Chapter 1: Corporate Finance and the Financial Manager (стр. 2 )

7. Can you compare or combine cash flows at different times?

No, you cannot compare or combine cash flows that occur at different times because a dollar today and a dollar at another point in time are not equivalent.

8. What do you need to know to compute a cash flow’s present or future value?

To compute a cash flow’s present or future value you need to know the interest rate and the number of time periods for discounting or compounding.

Chapter 4: Time Value of Money: Valuing Cash Flow Streams

1. How do you calculate the present value of a cash flow stream?

To calculate the present value of a cash flow stream, you must calculate the present value of each cash flow and then add these values together.

2. How do you calculate the future value of a cash flow stream?

To calculate the future value of a cash flow stream, you must calculate the future value of each cash flow and then add these values together.

3. What are some examples of perpetuities?

The perpetual bonds issued in the seventeenth century by the Hoogheemraadschap Lekdijk Bovendams are perpetuities that are still paying interest today. A common example of a perpetuity would be providing the money for an endowment that would allow an institution to spend money on a particular event every year forever.

4. What is the intuition behind the fact that an infinite stream of cash flows has a finite present value?

While an infinite stream of cash flows pays a cash flow forever, the very distant cash flows have very little value today (due to the time value of money). Thus, the stream of payments of a perpetuity can be replicated using a finite amount of money.

5. What are some examples of annuities?

A lottery that pays $20,000 a year for ten years to the winner would be an example of an annuity. Another example of an annuity would be saving $200 a month for 30 years in a retirement savings account.

6. What is the difference between an annuity and a perpetuity?

An annuity ends at some point in time while a perpetuity continues into infinity.

7. How can an infinitely growing stream of cash flows have a finite value?

While an infinitely growing stream of cash flows pays a cash flow forever, the very distant cash flows have very little value today (due to the time value of money). Thus, the stream of payments of a growing perpetuity can be replicated using a finite amount of money.

8. What is an example of a growing perpetuity?

An example of a growing perpetuity would be donating an amount of money that would fund a $10,000 scholarship next year and then a scholarship that increases at a rate of 4% each year to keep up with inflation forever.

9. How do you calculate the cash flow of an annuity?

The present value of an annuity of C for n periods with interest rate r is:

10. How do you calculate the rate of return on an investment?

The rate of return on an investment is the interest rate that sets the net present value of the cash flows equal to zero. You can guess the rate of return and manually calculate its value. An easier solution is to use a spreadsheet or calculator to automate the guessing process.

Chapter 5: Interest Rates

1. What is the difference between an EAR and an APR quote?

An annual percentage rate (APR) is the rate that interest earns in one year before the effect of compounding. An effective annual rate (EAR) is the rate that the amount of interest actually earns at the end of one year. Because the APR does not include the effect of compounding, it is typically less than the EAR.

2. Why can’t the APR be used as a discount rate?

Because the APR does not reflect the true amount you will earn in one year, the APR itself cannot be used as a discount rate.

3. How is the principal repaid in an amortizing loan?

The principal is repaid over the life of the loan in an amortizing loan. When each payment is made, some of the payment goes toward principal and some toward interest.

4. Why does the part of your loan payment covering interest change over time?

Each time a payment is made, the outstanding balance on the loan is reduced. Since the interest is calculated on the outstanding balance, the amount of interest owed decreases over time.

5. What is the difference between a nominal and real interest rate?

The nominal interest rate is the rate quoted by banks and other financial institutions, whereas the real interest rate is the rate of growth of purchasing power, after adjusting for inflation. The real interest rate is approximately equal to the nominal rate less the rate of inflation.

6. How are interest rates and the level of investment made by businesses related?

When the costs of an investment precede the benefits, an increase in the interest rate will decrease the investment’s PV. All else being equal, higher interest rates will therefore tend to shrink the set of positive-PV investments available to firms.

7. What is the opportunity cost of capital?

The opportunity cost of capital is the best available return offered in the market on an investment of comparable risk and term to the cash flow being discounted.

