11-7A answer11-7AB

continued, now let's look at project B for
Problem 11 -7 A answer
continued, next we are going to look at
11-7A
The internal rate of return
for project B. would equal 16.8%, if w
Problem 11-7 B, D answer
continued, now let's summarize
some
11-7B,C,D
o
The discounted payback period, first we have to discount
each
Problem 11-12, a company
is analyzing two mutually exclusive p
C
In terms of internal rate11-12
of return project A was 19.8% and proje
Problem 11-12 answer,DNPVIRR
in
order
to find the better project and th
11-12
Project
L has
-$1,000
today
and cash
zero cash
year one,
b
We
would
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the
appropriate
flowsflow
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ourboth
Excel
spread
The
answer
to B aisfirm
if the
projects are independent,
project
Problem
11-13,
11-13
Problem
because
both
projects
are the
same
size
Project
S11-13
would answer,
give
us11-13
net
present
value
of $39.14
and
an IRR
C/ If the
project
were
mutually
exclusive
then
only one
project
Y
Next we do the same thing for project Y, we would solve the futu
D/ The conflict between
net present value and internal rate of o
MIRRXYX
Since the modified internal rate of return of X is greater than the
Henry Wong11
3
5:
11.1
11.1.
3:
11.2
11.2
11.3.
11.3
11
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11.4.
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LLS

Push here to start
Henry Wong
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Introduction
CHAPTER 13 Capital Structu
Optimal versus target capital
Benefits and costs of using
Factors affecting capital str
Self Test 13.1
Self Test 13.2
Self Test 13.3
Self Test 13.4
What is business risk?
What determines business ri
What is operating leverage, a
Effect of operating leverage
Using operating leverage
What is financial leverage? F
Business risk vs. Financial ri
An example: Illustrating effec
Firm U: Unleveraged
Firm L: Leveraged
Ratio comparison between l
Risk and return for leverage
The effect of leverage on pro
Conclusions
Self Test 13.5
Self Test 13.6
Self Test 13.7
Self Test 13.8
Self Test 13.9
Self Test 13.10
1
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
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25
26
27
28
29
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31
32
33
34
35
36
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Self Test 13.11
Optimal Capital Structure
Sequence of events in a recap
Cost of debt at different debt
Why do the bond rating and
Analyze the recapitalization
Determining EPS and TIE at d
Stock Price, with zero growt
What effect does more debt h
The Hamada Equation
The Hamada Equation
Calculating levered betas an
Table for calculating levered
Finding Optimal Capital Stru
Table for calculating levered
Determining the stock price
What debt ratio maximizes
What is this firms optimal c
Self Test 13.12
Self Test 13.13
Self Test 13.14
Self Test 13.15
Self Test 13.16
Self Test 13.16 Answer (cont
Self Test 13.17
What if there were more/less
Other factors to consider whe
How would these factors affec
Modigliani-Miller Irrelevanc
Modigliani-Miller Irrelevanc
Incorporating signaling effec
38
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What are signaling effects

What can managers be expec
Conclusions on Capital Stru
Self Test 13.18
Self Test 13.19
Self Test 13.20
Self Test 13.21
Self Test 13.22
Self Test 13.23
Summary
CHAPTER 13 Answer Set Capi
Problem 13-2
Problem 13-2 Answer
Problem 13-4
Problem 13-4 Answer
Problem 13-8
Problem 13-8 Answer
Problem 13-8 Answer (cont.)
Problem 13-9
Problem 13-9(b) Answer (con
Problem 13-14
Problem 13-14 Answer (cont
81
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captivate
slide/cap13-13.swf
Script
Script
Welcome back. Im Professor
Henry Wong and today we are
goi
Henry
Wong
Let's first differentia
Again the reason why one

capital structure would be optimal ov
As weve learned in the
cost of capital it is beneficial to use som
associated
using
more
debt,why
because
it increases
the use
firms
So what arewith
some
of the
reasons
management
would
de
Now let's review. Self 3

3rd financial flexibility 13
which is the ability to raise capital on rea
Self test answer 13.2. First
and foremost is business risk - the ris
13.2
3rd
is
financial
flexibility
the
ability to raise this debt capital in
Self test answer 13.3. The
higher risk associated with using mor
13.3
Now let's talk about some
of the risk associated with using debt.
However
the
low
risk
company
willrisk
have
narrower
distribution
What exactly determines
business
oraaffect
the operating
in
What exactly is operating

leverage
and
how
does
it
affect
the
fir
Fo
There was a rush to production

in the marketplace. They release
Let's look at some of t
So generally Auto or airline industries will generally have a lot of

