Financial management
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This full document shows us the essence of corporate finance - Bachelor - Economics & Finance - Kyungpook National University,Daegu, South Korea - Jean Meilhoc
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Financial management
- 1. Chapter 1 Introduction to Financial Management
- 13. Figure 1.2
- 16. Chapter 2 Financial Statements, Taxes, and Cash Flow
- 19. Figure 2.1
- 20. U.S. Corporation Balance Sheet – Table 2.1
- 22. Klingon Corporation KLINGON CORPORATION Balance Sheets Market Value versus Book Value Book Market Book Market Assets Liabilities and Shareholders’ Equity NWC $ 400 $ 600 LTD $ 500 $ 500 NFA 700 1,000 Equity 600 1,100 1,100 1,600 1,100 1,600
- 24. U.S. Corporation Income Statement - Table 2.2
- 31. Table 2.5
- 35. Chapter 4 Introduction to Valuation: The Time Value of Money
- 43. Figure 4.3
- 49. Chapter 5 Discounted Cash Flow Valuation
- 63. EAR with APR Remember that the APR is the quoted rate, and m is the number of compounds per year
- 69. Amortization Table for Example Year Beg. Balance Total Payment Interest Paid Principal Paid End. Balance 1 5,000.00 1509.60 400.00 1109.60 3890.40 2 3890.40 1509.60 311.23 1198.37 2692.03 3 2692.03 1509.60 215.36 1294.24 1397.79 4 1397.79 1509.60 111.82 1397.78 .01 Totals 6038.40 1038.41 4999.99
- 70. Chapter 6 Interest Rates and Bond Valuation
- 73. Relationship Btn Price and YTM
- 76. Figure 6.2
- 88. Figure 6.6 – Upward-Sloping Curve
- 89. Figure 6.6 – Downward-Sloping
- 90. Figure 6.7 – Treasury Yield
- 92. Chapter 7 Equity Markets and Stock Valuation
- 99. Stock Price Sensitivity to Dividend Growth, g D 1 = $2; R = 20%
- 100. Stock Price Sensitivity to Required Return, R D 1 = $2; g = 5%
- 109. Chapter 10 Market History: Risk and Return
- 114. Average Returns Investment Average Return Large Stocks 12.3% Small Stocks 17.4% Long-term Corporate Bonds 6.2% Long-term Government Bonds 5.8% U.S. Treasury Bills 3.8% Inflation 3.1%
- 117. Example – Variance and Standard Deviation Note: Average return = .42 / 4 = .105 Variance = .0045 / (4-1) = .0015 Standard Deviation = .03873 Year Actual Return Average Return Deviation from the Mean Squared Deviation 1 .15 .105 .045 .002025 2 .09 .105 -.015 .000225 3 .06 .105 -.045 .002025 4 .12 .105 .015 .000225 Totals .42 .00 .0045
- 121. Chapter 11 CAPM: Risk and Return
- 130. Figure 11.1
- 133. Example: Portfolio Expected Returns and Betas R f E(R A ) A 0% 5% 10% 15% 20% 25% 30% 0 0.5 1 1.5 2 2.5 3 Beta Expected Return
- 137. SML and Equilibrium
- 138. Chapter 8 Net Present Value and Other Investment Criteria
- 157. NPV Profile for the Project IRR = 16.13%
- 160. Summary of Decisions for the Project Summary Net Present Value Accept Payback Period Reject Discounted Payback Period Reject Average Accounting Return Reject Internal Rate of Return Accept
- 164. NPV Profile IRR = 10.11% and 42.66%
- 167. Example With Mutually Exclusive Projects The required return for both projects is 10%. Which project should you accept and why? Period Project A Project B 0 -500 -400 1 325 325 2 325 200 IRR 19.43% 22.17% NPV 64.05 60.74
- 168. NPV Profiles IRR for A = 19.43% IRR for B = 22.17% Crossover Point = 11.8%
- 173. Chapter 9 Making Capital Investment Decisions
- 175. Table 9.1 Pro Forma Income Statement Sales (50,000 units at $4.00/unit) $200,000 Variable Costs ($2.50/unit) 125,000 Gross profit $ 75,000 Fixed costs 12,000 Depreciation ($90,000 / 3) 30,000 EBIT $ 33,000 Taxes (34%) 11,220 Net Income $ 21,780
- 176. Table 9.2 Projected Capital Requirements Year 0 1 2 3 NWC $20,000 $20,000 $20,000 $20,000 Net Fixed Assets 90,000 60,000 30,000 0 Total Investment $110,000 $80,000 $50,000 $20,000
- 177. Table 9.5 Projected Total Cash Flows Year 0 1 2 3 OCF $51,780 $51,780 $51,780 Change in NWC -$20,000 $20,000 Capital Spending -$90,000 CFFA -$110,00 $51,780 $51,780 $71,780
- 183. Example: Three-year MACRS BV in year 6 = 110,000 – 36,663 – 48,884 – 16,302 – 8,151 = 0 After-tax salvage = 17,000 - .4(17,000 – 0) = $10,200 Year MACRS percent D 1 .3333 .3333(110,000) = 36,663 2 .4444 .4444(110,000) = 48,884 3 .1482 .1482(110,000) = 16,302 4 .0741 .0741(110,000) = 8,151
- 184. Example: Seven-Year MACRS BV in year 6 = 110,000 – 15,719 – 26,939 – 19,239 – 13,739 – 9,823 – 9,823 = 14,718 After-tax salvage = 17,000 - .4(17,000 – 14,718) = 16,087.20 Year MACRS Percent D 1 .1429 .1429(110,000) = 15,719 2 .2449 .2449(110,000) = 26,939 3 .1749 .1749(110,000) = 19,239 4 .1249 .1249(110,000) = 13,739 5 .0893 .0893(110,000) = 9,823 6 .0893 .0893(110,000) = 9,823
- 186. Replacement Problem – Pro Forma Income Statements Year 1 2 3 4 5 Cost Savings 50,000 50,000 50,000 50,000 50,000 Depr. New 49,995 66,660 22,230 11,115 0 Old 9,000 9,000 9,000 9,000 9,000 Increm. 40,995 57,660 13,230 2,115 (9,000) EBIT 9,005 (7,660) 36,770 47,885 59,000 Taxes 3,602 (3,064) 14,708 19,154 23,600 NI 5,403 (4,596) 22,062 28,731 35,400
- 188. Replacement Problem Year 0 1 2 3 4 5 OCF 46,398 53,064 35,292 30,846 26,400 NCS -89,000 -10,000 In NWC 0 0 CFFA -89,000 46,398 53,064 35,292 30,846 16,400
- 191. Summary of Scenario Analysis Scenario Net Income Cash Flow NPV IRR Base case $19,800 $59,800 $15,567 15.1% Worst Case -15,510 24,490 -111,719 -14.4% Best Case 59,730 99,730 159,504 40.9%
- 192. Summary of Sensitivity Analysis Scenario Unit Sales Cash Flow NPV IRR Base case 6,000 $59,800 $15,567 15.1% Worst case 5,500 $53,200 -$8,226 10.3% Best case 6,500 $66,400 $39,357 19.7%
- 194. Chapter 12 Cost of Capital
- 214. Subjective Approach - Example Risk Level Discount Rate Very Low Risk WACC – 8% Low Risk WACC – 3% Same Risk as Firm WACC High Risk WACC + 5% Very High Risk WACC + 10%
- 215. Chapter 13 Leverage and Capital Structure
- 223. Figure 13.3
- 227. Case II - Example Unlevered Firm Levered Firm EBIT 5000 5000 Interest 0 500 Taxable Income 5000 4500 Taxes (34%) 1700 1530 Net Income 3300 2970 CFFA 3300 3470
- 231. Figure 13.4
- 234. Case II - Proposition II
- 238. Figure 13.5
- 239. Figure 13.6
- 242. Chapter 14 Dividends and Dividend Policy
- 244. Figure 14.2 The Ex-Day Price Drop
Hinweis der Redaktion
- Each of these topics will be discussed in more detail in the following slides. www: Several of the following slides will have hot links to a web site that provides information about different business jobs including descriptions, skills and traits, etc. The address is www.careers-in-business.com Video: Advice from recent graduates on what it takes to have a career in finance. The discussion on corporate finance is deferred until later in the chapter.
