Exam 2 Part 2
Answer any EIGHT of the ten questions. Each question is worth 5 points. Return your answers to me by 11:59 PM Sunday 11 November 2012 1. A number of publicly traded firms pay no dividends yet investors are willing to buy shares in these firms. How is this possible? Does this violate our basic principle of stock valuation? Explain.

Our basic principle of stock valuation is that the value of a share of stock is simply equal to the present value of all of the expected dividends on the stock. According to the dividend growth model, an asset that has no expected cash flows has a value of zero, so if investors are willing to purchase shares of stock in firms that pay no dividends, they evidently expect that the firms will begin paying dividends at some point in the future. 2. Explain why some bond investors are subject to liquidity risk, default risk, and/or taxability risk. How does each of these risks affect the yield of a bond?

Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others. If any of these risks exist, investors will require compensation by demanding a high yield. 3. The discussion of asset pricing in the text suggests that an investor will be indifferent between two bonds which have equal yields to maturity as long as they have equivalent default risk. Can you think of any real-world factors which might make a given investor prefer one of these bonds over the other?

4. Why do corporations issue 100-year bonds, knowing that interest rate risk is highest for very long-term bonds? How does the interest rate risk affect the issuer?

Treasury bonds make great safe, long-term investments, but is there any point in Why would the Fed consider issuing a bond with a 100-year maturation, are...

...discountedcashflow (DCF
In finance, discountedcashflow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cashflows are estimated and discounted to give their present values (PVs) — the sum of all future cashflows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cashflows in question.
Using DCF analysis to compute the NPV takes as input cashflows and a discount rate and gives as output a price; the opposite process — taking cashflows and a price and inferring a discount rate, is called the yield.
Discountedcashflow analysis is widely used in investment finance, real estate development, and corporate financial management.
Discount rate
Main article: Discounting
The most widely used method of discounting is exponential discounting, which values future cashflows as "how much money would have to be invested currently, at a given rate of return, to yield the cashflow in future." Other methods of discounting, such as hyperbolic discounting, are studied in academia and said to reflect intuitive...

...In finance, the discountedcashflow (DCF) analysis is a method of valuing a project, company or asset using the concepts of time value of money (Wikipedia, 2004). Three inputs are required to use the DCF, also called dividend-yield-plus-growth-rate approach, include: the current stock price, the current dividend, and the marginal investor’s expected dividend growth rate. The stock price and the dividend are east to obtain, but the expected growth rate is difficult to estimate (Ehrhardt & Brigham, 2011). The advantages and disadvantages of using DCF approach will be explained along with the further clarification on the cost of capital using DCF approach.
The cost of capital is a term used in the field of financial investment to refer to the cost of a company’s funds, both debt and equity, or from an investors’ point of view, the shareholders required return on a portfolio of a company’s existing securities. It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet (Wikipedia, 2004). In other words, it is the expected return that is required on investments to compensate for the required risk. It represents the discount rate that should be used for capital budgeting calculations. The cost of capital is generally calculated on a weighted average, also called Weighted Average Cost of Capital...

...Capital Asset Pricing Model (CAPM) Versus the DiscountedCashFlows Method
Managerial Analysis/BUSN 602
Capital asset pricing model or CAPM is a financial model that measures the risk premium inherent in equity investments like common stocks while DiscountedCashFlow or DCF compares the cost of an investment with the present value of future cashflows generated by the investment with the mindset being that if the cashflow is positive, then the investment is good. Generally speaking, CAPM is a model that describes the relationship between risk and expected return and DCF is a valuation method used to estimate the attractiveness of an investment opportunity. So what are the differences, advantages and disadvantages of each one? How do you go about applying them? They each have their own purpose. Let’s first take a look at CAPM.
“CAPM is a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.”("Capital asset pricing,") It looks at the risk and rates or return and compares them to the stock market. While it is impossible to have no risk, CAPM helps calculate investment risk with the return on investment that is predictable and expected. “The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk...

...Be prepared to discuss the case in class (your answers, your
analysis, etc.)
1
Valuation - Use NPV approach
How to make investment decisions:
1.
Estimate (expected) cashflows in each time period
2.
Choose an appropriate discount rate
3.
Use discountedcashflow analysis to calculate NPV
4.
Make decision that maximizes NPV
Fundamental principle: V(A+B)>V(A)+V(B)
Value driver:1)Eliminate overhead
3) Leveragen brom dname
Pay its=D(P)(P-VC)-FC
V(Pinkerton after)+V(CPP after)>V(Pinkerton before)+V(CPP before)
V(Pinkerton after)+∆V(CPP)>V(Pinkerton before)
NPV=∑FCF(Pink,t)/(1+WACC)^t+∑∆FCFcpp.t/(1+WACC)^t
t
t
Landing list:
1) Find WACC
2)Estimate FCFpink
3)Estimate∆FCFcpp
2
1. Use FCF analysis
• Case provides information about value drivers of the
acquisition
• Combine with accounting information to estimate
Free CashFlows
• Use method we discussed in class for calculating
FCFs. How to acount for
CapEx & Depreciation?
PP&E?
NWC?
Interest payments?
3
1. Separate into short and terminal terms
p=[ROE*(BVPS*Payout Ratio)]/(r-g)
In valuing a business, we typically forecast cashflows only for a certain period, e.g.:
C1
P
1 r
C2
1 r
2
C5
1 r
5
P5
.
5
1 r
– The expected future value, P5, is called the terminal
value, continuing value, or residual value
– Can estimate it by forecasting cashflows from year...