What exactly is the pra
What exactly is financi
Now let's compare busin
Let's take an example and

illustrate the effects of the use of fina
The
only
difference
between
bothsee
of these
companies
is their us
Let's first look at Firm U.
You can
that there
are 3 different
e
U
Let's now look at Firm L.
As you can see the probability and ope
The interest line as youL

can see here shows that the company h
Now let's compare these
ratios between these 2 firms. What we
2
Let's look specifically at
the expected or average economic case
Of course this means what

is the raw earning power of the firms
Why exactly do we get
a higher return on equity for using debt i
We can look at other risk measures as well and they bear out the
What kinds of conclusions
can we draw from Firm U and Firm L?
UL
So leverage in that case
is going to depress income. However th
Now let's take a momen
Finally the levered firm

has a much wider probability distribution
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slide/cap13-59.swf
Self test answer 13.10.13.10

Self test answer 13.11.13.11
Given the fact that weve
see how using debt in the capital struc
Let's take a hypotheti ROE1
We essentially are trading

off higher earnings, return on equity a
In reality a company would
contact a commercial banker or inve
Before we go on let's 8%
The cost of debt would
be 8%. The next option for our company
The first step that we need
to take is to calculate the earnings p
100%
1
That
give us
a debt
to
equity ratio
of 1.0%
a bond
rat
So
wewould
essentially
have
to
determine
the range
perand
share
and the
1
This assumes that the company
isnt going to pay any dividends
So now, we need to det$500,0009%
Also for the number of 1,000
shares outstanding now, we started off w
Again we do the same f$750,000
Finally, our last leve $1,000,000
Our next step is to calculate
the stock price, if you can recall fro
So we need to find the

If we pay out all our earnings
as dividends to our shareholders th
In 1969 a man by the name

of Robert Hamada,
this
1969Robert
Hamadarecognized
Again,
is going
to Hamada
help us look for the required rate of retur
So the what
Hamada
question
He developed what weHamada
call today the Hamada equation. It says b
Now let us use the Hamada

equation to calculate the levered be
Hamada
We can calculate the nHamada
This gives us a new levered
beta of 1.0857. What do we do with
Now its time to find the1.0857
optimal capital structure and again the c
So here is our table for

calculating the level betas and the cost o
1/ We can find the level
which
minimizes the average cost of ca
1/
If we look at the stock price

for each of these level of debt, it aff
This is probably also the

level that maximizes the stock price an
2/The
debt
level
which
maximizes
stockdone
price.on a workshee
So
let us
take
a look
at
all
the work the
we have
You can see the stock price

starts at $25.00 with no debt and gr
2/
$25.00
Let's make an importan1
Both thing
thesewe
methods
willwould
yield the
same
results.the shares repurc
First
would do
be to
calculate
What exactly is the te 11
We us
start
by using
the
equation
figure
out the
new
lev
Let
review
some
ofHamada
the
topics
we havetojust
covered.
Self
test
Hamada
What
happens
to
the
component
cost
of
debt
and
equity
when
t
Self
answer.
test question 13.12 answer.
Go
to
the
next
slide
when
you
are
ready.
Self test
question
13.12.increase because
Both
thequestion
component
of debt
and equity
Self test
13. costs
HamadaSelf test question 13
Self test 13.13 answer Self test 13.13 answers.

Hamada
Self
Write
test out
question
the equation
13.14. for calculating a
Please
take
a
few
moments
to
do
this
and
go toanswer.
the next slide w
Self test question 13.1Self

test question 13.14
Self test question 13.

Self test question 13. Hamada
Self test question 13.15 answer.
Self test question 13. Hamada
Self test question 13.16 answer continue
1
Self
answer.
test question
Not necessity,
13.17 answer.
a company can p
Now let us ask ourselve
Heres some other factors

to consider when establishing the firm
So how would some of

these other factors affect our target capi
1/ You can look at other
competitors debt ratio; thus if the indu
1/
How does capital structure
theory work in real life? In 1958 two
1/ Sales stability, obvious

if a company or firm has stable sales t
1/
3/
Lending
agencies
attitudes
toward taking on more debt, som
Couple
more
points on
MM
It has things such as there
is no such things as brokerage costs,
2/
2/ Higher
operating
leverage.
We effects
only talked
aboutinto
what
operat
So
we must
incorporate
signaling
or theory
our
M&M
4/ Reserve borrowing capacity.

