Lecture 1

ICP 1-2
Advantages and disadvantages of a corporation

Advantages:
-unlimited life
-easy transfer of ownership
-limited liability
-ease of raising capital

Disadvantages:
-double taxation
-higher setup cost
-endless report filing

Corporate finance.
Where does the money come from?
How do we pay the bills?

ICP 1-2 Goals of the Corporation?

Shareholders interested in :
Values
Dividends
Growth of the share

Profit maximization is nowell defined coprorate objectives

Here are the three reasons:
1. Maximize which years profits (increase current profits but damage future years profits)
2. Increase future profits by cutting this years dividend.
3. Calculate profits in different ways.

We want our cost of return to be more than our cost of borrowing

ICP 1-3
What do you think of this situation?
Manager benefited but not the coproration

Agency problem
The behavior of the managers may not always be conducive to the health of the corporation
-Managers are hired as the agents of the owners
-When the personal goals of these agents create conflict in the corporation, they create
agency problems
-Managers may overindulge in unessesarry expenses
They may shy away from attractive projects
They may engage in empire building

Most managers take the safe project (less risky)

How do corporations ensure that managers and shareholders interst coincide?

-conflicts of interest between managers and shareholders can lead to agency problems.
These problems are kept in check by:
-compensation plans
-monitoring of management by the board of directors, security holders, and creditors; and
-threat of takeover

ICP 1-4 How do maanagers affect shareholder wealth?

-making decisions that affect cash flows
-improve a firms ability to generate cash flows now and in the future by focusing on:
-amount of expected cash flows (bigger is better)
-timing of the cash flow stream (sooner is better)
-Risk of the cash flows (less risk is better)

Decision making
Capital budgeting
-what long-term investments or projects should the business take on?
Capital structure
-how should we pay for our assets?
-should we use debt or equity?
Working capital management
-how do we manage th day-to-day finances of the firm?

ICP 1-5
False

ICP 1-6
The goal of management should be to maximize the share price for the current shareholders

If management believes that it can improve the firm so that the share pric will exceed $25, then
they should fight ht eoffer from outside company

If the management believes that this bidder or other bidders will actually pay more than $25 pr
share, then they should still fight the offer

ICP 1-7
True
ICP -1-8
D

Finance Lecture 2 Tuesday, January 17,2017

3-1 True

3-3- A
3-4 - FALSE
3-5 B
3-6

DChange in Cash = sources- uses

375 190 + 210 105 - $290
Cash increased by $290

ICP 3-7 We can see how well we are doing

3-8 Solution posted.

3-9 ROE
Firm A
D/TA = .35
(TA-E)/TA=.35
Ta/Ta-E/Ta=.35
1-E/TA = .35
E / TA = 0.65
E=TA(0.65)

ROA = NI/TA = .12

NI = .12(TA)

ROE(firma)= NI/E
=.12(Ta)/.65(ta)
.12/.65
=18.46%

Firm B
1-.3=.7
.11/.7=15.71%
or

D/TA = .3
(TA-E) / TA -= .3
1-(e/ta)=.30
E/ta = .7
E= (/.7(TA)

Rearrageing ROA
NI/TA=.11
NI=.11(TA)

ROA(firmB)
.11/.7= 15.71%

ICP 3-10
Look at the limitations of financial ratios

ICP 3-11 Du Pont Identify solution

- ROE Is most important to shareholders
- The Du Pont identity emphasizes profitability, asset utilization
efficiency, and financial leverage,
- ROE may be misleading if low PM and high EM, if the firms margins
were to erode slightly, the ROE would be heavily impacted