- www: Clicking on the “web surfer” icon will take you to the Careers in Business Home page. “Commercial Banking”, “Insurance,” and “Investment Banking” all discuss job opportunities in the Financial Institutions area.
- Video Note: This video looks at the changing role of the Chief Financial Officer (CFO) at the Fortune 500 company, Abbot Laboratories.
- Provide some examples of capital budgeting decisions, such as what product or service the firm will sell, should old equipment be replaced with newer, more advanced, equipment, etc. Be sure to define debt and equity. Provide some examples of working capital management issues, such as: whom to grant credit, how much inventory should be carried, when should suppliers be paid, etc.
- www: Clicking on the “web surfer” will take you to a web site that will provide a discussion about which form of business may be appropriate for an entrepreneur. The following pages will provide links to specific pages on the web site that provide additional information about the legal aspects of each form of business, as well as a discussion of the advantages and disadvantages. The address is: http://www.nolo.com/encyclopedia/sb_ency.html#Subtopic16
- www: Click on the “web surfer” for more information about sole proprietorships. If you click on the “--Sole Proprietorship” link, you will be taken to an index that will provide a link to information about husband and wife sole proprietorships.
- www: Click on the “web surfer” for more information about partnerships. If you click on the “—Partnerships” link, you will go to an index that provides links to additional information about limited partnerships, partnership agreements and buy-sell agreements. Note that unlimited liability applies to all partners in a general partnership but only to the general partners in a limited partnership Written agreements are essential due to the unlimited liability. Limited partners cannot be involved in the business or else they may be deemed general partners.
- www: Click on the “web surfer” to go to a page that discusses corporations. If you click on the “—Corporations” link it will take you back to an index that provides links to additional information on corporations as well as limited liability corporations. Discuss how separation of ownership and management can be both an advantage and a disadvantage: Advantages You can benefit from ownership in several different businesses (diversification) You can take advantage of the expertise of others (comparative advantage) It is easier to transfer ownership Disadvantage Agency problems if management goals and owner goals are not aligned The instructor’s manual provides additional discussion of limited liability companies and S-corporations
- Try to have the students discuss each of the goals above and the inherent problems of the first three goals: Maximize profit – Are we talking about long-run or short-run profits? Do we mean accounting profits or some measure of cash flow? Minimize costs – We can minimize costs today by not purchasing new equipment or delaying maintenance, but this may not be in the best interest of the firm or its owners. Maximize market share – This has been a strategy of many of the dot.com companies. They issued stock and then used it primarily for advertising to increase the number of “hits” to their web sites. Even though many of the companies may have huge market share (i.e. Amazon) that still does not guarantee positive earnings, so their owners may not be happy. Maximize the current value of the company’s stock There is no short run vs. long run here. The stock price should incorporate expectations about the future of the company and consider the trade-off between short-run profits and long-run profits. The purpose of a for-profit business should be to make money for its owners. Maximizing the current stock price increases the wealth of the owners of the firm. This is analogous to maximizing owners’ equity for firms that do not have publicly traded stock. Not for profits can also follow the same principle, but their “owners” are the constituencies that they were created to help. The instructors manual provides a letter to stockholders that was written by former Coca-Cola CEO Roberto Goizueta. There is also a brief discussion of an article that appeared in Fortune magazine that discusses Coke vs. Pepsi and their different philosophies on business in the early 1990s. Ethics Note: See the instructor’s manual for a discussion of Dow-Corning, silicone breast implants and the ethics involved with pursuing owners’ wealth at all costs.
- Video Note: This video focuses on how one company handled the tough decision to cut jobs and managed to successfully increase shareholder value. It features ABT Co. in Canada. A common example of an agency relationship is a real estate broker – in particular if you break it down between a buyer’s agent and a seller’s agent. A classic conflict of interest is when the agent is paid on commission, so they may be less willing to let the buyer know that a lower price might be accepted or they may elect to only show the buyer homes that are listed at the high end of the buyer’s price range. Ethics Note: The instructor’s manual provides a discussion of Gillette and the apparent agency problems that existed prior to the introduction of the Sensor razor. Direct agency costs – the purchase of something for management that can’t be justified from a risk-return standpoint; monitoring costs. Indirect agency costs – management’s tendency to forgo risky or expensive projects that could be justified from a risk-return standpoint.
- Incentives – discuss how incentives must be carefully structured. For example, tying bonuses to profits might encourage management to pursue short-run profits and forgo projects that require a large initial outlay. Stock options may work, but there may be an optimal level of insider ownership. Beyond that level, management may be in too much control and may not act in the best interest of all stockholders. The type of stock can also affect the effectiveness of the incentive. Corporate control – ask the students why the threat of a takeover might make managers work toward the goals of stockholders. Other groups also have a financial stake in the firm. They can provide a valuable monitoring tool, but they can also try to force the firm to do things that are not in the owners’ best interest.
