quiz2

Review ofAccounting

Learning Objectives:

• Use of the balance sheet, the income statement, and the statement of cash flows by managers.

• Calculation of depreciation.• How depreciation affects cash flow.• How taxes affect a firm’s value.• Calculation of marginal and average

tax rates.

The Firm’s Financial Statements

• Annual report includes:

Income Statement Balance Sheet Statement of Cash Flows Accompanying Notes

Income StatementACME CORPORATION

Net Sales $15,000,000Cost of goods sold 5,000,000Gross profit 10,000,000Depreciation Expense 2,000,000S&A Expenses 800,000Operating Income (EBIT) 7,200,000Interest expense 1,710,000Income before taxes 5,490,000Income taxes (40%) 2,306,000

Net income $3,184,000

Earnings per Share (4,000,000 shares) $0.80

Common Dividends paid $400,000

Increase in Retained Earnings $2,784,000

For the Year Ended December 31, 2009


• Annual report includes:

Balance Sheet


Balance SheetAssets = Liabilities + Owners’ Equity

Current Assets:• Cash• Inventory• A/R

Fixed Assets: Land Plant Equipment

Less: Ac. Dep.

Current Liabilities: A/P Accruals S-T Debt

Long Term Liabilities: Bonds L-T Bank Debt Mortgages Preferred Stock

Owners’ Equity: Common Stock Capital in Excess of Par Retained Earnings

Balance Sheet

ACME CORPORATION

2009 2010 Change

Assets:

Cash $9,000,000 $10,000,000 1,000,000

Accounts receivable 700,000 1,000,000 300,000

Inventory 17,300,000 10,000,000 -7,300,000

Marketable Securities 9,000,000 8,000,000 -1,000,000

Prepaid Expenses 1,000,000 1,000,000 0

Total current assets 37,000,000 30,000,000 -7,000,000

Fixed Assets, Gross 14,000,000 28,000,000 14,000,000

less Accumulated Depr. (6,000,000) (8,000,000) -2,000,000

Fixed Assets, Net 8,000,000 20,000,000 12,000,000

Total assets $45,000,000 $50,000,000 5,000,000

December 31

Balance SheetACME CORPORATION

December 31

2009 2010 ChangeAssets:

Cash $9,000,000 $10,000,000 1,000,000Accounts receivable 700,000 1,000,000 300,000Inventory 17,300,000 10,000,000 -7,300,000Marketable Securities 9,000,000 8,000,000 -1,000,000Prepaid Expenses 1,000,000 1,000,000 0 Total current assets 37,000,000 30,000,000 -7,000,000Fixed Assets, Gross 14,000,000 28,000,000 14,000,000 less Accumulated Depr. (6,000,000) (8,000,000) -2,000,000 Fixed Assets, Net 8,000,000 20,000,000 12,000,000

Total assets $45,000,000 $50,000,000 5,000,000

2009 2010 Change

Liabilities & Equity:

Accounts Payable $7,000,000 $4,000,000 -3,000,000Notes payable 4,000,000 3,000,000 -1,000,000Accrued Expenses 3,000,000 2,000,000 -1,000,000Total current liabilities 14,000,000 9,000,000 -5,000,000 Long-term debt 10,784,000 15,000,000 4,216,000Total liabilities 24,784,000 24,000,000 -784,000Preferred Stock 2,000,000 1,000,000 -1,000,000Common stock 1,000,000 3,000,000 2,000,000Capital in Excess of Par 10,000,000 12,000,000 2,000,000Retained earnings 7,216,000 10,000,000 2,784,000Total common equity 18,216,000 25,000,000 6,784,000Total equity 20,216,000 26,000,000 5,784,000

Total liabilities & equity $45,000,000 $50,000,000 5,000,000

Balance SheetACME CORPORATION

Assets = Liabilities + Owner’s Equity

2009 2010 Change

Liabilities & Equity:

