Corporate Finance Completed Notes

Fundamental of
Corporate
Finance
Lecture Notes
For

MBA/M.Com/MEF/BS/BB
A
Sir M.Faseeh Khan
Sir M.Faseeh Khan-CF(notes) Page 1 of 50 copyright @TM
Federal Urdu Art and Science University
e-mail: faseeh_u@yahoo.com
Corporate Finance Course
Overview
__________________________________________________________
___
Instructor: Sir M.Faseeh Khan e-mail:
faseeh_u@yahoo.com
Subject: Corporate Finance
Class: BBA/MBA/M.Com Shift: Morning Session: Aug. Dec.
2010
Purpose:
The course is design to assist the students in building a conceptual
framework which with to make prudent financial decision in their jobs, personal
financial planning and decision making.
Topics:
Chapter #1: Introduction to Corporate Finance
Chapter #2: Long-Term Financial Planning and Growth
Chapter #3: Interest Rates and Bond Valuation
Chapter #4: Introduction to Valuation: The Time Value of Money
Chapter #5: Discounted Cash Flow Valuation
Chapter #6: Stock Valuation
Chapter #7: Net Present Value and Other Investment Criteria
Chapter #8: Project Analysis and Evaluation
Chapter #9: Return, Risk, and the Security Market Line
Chapter #10: Cost of Capital
Chapter #11: Dividends and Dividend Policy
Chapter #12: Short-Term Finance and Planning
Evaluation:
The grading component and Scale:
Final Examination ---------> 60 Marks
Mid-Term ---------> 20 Marks
Class Test ---------> 20 Marks(each @ 10)
Chapter 1: Introduction to Corporat e Finance
Corporate Finance
Some important questions that are answered using finance
What long-term investments should the firm take on?
Where will we get the long-term financing to pay for the investment?
How will we manage the everyday financial activities of the firm?
Financial Manager
Financial managers try to answer some or all of these questions
The top financial manager within a firm is usually the Chief Financial Officer
(CFO)
Treasurer oversees cash management, credit management, capital
expenditures and financial planning
Controller oversees taxes, cost accounting, financial accounting and
data processing
Financial Management Decisions
Capital budgeting
What long-term investments or projects should the business take on?
Capital structure
How should we pay for our assets?
Should we use debt or equity?
Working capital management
How do we manage the day-to-day finances of the firm?
Forms of Business Organization
Three major forms in the United States
Sole proprietorship
Partnership
General
Limited
Corporation
S-Corp
Limited liability company
Sole Proprietorship
Advantages
Easiest to start
Least regulated
Single owner keeps all the profits
Taxed once as personal income
Disadvantages
Limited to life of owner
Equity capital limited to owners personal wealth
Unlimited liability
Difficult to sell ownership interest
Partnership
Advantages
Two or more owners
More capital available
Relatively easy to start
Income taxed once as personal income
Disadvantages
Unlimited liability
General partnership
Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership
Corporation
Advantages
Limited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages
Separation of ownership and management
Double taxation (income taxed at the corporate rate and then dividends
taxed at the personal rate)
Goal of Financial Management
What should be the goal of a corporation?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the companys stock?
Does this mean we should do anything and everything to maximize owner
wealth?
Chapter 2: Long-Term Financial Planning and
Growth
2: Plowback and dividend payout ratios
Your company has net income of $1,600 for the year. You paid out $400 in dividends
to your stockholders.
What is the dividend payout ratio?
What is the plowback ratio?
What is the dollar increase in retained earnings?
Your company has net income of $1,600 for the year. You paid out $400 in dividends
to your stockholders.
25 .
600 , 1 $
400 $
income Net
dividends Cash
ratio payout Dividend
.75
.25 - 1
ratio payout dividend - 1 ratio Plowback
$1,200
.75 $1,600
ratio plowback income Net earnings retained o Addition t

This year your company expects net income of $2,800. You now adhere to a 60%
plowback ratio.
What is the expected dollar increase in retained earnings?
How much do you expect to pay in dividends?
What is the dividend payout ratio?
This year your company expects net income of $2,800. You now adhere to a 60%
plowback ratio.
120 , 1 $
680 , 1 $ 800 , 2 $
earnings retained o Addition t income Net paid Dividends

40%
$2,800
$1,120

income Net
dividends Cash
ratio payout Dividend
$1,680
.60 $2,800
ratio plowback income Net earnings retained o Addition t

6: Constant growth planning
Income Statement
Current Projected
Sales $800 $_______
Costs $700 $_______
Taxable income $100 $_______
Taxes (34%) $ 34 $_______
Net income $ 66 $_______
Balance Sheet
CurrentProjected CurrentProjected
Assets $400 $_______ Debt $150 $_______
Equity $250 $_______
Total $400 $_______ Total $400 $_______
You expect your sales, costs and assets to grow by 10% next year. You will not pay
any dividends. Can you complete the pro forma statement? Round all amounts to
whole dollars.
Income Statement
Current Projected
Sales $800 $880
Costs $700 $770
Taxable income $100 $110
Taxes (34%) $ 34 $ 37
Net income $ 66 $ 73
Balance Sheet
CurrentProjected CurrentProjected
Assets $400 $440 Debt $150 $117
Equity $250 $323
Total $400 $440 Total $400 $440
The computations are shown on the next slide.
$323
$73 $250
income net Projected equity Current equity Projected
+
+
$440
assets Total equity s liabilitie Total
+
$117
$323 - $440
equity - equity) s liabilitie (Total Debt
+
$440 $400(1.10) Assets
) ( $37 $34(1.10) Taxes
$770 $700(1.10) Costs
$880 $800(1.10) Sales