This basically means even thoug
2/
As you can see on this 3/
slide
as
a
result
of
M&M
theory
you
can
s
3/they
Increase
corporate
taxraising
rates, obviously
if the corporatio
If
have,ita the
choice
between
debt
and
using
retained
e
MM
5/ Effects of financing
and
control. Obviously, the possibility of
3/
That is exactly the question discussed prior in theory to capital s
4/ Increase
in you
personal
tax
rates.
Arguably,
is noin
effect
Why
wouldnt
use 4/
your
own money
thatthere
you have
youron
re
6/
Asset structure.
uponto,
what
kind
of assets
you
hav
Shareholders
desireDepending
not
being
able
not
wanting
to
take
on
th
4/
5/
7/
the
rate, as you
canobviously,
see, the use
of debt
any cap
5/ Finally
Increase
intax
bankruptcy
costs,
if there
is ainbetter,
m
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So what are some of these

signaling effects and capital structure
Self test question

This is a very important13.21
point answer.
so I want to stress it again and in a
1/ Managers of course
run
the business on a day to day basis so
1/
Lets draw some conclusions
on our capital structure discussion
1/ They will issue stock

if
they think the stock is overvalued.
1/
2/
Managers
aretopic
always
going
to
act in their self interest in relat
Lets
review the
1/ We need to make calculations

that we did but we should also
2/
1/
2/
debt if the
stock
is
undervalued.
Investors
view the com
SelfIssue
test question
13.
Self
test
question
13.18
answer.
3/ What can managers2/

be
expected
to do
then? We can assume
Self
test
question
13.18.

Self
test question 13.19.
3/
MM100%





Self test question 13.22 question.
Self test question 13. Self


Self test 13.23 answer.Self

Wide
test
variations
13.23 answer.
occur because factors un
Weve now reached the

end of Chapter 13. Let us summarize so
13
Let's review the homew13

1/ Managers can and do
set
target capital structures for their fir
Problem 13-2, Jackson1/

Trucking
company
is in
the process
of se
13-2
Jackson
Trucking
2/
Use of13-2
leverage
or debt
have its benefits and its costs.
Problem
answer,
t
At a debt ratio of 30%, 13-2WAC
the
projected earnings per share would b
2/
Problem 13-4, Harley M
13-4
3/ Overall the use of leverage
is goodHarley
if the Motor1000
basic earning power
At
a debt13-4
ratio answer,
of 50% we
have
a
projected
earnings per share p
Problem
f13-4
3/
Problem 13 -8, Cyclone
13-8 Cyclone software
Problem 13-8, the facts13-8
given that the current capital structure c
Problem 13-8 answer continued.
Step three,
we need to determ
13-83
Using the Hamada equation
the unlevered beta equals the lever
Problem 13-9, Tapley Inc.
currently
has
assets
of $5 million, zer
4
13-9Tapley
Inc.50
Step four. We determine
the firms the new cost
of equity under
Problem 13-9 A and B 10
answer, First thing we need to do is calcu
13-9A,B
The company is considering a recapitalization where it will issue
Problem 13-9B answer13-9B3
continued, step three,
now we have to c
B)
B/ We need to calculate the operating income before the recap

Problem 13-14, Elliot athletic
is trying to
determine
is optimal c
C)
4)1
13-14
athletic
4/ To calculate the dividend
expectedElliot
in year
one after the reca
C/ To
net income
after
the
capital
recapitalization
inte
I've
setcalculate
up a Microsoft's
spreadsheet
to
solve
this
problem,
on
th
5)
Elliotrs
Elliot uses an estimate Microsoft
to maintain its cost of common equity, RS
5/ Calculate
theanswer
price
of
recapitalization,
the prices
will
equal
to
Problem
13-14
continued,
let's review
the firms
optima
W
Next, we calculate the 13-14