- Video Note: This video discusses how capital is raised in financial markets and shows an open-outcry market at the Chicago Board of Trade. Discuss the cash flows to the firm. You might have students turn to Figure 1.2 in their book to see an illustration of the cash flows. The main point is that cash comes into the firm from the sale of debt and equity. The money is used to purchase assets. Those assets generate cash that is used to pay stakeholders, reinvest in additional assets, repay debtholders and pay dividends to stockholders. Students are often confused by the fact that the NASDAQ is an OTC market. Explain that the NASDAQ market site is just a convenient place for reporters to show how stocks are moving, but that trading does not actually take place there. See the instructor’s manual for a discussion of an October 1999 BusinessWeek article concerning the move by the NYSE and the NASDAQ toward becoming for-profit companies and the possible impact on investors. www: Click on the NYSE and NASDAQ hyperlinks to go to their web sites
- Liquidity is a very important concept. Students tend to remember the “convert to cash quickly” component of liquidity, but often forget the part about “without loss of value.” Remind them that we can convert anything to cash quickly if we are willing to lower the price enough, but that doesn’t mean that it is liquid. Also, point out that a firm can be TOO liquid. Excess cash holdings lead to overall lower returns. See the IM for a more complete discussion of this issue.
- The left-hand side lists the assets of the firm. Current assets are listed first because they are the most liquid. Fixed assets can include both tangible and intangible assets, and they are listed at the bottom because they generally are not very liquid. These are direct results of management’s investment decisions. (Please emphasize that “investment decisions” are not limited to investments in financial assets.) Note that the balance sheet does not list some very valuable assets, such as the people who work for the firm. The liabilities and equity (or ownership) components of the firm are listed on the right-hand side. This indicates how the assets are paid for. Since the balance sheet has to balance, total equity = total assets – total liabilities. The portion of equity that can most easily fluctuate to create this balance is retained earnings. The right-hand side of the balance sheet is a direct result of management’s financing decisions. Remember that shareholders’ equity consists of several components and that total equity includes all of these components, not just the “common stock” item. In particular, remind students that retained earnings belong to the shareholders.
- The first example computing cash flows has a link to the information in this table. The arrow in the corner is used to return you to the example. Here is an example of a simplified balance sheet. Some students might make it through business school without ever seeing an actual balance sheet, particularly those who are not majoring in finance or accounting. Later in the chapter, a hot link is provided to the 2004 annual report for McGraw-Hill. If you don’t have access to the internet for your presentation, I encourage you to bring in some annual reports and let the students see the differences between the simplified statements they see in textbooks and the real thing. This is a good place to talk about some of the specific types of items that show up on a balance sheet and remind the students what accounts receivable, accounts payable, notes payable, etc. are.
- Current assets and liabilities generally have book values and market values that are very close. This is not necessarily the case with the other assets, liabilities, and equity accounts of the firm. Assets are listed at historical cost less accumulated depreciation – this may bear little resemblance to what they could actually be sold for today. The balance sheet also does not include the value of many important assets, such as human capital. Consequently, the “Total Assets” line on the balance sheet is generally not a very good estimate of what the assets of the firm are actually worth. Liabilities are listed at face value. When interest rates change or the risk of the firm changes, the value of those liabilities change in the market as well. This is especially true for longer-term liabilities. Equity is the ownership interest in the firm. The market value of equity (stock price times number of shares) depends on the future growth prospects of the firm and on the market’s estimation of the current value of ALL of the assets of the firm. The best estimate of the market value of the firm’s assets is market value of liabilities + market value of equity. Market values are generally more important for the decision-making process because they are more reflective of the cash flows that would occur today.
- Shareholders are the ones that benefit from increases in the market value of a firm’s assets. They are also the ones that bear the losses of a decrease in market value. Consequently, managers need to consider the impact of their decisions on the market value of assets, not on their book value. Here is a good illustration: Suppose that the MV of assets declined to $700 and the market value of long-term debt remained unchanged. What would happen to the market value of equity? It would decrease to 700 – 500 = 200. The market-to-book ratio, which compares the market value of equity to the book value of equity, is often used by analysts as a measure of valuation for a stock. It is generally a bad sign if a company’s market-to-book ratio approaches 1.00 (meaning market value = book value) because of the GAAP employed in creating a balance sheet. It is definitely a bad sign if the ratio is less than 1.00. GAAP does provide for some assets to be marked-to-market, primarily those assets for which current market values are readily available due to trading in liquid markets. However, it does not generally apply to long-term assets, where market values and book values are likely to differ the most.
- Matching principle – this principle leads to non-cash deductions like depreciation. This is why net income is NOT a measure of the cash flow during the period.
- The first example computing cash flows has a link to the information in this table. The arrow in the corner is used to return you to the example. Remember that these are simplified income statements for illustrative purposes. Earnings before interest and taxes (EBIT) is often called operating income. COGS would include both the fixed costs and the variable costs needed to generate the revenues. Analysts often look at EBITDA (earnings before interest, taxes, depreciation, and amortization) as a measure of the operating cash flow of the firm. It is not true in the strictest sense because taxes are an operating cash flow as well, but it does provide a reasonable estimate for analysis purposes. The IM provides a discussion of Cendant and the problems that the company ran into when fraudulent accounting practices were discovered. It is important to point out that depreciation expense is often figured two different ways, depending on the purpose of the financial statement. If we are computing the taxes that we will owe, we use the depreciation schedule provided by the IRS. In this instance, the “life” of the asset for depreciation purposes may be very different from the useful life of the asset. Statements that are prepared for investors often use straight-line depreciation because it will tend to have a lower depreciation charge than MACRS early in the asset’s life. This reduces the “expense” and thus increases the firm’s reported EPS. This is a good illustration of why it is important to look at a firm’s cash flow and not just its EPS.
- Point out that taxes can be a very important component of the decision- making process, but that what they learn about tax specifics now could change tomorrow. Consequently, it is important to keep up with the changing tax laws and to utilize specialists in the tax area when making decisions where taxes are involved. www: Click on the web surfer icon to go to the IRS web site for the most up-to-date tax information. It is important to point out that we are concerned with the taxes that we will pay if a decision is made. Consequently, the marginal tax rate is what we should use in our analysis. Point out that the tax rates discussed in the book are just federal taxes. Many states and cities have income taxes as well and those taxes should figure into any analysis that we do.