Accounts Payable $7,000,000 $4,000,000 -3,000,000Notes payable 4,000,000 3,000,000 -1,000,000Accrued Expenses 3,000,000 2,000,000 -1,000,000Total current liabilities 14,000,000 9,000,000 -5,000,000 Long-term debt 10,784,000 15,000,000 4,216,000Total liabilities 24,784,000 24,000,000 -784,000Preferred Stock 2,000,000 1,000,000 -1,000,000Common stock 1,000,000 3,000,000 2,000,000Capital in Excess of Par 10,000,000 12,000,000 2,000,000Retained earnings 7,216,000 10,000,000 2,784,000Total common equity 18,216,000 25,000,000 6,784,000Total equity 20,216,000 26,000,000 5,784,000

Total liabilities & equity $45,000,000 $50,000,000 5,000,000

2009 2010 ChangeAssets:

Cash $9,000,000 $10,000,000 1,000,000Accounts receivable 700,000 1,000,000 300,000Inventory 17,300,000 10,000,000 -7,300,000Marketable Securities 9,000,000 8,000,000 -1,000,000Prepaid Expenses 1,000,000 1,000,000 0 Total current assets 37,000,000 30,000,000 -7,000,000Fixed Assets, Gross 14,000,000 28,000,000 14,000,000 less Accumulated Depr. (6,000,000) (8,000,000) -2,000,000 Fixed Assets, Net 8,000,000 20,000,000 12,000,000

Total assets $45,000,000 $50,000,000 5,000,000

The Firm’s Financial StatementsIncome Statement:

Revenues - Expenses = Net Income

SalesInvestment Income

GainsInterest ReceivedDividends Received

COGSSalariesDepreciation Exp.TaxesOther ExpensesInterest Paid

The Firm’s Financial StatementsIncome Statement:

Revenues - Expenses = Net Income

Dividends Δ Retained Earnings


Annual report includes:

Statement of Cash Flow


Statement of Cash Flows

Cash Inflow - Cash Outflow = Change in Cash

From Operations:

Cash Sales + Payments to Suppliers -Depreciation Exp. + Salaries -Collection of A/R + Increase A/R -Decrease inventory + Decrease Payables -

Decrease Accruals -

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Statement of Cash Flows

Cash Inflow - Cash Outflow = Change in Cash

From Investing:

Sale of Fixed Assets + Purchase of fixed assets - Purchase of other firms -

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Statement of Cash FlowsCash Inflow - Cash Outflow = Change in Cash

From Financing:

Sale of stock + Buy back stock -Issue of LT debt + Repay LT debt -or notes payable + Pay dividends -

Pay interest -

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Market vs. Book Value

Market Value & Book Value can be very different.

Book Value is recorded initially at cost.

Changes in book value (depreciation) follow specified accounting rules.

Market vs. Book Value Factors that determine the

disparity between market and book: Time since acquisition

More time, more difference

Inflation: Higher inflation, more difference

Tangible versus intangible assetsIntangible assets, more difference

Market vs. Book ValueLiabilities

As with assets, the market value of liabilities may diverge from the book value, but the relationship is less complex.

The main factor that determines the difference between market and book values for liabilities of a healthy firm is:

“the time until a liability must be paid off ”

At maturity, the market value will equal the book value.

Market vs. Book Value of Equity

Total Market Value of Equity is the market price per share times the number of shares outstanding.Book Value of equity reflects the changes in other asset and liability accounts since it is the account that can change to enforce the balance sheet identity.

Stockholders’ Equity = Assets - Liabilities

DEPRECIATION

Accounting depreciation is the allocation of an asset’s initial cost over time.

Allowable depreciation expense is determined by established accounting rules.

CALCULATION OF DEPRECIATIONDepreciable basis

Total amount to be depreciated over the accounting life of the asset.

Equal to cost of the asset plus any setup and delivery costs incurred.

Straight line depreciationBasis divided by accounting life with equal

amounts of depreciation allocated to each time period (except for half-year convention).

MACRS (Modified Accelerated Cost Recovery System) Specified percent charged each year.

