Test 3:
- Chapters 12, 14, 20, 21, CUM
Non – Excel
Excel
Question Type
Section
Section Total
Points
True / False (3 pts)
25
N.A.
25
75
Multiple Choice (4 pts)
18
2
20
80
Problems (4 pts)
2
3
5
20
45
5
50
175
 Slightly skewed to Chapter 12, Capital Budgeting (51 points, or ~30%)
 1. Payback 2. MPV 3. Internal rate of return. FV and PV for excel
 Excel Section: Chapter 12 and Chapter 9 Time-Value-Money
 Cumulative, 23 points
- Administration
o In-class; On-line Moodle (Look and feel like quizzes)
 Arrangements must be made if you are going to miss.
 24 hour notice required.
o Test will be taken in 2 sections:
 Students must first start with Non-Excel Section
 One submission allowed
 80 minutes available for this section
 Subsequently, Excel Section will be completed last
 Opens 20 minutes into class session
 One submission allowed
 60 minutes available for this section
o Important: Excel Section
 Students must submit completed Excel workbook provided for the test.
 Workbook must be completed for:
 Variables to solve the problem, AND
 Answer
 If not submitted with variables + answer, a zero will be graded for the
answer provided in Moodle.
o Calculators required for Non-Excel Section
 No use of Excel for this section
 Smart phones and smart watches not allowed
- Sample Test 3 – Available in Moodle
o Similar questions, answered provided
Chapter 12
Capital Budgeting
• Capital Budgeting: Concerned with evaluating investment alternatives and is a
comprehensive process that involves a broad range of the organization from marketing,
engineering, purchasing as well as finance and accounting.
• Cash flow-based evaluation methods
o Not Accounting Income!
•
Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $40,000,
and that it has a 20% tax bracket. What are the after-tax cash flows for the company?
EBDT
$100,000
Depreciation $ 40,000
EBT $ 60,000
Taxes (20%) $ 12,000
Net Income $ 48,000
Depreciation $ 40,000
Cash Flow
$ 88,000
• Three methods widely used methods for evaluating capital expenditures
o Payback method
o Internal rate of return
o Net present value
 Payback method:
• Advantages
1. Easy to understand
2. Emphasizes liquidity
3. Useful in industries characterized by dynamic technological
developments
• Shortcomings
1. Ignores cash inflows after the cutoff period
2. Does not consider time value of money
3. Can not find optimum or most economic solution to capital
budgeting problem
 NPV and IRR - Project Selection:
• Non-mutually-exclusive (Independent) projects
• NPV: Select all projects with positive NPV
• IRR: Select all projects > WACC
• Mutually-exclusive projects (Dependent projects)
• NPV: Select greatest NPV (if positive)
• IRR: Select greatest IRR (if > WACC)
 Re-investment assumption:
o NPV @ WACC
o IRR @ Project IRR
Mutual Exclusive (Dependent) Projects – When NPV and IRR conflict (e.g. give
different results for greatest value), use NPV as the decision criteria!
(Reinvestment assumption is empirically more valid)
Chapter 14
Capital Markets
• Capital Markets: Securities greater than 1 year
• Global capital markets are primarily influenced by
o A. interest rates.
o B. investor confidence.
o C. relative economic growth.
• Efficient Market Hypothesis –
o The efficient market hypothesis deals primarily with the degree to which prices
adjust to new information.
o Definition of an efficient market: Markets are efficient when prices adjust rapidly to
new information, continuous markets exist, and large dollar trades can be absorbed
without large price movements.
• Capital Structure
o Debt
o Preferred Stock
o Common Stock
Cash Flow Tax Deductible
Y
N
N
Ownership
N
N
Y
- From a CFO’s perspective, which security would you prefer to issue,
debt or preferred stock?
- From a CFO’s perspective, if you expect interest rates to rise, what is
your motivation relative to your long-term debt financing?
• Markets
o Primary Market: Company issues new securities
• Example is an Initial Public Offering (IPO)
• Company receives the proceeds
o Secondary Market: Investors trade securities of a company
• Company does not receive any proceeds
• Brokers act as agents on an organized exchange for investors to buy or sell
securities
• Spot v. Futures Market
o The main difference between spot and futures prices is the delivery date
• spot prices are for immediate buying and selling, while
• futures contracts delay payment and delivery to predetermined future dates.