ICP 3-12 Du Pont ROE

ROE = (PM)(TAT)(EM)
ROE=0.55x1.45x2.8=.1771 or 17.71%

ROA = (PM)(TAT

ICP 3-13 Equity Multiplier

The equity multiplier (EM) is :
EM = 1 + D/E
EM = 1+0.65= 1.65

ROE (ROA)(EM)
=0.85(1.65) = .14025

ROE can be computed as = NI/TE

So, NI = ROE(TE)
NI = .14025(540000) = 75 375
Chapter 4

ICP 4-1 True

Short-Term Financial Planning

Pro Forma into the future

ICP 4-2
- Sales are the driving force behind a business
- A firms asset and employees exist to support sales
- A firms future need for things like capital assets, employees,
inventory, and financing are determined by its future sales
level
Original Pro Forma Assumption
Sales 989000 1114800 +20%
Costs 723000 867,600
Other 19000 22,800
expenses ___________ ___________
EBIT 187000 224,400
Interest 14000 14000
Paid ___________ _________
Taxable 173,000 210400
Income
Taxes 60,550 73640 Same Rate
(35%) ___________ _________
Net 112,450 136,760
Income
Dividends 33,735_ 41,028 30% payour
Addition to 78,715 95,732 70% plowback
RE or retention
RE = 136760-44028 = 95732
Now RE OB 182,900 + 95732 = 278,632 Original Pro
Forma
Original Pro Forma AP 68000
+20%
Cash 25,300 +20% (30360) Notes 17000
na
AR 40,700 48700 Total 85000
Inventory 86,900 LTD 158000
na
Total CA 152,900 C/Stock 140000
na
Net Fixed Asset 413,000 RE 182900
322,900
Total 565,000 Total 565,000

Now RE OB 182,900 + 95732 = 278,632 Pro Forma

Pro Forma AP 81600 +20%
Cash 30360 Notes 17000
Same$
AR 48840 Total 85000
Inventory 104280 LTD 158000
same $Total CA 183480 C/Stock
140000
Net Fixed Asset 495600 RE 278

Total 565000 Total 675232

EFN = total asset total loabilities and equity

679080-675232
EFN = 3838

80% capacity
first we need to calculuate full capacity sale
929000/.80
= 1161250
the capital intensity ratio at full capacity is
= fixed asset/tull calacpity sales
=413,000/1161250
=0.355652138

The fixed asset required at full capciy sales I sthe capital intensity
ratio time sthe projected sales level
Total fixed assets = 0.355652138
(1114800)= 396480

EFN = (183480+396480) 675232 = -95272 NB. Assumes that

fixed assets are sold so the company has a 100% fixed asset
utilization

EFN = (183480+413000) 67523 = -78752

NB = Fixed assets are not sold

ICP 4-4
Retention ratio (plowback) is:
R = 1 payout ratio
R = 1 0.2 = 0.8

Internal growth rate = (ROAxR) / [1- (ROA x R)]

= (.09x.8)/[1-(0.9x.8)
=0.072/0.928
=0.07758 or 7.76%

ICP 4-5
Retention Ratio is
R = 1 payout ratio
R = 1 0.25 = 0.75

Sustainable growth rate = (ROA x R) / [ 1 (ROA x R)

= (.12x.75) / ( 1 [ .12x.75)]
=.09/.91
=.0989 or 9.89%

ICP 4-6 Solution

Must calculate the ROE using Du Pont Ratio:
ROE= (PM) (TAT) (EM)
ROE = (0.082) (1/0.75) (1+.4)
ROE = 0.153066667 or 15.31%

Rention Ratio
R=1-payout ratio
R = 1 (12,000/43000) = 0.720930233

Sustainable growth rate = (ROE x R )/1-(ROExR)

(.1531x.7209) / (1- (15.31x.7209)
=.124062547 or 12.41%

ICP 4-7
4500000/.9 = 500000
(500000/4500000) 1 = 11.11%

ICP 4-8

R = 1 - .3 = 0.7

Using the sustainbable growth rate equation and solving for ROE

Sustainable growth rate = (ROE x R ) / [1-(ROE x R)]

0.12 = (ROE x 0.7) / [1-(ROE x .7)
.12 - .084ROE = .7 ROE
.12 = .784 ROE
ROE = 0.1531 or 15.31%

ICP 4-8 soltuion

Now we can use the DU Pont identiyu to find the profit margin
ROE = PM (TAT)(EM)
.1531=PM (1/0.75) (1+1.2)
PM = .1531 / [(1/0.75)(2.2)]
PM = 0.052193182 or 5.22%

Calculate ROE
ROE = PM (TAT)(EM)
ROE = 0.067(1/1.35)(1+03)
ROE = 0.064518519 or 6.45%

Now we can use the SHR equation to find the retention ratio
SGR = (ROE x R) / ( 1 (ROExR)
0.12 = 0.0645 (R) / [1-0.0645(R)]
0.12 - .00774R = 0.645R
.12 = 0.7224R
R = 1.66
This implies that the payout ratio