rounded
9: Percentage of sales planning
The assets and current liabilities of Jennings, Inc. vary in direct proportion to the
increase in sales. The current sales are $2,000 and you expect them to increase by
20% next year. Net income is projected at 5% of sales. The firm is not planning on
issuing any more common stock nor paying any dividends.
Using this information, can you compile the pro forma balance sheet shown on the
next slide?
Current% of sales Projected
Cash $ 120 _____% $_______
Accounts receivable $ 500 _____% $_______
Inventory $ 840 _____% $_______
Fixed assets $2,600 _____% $_______
Total assets $4,060 _____% $_______
Accounts payable $ 600 _____% $_______
Long-term debt $ 700 _____% $_______
Common stock and paid in surplus $1,000 _____% $_______
Retained earnings $1,760 _____% $_______
Total liabilities and equity $4,060 _____% $_______
Refer to the prior slide for information pertaining to this problem.
Enter n/a where the % of sales does not apply.
Current % of sales Projected
Cash $ 120 6% $ 144
Accounts receivable $ 500 25% $ 600
Inventory $ 840 42% $1,008
Fixed assets $2,600 130% $3,120
Total assets $4,060 203% $4,872
Accounts payable $ 600 30% $ 720
Long-term debt $ 700 n/a $1,272
Common stock and paid in surplus $1,000 n/a $1,000
Retained earnings $1,760 n/a $1,880
Total liabilities and equity $4,060 n/a $4,872
% 30 30 .
$2,000
$600
payable Accounts
% 203 03 . 2
$2,000
$4,060
assets Total
% 130 30 . 1
$2,000
$2,600
assets Fixed
% 42 42 .
$2,000
$840
Inventory
% 25 25 .
$2,000
$500
receivable Accounts
% 6 06 .
$2,000
$120
Cash

$720 $2,400 .30 payable Accounts
$3,120 $2,400 1.30 assets Fixed
$1,008 $2,400 .42 Inventory
$600 $2,400 .25 receivable Accounts
$144 $2,400 .06 Cash
$2,400 1.20 $2,000 Sales

$4,872 assets Total equity owners' and s liabilitie Total
$1,880 $2,400) .05 ( $1,760 earnings Retained
$1,000 $0 $1,000 stock Common

+
+
Total liabilities and owners equity $4,872
Accounts payable -$ 720
Common stock and paid in surplus -$1,000
Retained earnings -$1,880
Long-term debt $1,272
14: External financing need
You project your sales will increase by $3,000 next year. Net income is 10% of sales
and accounts payable is 25% of sales. The capital intensity ratio is 2.5. No dividends
are anticipated.
How much external financing is needed to fund this growth?
Try to solve this problem without looking at the hints on the next slide.
You project your sales will increase by $3,000 next year. Net income is 10% of sales
and accounts payable is 25% of sales. The capital intensity ratio is 2.5. No dividends
are anticipated.
How much external financing is needed to fund this growth?
Hints:
Step 1: Compute the increase in total assets
Step 2: Compute the increase in accounts payable
Step 3: Compute the increase in retained earnings
Step 4: Compute the additional long-term debt and equity financing that is needed
Step 1
$7,500
2.5 $3,000
ratio intensity Capital Sales assets Total

Step 2
$750
$3,000 .25
Sales .25 payable Accounts

Step 3
$300
$3,000 .10
0 - sales) .10 (
paid Dividends - income Net earnings retained o Addition t
Step 4
$6,450
$300 - $750 - $7,500
earnings retained to Additions - payable Accounts - assets Total need financing External
17: Pro forma with external financing

Your firm currently has long-term debt of $4,400, common stock and paid in surplus
of $10,000 and retained earnings of $4,600. The capital intensity ratio is 2.2 and the
tax rate is 35%. Costs are 72% of sales and accounts payable are 30% of sales. Sales
currently are $10,000 and are expected to increase by 10% next year. The dividend
payout ratio is 20%. Long-term debt will be used to fund 40% of the external funding
need.
Chapter 3: Interest Rates and Bond Valuation
2: Coupon payment
A bond has a 7% coupon and pays interest semi-annually.
What is the amount of each interest payment if the face value of a bond is $1,000?
3: Coupon payment
35 $
2
70 $
2
000 , 1 $ 07 .
year per payments interest of Number
amount Face rate Coupon
payment Interest
4: Bond price
A bond has a 9% coupon rate, matures in 12 years and pays interest semi-annually.
The face value is $1,000.
What is the current price of this bond if the market rate of return is 8.3%?
5: Bond price
[ ]
55 . 052 , 1 $
8577 . 376 $ 6965 . 675 $
8577 . 376 $ ) 015477 . 15 45 ($
)
2
083 .
1 (
000 , 1 $
2
083 .
)
2
083 .
1 /( 1 1
2
000 , 1 $ 09 .
) r 1 (
F
r
) r 1 /( 1 1
C PV
2 12
2 12
t
t
+
+
+
+
'
1
]
1
+
+
'
'
7: Time to maturity
A bond is currently selling at a price of $977.03. The face value is $1,000 and the
coupon rate is 8%. Interest is paid semi-annually.
How many years is it until this bond matures if the market rate of return is 8.4%?
8: Time to maturity
9: Yield to maturity
A 6% bond pays interest annually and matures in 14 years. The face value is $1,000
and the current market price is $896.30.
What is the yield to maturity?
11: Current yield
An 8%, semi-annual coupon bond has a $1,000 face value and matures in 8 years.
What is the current yield on this bond if the yield to maturity is 7.8%?
12: Current yield
[ ]
74 . 011 , 1 $
18967 . 542 $ 54920 . 469 $
18967 . 542 $ ) 73873 . 11 40 ($
)
2
078 .
1 (
000 , 1 $
2
078 .
)
2
078 .
1 /( 1 1
2
000 , 1 $ 08 .
) r 1 (
F
r
) r 1 /( 1 1
C PV
2 8
2 8
t
t
+
+
+
+
'
1
]
1
+
+
'
'
% 91 . 7
07907 .
$1,011.74
$80
74 . 011 , 1 $
000 , 1 $ 08 .
price Current
interest Annual
yield Current