8. Can you ignore the cost of capital if you already have the funds inside the firm?

No, you cannot ignore the cost of capital if you already have funds inside the firm. These funds still have an opportunity cost and investors expect a return on these funds.

Chapter 6: Bonds

1. What types of cash flows does a bond buyer receive?

The cash flows that a bond buyer receives are the coupon payments and the par value at maturity.

2. How are the periodic interest payments on a bond determined?

The periodic interest payments on a bond are determined by multiplying the coupon rate by the bond’s par value, and dividing by the number of coupon payments per year.

3. Why would you want to know the yield to maturity of a bond?

The yield to maturity of a bond is the internal rate of return that an investor earns on the bond by holding the bond to maturity.

4. What is the relationship between a bond’s price and its yield to maturity?

The bond’s price and yield to maturity are inversely related.

5. What cash flows does a company pay to investors holding its coupon bonds?

Companies pay bond investors regular coupon payments and the par value at maturity.

6. What do we need in order to value a coupon bond?

In order to value a bond, we need to know the cash flows that will occur and the interest rate to use to discount those cash flows. For a coupon bond, the coupon rate multiplied by the face value of the bond gives us the periodic cash flows and the face value of the bond will occur at the bond’s maturity.

7. Why do interest rates and bond prices move in opposite directions?

Bond prices and interest rates move in opposite directions because the interest rates are used to discount the future cash flows of the bond. Thus, when interest rates increase, the present value of the cash flows decreases.

8. If a bond’s yield to maturity does not change, how does its cash price change between coupon payments?

The accrued interest changes as a bond moves from one coupon payment to the next. It is this accrued interest that causes a bond’s price to increase between coupon payments, even if the yield to maturity stays constant.

9. What is a junk bond?

A junk bond, also known as a speculative bond, is a bond rated BB or lower by Standard and Poor’s or Ba or lower by Moody’s.

10. How will the yield to maturity of a bond vary with the bond’s risk of default?

The yield to maturity will increase as a bond’s risk of default increases, as investors want to be compensated for taking additional risk with their investment.

Chapter 7: Stock Valuation

1. What is a share of stock and what are dividends?

Common stock is a share of ownership in a corporation. Dividends are periodic payments, usually in the form of cash, which shareholders receive. Shareholders share in the profits of the corporation through dividend payments.

2. What are some key differences between preferred and common stock?

Preferred stock has preference over common stock in the payment of dividends and in liquidation. Typically, common stocks carry the right to vote for the board of directors and in other important matters but preferred stock does not.

3. What is the role of a floor broker at the NYSE?

The floor broker receives orders from investors to buy and sell stock and the broker negotiates in order to get the best execution price for the investors.

4. What is the role of a dealer at the NASDAQ?

A dealer maintains inventory of a stock and posts a bid price at which the dealer is willing to buy the stock and an ask price at which the dealer is willing to sell the stock.

5. How do you calculate the total return of a stock?

The total return of a stock is the sum of the dividend yield and the capital gain rate.

6. What discount rate do you use to discount the future cash flows of a stock?

The equity cost of capital is used to discount the equity future cash flows. The equity cost of capital is the expected return of other investments available in the market that have the same risk as the firm’s shares.

7. What are three ways that a firm can increase the amount of its future dividend per share?

Because the dividend each year is the firm’s earnings per share multiplied by its dividend payout ratio, the firm can increase its dividend in three ways: (1) by increasing its earnings (net income), (2) by increasing its dividend payout rate, or (3) by decreasing its shares outstanding.

8. Under what circumstances can a firm increase its share price by cutting its dividend and investing more?

Cutting the firm’s dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV.

9. What are the main limitations of the dividend-discount model?

Two major limitations of the dividend-discount model are its reliance on dividend forecasts given that a firm’s future dividends carry a tremendous amount of uncertainty and the lack of applicability to non dividend-paying stocks.