Federal Income Taxation Marginal and Average Tax Rates

Marginal = Tax Rate on the next dollar of income. Average = Taxes paid divided by taxable income.

Progressive Tax System Average tax rate increases with the level of

taxable income. Marginal tax rate is greater than the average tax

rate. (The current corp. tax rate schedule is not strictly progressive.)

THE TAX SYSTEM EXPLAINED IN COFFEE• Suppose that every day, ten men go out for COFFEE AND CONVERSATION and the bill for all ten comes to $100...• If they paid their bill the way we pay our taxes, it would go something like this...

• The first four men (the poorest) would pay nothing. • The fifth would pay $1. • The sixth would pay $3.• The seventh would pay $7.• The eighth would pay $12.• The ninth would pay $18. • The tenth man (the richest) would pay $59.

The ten men drank COFFEE every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve ball. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily coffee bill by $20". Unlimited coffee for the ten men would now cost just $80. The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still drink for free. But what about the other six men? How could they divide the $20 windfall so that everyone would get his fair share? They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink THEIR COFFEE.

• At a bill of $80, in order to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.

• Now, the first four men along with the fifth would pay nothing.• The sixth now paid $2 instead of $3 (33% saving).• The seventh now paid $5 instead of $7 (28% saving). • The eighth now paid $9 instead of $12 (25% saving).• The ninth now paid $14 instead of $18 (22% saving). • The tenth now paid $49 instead of $59 (16% saving).

So, the owner suggested that it would be fair to reduce each man's bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.

THE TAX SYSTEM EXPLAINED IN COFFEE

Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, the men began to compare their savings. "I only got a dollar out of the $20 saving," declared the sixth man. He pointed to the tenth man AND SAID, "but he got $10!“ "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar too. It's unfair that he got ten times more benefit than me!“ "That's true!" shouted the seventh man. "Why should he get $10 back, when I got only $2? The wealthy get all the breaks!“ "Wait a minute," yelled the first four men in unison, "we didn't get anything at all. This new tax system exploits the poor!“ The nine men surrounded the tenth and beat him up.The next night the tenth man didn't show up for COFFEE AND CONVERSATION so the nine sat down and had their COFFEE without him. But when it came time to pay the bill, they discovered something VERY important. They didn't have enough money between all of them for even half of the bill!


And that, my dear students is exactly how our tax system works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking coffee overseas, where the atmosphere is somewhat friendlier. For those who understand this, no explanation is needed. For those who do not understand, no explanation is possible because you never will get it.


Income % of Total Income Tax Paid

Top 1% 40%

Top 10% 71%

Top 50% 97%

From 2009 IRS Data

Accounts Receivable Tax Building Permit Tax

CDL License Tax Cigarette Tax

Corporate Income Tax Dog License Tax

Federal Income Tax Federal Unemployment Tax (FUTA)

Fishing License Tax Food License Tax Fuel Permit Tax

Gasoline Tax

Hunting License Tax Inheritance Tax Inventory Tax

IRS Interest Charges (tax on top of tax) IRS Penalties (tax on top of tax)

Liquor Tax Luxury Tax

Marriage License Tax Medicare Tax Property Tax

Real Estate Tax Service charge taxes

Social Security Tax Road Usage Tax (Truckers)

Sales Taxes Recreational Vehicle Tax

School Tax State Income Tax

State Unemployment Tax (SUTA) Telephone Federal Excise Tax

Telephone Federal Universal Service Fee Tax Telephone Federal, State and Local Surcharge Tax

Telephone Minimum Usage Surcharge TaxTelephone Recurring and Non-recurring Charges Tax

Telephone State and Local Tax Telephone Usage Charge Tax

Utility Tax Vehicle License Registration Tax

Vehicle Sales Tax Watercraft Registration Tax

Well Permit Tax Workers Compensation Tax

Not one of these taxes existed 100 years ago...

and our nation was the most prosperous in the world.

We had absolutely no national debt... We had the largest middle class in the world... And there was only one wage-

earner per family

What happened?Can you spell

'politicians!'