% 91 . 7
07907 .
$1,011.74
$80
price Current
interest Annual
yield Current

14: Holding period yield
You bought a bond exactly one year ago for $1,004.50. Today, you sold the bond at a
price of $987.40. The bond paid interest semi-annually at a coupon rate of 6%.
What is your holding period yield on this bond?
15: Holding period yield
16: Interest rate risk
You own two bonds. Both bonds have a 6% coupon and pay interest semi-annually.
Both have a face value of $1,000. Bond A matures in two years while bond B matures
in 10 years.
What is the price of each bond at a market rate of 6%? What happens if the rate
increases to 7%.
19: Interest rate risk
You own two bonds. Both bonds mature in 5 years, have a $1,000 face value and pay
interest annually. Bond X has an 8% coupon rate while bond Y has a 3% coupon rate.
What is the price of each bond if the market rate of return is 7%? What happens to the
price of each bond if the market rate falls to 6%?
Chapter 4: The Time Value of Money
2: Simple versus compound interest
First United Bank pays 4% simple interest on their savings accounts. Second Federal
Bank pays 4% interest compounded annually on their savings accounts.
If you invest $1,000 in each bank, how much will you have in your accounts after
twenty years?
Why are the balances different?
3: Simple versus compound interest
First United Bank
Second Federal Bank
Difference
12 . 191 , 2 $
1.04 $1,000
r) (1 PV FV
20
t
t

+
12 . 391 $ 800 , 1 $ 12 . 191 , 2 $
800 , 1 $ 800 $ 000 , 1 $
800 $ 20 40 $
40 $ 04 . 000 , 1 $
+

4: Future value
You invest $3,000 in the stock market today.
How much will your account be worth forty years from now if you earn a 9% rate of
return?
5: Future value
( )
( )
26 . 228 , 94 $
40942 . 31 000 , 3 $
09 . 1 000 , 3 $
1
40

+
+
t
t
r PV FV
7: Present value
You want to have $7,500 three years from now to buy a car. You can earn 6% on your
savings.
How much money must you deposit today to have the $7,500 in three years?
8: Present value
( )
( )
14 . 297 , 6 $
191016 . 1
500 , 7 $
06 . 1
500 , 7 $
1
3
t
t
r
FV
PV
10: Interest rate for a single period
Last year your investments were worth $369,289. Today they are worth $401,382. No
deposits or withdrawals were made during the year.
What rate of return did you earn on your investments this year?
( )
( )
% 6905 . 8
086905 .
1 086905 . 1
1 289 , 369 $ 382 , 401 $
1
1
+
+
+
r
r
r
r
r PV FV
t
t
Chapter 5: Discounted Cash Flow Valuation
3: Financial review
If you invest $100 today for one year at a 10% rate of return, how much money will
you have one year from now?
You are spending $100 by investing it. You input that as a negative value using the
t key. You are receiving $110 back at the end of one year. That is the positive
value.
Positives and negatives are used to denote the direction of the cash flow. Generally
you use a positive value to indicate a cash inflow and a negative value to indicate a
cash outflow. All dollar amounts in this type of problem are, in actuality, positive
values.
5: Ordinary annuity present value
You will receive $12,000 a year for the next ten years from a trust fund your
grandmother is establishing.
What is this gift worth today at a 9% discount rate?
6: Ordinary annuity present value
( ) [ ]
[ ]
89 . 011 , 77 $
4176578 . 6 000 , 12 $
09 .
5775892 .
000 , 12 $
09 .
) 09 . 1 /( 1 1
000 , 12 $
1 / 1 1
C APV
10
'
'
+

'
+

r
r
t
8: Annuity due present value
You are buying some land from your parents today. You agree to pay them $5,000 a
year for six years. The first payment is due today.
What is the actual selling price of the land if your parents are only charging you 3%
interest?
( ) [ ]
( )
( ) [ ]
( )
54 . 898 , 27 $
03 . 1 4171914 . 5 000 , 5 $
03 . 1
03 .
.162515743
000 , 5 $
) 03 . 1 (
03 .
03 . 1 / 1 1
000 , 5 $
1
1 / 1 1
C PV A
6
Due
'
+

+
'
+
r
r
r
t
11: Ordinary annuity future value
You are planning on investing $3,500 in the stock market every year for your
retirement. You will make your first investment at the end of this year. The average
rate of return you expect to earn is 7%.
How much money do you expect to have when you retire forty years from now?
12: Ordinary annuity future value
89 . 722 , 698 $
63511 . 199 500 , 3 $
07 .
1 ) 07 . 1 (
500 , 3 $
1 ) 1 (
AFV
40
'

'
+

r
r
C
t
14: Annuity due future value
Your parents are giving you $3,000 at the beginning of each year for four years. You
are saving this money and earning a 2.5% rate of return on your savings.
How much money will you have at the end of the four years?
15: Annuity due future value
99 . 768 , 12 $
025 . 1 1525156 . 4 000 , 3 $
) 025 . 1 (
025 .
1 ) 025 . 1 (
000 , 3 $
) 1 (
1 1
AFV
4
'

+
'
+
r
r
r) (
C
t
17: Annuity annual payments
You plan on retiring at age 60 and then living another 25 years. Your goal is to have
$500,000 in your retirement savings on the day you retire and spend it all by the time
you die. During your retirement, you expect to earn 5% on your savings.
How much money can you withdraw from your savings each year during your
retirement if you withdraw the funds on the last day of each year?
What if you withdraw the money on the first day of each year?
18: Annuity annual payments
( ) [ ]
( ) [ ]
(rounded) $35,476.23 C
86 $35,476.22 C
14.0939446
$500,000
C
14.0939446 C 000 , 500 $
05 .
05 . 1 / 1 1
C 000 , 500 $
1 / 1 1
C APV
25
'
'
+

r
r
t
( )
88 . 786 , 33 $
05 . 1
2286 . 476 , 35 $
r 1
C
C
AD
20: Annuity monthly payments

