Valuing Preferred Stock: Vps = annual dividend = D required rate of return kps

Valuing Common Stock:

Common Stock Value With Zero Growth. “A zero growth stock is perpetuity”
P0 = D where: D dividend the investor expect
ks ks required rate of return
Common Stock with Single Holding (one year holding)
Vcs = D1+ P1
(1+ks) (1+ks)
Common Stock : Multiple Holding Periods
Vs = D1
ks – g

Cost of Capital:

Cost of Common Equity
DCF Approach:ks = D1 + g
P0
The CAPM Approach:ks = krf + (km-krf)β
The Risk-Premium Approach: ks = krf + (RPM)β

After-tax cost of debt = kd(1-Tax rate).
Cost of New Common Equity
ks = D1 + g
P0 - flotation cost

Cost of Retained Earning, ks = (D1 /P0) + g

Weighted Average Cost of Capital (WACC)

Capital Budgeting:

Payback Period = BY + UC
CF
BY= the year before full recovery
UC= the unrecovered cost at start of year
CF= the cash flow during the year

Net Present Value
NPV = S Annual Cash Flow - Initial Investment
(1+k)t

Internal Rate of Return: IRR
Initial Investments - S Annual Cash Flows...

...your business?
Your Answer Score Explanation
20060181.
18099548.
Do not have enough information to value. Correct 10.00 Correct. You know what information you need to value.
Total 10.00 / 10.00
Question Explanation
Understanding the valuation of a new business.
Question 6
(10 points) You have just returned to your job after completing your MBA, generously funded by the CEO. A few days later, your CEO requests you to evaluate the following news release he will issue to analysts. "For years we have thought about our business strategy, without worrying about financing. Times have changed and we need to think about our cost of capital. Since (a) debt is always cheaper than equity; (b) we have decided to use debt to finance our next major projects." What is your assessment of this statement?
Your Answer Score Explanation
The statement is false.
The statement is true.
The statement is partly true/false.
Total 0.00 / 10.00
Question Explanation
The basics of financing.
Question 7
(10 points) Two firms, Alpha, Inc., and Beta, Inc., are in the same business. Alpha, Inc., has debt that is viewed by the market as risk-less with a market value of $500 million. Beta, Inc., has no debt. Both firms are expected to generate cash flows of $100 million per year for the foreseeable future and the market value of the equity of Beta, Inc is $1 billion. Estimate the return on equity of Alpha, Inc. Assume there are no taxes,...

...economic risk+operational risk = business risk + financial risk = total firm’s risk
EVA = EBIT – TAX = the aftertax operating profit (sometimes referred to as net operating profit after taxes or NOPAT)
* Less the dollar cost of the capital employed to finance these assets = COST OF CAPITAL
Invested Capital =
Cash +
Net fixed assets +
WCR (investment the firm must make to support its operating cycle is the sum of its inventories and accounts receivable minus its accounts payable)
WCR = (Accounts receivable + Inventories + Prepaid expenses) – (Accounts payable + Accrued expenses).
Cash-to-cash period = cash collected from customers – cash paid to suppliers
Matching strategy = match the lifetime of an asset with its financing source
WCR is mainly a lt investment as it remains on the BS indefinitely- permanent part to be financed with LT finance, and seasonal part with ST finance
Liquidity issues arising from matching issues – the higher the proportion of WCR financed with LTF, the higher the liquidity
Net long-term financing (NLF) = Long-term debt + Owners’ equity – Net fixed assets
Net short-term financing (NSF) = Short-term debt – Cash
Net long-term financing working capital requirement
Percentage of working capital financed long term
* Liquidity position will improve if:
* Long-term financing increases, and/or
* Net fixed assets decrease, and/or
* WCR...

...Question 1
( 5 points) In a world with no frictions (taxes, etc.), value is created by how you finance a project.
True.
False.
Question 2
(5) The return of equity is equal to the return on debt of a project/firm
Always true.
Never true.
Sometimes true.
Question 3
(10 points) Moogle, Inc. is in the same business as Google, Inc., but has recently retired all its debt to become an all-equity firm. Its return on equity has dropped from 12.25% to 10.60% as a result of this. Google, Inc. continues to have debt in its capital structure, and its debt-to-equity ratio is 30%. What is the return on assets of Google, Inc.(No more than two decimals in the percentage interest rate, but do not enter the % sign.)
Answer for Question 3
Question 4
(10 points) Suppose CAPM holds, and the beta of the equity of your company is 2.00. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 4.5% and the risk-free rate is 3.00%. Suppose the debt-to-equity ratio of your company is 20% and the market believes that the beta of your debt is 0.20. What is return on assets of your business? (No more than two decimals in the percentage interest rate, but do not enter the % sign.)
Answer for Question 4
Question 5
(10 points) You are planning on opening a consulting firm. You have projected yearly cash flows of $2 million starting next year (t = 1) with a growth rate of 3% over the foreseeable future thereafter. This...