The maximum growth rate

SGR = (ROE x R ) / [1-(ROExR)]
SGR = 0.064518619(1)/[1-0.064518519(1)]
SGR= 0.064518519 / .935481481
SGR = .0689

Retention:
R = 1- 0.25= 0.75

ICP 410
Using internal growth rate equation to find ROA
IGR =. .
0.07= ROA(0.75)/[1-ROA(0.75)]
0.07 = 0.8025ROA
ROA = 0.087227414 or 8.72%\
Plugging ROA and PM into the equation and solving for TAT

ROA = PM(TAT)
0.0872=0.05(TAT)
TAT=0.0872/0.05
TAT = 1.74 times

ICP 4-11
True

ICP 4-12
-Treats them as if they were actual statements in order to
evaluate
-Compute liquidity, activity, debt and profitability expected
financial health of the firm
-review and question various assumptions and values used in
forecasting these statements

4-13
If a company has marketable securities , how might this impact
the calculation of external financing required?

If, MS provide a much lower ROR than the cost of financing, it

makes sense to first liquidate these securities before obtaining
EFN
The amount of EFN will be reduced by the value of MS; the
company will require less financing from external sources.

ICP 4-14 : Pro Forma Statements

D All of the above
ICP 4-15:
Measures: the $ of assets needed for each $1 increase in sales
Equations: A/S
Recognize : the alrger the number, the more capital intensive the
company , and the more assets that will be required for a given
increase in sales
An increase in assets then leads to a higher amount of required
financing

ICP 4-16
Measures: is the rate of sales growth(g) that can be financed
with only internal sources of financing
Equation: Use EFN formula , it is the point where EFN is zero and
solving for growth, G
Recognize: if a company knows this rate, it can plan early for
raising external financing

Chapter 5 - Time value of money

ICP 5-1 Simple Interest

Simple interest per year is:

$5000 x 0.8 = $400

so after 10 years:
$400 x 10 = $4000 in interest

The total balance will be $5000 +4000 = 9000

With comound interest:

FV = PV (1+r)^t
FV = 5000 (1.08)^10 = 10794.72

Difference is 10794.62 9000 = 1794.62

ICP 5-2
True

(Discounting = PV/ (1+ r)^t

PV = 121 / (1 + .1)^2
= 100)

ICP 5-3 Future Value

N=1
Interest = = 5
Present Value = 1000
Payment = ?
Future Value = ?

1 year : fvt = pv(1+r)^t

Fv= 1000(1+0.5)^1 = 1050

(1+r)^t is the FVIF

Financial calculator :
1N, 5 I/Y , 1000 PV, cpt FV 1050

Now 1 year 2 years

1000 1050 ?

2 years = FVt = PV (1+r)^t

FV = 1000(1+0.5)^2 = 1102.50

Financial calculator:
2N, 5 I/Y , 1000

5 years : F= PV (1+r)^t
Fv5 = 1000 ( 1+0.5)^5 = 1276.28

40 years
Fv40 = 1000 ( 1+0.5)40 = $7039.99

ICP 5-4 Calculating FV

45 year: FV = PV(1+r)t
Fv45 = 4000 ( 1+.11)45 = $438,120.97

35 year: FV = PV(1+r)t
Fv35 = 4000 ( 1+.11)35 = $154299.40

Waiting 10 years
$438120.97 154229.40 = 283821.57

Do not wait, invest today.

ICP 5-5

FV = PV (1+r)^t
FV15 = 2000 (1+0.5)^5 (1+0.6/2) ^2x5 (1+0.8/4)4x5
=2000 (1.05)^5 ( 1.03)^10 (1.02)^20 = $5087.44

5097.44/2000 investment = 2.54872

CAGR = (FV/PV) ^1/n 1

(1+r)^15 = 2.54872

r = 2.54872^1/15 - 1
r = 1.064359012 1 = 6.435% (compounded annual growth rate)

Present value=
The process of finding the present value is calle ddiscounting and
he interest rate used to calculate present values is called the
Discount rate.