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Differential Tax Treatmentof Interest and Dividends

Interest paid on corporate debt is a tax deductible expense.

Dividends paid to common and preferred stockholders is not tax deductible.

Dividends received by a corporation from another corporation have at least a 70% exclusion from taxable income.

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Differential Tax Treatmentof Interest and Dividends

Dividend IncomeCorp “B” owns 100 shares of Common Stock in Corp “A”

Corp “A”

Corp “B”

Corp “A” pays a $2/share dividend to shareholders.

$200

30% or $60 is Taxable 70% or $140 is Tax Free

Corp. “B” pays marginal tax rate of 25%

$60 x .25 = $15 Federal Taxes on dividend income

Income % of Total Income Tax Paid Top 1% 40% Top 10% 71% Top 50% 97%

From 2008 IRS Data

Who Pays all the Bills? The Taxpayer that’s Who (Just

Us) Don’t forgetWho pays the

bills.

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1. Explain the difference between debt and equity. Why must the two equal total assets?

2. Ajax Inc. had profits of $200,000 for the year. Their retained earnings account grew from $800,000 at the beginning of the year to $950,000 by year end. How much did the firm pay out in dividends?

3. Calculate earnings per share for the following:Net income $500,000Interest expense: $ 50,000Common Dividends paid $100,000Common shares outstanding 100,000

4. Working capital includes both current and non-current assets. Do you agree or disagree with this statement? Explain.

5. Explain why common stockholders are paid after preferred stockholders.

6. Are retained earnings and cash the same thing?

Homework Questions and Problems

37

Analysis of FinancialStatements

Learning Objectives

• How financial ratio analysis helps managers assess the firm’s health.

• Compute profitability, liquidity, debt, asset activity, and market value ratios.

• Compare financial information over time and among companies.

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Ratio AnalysisFinancial managers use ratios to

interpret the raw numbers on financial statements.

Relative measures allow comparison over time and to other firms.

Ratios are used by financial managers, other business managers, creditors, and investors.

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Ratio Analysis

• Profitability ratios• Liquidity ratios• Debt ratios• Asset activity ratios• Market value ratios

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Five Categories of Ratios

Ratio Analysis

• Measure the overall effectiveness of the firm’s management.

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Profitability Ratios

Ratio Analysis

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Gross Profit Margin =Gross Profit

Sales

How effective is the firm at generating revenue in excess of its cost of goods sold?


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Cash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s Equity Less:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300 Capital in Excess of Par 600 Total Assets $2,530 Retained Earnings 800

Total Owners’ Equity $1,700Total Liabilities and Owners Equity $2,530

Balance SheetExcalibur Corporation

Income StatementExcalibur Corporation

Sales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Net Operating Income $330Interest Expense 60 Income Before Taxes $270Taxes (40%) 108Net Income $162Common Dividends Paid 100Addition to Retained Earnings $62

$575 $1,450

Gross Profit Margin = = 39.7%

GrossProfit =Margin

Gross ProfitSales

Ratio Analysis

44

Operating Profit Margin =Operating Income

Sales

How effective is the firm in keeping costs of production low?


45


Cash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories625 Current Liabilities $230 Current Assets $1,230 Long-term Debt $600Plant & Equipment $2,500 Owner’s Equity Less:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300 Capital in Excess of Par 600 Total Assets $2,530 Retained Earnings 800


Sales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Operating Income $330Interest Expense 60Income Before Taxes $270Taxes (40%) 108Net Income $162Common Dividends Paid 100Addition to Retained Earnings $62


$330 $1,450

Oper. Profit Margin = = 22.8%

OperatingProfit =Margin

Operating IncomeSales

Ratio Analysis

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Net Profit Margin =Net Income

Sales

How much net profit is being generated from each dollar of sales?


Note: Net Income equals Earnings Available to CS

when there is no preferred stock.