You currently owe $3,780 on your credit card. You are not charging any more on the
account. The interest rate is 1.5% per month.
How much do you have to pay each month if you want to have this bill paid off within
two years?
( ) [ ]
( ) [ ]
$188.71 C
20.0304
$3,780
C
20.0304 C 780 , 3 $
.015
.300456
C 780 , 3 $
015 .
015 . 1 / 1 1
C 780 , 3 $
1 / 1 1
C APV
) 12 2 (
'
'
'
r
r
t
23: Annuity quarterly payments
Your company recently borrowed $12,000 to buy some office equipment. The
financing terms call for eight equal quarterly payments. The interest rate is 10%.
What is the amount of each quarterly payment?
24: Annuity quarterly payments
( ) [ ]
$1,673.61 C
7.170136
$12,000
C
7.170136 C 000 , 12 $
025 .
1792534 .
C $12,000
4 / 10 .
4
10 .
1 / 1 1
C $12,000
1 / 1 1
C APV
8
'
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1
1
]
1
,
_
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Chapter 6: Stock Valuation
2: Zero growth stock
Rainbow Rentals pays a constant annual dividend of $1.00 per share on their common
stock.
How much are you willing to pay for one share of this stock if you want to earn a 9%
rate of return?
11 . 11 $
09 .
00 . 1 $
r
D
P
0

Bits n Pieces pays a constant annual dividend of $.50 a share. The market price of the
stock is $5.41 today.
What is the rate of return on this stock?
% 24 . 9 r
09242 . r
50 $. r 41 . 5 $
r
50 $.
41 . 5 $
r
D
P
0

The common stock of Kathys Antiques, Etc. is priced at $12.50 a share. The stock
provides a 10% rate of return. The company pays a constant dividend.
What is the amount of the annual dividend?
25 . 1 $ D
10 .
D
50 . 12 $
r
D
P
0
8: Constant growth stock

JLE, Inc. just paid their annual dividend of $1.10 a share. JLEs policy is to increase
the dividend by 2% annually.
How much are you willing to pay today for a share of this stock if you require an 11%
rate of return?
47 . 12 $
46667 . 12 $
09 .
122 . 1 $
02 . 11 .
) 02 . 1 ( 10 . 1 $
g r
) g 1 ( D
g r
D
P
0 1
0

SLG, Inc. announced today that they will be increasing their annual dividend to $1.60
per share next year. After that, they expect to increase the dividend by 3% annually.
You want to buy shares of stock in this company but can not afford to do so for
another two years. At that time, you will buy shares if you can earn a 12% rate of
return.
How much will you be willing to pay for one share of this stock two years from
today?
86 . 18 $
09 .
69744 . 1 $
03 . 12 .
) 03 . 1 ( 60 . 1 $
g r
) g 1 ( D
g r
D
P
g r
D
P
2
2
1 3
2
1 t
t
+
Alexs Ventures, Inc. stock has a 13% rate of return and a current market price of
$16.18. The company pays annual dividends. The last dividend paid was $1.40 per
share.
What is the growth rate of this stock?
% 00 . 4 g
04001 . g
7034 $. g 58 . 17 $
g 40 . 1 $ 40 . 1 $ g 18 . 16 $ 1034 . 2 $
g 13 .
) g 1 ( 40 . 1 $
18 . 16 $
g r
) g 1 ( D
g r
D
P
0 1
0

C and F Fabrics is going to pay an annual dividend of $1.36 per share next week. The
dividends have been increasing by 2% annually and this trend is expected to continue.
The stock is selling for $15.11 per share.
What is the market rate of return on this stock?
% 00 . 11
1100 . r
6 622 . 1 $ r 11 . 15 $
3 6 . 1 $ 3022 $. r 11 . 15 $
02 . r
36 . 1 $
11 . 15 $
g r
D
P
1
0

The Thomas Co. is in a declining industry and has just announced that they will be
reducing their annual dividend by 2% annually from now on. The last dividend they
paid was $1.60. The market rate of return on this stock is 6%.
What is the market price of one share of Thomas Co. stock?
60 . 19 $ P
568 . 1 $ P 08 .
) 02 . ( 06 .
)] 02 . ( 1 [ 60 . 1 $
P
g r
) g 1 ( D
g r
D
P
0
0
0
0 1
0
18: Irregular growth stock

Isaacs Shoes just announced that they will commence paying annual dividends next
year. The plan is to pay $.50, $.75 and $1.00 per share over the next three years,
respectively. After that the company plans on increasing the dividend by 2.5%
annually. The market rate of return on this stock is 12.5%.
What should the market price of this stock be?
25 . 10 $
10 .
025 . 1 $
025 . 125 .
) 025 . 1 ( 00 . 1 $
g r
) g 1 ( D
g r
D
P
3 4
3
94 . 8 $
93826 . 8 $
90123 . 7 $ 59259 $. 44444 $.
) 125 . 1 (
25 . 10 $ 00 . 1 $
) 125 . 1 (
75 $.
) 125 . 1 (
50 $.
P
3 2 1
0
+ +
+
+
+
+
+

Nu-Tek, Inc. just paid their annual dividend of $1.20 per share. The company has
stated that dividends will increase by 20% a year for the next two years. After that, the
dividends will increase by 4% annually.
What is one share of this stock worth today if the required return is 14%?
728 . 1 $ ) 20 . 1 ( 20 . 1 $ D
44 . 1 $ ) 20 . 1 ( 20 . 1 $ D
2
2
1
+
+
9712 . 17 $
10 .
79712 . 1 $
04 . 14 .
) 04 . 1 ( 728 . 1 $
g r
) g 1 ( D
g r
D
P
2 3
2

42 . 16 $
42105 . 16 $
15789 . 15 $ 26316 . 1 $
) 14 . 1 (
9712 . 17 $ 728 . 1 $
) 14 . 1 (
44 . 1 $
P
2 1
0
+
+
+
+
+
Chapter 7: Net Present Value and Other Investment