ICP 5-6 Present Value (PV)

You expect o receive $100000 in n 20 yrs time, how much is this
worth today at 8%

N = 20
I/Y = 8
PV = ?
PMT?
= 10000

Prsent value = FV / (1+r)^t

PV = 100000 / (1+0.8)^20
= 21,454.82

Note that =
FV = pv(1+r) ^t
FV20 = 21454.82 ( 1+0.08)^20
= 1000000

ICP 5-7
PV = FFV (1+r)^t
PV = 15451 / (1.07)^6 = $10295.65

PV = FFV (1+r)^t
PV = 51557 / (1.13) ^7 = $21914.85

PV = 51557 / (1.12) ^7 = higher number

PV = 886073 / (1.14) ^23 = $43516.90

PV = 550164 / (1.09) ^18 =

ICP 5-8

PV = 100949.21

PV = FV (1+r)^t
PV = 1000000 / (1.05)^47 = %100949.21
PV = 164 435.63

PV = FV / (1+r)^t
PV = 1000000 / (1.05)^37 = 164 435.63

ICP 5-9

PV = 650 000 000 / (1.074)^20 = 1558930400.10

pV = 1558930400.10

ICP 5-10 present value of an uneven series (need to bring it all

into the same year individually)

Answer =
PV = FV (1+r)^t
Pv = $500 / 1 + .12)^1 + $600 / (1+.12)^2 + $700/(1+.12)^3
Pv = 446.43 + 478.32 + 498.25 = $1423

ICP 5 11 : doubl our money

Using Rule of 72 :
72 / r% = number of years
72 / r% = 9 years
= 8%

PV = FV / (1+r)^t
(1+r)^9 = 2000 / 1000 = 2

enter 2 , press yx enter (1/9( and press = key

1.080059
ICP 5 12
Using rule for 72
72 / 9% = 8 years

FV = PV (1+r)^t
300000 = 1500000 (1+0.9)^t
2=(1.09)t
t = Ln(2 ) / Ln (1.09)
t = 0.69314718/ 0.086177696
t = 8.043231727

ICP 5 13

Using rule of 72 / 7% = 10.28 years

FV = PV (1+r)^t
2 = 1(1+0.7)^t
t = Ln (2) / Ln (1.07)
t = 0.69314718 / 0.067658648
t = 10.24476835

Rule of 144: 144/7%

FV = PV (1+r)^t
4 = 1 (1+.07)^t
t = Ln(4) / Ln (1.07)
t = 1386294361 / 0.067658648
t= 20.489..

5-14 Calculating interest rate solution

FV = PV (1+r)5
R= (fV/Pv) ^ 1/t - 1
r = (290 0000 / 55 000) ^ 1/18 -1
r = 0.096763712 = 9.68%
5-15 Find the interest rate

FV = PV (1+r)^t
$250= $100(1+r)^10
(2.5)^(1/10) = (1+r)
1.0959 = (1+r)
r = 0.0959
= 9.59%

5-16
Using the Rule of 72 : 72/20% = 3.6
FV = PV (1+r)^t
$200 = $100(1+0.20)^t
$200/100 = 2 = (1.2)^t
Ln (2) = t x Ln (1.2
t = Ln (2) / Ln (1.2)
t = 0.69314718 / x

5-17
True

5-18
False
EAR = (1+APR/m)^m 1

More periods = more returns

EAR = APR only when m = 1

ICP 5 19

FV = PV (1+r ) ^t
75000= 10000 (1+0.11)^t
75/10 = (1.11)^t
Ln (7.5) = t x Ln (1.11)
t = Ln (7.5) / Ln (1.11)
t = 2.0124903012 / .
2 years + 19.31 = 21.31 years

ICP 5 20
FV = PV (1+r)^t
R = (fv / pv)^1/t = 1
R = (10311400/12377500)^1/4 - 1
r = 0.955371382 1 = -4.46%

Bonus Question

Find the future value at th end of 3 years of $600 nvested today

at an interest rate of 3%
655.64
FV = PV (1+r)^t
Fv = 600 (1.03)^3 = 655.64

Ordinary paid at the end

Annuity due Paid in the beginning

ICP 6 1-3 (check phone)

ICP 6-4

FVA = PMT [(1+r)^t 1) / r ]

FVA = 3000 [(1.07^30 1 / .07] = 283382.36

B)Annuity due
283382.36 x 1.07 = 303219.12
(or do it the long way)

6-5
75000[ 1 1/(1+0.8)^45 / 0.08
PV = 75000 [12.1084015] = 908130.1127
6-6 Assuming positive cash flows, the present value will fall and
the future value will rise.