- Tax liability: .15(50,000) + .25(75,000 – 50,000) + .34(100,000 – 75,000) + .39(335,000 – 100,000) + .34(4,000,000 – 335,000) = $1,356,100 Average rate: $1,356,100 / $4,000,000 = .339025 or 33.9025% The marginal tax rate comes from the table. It is 34% We should use the marginal rate with an expected additional 34,000 in taxes and a change in the average rate to $1,390,100 / $4,000,000 = .347525 or 34.7525%
- The first equation shows how the cash flow from the firm is divided among the investors that financed the assets. The second equation shows the cash flow that the firm receives from its assets. This is an important equation to remember. We will come back to it and use it again when we do our capital budgeting analysis. We want to base our decisions on the timing and risk of the cash flows we expect to receive from a project.
- Use the information from the balance sheet and income statement presented previously to work through this example. There is a hyperlink on “I/S” that will take you to that slide. Another one exists on “B/S.” The arrows on the Income Statement and Balance Sheet slides will bring you back here. OCF = 694 + 65 – 212 = 547 NCS = 1709 – 1644 + 65 = 130 Students often have a difficult time understanding why a cash outflow has a positive sign and a cash inflow has a negative sign. Emphasize that we are talking about SPENDING in the net capital spending formula and Investment in NWC. The formula for CFFA takes care of reducing cash flow when NCS is positive and increasing CF when it is negative. Ending NWC = 1403 – 389 = 1014 Beginning NWC = 1112 – 428 = 684 Changes in NWC = 1014 – 684 = 330 Net New Borrowing = ending LT debt – beginning LT debt = 454 – 408 = 46 CF to creditors = 70 – 46 = 24 Net New Equity = 640 – 600 = 40 (Be sure to point out that here we want to determine the amount of equity raised in the capital markets, not retained earnings. CF to Stockholders = 103 – 40 = 63
- This provides a summary for the various cash flow calculations. It is a good place to refer back when working on cash flows in the capital budgeting section.
- The instructor’s manual provides an exercise that can be used to illustrate how difficult this analysis can be using published financial statements. It uses the 2004 McGraw-Hill annual report as an example. Here is the additional information required to complete the income statement. You may want to give them this information and have them practice putting together a balance sheet and income statement. They should verify the 250 addition to retained earnings for 2006, and distinguish that from the retained earning balance at the end of 2006. Sales = 5000; Costs = 2000
- Remind the students that changes in RE are not included because there is no cash flow associated with them. Net new equity consists of the purchase and sale of stock in the market. If the company had repurchased stock during the year, you would need to include the change in the Treasury stock account. An increase in Treasury Stock is a decrease in net new equity since it is a cash outflow from the firm to stockholders.
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- 4. It’s important to point out that there are many different ways to refer to the interest rate that we use in time value of money calculations. Students often get confused with the terminology, especially since they tend to think of an “interest rate” only in terms of loans and savings accounts.
- 4. Point out that we are just using algebra when deriving the FV formula. We have 1,000(1) + 1,000(.05) = 1,000(1+.05)
- 4.
- 4.
- 4. It is important at this point to discuss the sign convention in the calculator. The calculator is programmed so that cash outflows are entered as negative and inflows are entered as positive. If you enter the PV as positive, the calculator assumes that you have received a loan that you will have to repay at some point. The negative sign on the future value indicates that you would have to repay 1,276.28 in 5 years. Show the students that if they enter the 1,000 as negative, the FV will compute as a positive number. Also, you may want to point out the change sign key (+/-) on the calculator. There seem to be a few students each semester that have never had to use it before. Calculator: N = 5; I/Y = 5; PV = 1,000; CPT FV = -1,276.28
- 4. Point out that the PV interest factor = 1 / (1 + r) t
- 4. Key strokes: 1.08 y x 17 +/- = x 150,000 = Calculator: N = 17; I/Y = 8; FV = 150,000; CPT PV = -40,540.34
- 4.
- 4.
- 4. It is very important at this point to make sure that the students have more than 2 decimal places visible on their calculator. Efficient key strokes for formula: 1,200 / 1,000 = y x 5 = 1/x - 1 = .03714 If they receive an error when they try to use the financial keys, they probably forgot to enter one of the numbers as a negative.
- 4. Remind the students that ln is the natural logarithm and can be found on the calculator. The rule of 72 is a quick way to estimate how long it will take to double your money. # years to double = 72 / r where r is a percent, not a decimal.
- 4. Calculator: I/Y = 10; FV = 20,000; PV = - 15,000; CPT N = 3.02 years
- 4. Click on the tabs at the bottom of the worksheet to move between examples.
- 5.
- 5. FV = 100(1.08) 4 + 300(1.08) 2 = 136.05 + 349.92 = 485.97 Year 1 CF: 4 N; -100 PV; 8 I/Y; CPT FV = 136.05 Year 3 CF: 2 N; -300 PV; 8 I/Y; CPT FV = 349.92 Total FV = 136.05 + 349.92 = 485.97
- 5. The easiest way to work this problem is to use the uneven cash flow keys and find the present value first and then compute the others based on that. CF 0 = 0; C01 = 100; F01 = 1; C02 = 200; F02 = 2; C03 = 300; F03 = 2; I = 7; CPT NPV = 874.17 Value in year 5: PV = 874.17; N = 5; I/Y = 7; CPT FV = 1,226.07 Value in year 3: PV = 874.17; N = 3; I/Y = 7; CPT FV = 1,070.90 Using formulas and one CF at a time: Year 1 CF: FV 5 = 100(1.07) 4 = 131.08; PV 0 = 100 / 1.07 = 93.46; FV 3 = 100(1.07) 2 = 114.49 Year 2 CF: FV 5 = 200(1.07) 3 = 245.01; PV 0 = 200 / (1.07) 2 = 174.69; FV 3 = 200(1.07) = 214 Year 3 CF: FV 5 = 200(1.07) 2 = 228.98; PV 0 = 200 / (1.07) 3 = 163.26; FV 3 = 200 Year 4 CF: FV 5 = 300(1.07) = 321; PV 0 = 300 / (1.07) 4 = 228.87; PV 3 = 300 / 1.07 = 280.37 Year 5 CF: FV 5 = 300; PV 0 = 300 / (1.07) 5 = 213.90; PV 3 = 300 / (1.07) 2 = 262.03 Value at year 5 = 131.08 + 245.01 + 228.98 + 321 + 300 = 1,226.07 Present value today = 93.46 + 174.69 + 163.26 + 228.87 + 213.90 = 874.18 (difference due to rounding) Value at year 3 = 114.49 + 214 + 200 + 280.37 + 262.03 = 1,070.89 Point out that C03 is in years 4 and 5. The “03” indicates the third cash inflow quantity, and will not be the same as the time period whenever a preceding cash flow frequency (e.g. F01) is set to something other than “1.”