Criteria
2: Net present value
You are considering a project which requires an initial investment of $24,000. The
project will produce cash inflows of $8,000, $9,800, $7,600 and $6,900 over the next
four years, respectively.
What is the net present value of this project if the required rate of return is 12%?
Should this project be accepted?
96 . 749 $
07 . 385 , 4 $ 53 . 409 , 5 $ 50 . 812 , 7 $ 86 . 142 , 7 $ 000 , 24 $
) 12 . 1 (
900 , 6 $
) 12 . 1 (
600 , 7 $
) 12 . 1 (
800 , 9 $
) 12 . 1 (
000 , 8 $
000 , 24 $ NPV
4 3 2 1
+ + + +
+
+
+
+
+
+
+
+
CF0 = -$24,000
CO1 = $ 8,000 FO1 = 1
CO2 = $ 9,800 FO2 = 1
CO3 = $ 7,600 FO3 = 1
CO4 = $ 6,900 FO4 = 1
I = 12%
NPV CPT
$749.96
5: Payback
A project has an initial cost of $199,000. The project produces cash inflows of
$46,000, $54,000, $57,500, $38,900 and $46,500 over the next five years,
respectively.
What is the payback period for this project?
Should the project be accepted if the required payback period is 3 years?
6: Payback
Year Cash flow Cumulative cash flow
1 $46,000 $ 46,000
2 $54,000 $100,000
3 $57,500 $157,500
4 $38,900 $196,400
5 $46,500 $242,900
years 06 . 4 0559 . 4
500 , 46 $
600 , 2 $
500 , 46 $
400 , 196 $ 000 , 199 $
4 Payback
+
7: Discounted payback
A project has an initial cost of $200,000 and produces cash inflows of $86,000,
$93,600, $42,000 and $38,000 over the next four years, respectively.
What is the discounted payback period if the discount rate is 10%?
Should this project be accepted if the required discounted payback period is 3 years?
8: Discounted payback
Year Discounted Cumulative discounted
cash flow cash flow
1 $86,000/(1+.10)1 = $78,181.82 $ 78,181.82
2 $93,600/(1+.10)2 = $77,355.37 $155,537.19
3 $42,000/(1+.10)3 = $31,555.22 $187,092.41
4 $38,000/(1+.10)4 = $25,954.51 $213,046.92
years 50 . 3 4973 . 3
51 . 954 , 25 $
59 . 907 , 12 $
51 . 954 , 25 $
1) $187,092.4 - ($200,000
3 payback Discounted +
9: Average accounting return
A project has an initial cost of $134,000 for equipment. This equipment will be
depreciated using straight line depreciation to a zero book value over the four year life
of the project. The project is expected to produce annual net income of $4,700,
$5,100, $5,800 and $6,500 over the four years, respectively.
What is the average accounting return (AAR)?
Should this project be accepted if the required AAR is 8%?
10: Average accounting return
% 25 . 8
08246 .
000 , 67 $
525 , 5 $
2
0 $ 000 , 134 $
4
500 , 6 $ 800 , 5 $ 100 , 5 $ 700 , 4 $
book value Average
income net Average
AAR
+
+ + +
11: Internal rate of return

You are considering a project with an initial cost of $48,500. The project has a five
year life and produces cash inflows of $9,800, $12,200, $12,850, $13,200 and
$13,600 over the five years, respectively.
What is the internal rate of return on this project?
Should this project be accepted if the required rate of return is 8%?
12: Internal rate of return
CF0 = -$48,500
CO1 = $ 9,800 FO1 = 1
CO2 = $12,200 FO2 = 1
CO3 = $12,850 FO3 = 1
CO4 = $13,200 FO4 = 1
CO5 = $13,600 FO5 = 1
IRR CPT
8.14%
Chapter 8: Project Analysis and Evaluation
2: Scenario analysis
Wilsons Woods is considering a project which involves producing inexpensive golf
clubs for teenagers. The company expects to sell these clubs for $100 a set, plus or
minus 2%. The sales manager estimates that 20,000 sets can be sold, plus or minus
5%.
What is the expected amount of sales under the worst case scenario?
000 , 862 , 1 $
98 $ 19,000
.02) (1 $100 .05) - (1 20,000 scenario case for worst Sales

Bobs Custom Wheels is considering designing and selling customized steering
wheels for hot rods. The projected fixed costs of this project are $18,000. Variable
costs are estimated at $54.90 per wheel. The cost estimates are considered accurate
within a plus or minus range of 5%. The depreciation expense is $8,000 per year.
Bobs expects to sell 1,500 wheels, plus or minus 3%. The sales price is estimated at
$139.00, plus or minus 5%.
What is the projected earnings before interest and taxes under the best case scenario?
Note: Totals are rounded to whole dollars.
Sales = 1,500 (1 + .03) $139.00 (1 + .05) = $225,493
Variable cost = 1,500 (1 + .03) $54.90 (1 - .05) = $ 80,579
Fixed cost = $18,000 (1 - .05) = $ 17,100
Depreciation = $8,000 = $ 8,000 EBIT
= $119,814
6: Sensitivity analysis
Kettle Corn and Chips is considering selling snack foods at sporting events. The
company has developed the following estimates:
Sales 25,000 units t 10%
Variable cost $.59 per unit t 5%
Fixed cost $7,500 t 2%
Selling price $1.25 per unit t 5%
Depreciation $1,000
What is the earnings before interest and taxes for a sensitivity analysis using a
variable cost of $.60 per unit?
Sales = 25,000 $1.25 = $31,250
Variable cost = 25,000 $.60 = $15,000
Fixed cost = $7,500 = $ 7,500
Depreciation = $1,000 = $ 1,000 EBIT
= $ 7,750
The Sweet Shoppe is considering opening a kiosk and selling homemade cookies on
the waterfront during tourist season. The company has developed these estimates:
Sales 6,000 cookies t 20%
Variable costs $.69 per cookie t 4%
Fixed costs $500 t 3%
Sales price $1.10 t 5%
Depreciation $800
Tax rate 34%
What is the operating cash flow for a sensitivity analysis using a sales quantity of
6,500 cookies?
Sales = 6,500 $1.10 = $7,150
Variable cost = 6,500 $.69 = $4,485
Fixed cost = $500 = $ 500
Depreciation = $800 = $ 800
EBIT = $1,365
Tax = .34 $1,365 = $ 464
Net income = $ 901
OCF = EBIT + Depreciation Taxes
= $1,365 + $800 - $464 = $1,701
OCF = [(Sales Costs) (1 Tax rate)] + [Depreciation tax rate]
= {[6,500 ($1.10 - $.69)] - $500} {1 - .34} + {$800 .34}
= $1,428.90 + $272.00
= $1,700.90
= $1,701 (rounded to whole dollars)
11: Total cost
Sandwiches To Go sells 500 sandwiches per day. The company pays $1,200 a month
for rent. Other fixed costs are $500 monthly.
The variable cost per sandwich is $2.89. Assume a month has 30 days.
What are the monthly total costs incurred by Sandwiches To Go?
12: Total cost