levered beta, and of course in calculating
What is the firms optimal
structure and what would be the aver
%
B)
B/ If the firm's business risk increases, then the firms capital str
The levered beta is 1.20
and again a zero percent debt or zero d
C)
C/ If Congress dramatically increases the corporate tax rate, the
Finally, we can use all this information to calculate the weighted
Henry Wong13
13.1
13.1
13.24
13.2
13.3
13.3
13.4
13.4
FordFord Pinto
2AB
(PL)
2
U20,000U20,000
U325%
0EBIT
U
2UU10%15%
3
1
13.5
13.5EBIT
13.6
13.61
13.7
13.7
13.8
13.8
13.9
13.9
13.10
13.10
13.11
13.11
ROE1
8%5025%
100%BB14%
11
4
1
$500,0009%1$500,000
1,00010,000
50,00011.25%$750,0001$2530,0
$1,000,00014%1$25.00$1,000,00040,000
1
obert Hamada
a
Hamada
ada
Hamada
1.0857
WACC
25%
$40,000
$25.00$26.03$500,000$26.09$26.59$25
1$3.90$1,000,000
11
$26.89$500,000$2,000,000
Hamada
estion 13.12 answer.
estion 13.12.
.13 answers.
estion 13.14.
estion 13.15.
X1.2540%
1.25
estion 13.16.
1.0X5%
1.00.87141
estion 13.16 answer continued,
0.58Hamada0.87
estion 13.17.
1
11
19582Franco
ModiglianiMerton Miller
MM
MM
MMMM
60%60%
MM
MM
estion
13.18.
MM
estion
13.19.
100%
estion 13.20.
estion 13.22.
estion 13.22 question.
estion 13.23.
.23 answer.
Jackson Trucking CEO20%5

WACCJackson30%
Harley Motor1000200800Harley
1+
Cyclone software2575
2575 5 6
1+
3
CAPM
Tapley Inc.5040%1040
10
1400,0
100,00016.67
3
16.71011%.660%
1D934,00040%160,0002.34
Elliot
athletic
1rs-g12.45
rs 5% 6%40%
Microsoft
WACCElliot

WACCElliottWACC40%
1.20CAPM
WACC
(EBIT)
(PL)
B
2
2UL
U20,00040%L10,000
25%50%25%
EBIT2,0003,0004,000
10%15%20%L
U6%9%
ULUL
U2.21%
25%33%
1EBIT
400,0000.6
$250,000$250,000
$500,0001$2520,000
1$3.26EBIT
1$2530,000111.25%$750
000,00040,00014%$1,000,000
0DRS
111
Hamada
6%
$250,0001.00.10.4
25%
$40,00040%80,0001$25
$26.59$25$500,000$26.89
$1,000,00050%1RS100%
1
0,000$2,000,00025%25%50%
KSWACC
40%42%58%
1.250.4
5%4%40%0.8714
11.6
0.871410.60.42
11
aniMerton Miller MM
M
MM
60%
20%50%1
Jackson30%30%70%
Harley1.240%Harley
1+
CEO
5 640 14CAPM
1.51+(1-40%)25%:75%
1.251+
6%2
405200,000
11%14.5%
400,000200,0002.00D12.001+
16.67 100%
200,0001025.00160,000
60%934,000
2.3411+2.45
12.4514.5%52
6%40%Elliot 1.2
1
1+(1-)
ElliottWACC40%60%11.45%
CAPM5% 6%
60%40%
2
(EBIT)11
(PL)
A40
2LHLEBIT
L2
10,00012%20,00010,000
2,0003,000
4,00040%8001,200
1,2001,2001,200
%9%12%
ULL9%U10.8%
U2.21%L4.24%
(ROE)(ROA)
00
A750,000
0.6800,00013
1%
20,0001$400,0009%$500,000
EBIT$400,000$20,00020
11.25%$750,00080,00030,00050,00
1,000,00080,00040,000
DRS11
Hamada
1.0
0.10.40.6$250,000
$250,00012.51%12
RS
2RS
6%
$26.89$500,00025%
100%50%
1KS
50%1
WACC1
0.40.420.581.251
5%4%0.8714
0.420.581.25
MM
12013.20
30%70%WACC
y
+ 1.21+1-40%
5 640Cyclone
CAPM14%5%+6%
25%:75%
1.25
50%50%
217%
200,000WACC13.4%
4.5%
2.001+2.1012.10rs13.4%
60,000
2.45
25.81
1.2
1-4.2%
12.2%
%40%1
()()
EBIT
4080B4080
LEBITH
EBIT
10,00040%
3,0004,000
1,2001,6001,200
12%10,000
EBIT
L
U10.8%L
U2.4L0.39
0250,000
750,000337.5%60%
13
9%$500,00080,000
20
00030,00050,0001$3.77
80,00040,00040,0001$3.92
$2,000,000
$250,000$750,000
12%$500,00013.2%$
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RS
$26.89WACC$500,00011.25%
0.87148.49%
55%4%
3.2035.003013.4536.50
1.21+1-40%200800 1.0435
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2
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4.2%
WACC40%WACC11.45%
16040
)()
4080A80120B
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000(EBT)8001,800
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80,00020,00060,0001$3.55
$400,000$86,2504.6
$400,000$140,0002.9
13.2%$750,00014%$1,000,00012%
6%1.085712.5%
$500,000
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480
6%4.8%
10050%
$400,0000.808$250,000
$500,0008.9
JacksonWACC
4801,0801,680
(TIE)
$250,0000.6
WACC
70FordFord Pinto
FordFord Pinto
1.67x2.5x
x3.3x