- 5.
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- 5. The students can read the example in the book. After carefully going over your budget, you have determined you can afford to pay $632 per month towards a new sports car. You call up your local bank and find out that the going rate is 1 percent per month for 48 months. How much can you borrow?
- 5. Calculator: 4(12) = 48 N; 20,000 PV; 8/12 = .666666667 I/Y; CPT PMT = 488.26
- 5. FV = 2,000(1.075 40 – 1)/.075 = 454,513.04 Remember the sign convention!!! 40 N 7.5 I/Y -2,000 PMT CPT FV = 454,513.04
- 5. Note that the procedure for changing the calculator to an annuity due is similar on other calculators. Calculator 2 nd BGN 2 nd Set (you should see BGN in the display) 3 N -10,000 PMT 8 I/Y CPT FV = 35,061.12 2 nd BGN 2 nd Set (be sure to change it back to an ordinary annuity) What if it were an ordinary annuity? FV = 32,464 (so receive an additional 2,597.12 by starting to save today.)
- 5. This is a good preview to the valuation issues discussed in future chapters. The price of an investment is just the present value of expected future cash flows. Example statement: Suppose the Fellini Co. wants to sell preferred stock at $100 per share. A very similar issue of preferred stock already outstanding has a price of $40 per share and offers a dividend of $1 every quarter. What dividend will Fellini have to offer if the preferred stock is going to sell.
- 5. Where m is the number of compounding periods per year Using the calculator: The TI BA-II Plus has an I conversion key that allows for easy conversion between quoted rates and effective rates. 2 nd I Conv NOM is the quoted rate, ENTER up arrow to C/Y (compounding periods per year), ENTER up arrow to EFF (the effective rate) and then CPT (compute). You can compute either the NOM or the EFF by entering the other two pieces of information, then going to the one you wish to compute and pressing CPT.
- 5.
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- 5. Point out that the APR is the same in either case, but your effective rate is different. Ask them which account they should use.
- 5.
- 5. Remind students that rates are quoted on an annual basis. The given numbers are APRs, not daily or semiannual rates. Calculator: 2 nd I conv 5.25 NOM ENTER up arrow, 365 C/Y ENTER up arrow, CPT EFF = 5.39% 5.3 NOM ENTER up arrow, 2 C/Y ENTER up arrow, CPT EFF = 5.37%
- 5. 2(12) = 24 N; 16.9 / 12 = 1.408333333 I/Y; 3500 PV; CPT PMT = -172.88
- 5. 35(12) = 420 N 9 / 12 = .75 I/Y 50 PMT CPT FV = 147,089.22
- 5. Remind students that the value of an investment is the present value of expected future cash flows. 1 N; 10,000 FV; 7 I/Y; CPT PV = -9,345.79
- 5. 4 N 8 I/Y 5,000 PV CPT PMT = -1,509.60
- 5. The reason that the loan balance does not decline to exactly zero is because of the rounding of the interest payments. Technically, the last payment would be 1,509.61 so that the loan balance would be zero after the last payment. This is a common issue.
- 6.
- 6. This formalizes the calculations we have been doing.
- 6. Remember the sign convention on the calculator. The easy way to remember it with bonds is we pay the PV (-) so that we can receive the PMT (+) and the FV(+). Slide 6.8 discusses why this bond sells at less than par
- 6. Bond characteristics: Coupon rate = 8% with annual coupons; Par value = $1,000; Maturity = 10 years
- 6. There are the purely mechanical reasons for these results. We know that present values decrease as rates increase. Therefore, if we decrease our yield below the coupon, the present value (price) must increase above par. On the other hand, if we increase our yield above the coupon, the present value (price) must decrease below par. There are more intuitive ways to explain this relationship. Explain that the yield-to-maturity is the interest rate on newly issued debt of the same risk and that debt would be issued so that the coupon = yield.Then, suppose that the coupon rate is 8% and the yield is 9%. Ask the students which bond they would be willing to pay more for. Most will say that they would pay more for the new bond. Since it is priced to sell at $1,000, the 8% bond must sell for less than $1,000. The same logic works if the new bond has a yield and coupon less than 8%. Another way to look at it is that return = current yield + capital gains yield. The current yield, in the case of a par value bond, is just the coupon rate. The capital gains yield has to make up the difference to reach the yield to maturity. Therefore, if the coupon rate is 8% and the YTM is 9%, the capital gains yield must equal 1%. The only way to have a capital gains yield of 1% is if the bond is selling for less than par value. (If price = par, there is no capital gain.)
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- 6. This is standard terminology in the U.S. – but it may not transfer to other countries. For example, debentures are secured debt in the United Kingdom
- 6. Debenture: secured debt is less risky because the income from the security is used to pay it off first Subordinated debenture: will be paid after the senior debt Bond without sinking fund: company has to come up with substantial cash at maturity to retire debt and this is riskier than systematic retirement of debt through time Callable – bondholders bear the risk of the bond being called early, usually when rates are lower. They don’t receive all of the expected coupons and they have to reinvest at lower rates.
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- 6. You should be willing to accept a lower stated yield on municipals because you do not have to pay taxes on the interest received. You will want to make sure the students understand why you are willing to accept a lower rate of interest. It may be helpful to take the example and illustrate the indifference point using dollars instead of just percentages. The discount you are willing to accept depends on your tax bracket. Consider a taxable bond with a yield of 8% and a tax-exempt municipal bond with a yield of 6% Suppose you own one $1,000 bond in each and both bonds are selling at par. You receive $80 per year from the corporate and $60 per year from the municipal. How much do you have after taxes if you are in the 40% tax bracket? Corporate: 80 – 80(.4) = 48; Municipal = 60
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- 6. The approximation works pretty well with “normal” real rates of interest and expected inflation. If the expected inflation rate is high, then there can be a substantial difference.