Total monthly cost = (500 30 $2.89) + $1,200 + $500
= $43,350 + $1,700
= $45,050
13: Average vs. marginal cost
Daisys Flowers raises and sells 36,000 bouquets of fresh cut flowers each year. Total
labor cost for the year are $68,000. Total material costs for the year are $28,470.
Daisys computed that at the current level of production the labor cost per additional
unit is $1.40 and the material costs are $2.09.
Fixed costs for the year are $50,000. Annual depreciation is $55,000 on the
greenhouses and equipment. Ignore taxes.
What is the average total cost per bouquet?

What is the minimum price Daisys should charge if they can obtain a one-time
special order for an additional 250 bouquets?
14: Average vs. marginal cost
) rounded ( 60 . 5 $
36,000
$55,000 $50,000 $28,470 $68,000
cost total verage A
+ + +
$3.49
$2.09 $1.40 order time - one for price Minimum
+
15: Contribution margin
Jacks Custom Kars manufactures motorized toy cars for children aged 3 to 6. Jacks
sells these cars for $320 each. The company has fixed monthly expenses of $1,500.
The variable cost per car is $212. During an average month, Jacks sells 20 of these
toy cars.
What is the contribution margin per car sold?
Chapter 9: Return, Risk, and the Security Market
Line
2: Expected return of individual stock
You own 500 shares of ABC, Inc. This stock has the following expected returns given
the various possible states of the economy.
State of Probability of Rate of Return
Economy State of Economy if State Occurs
Boom .20 28%
Normal .70 12%
Recession .10 -40%
What is your expected return on this stock?
3: Expected return of individual stock
% 10
10 .
04 . 084 . 056 .
) 40 . 10 (. ) 12 . 70 (. ) 28 . 20 (. E
r
+
+ +
4: Standard deviation of individual stock
A stock has returns of 6.8%, 9.2%, -4.3% and 18.7% over the last four years,
respectively.
What is the standard deviation of this stock assuming the returns are normally
distributed?
5: Standard deviation of individual stock
076 .
4
304 .
4
187 . 043 . 092 . 068 .
E
r
+ +
% 45 . 9
0945 .
008934 .
3
026802 .
3
012321 . 014161 . 000256 . 000064 .
1 4
) 076 . 187 (. ) 076 . 043 . ( ) 076 . 092 (. ) 076 . 068 (.
2 2 2 2
+ + +
+ + +