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Cash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories625 Current Liabilities $230 Current Assets $1,230 Long-term Debt $600Plant & Equipment $2,500 Owner’s Equity Less:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300 Capital in Excess of Par 600 Total Assets $2,530 Retained Earnings 800



Assets Liabilities



$162 $1,450

Net Profit Margin = = 11.2%

NetProfit =Margin

Net IncomeSales

Ratio Analysis

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Return on Assets = Net IncomeTotal Assets

How effectively is the firm generating net income from its assets ?


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Cash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230 Current Assets $1,230 Long-term debt $600Plant & Equipment $2,500 Owner’s Equity Less:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300 Capital in Excess of Par 600 Total Assets $2,530 Retained Earnings 800



Assets Liabilities

Sales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Operating Income $330Interest Expense 60Income Before Taxes $270Taxes (40) 108Net Income% $162Common Dividends Paid 100Addition to Retained Earnings $62


$162 $2,530ROA = = 6.4%

Return onAssets

Net IncomeTotal Assets=

Ratio Analysis

50

Return on Equity = Net Income Common Equity

How well is the firm generating return to its equity providers?


51


Assets Liabilities

Cash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230 Current Assets $1,230 Long-term Debt $600Plant & Equipment $2,500 Owner’s Equity Less:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300 Capital in Excess of Par 600 Total Assets $2,530 Retained Earnings 800

Total Owners’ Equity $1,700Total Liabilities and Owners Equity $2,530Sales $1,450

Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Operating Income $330Interest Expense 60Income Before Taxes $270Taxes (40%) 108Net Income $162Common Dividends Paid 100Addition to Retained Earnings $62


$162 $1,700

ROE = = 9.53%

Return on Equity = Net Income Common Equity

Ratio Analysis

Measure the ability of the firm to meet its short-term financial obligations.

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Liquidity Ratios

Current Ratio = Current Assets Current Liabilities

Are there sufficient current assets to pay off current liabilities? What is the cushion of safety?

53


Assets Liabilities



$1,230$230

Current Ratio = = 5.35x

Current Ratio = Current Assets Current Liabilities

Ratio Analysis

• Measure the ability of the firm to meet its short-term financial obligations.

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Liquidity Ratios

Acid-Test Ratio = Current Assets - InventoryCurrent Liabilities

What happens to the firm’s ability to repay current liabilities after what is usually the least liquid of the current assets is subtracted?

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Assets Liabilities

$1,230 -$625$230

Acid-Test Ratio = = 2.63x

Acid-Test Ratio = Current Assets - Inventory Current Liabilities



Ratio Analysis

Measure the relative size of the firm’s debt load and the firm’s ability to pay off the debt.

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Debt Ratios

Ratio Analysis

57

Debt Ratio = Total Debt Total Assets

What proportion of the firm’s assets is financed with debt?

Debt Ratios

58




Assets Liabilities



$230 + $600 $2,530

Debt Ratio = = 33%

Debt Ratio = Total Debt Total Assets

Ratio Analysis

59

What is the proportion of debt relative to equity financing for the firm?

Debt Ratios

Debt to Equity Ratio

Total Debt Common Equity

=

60




Assets Liabilities



$230 + $600 $1,700

D/E = = 48.8%

Debt to Equity Ratio

Total Debt Common Equity=

Ratio Analysis

61

Times Interest Earned Ratio = Operating IncomeInterest Expense

What is the firm’s ability to repay interest payments from its operating income?

Debt Ratios

62




Assets Liabilities

$330 $60TIE Ratio = = 5.50x

TimesInterest =Earned Ratio

Operating IncomeInterest Expense



Ratio Analysis

• Help assess how effectively the firm is using assets to generate sales.

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Asset Activity Ratios

Ratio Analysis

64


How long does it take for the firm on average to collect its credit sales from customers?

Average Collection Period = Accounts Receivable Avg. Daily Credit Sales

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Cash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s Equity Less:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300 Capital in Excess of Par 600 Total Assets $2,530 Retained Earnings 800



Assets Liabilities



AverageCollection = Period

Accounts ReceivableAvg. Daily Credit Sales

$430 $1,450/365 ACP = = 108.24 days

Days in a year

Additional Info:We assume all sales are creditsales.

