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- Brachman
- Playbook for Test 2-3.docx

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Chapter 8 Common Stock Difficult to value b/c future CFs unknown; investment life is forever; and no easy way to observe required rate of return. P0 = ? { Dn / (1+R) n } + Pn/ (1+R) n Zero Growth ? D is constant Per Share value P0 = D / R Constant Growth ? D is growing Dt = D0 (1+g) t Pt = [Dt *(1 + g)] / (R - g) = Dt+1 / (R - g) Non-Constant Growth P0 = [D1/(R ? g1)]+..+[Dt/(1+R) t]+[Pt/(1+R) t] Two Stage Growth ? dividend grows at g1 for t periods, then g2 forever (gs) P0 = [D1/(R ? g1)]*{1? [(1 + g1)/(1+R)]t} + Pt /(1+R)t Pt = Dt+1/(R - g2) = [D0*(1+g1)t * (1+g2)]/(R-g2) Required Return ? discount rate Dividend Growth Model ? R = (D1 / P0) + g = Dividend yield + Capital Gains Yield Dividend Yield ?expected cash dividend divided by current price Capital Gains Yield ? the dividend growth rate Dividend Payout Ratio DPR =Div / E (Earnings) E0 * (1 + DPR) = E1 gs = ROE * (1 ? DPR) Common stock ? equity without priority for dividends or in bankruptcy Cumulative voting ? shareholder may cast all votes for one member of the board of directors: votes = # of shares * # of directors to be elected Straight vote ? shareholder may cast all votes for each member of the board of directors: votes = # of shares; multiple elections Proxy voting ? grant authority to allow another to vote on owner?s behalf Proxy fight ? vote by proxy in an attempt to replace any management Unequal common stock ? different types reflect different voting strength, keeps founders and owners in office Rights - to share proportionally in dividends paid; in liquidation, to share assets, after paid liabilities; to vote; preemptive right to own = % of shares after new offering Dividends ? not firm?s liability; not business expense, not tax deductable; receiving dividends is income and taxable Preferred stock ? equity; cumulative ? declared dividends carried over; non-cumulative ? not carried over; often callable, convertible, given ratings, like bonds Stock Markets Primary ? original IPO sold Secondary ? prev. issued securities traded Dealer ? maintains inventory, buys and sells Bid Price ? what dealer is willing to pay Ask Price ? what dealer is willing to spend Spread ? Dealer?s profit, Ask-Bid Broker ? brings buyers and sellers together NYSE ? member is an owner of a trading license on NYSE (1366) Commission broker ? member who executes customer orders to buy and sell stock transmitted to exchange floor (500) Specialist ? dealer of small # of securities Floor Brokers ? executes orders for commission brokers on a fee basis $2 SuperDOT system ? allows orders go directly to specialists Floor traders ? traders of their own accounts Order flows ? flow of customer orders Specialist post ? fixed place on exchange floor where specialist operates, diff coats NASDAQ Dealer market ? OTC no physical location Electronic Communications Network (ECN) Inside quotes ? high and low ask quotes Yield % = Div/Close, PE = Close/Ann EPS Chapter 9 Net Present Value ? Investment?s PV Advantages: accounts for TVM, maximizing NPV maximizes shareholder value. Is additive. Capital Budgeting ? create value by identifying an investment worth more in market then cost for acquisition Discounted Cash Flow (DCF) valuation Rule: Positive NPV means we should invest Annuity PV = C * {1 ? [1/ (1 + r)t ] /r} NPV/ Outstanding Shares = adjust value/share Payback Period ? acceptable investment if the payback is within predetermined timeline, amount of time investment generates positive cash flows, non discounted, fractions Advantages: cost of analysis low, great for short term; liquidity bias frees cash quick; cash may come unexpectedly later Problems: ignores TVM, ignores differences in risk; no objective basis for a cut off period; cash flows after disregarded; short term bias Answers: time to recover from investment, break even, not investment worthy Discounted Payback Period ? same as payback period but with discounted CFs, fractions OK Advantages: Includes TVM; easy to understand; doesn?t accept -(NPV), bias towards liquidity Problems: may reject +(NPV) installments; arbitrary cut off, ignores future CFs, biased against long term projects Average Accounting Return (AAR) Acceptable if AAR > target average return AAR = Average NI / Average Book Value Average Book Value = (sum of costs)/ # costs Advantages: easy to calculate; needful information will usually be available Disadvantages: not true rates of return, TVM ignored; arbitrary cut off; based on accounting book values, not market values Internal Rate of Return (IRR) NPV of investment = 0 Rule: investment is acceptable if the IRR > the required return, rejected otherwise Economic Break-Even when NPV = 0 Calc: PV=-(investment), +PMT, FV=0, CPT R DCF return graph: R (x), NPV (y), lines invests, Intersection ? crossover point, x-inters IRR Larger number of points called NPV Profile IRR decision = NPV decision when: cash flows are conventional, projects are mutually ex. Advantages: closely related to NPV, identical decisions(except in non-conventional cash flows and mutually exclusive projects); easy to understand Disadvantages: poss. multiple answers when non-conventional CFs; can lead to incorrect decisions in comparing mutually exclusive investments, taking one prevents taking another; not as productive as NPV in long run, not additive, no $$ measure Modified Internal Rate of Return (MIRR) Method 1: Discount Approach Discount all (-) CFs to PV then sum them up and add to the initial cost, then get IRR Method 2: Reinvestment Approach Compound all CFs (+ and -) except first out to the end of the project?s life, then get IRR Method 3: Combination Approach (-) CFs are discounted to present, (+) CFs are compounded to the end, IRR, highest IRR Advantages: adjust for TVM, only 1 answer Disadvantages: no clear best method; if we have relevant R, why not take NPV; not truly based on ?internal? b/c not based on CFs Profitability Index ? PI or benefit-cost ratio PI = PV of future CFs / initial cost (greater then) 1 for (+) NPV, < 1 for (-) NPV Advantages: closely related to NPV; easy to understand; maybe useful when available investment funds are limited Disadvantages: may lead to incorrect decisions about mutually exclusive investments Chapter 10 Project CF ? a relevant CF for a project is a change in the firm?s overall future CFs that comes about as a direct consequence of the decision to take the project Incremental CF ? difference between a firm?s future CFs with a project and those without a project, any CF that exists regardless of taking the project is not relevant. Stand Alone Principle ? assumption that evaluation of a project may be based on the project?s incremental CFs Common Mistakes for Incremental CFs Sunk costs ? cost that has already been incurred and cannot be removed therefore should not be considered, ex fees Opportunity cost ? should include the most valuable alternative given up if an investment it taken up, ex sales price of in use building Side Effects ? erosion: include cash flows of a new project that comes as an expense of a firm?s existing project, relevant only when sales would not otherwise be lost, if competitor makes same effect don?t include Net Working Capital ? additional investment in NWC at beginning of a project and recovered at the end when NWC is sold Financing Costs ? do not include interest paid or payments of dividends because we only want cash flows generated by asset Other Issues ? interested in only measuring each cash flow not when it is accrued, interested in after tax flow because taxes are a cash flow, always after tax Pro Forma Financial Statements and CF Financial statements projecting future years operations estimates: unit sales, selling price, variable cost, total fixed cost, organized without interest expense Sales Net Sales - Variable Cost - COGS Subtotal - Depreciation - Fixed Cost EBIT - Yearly Depreciation - interest not rel. EBIT Taxable Income - Taxes (at tax rate) - Taxes (at rate) Net Income Net Income Total Investment = NWC + Net Fixed Assets Total (Projected) Cash Flows = (Projected) Operating cash flows - (Projected) Change in NWC - (Projected) Capital Spending Total (Projected) Operating Cash Flows = EBIT + Depreciation - Taxes Change in NWC = - (NWC) at investment Capital Spending = Investment of asset at beg. Sales ? Cost = Net Income A/R (+ inventory) ? A/P = NWC Beg NWC ? End NWC = Total change in NWC Projected Total Cash Flow (NPV) = Total Projected Cash Flow at Beg + Discounted Total Cash Flow Revenues = Unit Sales * Unit Price EBIT = Rev ? VC ? FC ? Dep OCF = EBIT + Dep - Taxes Cash income = Sales ? increase in A/R Cash costs = Costs ? increase in A/P Cash flow = cash inflow ? cash outflow = OCF ? change in NWC Depreciation ? non cash deduction, has cash flow consequences, influences tax bill, ACRS accelerated depreciation under US law Include Shipping and Installation costs Modified ACRS (MACRS) every asset of a particular class determined life and dep Land not depreciated Dep Tax Savings = D * Marg. T CF = OCF + Dep Tax Savings ? change NWC When asset is sold taxes taken from: Capex = (MV - BV) * tax rate If MV > BV, the difference is tax liability If MV < BV, the difference is a loss for tax OCF methods: Bottom Up OCF = NI + Dep Top Down OCF = Sales ? Costs ? Taxes Tax-shield approach OCF = (Sales ? Costs)*(1-taxes) + D*T OCF = ((P-v)Q ? FC)*(1-T) + TD Decreased Operating Cost OCF = Decrease in Oper Cost * (1 ? Marg. T) Chapter 11 Project Analysis and Evaluation Forecasting Risk ? the possibility that errors in projected cash flows will lead to incorrect decisions (estimation risk) Base Case ? initial set up of projected CFs, based on average of Lower Bound and UB Scenario Analysis ? the determination of what happens to NPV estimates when we ask what if questions, determining LB and UB Sensitivity Analysis ? investigations of what happens to NPV when 1 variable is changed Simulation Analysis ? combination of scenario and sensitivity, considers interrelationship Forecasting risk high when analysis is volatile Break Even Analysis ? relationship between sale volume and profitability Variable Cost ? costs that change when the quantity of output changes VC = Q * v, v = variable cost per unit Fixed cost ? costs that do not change when the quantity of output changes, LT all costs var Total Cost TC = VC + FC, TC = Q *v + FC Marginal, or incremental, costs ? change in cost that occurs when there is a small change in output = line slope, revenue as well Accounting Break Even ? the sales level that results in 0 project net income Contribution margin per unit = selling price- VC Accounting expenses cover FC and Dep Quantity of output/sales volume (x), sales and costs/$ (y), lines: total revenue, TC NI = (Sales ? VC ? FC ? Dep)*(1-Taxes) If NI=0, then T=0, solve for Q Q = (FC + D) / (P ? v) Easy to calc; shows effect on tot earnings; breaking even only loses on financial or OC Acct B-E, EBIT = T = 0, OCF = D, IRR = 0 Payback = life of the project if same every year OCF = Q*(P ? v) ? FC Cash B-E

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About this note

Author: Alex K.

Textbook: Essentials of Marketing

Created: 2009-05-03

Updated: 2009-05-03

File Size: 2 page(s)

Keywords: flash card flashcards digital flashcards note sharing notes textbook wiki college dorm class classroom exam homework test quiz university college education learn student teachers tutors share, study blue studyblue studyblu

Views: 30

Textbook: Essentials of Marketing

Created: 2009-05-03

Updated: 2009-05-03

File Size: 2 page(s)

Keywords: flash card flashcards digital flashcards note sharing notes textbook wiki college dorm class classroom exam homework test quiz university college education learn student teachers tutors share, study blue studyblue studyblu

Views: 30

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