HB 311 Exam 2 Study Guide Chapter 4 Financial Planning 1 Understand the types of Business Plans 3 4 concept questions associated with this a Strategic Long term plan that addresses broad issues and ask questions that approximate financial projections often 5 years ahead b Operational Day to day short term goals that give a detailed representation of objectives and goals over about a years span c Budgeting Short term updates of annual plans Lays out exactly how much money labor and material will flow through an organization d Forecasting Quick estimates of short term financial results such as cash flow 2 Understand planning assumptions Involves forecasting changes in ongoing businesses Often plans next year based on previous year s assumptions 3 Understand the concept and calculation of Sustainable growth rate 2 3 questions A firm can grow at its Sustainable Growth Rate without selling new stock if its financial ratios remain constant Formula 1 d x EAT Sales x Sales Assets x Assets Equity Firm s ability to grow depends on four fundamentals 1 Ability to earn profits on sales as measured by its ROS EAT Sales 2 Its talent at using assets to generate sales as measured by the equity multiplier assets equity 3 Its use of leverage borrowed money as measured by the equity multiplier assets equity 4 The percentage of earnings it retains as measured by 1 d the earnings retention ratio 4 Understand the concept of external funding requirement A growing firm must have enough money on hand to purchase the new assets it needs to support its growth Reduced by 2 automatic sources 1 Amount by which current liabilities grow and 2 the amount the firm earns during the year but doesn t pay out in dividends 5 Calculation of external funding requirements and financial projections as practiced in class Review in class and practice problems EFR g assets this year g x current liabilities this year 1 d ROS 1 g Sales this year Payout ratio divident EAT ROS EAT Sales Growth in assets growth in current liabilities earnings retained EFR g increase in sales sales this year Chapter 6 Time Value of Money 1 Know how to calculate Present Value Future Value Present Value of Annuity Future Value of Annuity Review in class and practice problems Present Value A dollar in 3 years is worth how much today Present Value Formula PV FVn 1 1 K n Future Value How much would a dollar today be worth in 1 year Future Value Formula FVn PV 1 K n n being of years K being the Future Value of Annuity a finite series of equal payments separated by equal time intervals Future Value of Annuity Formula FVA PMT 1 K 0 PMT 1 k 1 PMT 1 K 2 Present Value of Annuity The current value of a set of cash flows in a given future date given a specified rate of return or discount rate The future cash flows of the annuity are discounted at the discount rate and the higher the discount rate the lower the present value of the annuity This calculates the present value of an ordinary annuity To calculate the present value of an annuity due multiply the result by 1 i The payments start at time zero instead of 1 period into the future Chapter 7 Valuation of Bonds 1 Review section on The Basis of Value what is the basis for value of a bond A bond issue represents borrowing from many lenders at one time under a single agreement While one person may not be willing to lend a single company 10 million 10 000 investors may be willing to lend the firm 1 000 each 2 Understand bond terminology a Face value The nominal or dollar value of a security stated by the issuer For stocks it is the original cost of the stock shown on the certificate For bonds it is the amount paid to the holder at maturity Also known as Par value or par b Non amortization concept No repayment of principal is made during the life of the bond Rather the face value is repaid in a lump sum on the maturity date c Maturity The time from the present until the principal is to be returned 3 Understand the relationship between bond price and interest rates When you buy a bond either directly or through a mutual fund you re lending money to the bond s issuer who promises to pay you back the principal or par value when the loan is due on the bond s maturity date In the meantime the issuer also promises to pay you periodic interest payments to compensate you for the use of your money The rate at which the issuer pays you the bond s stated interest rate or coupon rate is generally fixed at issuance 4 Understand concept of current yield Yield to maturity and how to calculate Current Yield Annual income interest or dividends divided by the current price of the security This measure looks at the current price of a bond instead of its face value and represents the return an investor would expect if he or she purchased the bond and held it for a year This measure is not an accurate reflection of the actual return that an investor will receive in all cases because bond and stock prices are constantly changing due to market factors Yield to Maturity The rate of return anticipated on a bond if held until the end of its lifetime YTM is considered a long term bond yield expressed as an annual rate The YTM calculation takes into account the bond s current market price par value coupon interest rate and time to maturity It is also assumed that all coupon payments are reinvested at the same rate as the bond s current yield YTM is a complex but accurate calculation of a bond s return that helps investors compare bonds with different maturities and coupons 5 What is a call provision When is it typically exercised A provision on a bond or other fixed income instrument that allows the original issuer to repurchase and retire the bonds If there is a call provision in place it will typically come with a time window under which the bond can be called and a specific price to be paid to bondholders and any accrued interest are defined Callable bonds will pay a higher yield than comparable non callable bonds 6 Understand Convertible bonds Why do companies issue them A bond that can be converted into a predetermined amount of the company s equity at certain times during its life usually at the discretion of the bondholder Issuing convertible bonds is one way for a company to minimize negative investor interpretation of its corporate actions For example if an already public company chooses to issue stock the market usually interprets this as a sign that the company s share price is somewhat overvalued To avoid this negative