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- 6. www: Click on the web surfer to go to Bloomberg to get the current Treasury yield curve
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- 7. If you have taught students how to use uneven cash flow keys, then you can show them how to do this on the calculator. The notation below is for the TI-BA-II+ Or CF 0 = 0; C01 = 2; F01 = 1; C02 = 16.80; F02 = 1; NPV; I = 20; CPT NPV = 13.33
- 7. Remind the students that if dividends are paid quarterly, then the discount rate must be a quarterly rate. Also, if students have been using a financial calculator for most of their calculations, they often forget to convert the interest rate and leave it as a percent, i.e., P = .5 / (10/4) = .2. Ask them if this is a reasonable answer – “Would you only be willing to pay $0.20 for an asset that will pay you $0.50 every quarter forever?”
- 7. g is the growth rate in dividends; the subscripts denote the period in which the dividend is paid
- 7. The biggest mistake that students make with the DGM is using the wrong dividend. Be sure to emphasize that we are finding a present value, so the dividend needed is the one that will be paid NEXT period, not the one that has already been paid.
- 7. As the growth rate approaches the required return, the stock price increases dramatically.
- 7. As the required return approaches the growth rate, the price increases dramatically. This graph is a mirror image of the previous one.
- 7.
- 7. Point out that the formula is completely general. The dividend in the numerator is always for one period later than the price we are computing. This is because we are computing a Present Value, so we have to start with a future cash flow. This is very important when discussing supernormal growth. We know the dividend in one year is expected to be $4 and it will grow at 6% per year for four more years. So, D 5 = 4(1.06)(1.06)(1.06)(1.06) = 4(1.06) 4
- 7. Point out that D 1 / P 0 is the dividend yield and g is the capital gains yield
- 7.
- 7. Shareholders have the right to vote for the board of directors and other important issues. Cumulative voting increases the likelihood of minority shareholders getting a seat on the board. Proxy votes are similar to absentee ballots. Proxy fights occur when minority owners are trying to get enough votes to obtain seats on the Board or affect other important issues that are coming up for a vote. Different classes of stock can have different rights. Owners may want to issue a nonvoting class of stock if they want to make sure that they maintain control of the firm.
- 7. See the instructors manual for a discussion of the tax law changes regarding dividends received by individuals Dividend exclusion: If corporation A owns less than 20% of corporation B stock, then 30% of the dividends received from corporation B are taxable. If A owns between 20% and 80% of B, then 20% of the dividends received are taxable. If A owns more than 80%, a consolidated statement can be filed and dividends received from B are essentially untaxed.
- 7. Point out that there are a lot of features of preferred stock that are similar to debt. In fact, many new issues have sinking funds that effectively convert what was a perpetual security into an equity security with a definite maturity. However, for tax purposes, preferred stock is equity and dividends are not a tax deductible expense, unless they meet specific characteristics as discussed in the text.
- 7. r = [1.5(1.05)/18.75] + .05 = 13.4%
- Be sure to emphasize that you do not have to actually sell the stock for you to earn the dollar return. The point is that you could.
- Note that the “dividend” yield is really just the yield on intermediate cash flow
- You might want to point out that total percentage return is also equal to total dollar return / beginning price. Total percentage return = 6.25 / 35 = 17.86%
- Ask the students to think about why the different investments have different risk premiums.
- Remind students that the variance for a sample is computed by dividing by the number of observations – 1 The standard deviation is just the positive square root of the variance
- (1.08 x 1.12 x .96)^.3333 – 1 = .0511 Mean = ( .08 + .12 + -.04) / 3 = .0533 Variance = (.08 - .0533)^2 + (.12 - .0533)^2 = (-.04 - .0533)^2 / (3 - 1)= .00693 Standard deviation = .00693 ^ .5 = .0833 Probability: a 3% loss (return of -3%) lies one standard deviation below the mean. There is 16% of the probability falling below that point (68% falls between -3% and 13.66%, so 16% lies below -3% and 16% lies above 13.66%).
- Use the following example to illustrate the mathematical nature of expected returns: Consider a game where you toss a fair coin: If it is Heads then student A pays student B $1. If it is Tails then student B pays student A $1. Most students will remember from their statistics that the expected value is $0 (=.5(1) + .5(-1)). That means that if the game is played over and over then each student should expect to break-even. However, if the game is only played once, then one student will win $1 and one will lose $1.
- What is the probability of a recession? 0.2 If the risk-free rate is 6.15%, what is the risk premium? Stock C: 9.9 – 6.15 = 3.75% Stock T: 17.7 – 6.15 = 11.55%
- It’s important to point out that these formulas are for forecast data, and thus use probabilities to weight possible future outcomes, unlike the formulas in chapter 10 that were for historical data (divided by n-1),as past outcomes are all equally likely. Remind the students that standard deviation is the square root of the variance
- The instructor’s manual provides information on how to compute the portfolio variance using the correlation or covariance between assets.
- This is based on Fig. 11.2a in the book. Point out that there is a linear relationship between beta and expected return. Ask if the students remember the form of the equation for a line. Y = mx + b E(R) = slope (Beta) + y-intercept The y-intercept is = the risk-free rate, so all we need is the slope
- Based on the discussion earlier, we now have all the components of the line: E(R) = [E(R M ) – R f ] + R f
- 8. This example will be used for each of the decision rules so that the students can compare the different rules and see that conflicts can arise. This illustrates the importance of recognizing which decision rules provide the best information for making decisions that will increase owner wealth.
- 8. Again, the calculator used for the illustration is the TI- BA-II plus. The basic procedure is the same; you start with the year 0 cash flow and then enter the cash flows in order. F01, F02, etc. are used to set the frequency of a cash flow occurrence. Many calculators only require you to use that if the frequency is something other than 1. Since we have a positive NPV, we should accept the project.
- 8. The payback period is year 3 if you assume that the cash flows occur at the end of the year, as we do with all of the other decision rules. If we assume that the cash flows occur evenly throughout the year, then the project pays back in 2.34 years. Either way, the payback rule would say to reject the project.
- 8. The answer to all of these questions is no.
- 8. No – it doesn’t pay back on a discounted basis within the required 2-year period
- 8. The answer to the first two questions is yes. The answer to the third question is no because of the arbitrary cut-off date. Since the rule does not indicate whether or not we are creating value for the firm, it should not be the primary decision rule.
- 8. The example in the book uses straight line depreciation to a zero salvage; that is why you can take the initial investment and divide by 2. If you use MACRS, you need to compute the BV in each period and take the average in the standard way.
- 8. Students may ask where you came up with the 25%. Point out that this is one of the drawbacks of this rule. There is no good theory for determining what the return should be. We generally just use some rule of thumb. This rule would indicate that we reject the project.