• Stock Market Exchanges (US)
o NYSE
o NASDAQ
• Both located in New York, the largest capital market in the world
• Stock Market Indices (e.g. Market Measurements)
o Dow Jones Industrial Average (30 stocks)
o S&P 500 (500 largest stocks by market capitalization)
o NASDAQ (Companies listed on the NASDAQ exchange)
• Markets are Regulated, Examples:
o Three major laws govern sale and subsequent trading of securities
1. Securities Act of 1933
2. Securities Exchange Act of 1934
3. Securities Acts Amendments of 1975
o Securities and Exchange Commission
• Responsible for the regulation and oversight of public markets
o Sarbanes Oxley 2002
• Largely deals with internal controls and disclosures
• Public officers (CEO and CFO) are accountable for the firm’s financial
statements
Chapter 20 Mergers and Acquisitions
Strategies:
1.
2.
3.
4.
Vertical – Acquiring in the supply chain
Horizontal – Acquiring similar company in same industry (competitor)
Conglomerate – Acquiring dissimilar company in dissimilar industry
Concentric – Similar to horizontal; Company is in different level of the supply chain (ex.
Disney + Pixair)
Financial Benefits:
1. Synergies: 2+2=5
a. Value of the combined companies is greater than stand-alone
b. Remember, synergies are often overestimated.
2. Capital Markets Access
a. M&A benefits can include the financing flexibility that a larger company can
achieve.
3. Portfolio Benefit
a. Diversity, less-riskiness of cash flows
4. Financial assets such as a tax loss carry-forward) may be available to the buyer
a. Example: Tax loss carry-forward of $100,000. If the tax rate of the acquirer is
40%, the acquirer will enjoy a $40,000 benefit ($100,000 x40%)
Value creation:
1. Net Present Value of Cash Flows
2. Accretion / Dilution (EPS)
Merger – Two similar companies combine, or merge, together
o Share-to-share exchange (exchange ratio)
o Shareholders of both companies now one the one merged company
o The earnings-per-share impact of a merger is influenced by relative price-earnings
ratios and the terms of exchange.
 A higher P/E multiple merging with a lower P/E multiple will always be
accretive (class example)
Acquisition – One company buying a target (selling) company
o Financial Consideration:
 Cash (Seller view: Immediate exit)
 Stock (Seller view: Liquidity, Valuation and upside potential of combined,
acquiring company)
o Selling shareholders expect a premium to current trading price (enterprise value)
o Can legally acquire either,
 Assets of the Company, or
 Stock of the Company
Chapter 21 International Finance
International Strategies:
o Enabler for companies to grow, diversify and gain access to new markets, lower-cost
supply and financial capital
o For a U.S. company, foreign business operations are more complex as the
o host country's economy may be different from the domestic economy.
o rules of taxation are different.
o structure and operations of financial markets vary.
Can take several forms
o Exporter
o A company that produces a product within its own borders but sells in a foreign
market.
o Licensing agreement
o Allows a foreign firm to use its technology in exchange for a fee.
o Franchising
o Transfer of a brand and/or business system for a royalty fee (ex. McDonald’s)
o Joint venture (contractual and equity)
o Often used to manage political risk (and often preferred by indigenous
governments); JV’s offer the lowest form of political risk to enter a foreign
country.
o Fully-owned foreign subsidiary
o Full control; Full risk – Fully exposed to regulatory, political, tax, financial and
other risks.
o Higher political risk
Foreign Exchange Rates:
o Relationship between values of two currencies.
o Specifies how much a currency is worth in terms of another currency.
o Relative Value (Currency Pairs):
o When a country has a strong currency relative to another country, good
purchased by visitors of the country with a stronger currency in weaker currency
country will be less expensive for people that don’t live in that country.
o Exchange rates are influenced by:
o Inflation (Economic cycles)
o Interest rates
o Balance of trade
o Government policies
o Spot rate
o Exchange rate at which currency traded for immediate delivery
o Forward rates
o Trading currencies for future delivery
Cumulative
 Review of Accounting –
o Financial Statements: What are they?
 Income statement – Measure profitability over a period of time.
 Balance sheet – Measures assets, liability and shareholders’ equity at a point
in time. (A = L + SE)
 Cash flow – Measures cash flow over a period of time.
o Cash flow – Changes in balance sheet accounts
 Increase in an asset = cash outflow
 Increase in a liability = cash inflow
 Financial Analysis
o DuPont Equation: System of analysis emphasizes that profit generated by assets can
be derived by a combination of profit levels and how fast an asset can turnover.
 ROE = ROA x Equity Multiplier, or
 Net Income / Shareholders’ Equity
 ROA = Profit Margin x Asset Turnover, or
 Net IncoFme / Total Assets
 Time Value of Money
o Future Value calculation
o Present Value calculation
o Amortizing loan
 Payment same each period
 Amount paid for interest declines each period
 Amount paid for principle increases each period.
o Change in interest rates and impact on Bond Value
 Increase in rates, reduces bond fair value
 Decrease in rates, increase bond fair value
 Market interest rate = Coupon interest rate, bond trades at par