6: Portfolio weights
You own 50 shares of Stock A and 200 shares of stock B. Stock A sells for $30 a
share and stock B sells for $22 a share.
What are the portfolio weights for each stock?
7: Portfolio weights
Stock Number of Price per Total Portfolio
Shares Share Value Weight
A 50 $30 $1,500 25.4%
B 200 $22 $4,400 74.6%
Totals $5,900 100.0%
8: Portfolio expected return
You have $3,600 invested in stock A and $5,400 invested in stock B. Stock A has an
expected return of 11% and stock B has an expected return of 7%.
What is the expected return of your portfolio?
Stock Expected Return Amount Invested Portfolio Weight
A 11% $3,600 40%
B 7% $5,400 60%
Totals $9,000 100%
% 6 . 8
086 .
042 . 044 .
) 07 . 60 (. ) 11 . 40 (. E
r
+
+
Your portfolio consists of the following stocks:
Stock Expected Return Number of Shares Stock Price
A 9% 640 $25
B 14% 250 $40
C 7% 700 $20
What is the expected return on your portfolio?
Expected Number Price Stock Portfolio
Stock Return of Shares per Share Value Weight
A 9% 640 $25 $16,000 40%
B 14% 250 $40 $10,000 25%
C 7% 700 $20 $14,000 35%
Totals $40,000 100%
% 55 . 9
0955 .
0245 . 035 . 036 .
) 07 . 35 (. ) 14 . 25 (. ) 09 . 40 (. E
r
+ +
+ +
You have a portfolio with an expected return of 12.94%. Your portfolio consists of
stock A and stock B only. Stock A has an expected return of 18% and stock B has an
expected return of 7%.
What are the portfolio weights?
% 54 w
54 . w
w 11 . 0594 .
w 07 . 07 . w 18 . 1294 .
] 07 . ) w 1 [( ] 18 . w [ 1294 .
) E w ( ) E w ( E
A
A
A
A A
A A
B r B A r A portfolio r
+
+
+
1294 . 1294 .
0322 . 0972 . 1294 .
] 07 . ) 54 . 1 [( ] 18 . 54 [. 1294 .
+
+
State of Probability of Rate of Return
Economy State of Economy if State Occurs
Boom .15 18%
Normal .60 11%
Recession .25 2%
What is the expected return on this portfolio?
% 8 . 9
098 .
005 . 066 . 027 .
) 02 . 25 (. ) 11 . 60 (. ) 18 . 15 (. E
r
+ +
+ +
State of Probability of Rate of Return if State Occurs
Economy State of Economy Stock A Stock B Stock C Boom
.20 17% 13% 40%
Normal .50 8% 6% 13%
Recession .30 -12% -5% -50%
Your portfolio consists of 50% stock A, 40% stock B and
10% stock C.
What is the expected return on your portfolio?
Chapter 10: Cost of Capital
2: Cost of equity
Isabelle Thomas and Son, Inc. just paid the annual dividend on their common stock in
the amount of $1.20 per share. The company expects to maintain a constant 3% rate of
growth in their dividend payments. Currently, the stock is selling for $20.40 a share.
What is the cost of equity for Isabelle Thomas and Son, Inc.?
3: Cost of equity
% 06 . 9
0906 .
03 . 0606 .
03 .
40 . 20 $
) 03 . 1 ( 20 . 1 $
g
P
) g 1 ( D
g
P
D
R
0
0
0
1
E
+
+
+
+
+
+
4: Cost of equity
The Curtis Plane Co. has paid $1.10, $.90, $.83 and $.75 in annual dividends over the
past four years, starting with the latest year first. This year the company is paying a
dividend of $1.22 a share.
What is the average growth rate of the dividends?
5: Cost of equity
$1.22
($1.22 - $1.10) $1.10 =
.10909
$1.10
($1.10 - $.90) $.90 =
.22222
$ .90
($.90 - $.83) $.83 =
.08434
$ .83
($.83 - $.75) $.75 =
.10667
$ .75 --- ---
Total .52232
% 06 . 13 13058 .
4
.52232
rate growth Average
6: Cost of equity
The stock of Neal & Co. has a beta of 1.40. The risk-free rate of return is 3.5% and
the risk premium is 8%.
What is the expected rate of return on Neal & Co. stock?
7: Cost of equity
% 7 . 14
147 .
112 . 035 .
08 . 4 . 1 035 .
) R R ( R R
f m E f E
+
+
+
8: Cost of preferred
The 7% preferred stock of Anderson, Inc. is selling for $72.92.
What is the cost of preferred stock?
9: Cost of preferred
% 60 . 9
0960 .
92 . 72 $
00 . 7 $
92 . 72 $
100 $ 07 .
P
D
R
0
P
10: Cost of debt

The bonds of TA, Inc. have a face value of $1,000 per bond, mature in 13 years, and
pay 8% interest annually. These bonds currently sell for $969.08.
What is the pre-tax cost of debt?
12: Cost of debt
Four years ago, JE, Inc. issued twenty-year bonds that have a face value of $1,000 per
bond and pay interest semi-annually. These bonds currently sell for $1,012.30 and
have a 9% coupon.
What is the pre-tax cost of debt?
Chapter 11: Dividends and Dividend Policy
2: Ex-dividend date
The Marla James Co. declared a dividend of $1.50 a share to holders of record on
Thursday, July 19. The dividend is payable on July 31. Suzie purchased 100 shares of
Marla James stock on Tuesday, July 17. Jim purchased 100 shares of Marla James
stock on Monday, July 16.
How much did Suzie receive in dividends on July 31?
How much did Jim receive in dividends on July 31?
3: Ex-dividend date
Suzie will receive $0 on July 31 because she bought the stock on the ex-dividend date.
Jim will receive $1.50 a share for a total of $150 on July 31 because he bought the
stock cum dividend.
4: Homemade dividends
You own 100 shares of Big Boys Burgers. The company will pay a $.50 per share
dividend this year and a final liquidating dividend of $42 per share next year. The
required return on this stock is 14%. Ignore taxes.
What is the current market value of one share of this stock?
What will your homemade dividend per share be next year if you do not want any
dividend this year?
5: Homemade dividends
76 . 32 $
7562 . 32 $
3176 . 32 $ 4386 $.
1.14
42 $
1.14
$.50
ue market val Current
2 1
+
+
$42.57
$42 $.57
$42 1.14) $.50 ( 2 year for dividend Homemade
+
+
6: Residual dividend
Food, Etc. has after-tax earnings of $1,300 for the year. The company maintains a
debt/equity ratio of .60 and has a residual dividend policy. $1,500 is needed for new
investments.
What is the amount of new borrowing?
What amount, if any, is paid out in dividends?
7: Residual dividend
Weight
D = .6 37.5%
E = 1.0 62.5%
V = 1.6 100.0%
Equity 50 . 937 $ 625 . 500 , 1 $
Debt 50 . 562 $ 375 . 500 , 1 $

50 . 362 $
50 . 937 $ 300 , 1 $ Dividend

8: Cash dividend vs. Share repurchase
Net income = $750
Market value = Book
value
Current $1,000
cash
Dividend
$1,000 share
repurchase
Excess cash $1,000
Other assets $9,000
Equity $10,000
# of outstanding shares 5,000
Earnings per share $.15
Stock price $2.00
Dividend per share $0
Stockholder value per
share
$2.00
share per Dividend price Stock share per value r Stockholde
shares g outstandin of Number
paid Dividend
share per Dividend
) book value ue market val Assumes : (Note Equity
price Stock
income Net
share per Earnings
+

shares 500
2 $
000 , 1 $
share per price Stock
repurchase of amount Dollar
d repurchase shares of Number

Net income = $750 Current $1,000
cash
Dividend
$1,000 share
repurchase
Excess cash $1,000 $0 $0
Other assets $9,000 $9,000 $9,000
Equity $10,000 $9,000 $9,000
# of outstanding shares 5,000 5,000 4,500
Earnings per share $.15 $.15 $.1667
Stock price $2.00 $1.80 $2.00
Dividend per share $0 $.20 $0
Stockholder value per
share
$2.00 $2.00 $2.00
12: Small stock dividend
Current 10% (small)
stock dividend
Common stock $5,000
Capital in excess of par $20,000
Retained earnings $10,000
Total equity $35,000
# of outstanding shares 5,000
Par value $1
Book value per share $7.00
Market value per share $10.00
Total market value $50,000
500 5,000 .10
g outstandin Shares percentage Dividend issued be to shares of Number