(PV of perpetuity slide)

PV of perpetuity = C / R = ?
PV of perpetuity = 100000 / 0.10 = 1000000

ICP 6-8

PV = C1 / r g
=100/.1-0.5
= 2000

NB. Without growth

100/.1 = 1000

ICP 6-9

PVA = c [1-1/(1+r)^t / r]
100000 = PMT [ 1 - 1/1+0.08)^5 / 0.08 ]
100000 = PMT [ 3.992710037]
PMT = 100000 / 3.992710037 = 25045.65

8%
Time PMT Interest Principle
Balance
0 100000

1 $25045.65 8000 [100000x0.08] 17045.65

82945.35

2 $25045.65 18409.30 18409.30

64545.09

3 25045.65 5163.60 19882.05 44663.04

2N, 8 , - 25045.65 PMT

PV = 44663.02
Or get the answer doing this
PMT = [ 1- 1/(1+r)^e /r ]

PV 5 yrs beg 10 years

_____________________ _______________>

5000 annuity
----------------------------

PVA = 5000 [ 1 1 / 1+0.09)^10 / 0.09 ]

PVA = 5000 [6.417657701] = 32088.28851 (BEGINNING OF 5th
years)

PV = FV / (1+r)^t
= 32088.29/(1+.09)^4
= $22732.15
ICP 6-11

PV Annuity
PVA = 105000 [ 1 1/(1+0.07)^20 / .07]
PVA = 105000 [10.59401425] = 1112371.50

a) make equal annual deposits

FVA = C [ (1+r)^t 1 / r]
1112371.5 = c [1+0.07)^30 -1 / 0.07 -
C = 1112371.5 / [94.46078632] = 11776.01

b) 1112371/5 = pv(1.07)^30
PV = 1112371.5/(1.07)^30
= 146129.04

c subtract value of lump sum savings to find out how much your
friend is short
FV Trust fund = 150 000 (1.07)^10 = 295072/70

So the amount your friend still needs at retirement is :

FV = 1112371.5 295072.7 = 817298.80

C) using FVA sole for the payment

FVA = C [ (1+r)^t 1 / r ]
817298.8 = c [(1+0.07)^30 - 1 / 0.07]
C = 817298.8 / [94.46078632] = 8652.24

Employer will contribute 1500 per year, so

8652.25 - 1500 = 7152.25

PV = (10000 / (1+0.05)^5 ) = 7835.26

+ PV = 12278.27 ( didnt do math)

= 20113.53
EAR = APR only when m is 1
USUALLY EAR is larger

Takes compounded interest into consideration

ICP 6-13
EAR = (1 + 0.12/12 ) ^12 - 1 = 12.68%

6-14
EAR = (1 + 0.142/12) ^12 - 1 = 15.16%
EAR = (1+ 0.145 / 2)^2 1 = 15.03%

Therefore choose first united bank 14.5 % , 15.03%

ICP 7-1
Coupon Rate and Required Return SOLUTION
Bond issuers look at outstanding bonds of similar maturity and
risk . the yeilds on such bonds are used to establish the coupon
rate necessary for a particular issue to initially sell them

The coupon rate is fixed and simply determined what the bonds
coupon payments will be

The required return is what investors actually demond on the

issue, and it will fluctuate through time

Ghe coupon rate and the rquired return are equal only if the bond
sells for exactly par