Push here to start
Henry Wong
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Introduction
1
CHAPTER 14 Distributions to
1
What is dividend policy?
2
Do investors prefer high or
3
Dividend irrelevance theory
4
Bird-in-the-hand theory
5
Tax Preference Theory
6
Possible stock price effects
7
Possible cost of equity effec
8
Which theory is most correc
9
Why investors might prefer
10
Why investors might prefer c
11
Self Test 14.1
12
13
Self Test 14.2
14
15
Self Test 14.3
16
17
Self Test 14.4
18
19
Whats the information cont
20
Whats the clientele effect
21
Self Test 14.5
22
23
The residual dividend model
24
Residual dividend model
25
Residual dividend model: Ca
26
Residual dividend model: Wh
27
How would a change in invest
28
Comments on Residual Divid
29
Self Test 14.6
30
31
Self Test 14.7
32
33
Self Test 14.8
34
35
Whats a dividend reinvest
36
Open Market Purchase Plan
37
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New Stock Plan

Self Test 14.9
Self Test 14.10
Setting Dividend Policy
Self Test 14.11
Self Test 14.12
Self Test 14.13
Self Test 14.14
Stock dividends vs. Stock spl
Stock dividends vs. Stock spl
When and why should a firm c
Self Test 14.15
Self Test 14.16
Self Test 14.17
Self Test 14.18
Stock Repurchases
Advantages of Repurchases
Disadvantages of Repurchas
Self Test 14.19
Self Test 14.20
Self Test 14.21
Self Test 14.22
Summary
CHAPTER 14 Answer Set Distr
Question 14-1
Question 14-5
Question 14-5(a), (b) Answe
Question 14-5(c), (d) Answer
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Problem 14-1 Answer
Problem 14-5
Problem 14-5 Answer
Problem 14-6
Problem 14-6 Answer
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captivate
Script
Script
Welcome back. I am professor
Henry Wong and today weWong
are go
Henry
Lets first start off by asking
the question what exactly is dividen
Next we talk about some

of the signaling effects of the these spe
You might have guessed

already
that the answers to the questio
1/Dividend policy is the

management
process in which the deci
1/
Finally
we talk
about
share
repurchases
dividend
payouts.
S
Lets
start
offpolicy:
with
the
dividend
irrelevance
theory.
Which
basica
2/
Dividend
should
we
pay
out
a and
dividend
yes
or
no?
if w
Well really, there are three
theories to the
dividend
policy
that
w
2/
3/ Should
makeisit called
a2Bird
stable
orinirregular
The
secondwe
theory
thedividend
bird in hand
theory.dividend?
If you recall
Hand
Investors
in a sense
can
create
their own dividend
policy. If they
4/
How
often
to
do
we
pay
out
dividends
to
shareholders?
3/
1/ The
first
one is called
the
dividendtheory.
irrelevance
theory:
ba
The
final
theory
the tax
preference
Capital
gainsthis
is tax
5/ How do
we announce
it
in the
Investors
thinks
dividends
are
lessmarketplace?
risky than future profits or hig
1/1
4/
So lets look again at these

three
different
dividend
theories,
the
2/ The
birdforce
in hand
theory:
says
investors
do care
and they
This
could
investors
toThis
prefer
firms
with lower
payouts
thu
5/
Let us also look at the possible

effects
on the cost of equity give
2/
bird
in
hand
Finally there is the tax preference
theory represented by the red
3/
theory:
investors care but they prefer a low p
So Tax
nowpreference
that we have
loo
3
They
can
urge
company
team
to usetheories
retaine
In
next
fewthe
slides,
willorgomanagement
into each one
of these
3/
Sothe
lets
summarize:
invwe
Finallyagain,
the bird
hand
theory
which prefer
says the
higher
we gopayo
out i
Then
we in
know
some
investors
low
a dividend
Bird
in hand

