Finance Final Cheat Sheet
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NPV decision rule = NPV PV(Benefits) - PV(Costs) (if positive accept if negative reject) C= cash amount / cash flow , r= discount rate n=time period (# of yrs/months/etc T =time
The project costs $250 million and is expected to generate cash flows of $35
million per year, starting at the end of the first year and lasting forever.
• The NPV (depending on discount rate) of the project is calculated as EX: project w following cashflows yr 0 –10,000 yr 1-4 = 4000, 15% DR r= 1.15
Find present value The IRR rule: Take any investment where the IRR exceeds the cost of capital/Turn down any investment whose IRR is less than the cost of capital. (whenever the cost of capital is below the IRR of 14%, the project has a positive NPV, and you should undertake the investment.
Which of the following statements is FALSE?
A.
If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.
B.
The IRR investment rule will identify the correct decision in many, but not all, situations.
C.
By setting the NPV equal to zero and solving for r
, we find the IRR.
D.
The simplest, though least accurate, investment rule is the NPV investment rule.
- (FFL (GS), is considering offering one hour photo developing in their store. The firm expects that sales from the new one−hour machine will be $150,000 per year.
FFL currently offers overnight film processing with annual sales of $100,000. While many of the one−hour photo sales will be to new customers, FFL estimates that 60% of their current overnight photo customers will switch and use the one−hour service. Suppose that of the 60% of FFL's current overnight photo customers, half would start taking their film to a competitor that offers one−hour photo processing if FFL fails to offer the one−hour service. The level of incremental sales in this case is closest to: $
120,000 – Incr Sales- can sales = $150,000- (60%)(%50%)($100,000)= ANSR
FCF= EBIT (1-TAX RATE)- NONCASH EXPED(depreciation/amortis)-increase working cap+decrease in working capital-CAPEX
• Kenneth Cole (K C P) had sales of $518 million in 2005. Suppose you expect its sales to grow at a 9% rate in 2006, but that this growth rate will slow by 1% per year to a long –run growth rate for the apparel industry of 4% by 2011. Based on K C P’s past profitability and investment needs, you expect E B I T to be 9% of sales, increases in net working capital requirements to be 10% of any increase in sales, and net investment (capital expenditures in excess of depreciation) to be 8% of any increase in sales. If K
C P has $100 million in cash, $3 million in debt, 21 million shares outstanding, a tax rate of 37%, and a weighted average cost of capital of 11%, what is your estimate of the value of K C P’s stock in early 2006
Rearden Metals has a current stock price of $30 share, is expected to pay a dividend of $1.20 in one year, and its expected price right after paying that dividend is $33.
Rearden's expected capital gains yield is closest to: ---stock price $30 dividend in 1 yr $1.20 Stock Price in 1 year = $33 (
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---35-30/30= Von Bora Corporation is expected to pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of the second year. You expect Von Bora's stock price to be $25.00 at the end of two years. Von Bora's equity cost of capital is 10%.Suppose you plan on purchasing Von Bora stock in one year, right
after the $1.40 dividend is paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid. The total return that you will receive on your investment is closest to:
D1=1.40 D2= 1.50 Cost of capital (r ) 10% -- after 2 years P2 $25 𝑃
1
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Delayed Investments: you just retired as the C E O of a successful company. Has offered you a book deal.
The publisher will pay you $1 million upfront if you agree to write a book about your experiences. You estimate that it will take three years to write the book. The time you spend writing will cause you to give up speaking engagements amounting to $500,000 per year. You estimate your opportunity cost to be 10%. Financial calculator solution (remember to clear memory!): • CF 1000000 ENTER -500000 ENTER 3 ENTER IRR CPT --- IRR is greater than the cost of capital: Accept! NPV RULE
𝑁𝑃𝑉
=
1,000,000
−
500000
1.1
−
500000
1.1
2
−
500000
1.1
3
=
243,426
Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per share and use the extra funds to expand its operations. Kinston's dividends were expected to grow at a 2% rate, and its share price was $37.50. With the new expansion, Kinston dividends are expected to grow at a 5% rate. Kinston's share price following this announcement should be:
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10%
The $7.5 million in new equipment is a cash expense, but it is not directly listed as an expense when calculating earnings.---7.5 divided by 5 Note: A negative tax is equal to a tax credit. • Unlevered Net Income Calculation. Income Tax EBIT x
𝜏 𝑐
Unlevered Net Income (Revenues Costs Depreciation) EBIT x (1-) --revenue-costs-depreciation x (1-
𝜏 𝑐
) Suppose HomeNet’s new lab will be housed in warehouse space that the company would have otherwise rented out for $200,000 per year during years 1 – 4. How does this opportunity cost affect HomeNet’s incremental earnings?-- The opportunity cost of the warehouse space is the forgone rent. This cost would reduce HomeNet’s incremental earnings during years 1-4 by: the after-tax benefit of renting out the warehouse space. $200,000 x (1-20%)= $160,000,
Which is false? Riskier investments must offer investors higher average returns to compensate them for the extra risk they are taking on.
Investments with higher volatility should have a higher risk premium and therefore higher returns.
.
Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios and the returns of individual securities.
Portfolios with higher volatility have historically rewarded investors with higher average returns.
Which of the following is NOT a diversifiable risk?
The risk of a product liability lawsuit
The risk that the CEO is killed in a plane crash
The risk of a key employee being hired away by a competitor
The risk that oil prices rise, increasing production costs
Company
Ticker
Beta
Ford Motor Company
F
2.77
International Business Machines
IBM
0.73
Merck
MRK
0.90
If the risk−free rate is 5% and the expected return of investing in Merck is 11.3%, then the expected return on the market must be:
5%+2.77x11.3%--
Suppose you invest $15,000 in Merck stock and $25,000 in Home Depot stock. You receive an actual return of − 8% for Merck and
12% for Home Depot. What is the actual return on your portfolio?(15,000+25,000)=40,000---15,000/40,000*-8) 25000/40,000*12)=4.5%
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£
£
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Discount
Factors
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Project C
CF
DCF
CF
DCF
CF
DCF
£
£
£
£
£
£
Year 1
Year 2
Year 3
Year 4
Year 5
Total DCF
Initial investment
Net present value
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