...the subsequent event of 9/11 terrorist attack. This report attempts to calculate and evaluate the IPO valuation of JetBlue’s stocks and provide recommendation and adjustments where necessary to reflect the true value of JetBlue.
Assumptions made in Exhibit 13
There were several valuation techniques used by analysts and underwriters to value an enterprise’s share, they are respectively the DiscountedCashFlow Method (DCF) for instance, FreeCashFlow to Equity (FCFE), Free CashFlow to Firm (FCFF), and Dividend Discount Model, and the Relative Valuation Techniques, for instance Price Earnings Ratio (P/E) and Price Book Value Ratio (P/BV). Dividend Discount Model requires input of next year’s expected dividend distributed, a required rate of return by shareholders and an estimation of growth rate. Since JetBlue does not pay out dividend before listed (despite dividend distributed to preferred shares shareholders), such model is considered as inapplicable. The FCFE and FCFF method were developed for firms which does not distribute dividend and their valuation is based on the free cashflow available to the equity holders or to the firm, and thus calculate the share price of a firm after attributing outstanding shares. The difference between the FCFE and FCFF method lies on the discount rate uses, where the latter uses cost of capital as the discount...

...Technical Questions
1. Can you explain quarterly forecasting, updating revenue and expense models?
2. What projects have you implemented these skills?
3. In conjunction with these projects how do you execute input of detailed plans and forecast into the financial systems?
4. Describe how you coordinate plan transfers.
5. Are you familiar with creating daily sales reports?
6. What processes do you use to create reports?
7. Have you created month-end sales reports?
8. Have these reports involved your knowledge of analysis concerning actual and planned revenues, balance sheets and expenses?
9. Can you describe the practices you use for analysis of financial and management reporting?
10. Do you have experience in annual planning processes?
11. What profitability models have you used for forecasting a project?
12. Are you familiar with developing business casing and ad hoc analysis?
13. How would you maintain these items during a project?
14. Have you ever worked on a budget for an expansion program?
15. What financial practices did you target for this project?
Responsibility
1. How do you relate with program administrators and financial personnel?
2. Do you compile and share monthly data involving income, investment, sales forecasting, shipments and cashflow reports?
3. What long range plans have you implemented for the business area?
4. Are you accounting and knowledge of financial systems abilities used to...

...c. What is the discounted payback period for the bond assuming its 4% coupon rate is the required return? What general principle does this example illustrate regarding a project’s life, its discounted payback period, and its NPV?
A8-1. a. Payback on this bond is 25 years. You pay $1,000. You receive $40 a year for 25 years, a total of $1,000.
b The bond is not necessarily a bad investment. Payback does not take time value of money into account, nor does it account for cashflows received after the payback period. It is more appropriate to calculate the NPV of an investment. Given the risk level of the bond, is 4% a fair return? If the answer is yes, then the bond may be a good investment.
c The discounted payback, using a 4% discount rate, is 30 years. This shows that unless the acceptable payback period is decreased when discounted payback is used, vs. regular payback, then projects which return money late in the life of the investment are even more disadvantaged under discounted payback than under regular payback. NPV is a more appropriate method to use to determine the value of an investment project.
P8-4. Calculate the net present value (NPV) for the following 20-year projects. Comment on the acceptability of each. Assume that the firm has an opportunity cost of 14%.
a. Initial cash outlay is $15,000; cash inflows are $13,000 per...

...Sample Questions Ch. 10
1- The possibility that errors in projected cashflows can lead to incorrect NPV estimates is called:
A) Forecasting risk.
B) Projection risk.
C) Scenario risk.
D) Monte Carlo risk.
E) Accounting risk
2- An analysis of what happens to NPV estimates when we ask what-if questions is called:
A) Forecasting analysis.
B) Scenario analysis.
C) Sensitivity analysis.
D) Simulation analysis.
E) Break-even analysis
3- An analysis of what happens to NPV estimates when only one variable is changed is called:
A) Forecasting analysis.
B) Scenario analysis.
C) Sensitivity analysis.
D) Simulation analysis.
E) Break-even analysis.
4- An analysis of the relation between sales volume and various measures of profitability is called:
A) Forecasting analysis.
B) Scenario analysis.
C) Sensitivity analysis.
D) Simulation analysis.
E) Break-even analysis.
5- Variable costs _________________________.
A) change as a function of the quantity of output produced
B) (for a given time period) are constant no matter the quantity of output produced
C) change as a function of the next unit of output produced
D) comprise the sum total of all production expenses of the firm for some time period
E) comprise the sum total of all production expenses of the firm for some time period, expressed relative to the total output produced for that same time period
6- Fixed costs...