If an investor holds the
stock until his or her death, beneficiaries
Self test 14.1 answer.
Self test 14.1 answers.
Self
Self test
test question
question 14.1.
14.2.
Self test question 14. MM

Self test question 14. MM


Self test question 14.4Self

test question 14.4 answer
Lets also talk about what

the clientele effect means: it means th
Clientele effects impede

changing dividend policy because taxe
14.5.answers.
Self test 14.5 answers Self test 14.5
Given all these implications

of dividend policy, we have now com
So now, lets take a n

This is the reason why
it would minimize any signaling cost, and
Lets go on with our residual
model and calculate the dividends
Now lets take a look at$400

the residual dividend model and if the in
1/ Calculate the portion
of the capital budget to be funded by e
1/
So how would a change
in
investment opportunities also affect t
So if they payout would$400,000

be zero over the net income of $400,00
2/ Calculate
theclosing
excessconclusions
or need for capital
equity
beyondpolicy
that. S
Lets
find some
on residual
dividend
A good example of this1/
in
real life is Microsoft. Microsoft M
for a ve
2/
Microsoft
3/sends
We can
calculatesignals
this
dividends
as abecause
payout ratio
as irregulari
taking th
It
conflicting
as well, and
of this
2/
question
14.6.
test 14.6
answers.
3/
3/ Ittest
alsoquestion
increases
riskSelf
overall,
as investors
become
unsur
Self
14.7.
Which
testare
question
more critical
14.7.
to themore
dividends
1/ We first need to find1/
the
retained earnings needed for the ca
3/
Self test question 14.7Self test question 14.7 answer.

4/ It doesnt really appeal to any clientele if it is moving around
2/
any left14.
over
earnings
the residualSelfPay
testout
question
Self
test question
14.8. as dividends
4/
2/
So
is we$30million$35m
consider
theanswers.
residual policy when we se
Selfthe
testconclusion
14.8 answers
Self
test 14.8
3/ This policy would minimize flotation and equity signaling cos
In terms of actually p
3/
An open market purchas
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The second way is a new

stock plan in which the firm issues new
2
So most New York stock
exchange companies have some sort of
14.9.answer.
Self test question 14. Self test question 14.10.
Self test 14.10 answer Self

test 14.10 answers.
So how should a management

team or company consider settin
1/ They should forecast

the
capital needs over a planning perio
1/
5
14.11.
Self
answer.
test question
The four14.11
thingsanswer.
that constrain a
2/ Set
a capital
tax14.12.
structure,
from 14.12
last
discussion
onpolicy
optim
Self
test
question
Self
What
testrecall
constraints
question
affect
question.
dividend
1/ Constraints on dividend
payment themselves, i.e., capital cas
2/

Self
answer.
test question
The four14.12
thingsanswer.
that constrain d
3/ Estimate annual equity
needs.
1/
2/ Investment
opportunities.
The
more investment
opportunitie
Self
test question
14.13.
Self
How
test
do
question
investment
14.13.
opportunities
affec
1/ Stockholders desire3/
for
current versus future income.
4/
Set
the
target
payout
based
on
residual
model.
3/ The availability and 2/
the
cost of available sources of capital, in
1/
4/dividends
2/
risk of
versus14.14.
capital gains.
SelfThe
testperceived
question 14.
Self
test question
5/ Generally some dividend growth rate emerges. Maintain that
4/ The
of dividend
policy
on the
cost
of answer.
equity.
3/answer.
Self
testeffects
question
14.14
Self
test question
The
cost
14.14
of selling
new stock: if
3/ The tax advantages 2/

of capital
gains over dividends.
5/
Now we move away from

dividend policy and turn our attention
Finally, the last issue is
an
issue of control: selling stock means l
4/
4/
The
signaling
effects
of
dividend
policy. vs. stock splits and
3/
So lets talk a little bit about
stock dividends
A stock dividens is when

a
firm
issues
new shares in lieu of payin
So when and why should
Unless the dividend or4/

split
conveys some kind of information o
A
share
stock
is when
a firm increases the number of share
Now
lets
takesplit
a momen
14.15.answer.
Self test question 14.1Self test question 14.15
Self test question 14. Self test question 14.16.


