Five to Six Questions - Similar Format to Exam 1
Know how stock prices typically vary with changes in the discount rate
Think about the dividend discount model - denominators of fractions (can’t be negative)
Bigger discount rate means lower stock prices
Know the defining assumption of the constant dividend growth model
Constant dividend growth
Know how stock prices typically vary with expected dividends
Dividends are in numerator - bigger dividends higher PV higher stock price and vice
versa
Smaller dividends could mean less risk
Know that preferred stock has priority over common stock, but not debt. Know what
that means.
Bonds > Preferred Stock > Common Stock
Holders of stock are residual claimants
Know that capital budgeting is the process of planning and evaluating long-term
investment expenditures
Know what IRR is
Internal Rate of Return - Discount rate that would make NPV = 0
(NPV is preferred to IRR)
Know when and how IRR can deviate from NPV
IRR can rank competing investment projects wrong - does not consider WACC
If you don’t have all negative cash flows up front - you can have multiple IRRs
Know that NPV, not IRR, is the preferred criterion
Know what free cash flows represent
Cash flows free to return to creditors and owner
Free to distribute to financiers of the enterprise
Know why interest expenses do not appear in the calculation of free cash flows
We separate investment and finance decisions
Know what net working capital is
Know the component(s) of current assets
Cash, Inventory, Accounts Receivable
Know the component(s) of current liabilities
Accounts Payable
Know why we need managers and entrepreneurs
We are uncertain about our uncertainty
Know why a corporation’s equity usually has a higher discount rate than its debt.
Know that a valuation multiple is a ratio of a firm’s value to some measure of the firm’s
scale or cash flow.
Know that it is generally hard to know whether your opinion is better than average.