Corporate Finance: Midterm Exam Guide

• The midterm exam is scheduled for March 17, from 10:35 AM to 12:05 PM, lasting 1 hour and 30 minutes.
• The exam will cover Chapters 1, 4, and 5, and section 6.1 of Chapter 6.
• Students are allowed to bring a handwritten cheat sheet, limited to both sides of a letter-sized sheet, which must be submitted with the exam.
• Printouts of lecture notes are not allowed.
• A Scantron will be used for multiple-choice questions.
• Students must bring a financial calculator, a Scantron sheet, and writing utensils.
• Showing all work is required for calculation problems in the short answers section to receive full or partial credit.
• Any violation of academic honesty will be reported to the Division of Student Affairs.
• There will be two versions of the exam to prevent cheating.

Corporate Finance Decisions

• Capital budgeting involves choosing long-term investments.
• Capital structure involves deciding between debt and equity financing.
• Working capital management involves managing short-term assets and liabilities.

Sole Proprietorship & Corporation

• Sole proprietorships are easy to start, have less regulation, and are taxed only once.
• Sole proprietorships have unlimited personal liability, make transferring ownership difficult, and raising capital is difficult.
• Corporations have unlimited life, limited liability, and ease of raising capital.
• Corporations have high set-up and regulation costs and are subject to double taxation.

Goal of Financial Management

• The goal is to maximize firm value, which equals maximizing stock price and shareholders’ wealth.

Discounted Cash Flow (DCF) Valuation

• Present values of future cash flows are calculated to determine an asset’s value today for bonds, stocks, firms, and business projects.

Financial Calculator

• Review financial calculator functions such as PV, FV, I/Y, N, and PMT.
• Use 2nd [CLR TVM] to clear the calculator.
• Being able to solve calculation problems on the slides is important for a good score on the exam.

Future Value (FV) of a Lump Sum

• To calculate the future value of a lump sum, input PV, I/Y, and N into the calculator and compute FV.
• Example: Investing $1,400 at 12% for five years results in $2,467.28.

Present Value (PV) of a Lump Sum

• To calculate the present value of a lump sum, input FV, I/Y, and N into the calculator and compute PV.
• Example: To have $45,000 in 17 years with a 4% interest rate, you need to invest $23,101.80 today.

Interest Rate (I/Y) of a Lump Sum

• To calculate the implied rate of interest, input PV, FV, and N into the calculator, compute I/Y, and note that the sign convention matters.
• Example: Buying an asset for $335 and selling it in three years for $400 yields an interest rate of 6.09%.

Number of Periods (N) of a Lump Sum

• To calculate the number of periods needed to double your money, input PV, FV, and I/Y into the calculator and compute N.
• Example: With a 20% return per year, it will take 3.80 years to double your money.

Future Value (FV) of Multiple Cash Flows

• Calculate the value at a specific year (e.g., Year 3) of each cash flow and add them together.
• Example: Given cash flows of $7,000 today, $4,000 in Year 1, $5,000 in Year 2, and $2,000 in Year 3, with a discount rate of 8%, the total value in 3 years is $20,883.58.

Present Value (PV) of Multiple Cash Flows

• Find the PV of each cash flow and add them.
• Example: Given cash flows of $200 in Year 1, $400 in Year 2, $600 in Year 3, and $800 in Year 4, with a discount rate of 12%, the total PV is $1,432.93.

Annuities

• Annuities are a series of equal payments made at regular intervals for a fixed period of time.
• Ordinary Annuity: Payments made at the end of each period.
• Annuity Due: Payments made at the beginning of each period.
• If the type of annuity is not specified, it is assumed to be an ordinary annuity.
• The PV of an annuity due is greater than that of an ordinary annuity by a factor of (1 + r) because all cash flows occur one period earlier.
• The FV of an annuity due is also greater than that of an ordinary annuity because all the cash flows occur one period earlier, allowing them to earn more interest.

Annuities and the Financial Calculator

• Input the values for PMT, N, and I/Y to calculate the FV or PV of an annuity.
• When solving annuity due problems, make sure the "BGN" sign is turned on.

Present Value (PV) of an Ordinary Annuity

• To calculate the PV of an ordinary annuity, input PMT, I/Y, and N into the calculator and compute PV.
• Example: Lottery winnings of $3.5 million per year for 30 years, with a discount rate of 4%, are worth $60.522 million today.

Future Value (FV) of an Ordinary Annuity

• To calculate the FV of an ordinary annuity, input PMT, I/Y, and N into the calculator and compute FV.
• Example: Depositing $6,500 per year for 45 years with an interest rate of 5% will result in $1,038,051.01 at retirement.

Payment (PMT) of an Annuity

• To calculate the PMT of an annuity, input FV, I/Y, and N into the calculator and compute PMT.
• Example: To have $500,000 in 10 years with an interest rate of 6%, Mario needs to deposit $35,786.77 at the beginning of every year.

Interest Rate (I/Y) of an Annuity

• To calculate the interest rate of an annuity, input PV, PMT, and N into the calculator and compute I/Y.
• Example: Borrowing $10,000 and paying $2,000 per year for 6 years results in a yearly interest rate of 5.47%.

Time Value of Money Concepts

• Understand how the number of time periods and interest rates affect present value and future value.
• Understand how the value changes depending on the type of annuity.

Multiple Choice Concepts

• A higher number of compounding periods leads to a higher future value.

Debt

• Debt involves fixed payments (interest and principal).
• Failure to pay can lead to loss of control and potential bankruptcy.
• Debt has priority over equity holders in case of liquidation.

Equity

• Equity represents an ownership interest.
• Dividends are not obligatory.
• Equity has a higher risk compared to debt.

Bonds

• Bonds are public debt securities where the issuer is obligated to pay coupons and principal.
• Coupon Rate: Determines annual interest payment made by the bond issuer.
• Face Value: The principal amount of the bond to be repaid at maturity.
• Maturity: The specified date on which the principal amount of a bond is paid.
• Yield to Maturity (YTM): The total return expected on a bond if held until maturity.
• Bond Value = PV of an annuity (coupons) + PV of a lump sum (face value).

Bond Valuation

• To calculate the price of a bond, input PMT (coupon payment), FV (face value), N (years to maturity), and I/Y (YTM) into the calculator and compute PV.
• Example: A bond with a 10% coupon rate, $1000 face value, 5 years to maturity, and an 11% YTM has a price of $963.04.

Finding the Yield to Maturity (YTM)

• To calculate the YTM of a bond, input N (years to maturity), PV (current price), FV (face value), and PMT (coupon payment) into the calculator and compute I/Y.
• Example: A bond with a 10% coupon rate, 15 years to maturity, a par value of $1,000, and a current price of $928.09 has a YTM of 11.00%.

Relationship Between Coupon Rate, YTM, and Bond Price

• If YTM > coupon rate, the bond is a discount bond (bond price < face value).
• If YTM < coupon rate, the bond is a premium bond (bond price > face value).

Bond Prices

• Bond prices change over time.
• Interest Rate Risk: The risk that a bond’s price will fluctuate due to changes in interest rates.
• Long-term bonds have more price risk than short-term bonds.
• Bonds with lower coupon rates have more price risk than bonds with higher coupon rates.