...Final Finance Exam Notes
Definitions:
1. Capital Budgeting is the process of evaluating proposed large, long-term investment projects.
Capital budgeting is primarily concerned with evaluating investment alternatives.
The first step in the capital budgeting process is idea development.
A characteristic of capital budgeting is the internal rate of return must be greater than the cost of capital.
One of the simplest capital budgeting decision method is the payback method.
Capital budgeting techniques are usually used only for projects with large cash outlays.
2. Payback period is the number of time periods it will take before the cash inflows of a proposed project equal the amount of the initial project investment (a cash outflow). The payback period is calculated by counting the number of years it will take to recover the cash invested in a project.
3. Net present value is the dollar amount of the change in the value of the firm as a result of undertaking the project.
With non-mutually exclusive projects, the net present value and the internal rate of return methods will accept or reject the same project.
The Net Present Value Method is a more conservative technique for selecting investment projects than the Internal Rate of Return method because the NPV method assumes that cash flows are reinvested at the firm's weighted average cost of capital.
The net present value assumes returns are reinvested at the cost of capital.
If an...

...Finance 301
1. The NPV for the truck and the pulley are $2026.75 and $5586.05 respectively. Since these projects are independent, the company can choose either project. They both will give the company a return higher than 12% as well. (Math is on last page)
2. A. NPV for Alt A is $1892.17 while the payback is 2.86 years. NPV for Alt B is 2289.66 while the payback is 4.62 years. (Math on last page)
B. Since these projects are mutually exclusive only one can be chosen. Since NVP is a better way of estimating value and return, it should be used when picking between two projects. Therefore, the Smith Pie Company should go with alternative B. Even though Alt B has a longer payback period than Alt A, it will look better in the company assets longer and have a better return.
3. CAPM is equal to the cost of capital, which provides a usable measure of risk for the investor and their investment. It let’s investors know if they will get the return they deserve prior to making any decisions. Also, the higher the risk the higher a return could be.
4. A. 11% is the required return on the stock.
B. Beta is .9
C. The company’s cost of capital is 9.8 percent.
D. If the risk of the project is similar to the risk of the other assets, then the appropriate return is the cost of capital, which in this case is 9.8%
(Math is on last page)
5. The beta for the portfolio is .5 (Math is on last page)
6. The alpha for this portfolio is 1.79 while the beta is .71. What...

...Question 1
(5 points) In a world with no frictions (i.e., taxes, etc.), having debt is always better because it increases the value of the firm/projet.
Your Answer | Score | Explanation |
False | 5.00 | Correct. You understand the irrelevance of financing. |
Total | 5.00/5.00 | |
Question Explanation | | |
Fundamental question about value creation. |
Question 2
(5) the return of equity is equal to the return on debt of a project/firm
Your Answer | Score | Explanation |
Never true | 5.00 | Correct. Equity is always riskier. |
Total | 5.00/5.00 | |
Question Explanation | | |
Financing`s effects on equity. |
Question 3
(10 points) Suppose the expected returns on equity of two firms, Macrosoft and Microsoft, that operate in the same industry are 10.50% and 12.60%, respectively. What is the return on assets in this business if Macrosoft has no debt? (No more than two decimals in the percentage interest rate, but do not enter the % sign.)
Your Answer | Score | Explanation |
10.50 | 10.00 | Correct. You understand that return on assets in a business connot vary for different forms. |
Total | 10.00/10.00 | |
Question Explanation | | |
The effects of leverage on business risk. |
Question 4
(10 points) Suppose CAPM holds, and the beta of the equity of your company is 2.30. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 5% and the risk-free rate is 3.25%. Suppose the...

...Cost of Capital The required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity.
AW´s Cost of Equity Capital RS = RF + β x (RM - RF)
AW´s Cost of Capital of All Equity RS = R0 + B/S (1 – t c) (R0 – RB)
Cost of Equity Capital for WWE´s Widget Venture
RS = R0 + B/S (1 – t c) (R0 – RB)
RWACC for WWE´s Widget Venture RWACC = B/S +B RB (1 – t c) + S/S +B RS
APV Taking into account financing benefits, APV includes tax shields such as those provided by deductible interests
All-Equity Value Initial cost+ Depreciation tax shield + Present value of (Cash revenues + Cash expenses)
Flotation Costs are paid immediately but are deducted from taxes by amortizing on a straight-line basis over the life of the loan
Tax Subsidy interest must be paid on the gross proceeds of the loan, even though intermediaries receive the flotation costs.
NPV Compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account.
Non-Market-Rate Financing a number of companies are fortunate enough to obtain subsidized financing from a governmental authority.
The No-Tax Case βEquity = βAsset (1+ Debt/Equity)
The Corporate Tax Case βEquity = (1+ (1 - t c) Debt/Equity) βUnlevered Firm
Unlevered Beta (Equity/Equity + (1-tc) X Debt) βEquity = βUnlevered Firm...

...PRINCIPLES OF BANKING AND FINANCE
MT.KENYA UNIVERSITY
INSTRUCTIONS
Answer at least TWO questions from section A and TWO others from section B
SECTION A
1. a. Compare and contrast the main features of the financial systems of US and Germany.
15 marks
b. Discuss the reasons for the internet bubbles of the late 1990s
10 marks
2. a. Explain the adverse selection problem in financial markets and also discuss the solutions to this problem
12 marks
b. Define financial intermediaries and explain the major functions of Commercial Banks of Kenya.
13 marks
3. a. For the last few years, the Central Bank of Kenya has been on the spot about the way it controls risk. Name FOUR types of Bank risks and discuss....