ICP 7-2
7[( 1 1 /1+0.0875)^10 / .0875] + 1000/(1+0.0875)^10
= 918.89

ICP 7-3

Bond value = 90 [ 1 (1+r)^9 / R ] + 1000 / ((1+R)^9

= 934

R will be higher than 9% because $934

<1000 facevalue
YTM = R = 10.153

ICP 7-4

Coupon - 1000 x 6.5/2 = 32.50

Time = 3 years x 2 = 6 semi annual periods

YTM
A) 6.5/2 = 3.25%

Bond value = 32.50 [ 1 1 / (1+0.0325)^6 / 0.0325 ] + 1000 /

(1+0.0325)^6
= 1000 sells at par when the coupon rate is equal to the rate of
maturity

b) 5.1/2 = 255%

Bond Value = 32.50 [1 1 / (1+0.0255)^6 / 0.0255 ] + 1000 /

(1+0.0255)^6
=1038.49 sells at premium ( more than 1000)

c) 15%/2 = 7.5%

Bond value = 32.50 [ 1 1 / (1+0.075)^6 / 0.075 ] + 1000 / ( 1+

0.075)^6
= 800.51 sells at discount

ICP 7-5
= 34.50 [6.9/2 x 100 how we got it] ( 1 1 / (1+0.037)^20 / 0.037
) + 1000 / ( 1+0.037)^20
= 965
ICP 7-6
Bond value = c[ 1- 1/ (1+0.034)^29] + 1000/(1+0.034)^29
= 924
Coupon payment copon rate % /2 x 1000

924 = c [ 18.257897777 ] + 1000 / 2.636911923

544.77 = C [ 18.25789777]
C = 29.84 (this is a semi annual payment)

29 .84 x 2 = 59 .68 Annual coupon payment

The coupon rate = annual coupon payment divided by par value

so coupon rate = 59.68/1000
= 0.05968 or 5.968%

7-7
B

ICP 7-8

Bond Coupon YTM

A 8% 10%
B 10% 10%
C 12% 10%

Bond discount will rise

Bond premium will drop

ICP 7-9

In this case, the matiruty is indeterminate

Abond selling at par can have any length of maturity
ICP 7-10
1 month 5 months
Issued Purchase Price Interest Payment Date

Accrud interest = $74/2 x 1/6 = 6.17

Clean price = dirty price accrued interst
967 6.17 = 961.83

ICP 7-11

3 month 3 months
Issued Purchase Price Interest Payment Date

Accrued interest = $68/2 x 3/6 = $17

Clean price = dirty price accrued interest
Dirty price = clean price + accrued
1073 + 17 = 1090

ICP 7-12 compannies pay to have their bonds rated because:

Unrated bonds can be difficult to sell
Many large investors are prohibited from investing in unrated
issues

ICP 7 13

Only using back part because 0

Back part = F + (1+ r)^t

Zero bond value = 1000 (1.09)^25

P = 115.97 (you pay the corporation 115.57 so you can get a
1000 later)
Part b.
1000/ 1.09^24 = 126.40

The interest deduction is the price of the bond at the end of the
year, minus the price at the beginning of the year so:
Year 1 interest deduction = 126.40 115.97 = 10.43

1000 / 1.09^1 = 916.43

Year 24 interest deduction = 1000 917.43= 92.57

The company would prefer staright line methods allowed because

the valuable interest deduction occur earlier in the life of the
bond.
Under the zeroc coupoin method, can only deduct the accued
interest of $10.43 in the first year.

Yield Curve Solution

The term structure of interest rate:
Based on pure discount bonds (no default risk)
The yeield curve :
Based on coupon bearing issues

ICP 7-15

Ytm = 11%
P sam = 45 ( PVIFA 5.5% , 6) + 1000 ( PVIF 5.5% , 6)
= 224.7988639 = 725 833
= 950.04
Percentage chagne in price = (new price original price) / original
price

950.04-1000 / 1000
= - 5.00

Bond Dave = 11%

P dave = 45 ( PVIFA 5.5% , 40) + 1000 (PVIF 5.5%, 40)
= 722.0756108 + 117.4631423
= 839.54

The percentage change in price

= 839 1000 / 1000
= -16.05

Bond same YTM = 7%

Bond Sam = 7%
P sam = 45 ( PVIFA 3.5% , 40) + 1000 (PVIF 3.5%,6)
= 239.7848859 + 813.5006443
= 1053.29

The percentage change in price = new price original price /

original price
= 1053.29 -1000 / 1000
= 5.33

Part c
Bond Dave YTM = 7%
Bond dave = 7%
P dave = 45 ( PVIFA 3.5% , 40) + 1000 (PVIF 3.5%,40)
= 1213.55

Percentage change in price

1214.55- 1000
P dave = + 21.36
All else is the same, the longer the maturity of the bond, the
greater is its sensitivity to changes in interest rates