Self
Self test question 14.1Self test question 14.17 answer.

Self test question 14.18 question.
Tillman
Self
answer.
test question
We canindustries
14.18
figure answer.
out1
the number o
2
Now lets talk about stock
repurchases, this is when the corpora
We can also figure out
the dividends per share after split by taki
Some of the advantages
of repurchases include: the stockholde
1/
1/ Use it as an alternative
to distributing cash as dividends.
1
1/
There are disadvantages

of
repurchases as well:
2/ It helps avoid setting

a
high
dividend that cannot be maintain
2/ Dispose
of one
time2/
cash
from an
asset
sale.
Now
lets take
a moment
to
review
the
topics
we have just cove
1/ It could be viewed by
the
investment
community
as a negativ
2/
1/
3/ Repurchased
can
be used
for takeovers
or be used to r
Self
test questionstock
14.19
Self
answer.
test
question
14.19 answer.
3/ Help
Makestockholders
a large capital
structure
change.
1/
hold
down taxes?
3/
test
2/
could impose
some
penalties14.19.
if repurchases were pri
SelfThe
testIRS
question
14. Self
Self
test question
question
14.20.
3/
4/ As
Stockholders
maytotake
this as a cash
positive
signal thatthus
the mana
1/
an alternative
distributing
as dividends,
stock
2/
1/
2/
their capital
structures?
SelfChange
test question
14.2Self
3/ Selling stockholders4/
may
not be well informed, hence be trea
2/
make
a large14.
capital
structure
chance.
Repurchases can c
SelfTo
test
question
Self
test question
14.21.
3/
2/
Please take a moment 1/

to answer
and go to the next slide when y
4/ The
ups the
price
totest
make
the repurchase
thus
paying to
Self
testfirm
question
14.21
Self
answer.
question
Stock
repurchase
14.21 answer.
advantages
in
4/
2/
Negatives are that it can be viewed as a negative signal because
Self test question 14. Self test question 14.22 answer.
We have now come to

the end of Chapter 14. So lets summariz
14
Now let's review the 14
Secondly, we asked the
question what message does dividend p
Question 14-1. Discuss14-1
How
do firms
stock14-1
dividends, splits and repurchase to max
Question
14-1use
answer.
Question 14-5. How would

each of the following changes tend t
14-5
A/
An
increase
in
the
personal
income tax rate.
Question 14-5A&B answer.
A)
14-5A,B
B/
A
liberalization
of
depreciation
forview,
federal
income tax
purpos
A/
>From 14-5
the stockholder's
point
of
an increase
in the
per
Question
C andrates
D14-5C,D
answer
continued.
B)
A)
C/ A rise in
interest
D/
Anthe
increase
in corporate
profits.
C)
B)
C)
B/
If
depreciation
allowances
were
cash
flowsmake
would
C/
If decline
interest
rates
were
to increase,
theraised,
increase
would
re
E/ A
in
investment
opportunities.
D)
D)
F/ Permission for corporations to deduct dividends for tax purpo
D/
A change
permanent
increase
in profits
probablyand
lead
to an in
G/ A
in the
tax E)
code
so thatwould
both realized
unrealize
F)
G)
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Question 14-5 E, F and14-5E,F,G

G answers.
Problem 14-1. Axel Tel14-1
E)
Axel
Telecommunications
E/ If investment opportunities for firms