- 8. The answer to all of these questions is no. In fact, this rule is even worse than the payback rule in that it doesn’t even use cash flows for the analysis. It uses net income and book value.
- 8. The IRR rule is very important. Management, and individuals in general, often have a much better feel for percentage returns and the value that is created, than they do for dollar increases. A dollar increase doesn’t appear to provide as much information if we don’t know what the initial expenditure was. Whether or not the additional information is relevant is another issue.
- 8. Many of the financial calculators will compute the IRR as soon as it is pressed; others require that you press compute.
- 8. The answer to all of these questions is yes, although it is not always as obvious. The IRR rule accounts for time value because it is finding the rate of return that equates all of the cash flows on a time value basis. The IRR rule accounts for the risk of the cash flows because you compare it to the required return, which is determined by the risk of the project. The IRR rule provides an indication of value because we will always increase value if we can earn a return greater than our required return. We should consider the IRR rule as our primary decision criteria, but as we will see, it has some problems that the NPV does not have. That is why we end up choosing the NPV as our ultimate decision rule.
- 8. You should point out, however, that if you get a very large IRR that you should go back and look at your cash flow estimation again. In competitive markets, extremely high IRRs should be rare. Also, since the IRR calculation assumes that you can reinvest future cash flows at the IRR, a high IRR may be unrealistic.
- 8. So what should we do – we have two rules that indicate to accept and three that indicate to reject.
- 8. NPV = 132,000 / 1.15 + 100,000 / (1.15) 2 – 150,000 / (1.15) 3 – 90,000 = 1,769.54 Calculator: CF 0 = -90,000; C01 = 132,000; F01 = 1; C02 = 100,000; F02 = 1; C03 = -150,000; F03 = 1; I = 15; CPT NPV = 1769.54 If you compute the IRR on the calculator, you get 10.11% because it is the first one that you come to. So, if you just blindly use the calculator without recognizing the uneven cash flows, NPV would say to accept and IRR would say to reject.
- 8. You should accept the project if the required return is between 10.11% and 42.66%
- 8. As long as we do not have limited capital, we should choose project A. Students will often argue that you should choose B because then you can invest the additional $100 in another good project, say C. The point is that if we do not have limited capital, we can invest in A and C and still be better off. If we have limited capital, then we will need to examine what combinations of projects with A provide the highest NPV and what combinations of projects with B provide the highest NPV. You then go with the set that will create the most value. If you have limited capital and a large number of mutually exclusive projects, then you will want to set up a computer program to determine the best combination of projects within the budget constraints. The important point is that we DO NOT use IRR to choose between projects regardless of whether or not we have limited capital.
- 8. If the required return is less than the crossover point of 11.8%, then you should choose A If the required return is greater than the crossover point of 11.8%, then you should choose B
- 8. Even though payback and AAR should not be used to make the final decision, we should consider the project very carefully if they suggest rejection. There may be more risk than we have considered or we may want to pay additional attention to our cash flow estimations. Sensitivity and scenario analysis can be used to help us evaluate our cash flows. The fact that payback is commonly used as a secondary criterion may be because short paybacks allow firms to have funds sooner to invest in other projects without going to the capital markets
- With each of these types of cash flows, you should ask the class the question on the previous slide so that they can start to determine if the cash flows are relevant. Sunk costs – our government provides ample examples of inappropriately including sunk costs in their capital allocation decisions. Opportunity costs – the classic example of an opportunity cost is the use of land or plant that is already owned. It is important to point out that this is not “free.” At the very least we could sell the land; consequently if we choose to use it, we cost ourselves the selling price of the asset, net of possible tax effects. A good example of a positive side effect is when you will establish a new distribution system with this project that can be used for existing or future projects. The benefit provided to those projects needs to be considered. The most common negative side effect is erosion or cannibalism, where the introduction of a new product will reduce the sales of existing, similar products. A good real-world example is McDonald’s introduction of the Arch Deluxe sandwich. Instead of generating all new sales, it primarily reduced sales of the Big Mac and the Quarter Pounder. Had it drawn in adults to eat who were accompanied by their kids who then consume a Happy Meal, then it would have had a positive side effect. It is important to consider changes in NWC. We need to remember that operating cash flow derived from the income statement assumes all sales are cash sales and that the COGS was actually paid in cash during that period. By looking at changes in NWC specifically, we can adjust for the difference in cash flow timing that results from accounting conventions. Most projects will require an increase in NWC initially as we build inventory and receivables. We do not include financing costs in the cash flows of the project. They are impounded, percentage-wise, into the discount rate. Taxes will change as the firm’s taxable income changes. Consequently, we have to consider cash flows on an after tax basis.
- Ask the students why net fixed assets is decreasing each year. It is important that they understand this when they go to compute the net capital spending in the next slide.
- OCF = EBIT + depreciation – taxes = 33,000 + 30,000 – 11,220 = 51,780; or OCF = NI + depreciation = 21,780 + 30,000 = 51,780 Note that in the Table in the book, the negative signs have already been carried throughout the table so that the columns can just be added. Ultimately, students seem to do better with this format even though the CFFA equation says to subtract the changes in NWC and net capital spending. Change in NWC = We have a net investment in NWC in year 0 of 20,000; we get the investment back at the end of the project when we sell our inventory, collect on our receivables, and pay off our payables. Students often forget that we get the investment back at the end. Capital Spending – remember that Net capital spending = change in net fixed assets + depreciation. So in year one NCS = (60,000 – 90,000) + 30,000 = 0; The same is true for the other years.
- The MACRS percentages are given in Table 9-7
- Note that with MACRS you do not subtract the expected salvage from the initial cost. Also note that the MACRS % is multiplied by the initial cost every year. For some reason, students want to multiply by the book value.
- The year-5 cash flow is the most difficult for students to grasp. It is important to point out that we are looking for ALL changes in cash flow associated with selling the machine today instead of in 5 years. If we do not sell the machine today, then we will have after-tax salvage of 10,000 in 5 years. Since we do sell the machine today, we LOSE the 10,000 cash flow 5 years from now.
- The negative signs in the CFFA equation were once again carried through the table. That way outflows are in the table as negative and inflows are positive. OCF = NI + Depr. Exp. From slide 9-22.
- Click on the excel icon to go to a spreadsheet that includes both the scenario analysis and the unit sales sensitivity analysis presented in the book.
- If you face hard rationing, you need to reevaluate your analysis. If you truly estimated the required return and expected cash flows appropriately and computed a positive NPV, then capital should be available.