$500
500 $1
shares of Number value ar P stock common in Change

$4,500
500 $1) - ($10
shares of Number Par value) - lue (Market va par of excess in capital in hange C

$5,000 -
500 $10 1 -
shares of Number share per ue Market val 1 - earnings retained in Change

36 . 6 $
500 , 5
000 , 35 $
equity Total
share per value Book

09 . 9 $
500 , 5
000 , 50 $
ue market val Total
share per ue Market val
Chapter 12: Short-Term Finance and Planning

2: Sources and uses of cash
Account Beginning
Balance
Ending
Balance
Source
of Cash
Use
of Cash
Cash 444 460 U
Accounts receivable 996 980
Inventory 1,387 1,405
Fixed assets 4,813 5,209
Accounts payable 1,042 1,234
Note payable 250 500
Long-term debt 1,500 1,200
Common stock 2,900 3,000 S
Retained earnings 1,948 2,120
3: Sources and uses of cash
Account Beginning
Balance
Ending
Balance
Source
of Cash
Use
of Cash
Cash 444 460 U
Accounts receivable 996 980 S
Inventory 1,387 1,405 U
Fixed assets 4,813 5,209 U
Accounts payable 1,042 1,234 S
Note payable 250 500 S
Long-term debt 1,500 1,200 U
Common stock 2,900 3,000 S
Retained earnings 1,948 2,120 S
4: Operating and cash cycles
Given the information in the table, compute the operating and cash cycles.
Average accounts receivable $ 2,080
Average inventory 2,400
Average accounts payable 1,135
Sales 15,600
Cost of goods sold 9,761
5 . 7
080 , 2 $
600 , 15 $
receivable accounts Average
sales Credit
turnover s Receivable
days 7 . 48
7.5
days 365

turnover s Receivable
days 365
period ceivables Re

0671 . 4
400 , 2 $
761 , 9 $
inventory Average
sold goods of Cost
turnover Inventory

days 7 . 89
0671 . 4
365
turnover Inventory
days 365
period Inventory

6 . 8
135 , 1 $
761 , 9 $
payable accounts Average
sold goods of ost C
turnover Payables
days 4 . 42
8.6
days 365
turnover Payables
days 365
period ayables P

days 138. 4
48. 7 89. 7
period s Receivable period Inventory cycle Operating
+
+
days 96
42.4 - 138.4
period Payables - cycle Operating cycle Cash
9: Receivables schedule
The receivables period is 60 days.
Assume that each month has 30 days.
Can you complete this table?

Q1 Q2 Q3 Q4
Beginning receivables 290
Sales 300 270 360 420
Cash collections
Ending receivables
10: Receivables schedule
Q1 Q2 Q3 Q4
Beginning receivables 290 200 180 240
Sales 300 270 360 420
Cash collections 390 290 300 380
Ending receivables 200 180 240 280
$280 ) 60/90($420 s receivable ending Q4
$380 ) 30/90($420 ) 60/90($360 s collection Q4
$300 ) 30/90($360 ) 60/90($270 s collection Q3
$290 ) 30/90($270 ) 60/90($300 s collection Q2
$390 30/90(300) $290 s collection 1 Q

+
+
+
+
11: Payables schedule
Q1 Q2 Q3 Q4
Sales 300 270 360 420
Beginning payables 90
Purchases
Payments 171
Ending payables
Sales for Q1 of the following year are $310.
Purchases are equal to 60% of the next quarter sales.
The payables period is 45 days.
Assume that each month has 30 days.
12: Payables schedule
Q1 Q2 Q3 Q4
Sales 300 270 360 420
Beginning payables 90 81 108 126
Purchases 162 216 252 186
Payments 171 189 234 219
Ending payables 81 108 126 93
Q1 payments = $90 + 45/90($162) = $171
Q2 payments = 45/90($162)+ 45/90($216) = $189
Q3 payments = 45/90($216) + 45/90($252) = $234
Q4 payments = 45/90($252) + 45/90($186) = $219
Q1 purchases = .6($270) = $162
Q2 purchases = .6($360) = $216
Q3 purchases = .6($420) = $252
Q4 purchases = .6($310) = $186
Sales for Q1 next year = $310
13: Disbursements schedule
Q1 Q2 Q3 Q4
Payment of accounts 171 189 234 219
Wages, taxes, other expenses 70 85 90 110
Capital expenditures 80 35
Long-term financing expenses 12 12 12 12
Total cash disbursements
14: Disbursements schedule
Q1 Q2 Q3 Q4
Payment of accounts 171 189 234 219
Wages, taxes, other expenses 70 85 90 110
Capital expenditures 80 35
Long-term financing expenses 12 12 12 12
Total cash disbursements 253 366 371 341
<<< The End >>>

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Corporate Finance Completed Notes

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Fundamental of

17: Pro forma with external financing

Sir M.Faseeh Khan-CF(notes) Page 14 of 50 copyright @TM

20: Annuity monthly payments

4: Zero growth stock

6: Zero growth stock

8: Constant growth stock

10: Constant growth stock

14: Constant growth stock

16: Constant growth stock

18: Irregular growth stock

20: Irregular growth stock

Chapter 7: Net Present Value and Other Investment

11: Internal rate of return

10: Cost of debt

10: Cash dividend vs. Share repurchase

11: Cash dividend vs. Share repurchase

Sir M.Faseeh Khan-CF(notes) Page 44 of 50 copyright @TM

Chapter 12: Short-Term Finance and Planning

6: Operating and cash cycles

Sir M.Faseeh Khan-CF(notes) Page 46 of 50 copyright @TM

7: Operating and cash cycles

8: Operating and cash cycles

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