declined
while cash inflo
The following information is given to us. T
F)
F/
Dividends
currently
paid out of after-taxPacific
dollarsHeating
and inter
Problem
14-5.are
Northern
G)
an
The first thing we need14-5Northern
to know is the equity retained.
The equit
Question 14-5 answer.14-5
In
order
to
solve
this
problem
we
need
to
20
G/ This change would make capital gains less attractive and wo
So, we know
that
the
net
income
is two
million,
and three
if we
take
ou
Problem
14-6.
The
Weltch
Company
is
considering
indepe
Weltch
Company
3
Next, we need to figure14-6
out the external
equity
required.
The tot
Weltch72.875
Weltch expects to have net income of 7.2875 million. If Weltch
4
This problem involves four steps.
1)
1/ We need to determine
the capital budget by selecting only th
2)
72.875
2/ Now we must determine how much of that capital budget wil
We were given that there was 7.8725 million in net income and
Henry Wong14
Bird
in Hand
20%
Bird
in hand
and
in hand
.1 answers.
estion
estion 14.1.
14.2.
estion 14.2 answer.
estion 14.3.
estion 14.3 answer.
Bird
in theory
estion 14.4.
estion 14.4 answer
.5.answers.
.5
$400,000$800,000
$800,0000.6
$400,0000$800,000
$600,000$
Microsoft
Microsoft
estion
14.6.
.6
answers.
$120,000$600,0000.220%
estion 14.7.
estion 14.7 answer.
estion
14.8.
$30million$35million45%55%
.8 answers.
$3
14.9.answer.
estion 14.9
estion 14.10.
.10 answers.
5
14.11.answer.
estion
14.11
estion
14.13.
estion
14.13 answer.
estion
14.14.
estion
14.14 answer.
10%10010
$20$80
2
14.15.answer.
estion 14.15
10%
estion 14.16.
estion 14.17.

man industries
1001$4.001$2.00
estion
14.18 answer.
21002001
1$2.00$1
estion
14.19.
estion
14.20.
IRS
estion
14.20 answer.
estion
14.21.
estion
14.22.
14
14
(payout ratio)
Axel Telecommunications 70%30%30
Axel Telecommunications70%30
Northern Pacific Heating30%900,000

and Cooling Inc.6
20900,00011
112055%
1-1
Weltch
Company 350
72.875Weltech residual model
.8755022.875
1
ModiglianiMiller
Bird in h
ory
$800,00040%
$400,000$400,00060%
0.6$480,000
$800,000$800,00060%$700,000
$480,000$120,000
Microsoft
0000.220%
$35million55%$30million
10010
$20$80
10010
$20$80
$2.001$60Tillman12
1$4.002$2.00
$602$
IRS
MCC
30Axel20
3020
30%900,000900,000
10040%
11
1-
1001-40%60%
IRR50%50%
H16%IRR20%
H,LH,LIRRWACC
50
22.875422.87578.72531.3
Miller
Bird
in hand
Bird in hand
0040%60%$600,000
60%$800,000$80,000
$700,000$380,000$380,000$800,000
$18.5million$35million52.86%
2
21
2$30
MCC
900,000
40
1-5055%
606027.5
50%50%
16%IRR20%12%IRR10%
100
.72531.39%
$600,000
$80,000
$800,00040%
Bird in hand
45%200550
5%27.5
27.532.5
12%IRR10%8%IRR9%
50 Northern Pacific 2006

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Introduction to Financial Decisions

Welcome to the Introduction Financial Decisions e-lecture series.

Push here to start

Self Test 1.7

Every Job is a Finance Job!

There are four

Self test question 1.7 1.7: Boeing

And we need not look any

Self test 1.11 answer:

Lets take a moment

Although we have been

Question 1-1. If you b

Question 1-2. Are the Question 1-2.

Question 1-2 answer. No

Question 1-3 answer. IAB

Question 1-4 answer. No

Question 1-6 answer. Eq

Question 1-9 answer. T

Question 1-15. Edmonds

joint and several liability

1.2Sub chapter S-corporationsIBM

rational economic beings

odsSouth Seas Oil Exploration Company

Coca Cola, Exxon, General Electr

corporate shield.corporate shield.

perceived investor returns

Enron Corporation Worldcom Corporation Tyco

New York City World Trade CenterPentagon

rldcom Corporation Tyco

New York City

Arthur AndersonArthur Anderson

(limited partnership)(general partner)

(general partner)(limited partners)

New York City San Francisco

psychological financebehavioral finance

The Delaware Supreme Court of Corporations

Chief Operating Officer

Sub Chapter S corporationsC-corporations S-c

orations S-corporations S-corporation

(Limited Liability Companies LLCs)

ility Companies LLCs)

Push here to start

Self Test 2.10

Self Test 2.23

Step 4: Find the ending bala

These next two examples

Now that weve gone ov

Self test 2.1 answer: T 2.1

So for example, our fi 100

Now that weve covered

Self test 2.4 answer: 2.4

Now that weve covered

We start off with the s

Now that weve looked

Self test question 2.9 2.9510010

If we hit okay we see that

Now lets do a couple

We can use Microsoft Excel

In this example we ask

The other way to do it is

Self test question 2.1 2.16Annuity

Now that we have covered

Now that weve talked

Now lets take a mome0