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- 12. Remind students that D 1 = D 0 x (1 + g) You may also want to take this time to remind them that return is comprised of the dividend yield (D 1 / P 0 ) and the capital gains yield (g)
- 12. So, investors are currently requiring a return of 11.1% on our equity capital.
- 12. You will often hear this referred to as the Capital Asset Pricing Model Approach as well. www: Click on the web surfer to go to Bloomberg’s website. To get the T-bill rates, go to Market Data, Rates and Bonds, and then look under US Treasuries. To get betas, go to moneycentral.msn.com and enter a ticker symbol to get the stock quote and Beta can be found at the bottom. Other sites that provide betas include http://finance.yahoo.com
- 12. Since the two models are reasonably close, we can assume that our cost of equity is around 19.5%
- 12. Point out that the coupon rate was the cost of debt for the company when the bond was issued. We are interested in the rate we would have to pay on newly issued debt, which could be very different from past rates.
- 12. Remind students that it is a trial and error process to find the YTM if they do not have a financial calculator or spreadsheet.
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- 12. Note that for bonds we would find the market value of each bond issue and then add them together. Also note that preferred stock would just become another component of the equation if the firm has preferred stock outstanding. Finally, we generally ignore current liabilities in our computations. However, if a company finances a substantial portion of its assets with current liabilities, they should be included in the process.
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- 12. Point out that if we have other financing that is a significant part of our capital structure, we would just add additional terms to the equation
- 12. Remind students that bond prices are quoted as a percent of par value
- 12. Point out that students do not have to compute the YTM based on the entire face amount. They can still use a single bond.
- 12. Video Note: This is a good place to show the “Economic Value Added” video to reinforce the contents of the Reality Bytes box in the text.
- 12. It is important to point out that the WACC is not very useful for companies that have several disparate divisions. www : Click on the web surfer icon to go to an index of business owned by General Electric. Ask the students if they think that projects proposed by “GE Infrastructure” should have the same discount rate as projects proposed by “GE Healthcare.” You can go through the list and illustrate why the divisional cost of capital is important for a company like GE. If GE’s WACC was used for every division, then the riskier divisions would get more investment capital and the less risky divisions would lose the opportunity to invest in positive NPV projects.
- 12. Ask students which projects would be accepted if they used the WACC for the discount rate? Compare 15% to IRR and accept projects A and B. Now ask students which projects should be accepted if you use the required return based on the risk of the project? Accept B and C. So, what happened when we used the WACC? We accepted a risky project that we shouldn’t have and rejected a less risky project that we should have accepted. What will happen to the overall risk of the firm if the company does this on a consistent basis? Most students will see that the firm will become riskier.
- 13. Click on the Excel icon to go to a spreadsheet that contains all of the information for the example presented in the book.
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- 13. The main point with case I is that it doesn’t matter how we divide our cash flows between our stockholders and bondholders, the cash flow of the firm doesn’t change. Since the cash flows don’t change; and we haven’t changed the risk of existing cash flows, the value of the firm won’t change.
- 13. Remind students that case I is a world without taxes. That is why the term (1 – T C ) is not included in the WACC equation.
- 13. Remind students that if the firm is financed with 45% debt, then it is financed with 55% equity. At this point, you may need to remind them that one way to compute the D/E ratio is %debt / (1-%debt) The second question is used to reinforce that R A does not change when the capital structure changes Many students will not immediately see how to get the % of equity from the D/E ratio. Remind them that D+E = V. We are looking at ratios, so the actual $ amount of D and E is not important. All that matters is the relationship between them. So, let E = 1. Then D/1 = 1.5; Solve for D; D = 1.5. Then V = 1 + 1.5 = 2.5 and the percent equity is 1 / 2.5 = 40%. They often don’t understand that the choice of E = 1 is for simplicity. If they are confused about the process, then show them that it doesn’t matter what you set E equal to, as long as you keep the relationships intact. So, let E = 5; then D/5 = 1.5 and D = 5(1.5) = 7.5; V = 5 + 7.5 = 12.5 and E/V = 5 / 12.5 = 40%.
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- 13. Intuitively, an increase in financial leverage should increase systematic risk since changes in interest rates are a systematic risk factor and will have more impact the higher the financial leverage. The assumption that debt is riskless is for simplicity and to illustrate that even if debt is default risk-free, it still increases the variability of cash flows to the stockholders and thus the systematic risk.
- 13. Point out once again that this result assumes that the debt is risk-free. The effect of leverage on financial risk will be even greater if the debt is not default-risk free.
- 13. Point out that the government effectively pays part of our interest expense for us; it is subsidizing a portion of the interest payment.
- 13. The levered firm has 6250 in 8% debt, so the interest expense = .08(6250) = 500 CFFA = EBIT – taxes (depreciation expense is the same in either case, so it will not affect CFFA on an incremental basis)
- 13. Point out that the increase in cash flow in the example is exactly equal to the interest tax shield The assumption of perpetual debt makes the equations easier to work with, but it is useful to ask the students what would happen if we did not assume perpetual debt.
- 13. R U is the cost of capital for an unlevered firm = R A for an unlevered firm V U is just the PV of the expected future cash flow from assets for an unlevered firm.
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- 13. Remind students that a D/E ratio = 1 implies 50% equity and 50% debt. The amount of leverage in the firm increased, the cost of equity increased, but the overall cost of capital decreased.
- 14. Assuming that the second dividend is a liquidating dividend and the firm ceases to exist after period 2. PV = 10,000 / 1.12 + 10,000 / 1.12 2 = 16,900.51 PV = 9000 / 1.12 + 11,120 / 1.12 2 = 16,900.51
- 14. If a firm changes its policy, it will just have different investors. Consequently, dividend policy won’t affect the value of the stock.
- 14. Discuss how an increase in dividends sends a signal that prospects are good and that the firm will be able to maintain the higher dividend. If future dividends are expected to be higher, what should happen to the price? A decrease in dividends is usually an indication that the firm can no longer sustain the current dividend level. If dividends are expected to be lower in the future, what should happen to the stock price?
- 14. We will talk about the residual policy and the compromise policy in more detail Given the information content of dividends, will a constant growth policy be good for the stockholders? Given the information content of dividends, will a constant payout ratio be good for stockholders?
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- 14. Remind students how to get % debt and % equity given D/E: If D/E = 2/3, the V = 2 + 3 = 5, so D/V = 2/5 = 40% and E/V = 3/5 = 60%
- 14. www: Click on the web surfer icon to find out about upcoming stock splits and dividends