Ratio Analysis

66

Inventory Turnover Ratio = Sales Inventory

Is inventory efficiently translating into sales for the firm?


67




Assets Liabilities



$1450$625

Inventory Turnover = = 2.3x

InventoryTurnover =Ratio

Sales Inventory

Ratio Analysis

68

Fixed Asset Turnover Ratio = Sales

Net Fixed Assets

How effective is the firm in using its fixed assets to help generate sales?


69




Assets Liabilities



$1,450$1,300

Fixed Asset Turnover = = 1.12x

Fixed AssetTurnover = Ratio

Sales Net Fixed Assets

Ratio Analysis

70

Total Asset Turnover Ratio = Sales Total Assets

How effective is the firm in using its overall assets to generate sales?


71

Assets Liabilities




$1,450 $2,530

Total Asset Turnover = = 0.57x

Total AssetTurnover = Ratio

Sales Total Assets



Ratio Analysis

72

Price to Earnings Ratio = Market Price per ShareEarnings per Share

How much are investors willing to pay per dollar of earnings of the firm?

(Indicator of investor’s attitudes toward future prospects of the firm and of the firm’s risk.)

Market Value Ratios

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Assets Liabilities


Additional Info:100 shares$20.00 per share

$20.00 $162/100

P/E ratio = = 12.35x

P/E Ratio

Market Price/ShareEPS

=

Sales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200Operating Income $330Interest Expense 60 Income Before Taxes $270Taxes (40%) 108Net Income $162Common Dividends Paid 100Addition to Retained Earnings $62


Ratio Analysis

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Market to Book Ratio = Market Price per ShareBook Value per Share

How much are investors willing to pay per dollar of book value?

Market Value Ratios

75

Assets Liabilities


$20.00 $1,700/100

M/B = = 1.18x

Market to = Book

Price/Share Common Equity/ # shares



Additional Info:100 shares$20.00 per

share



EBITDAEBITDA stands for Earnings Before

Interest, Taxes, Depreciation, and Amortization.

It is often of great interest to financial analysts although FASB does not require that this number be reported.

It measures the amount of cash thrown off from the operations of the company.

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77

Ratio Industry ExcaliburProfitabilityGross Profit Margin 38% 39.7%Operating Profit Margin 20% 22.8%Net Profit Margin 12% 11.2%Return on Assets 9.0% 6.4%Return on Equity 13.4% 9.5%

Excalibur is good at keeping operating costs down, but not as

good at total costs. ROA and ROE are low mainly due to productivity

problems.

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Ratio Industry ExcaliburLiquidityCurrent Ratio 5.00x 5.35xAcid-Test Ratio 3.00x 2.63x

Looking at the current ratio it appears that Excalibur is more liquid than the industry.... however when looking at

Acid Test (a better measure) they are not as liquid indicating that inventory

levels are probably too high.

Summary of Excalibur Corporation Ratios

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Ratio Industry ExcaliburDebtDebt Ratio 35% 33%Times Interest Earned 7.00x 5.50xDebt to Equity 49% 48% While the debt ratio is close to the industry

average, Excalibur is not able to cover interest payments as easily as the industry. This indicates Excalibur may have too much

debt relative to what they can realistically afford.

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Ratio Industry Excalibur

Asset Activity Avg. Collection Period 90 days 108 daysInventory Turnover 3.00x 2.32xFixed Asset Turnover 1.00x 1.12xTotal Asset Turnover 0.75x .57x

Collection policies need examining, as Excalibur is slower than average at collecting receivables.

Inventories are being sold more slowly than the industry average, again indicating inventories that

are too high. Excalibur is very efficient at converting Fixed Assets to Sales (fixed assets are productive).

However, overall assets are not productive indicating Current Assets (e.g. inventories) are not

as productive as for the industry.

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Ratio Industry ExcaliburMarket Value Price Earnings 18.0 12.35 Market to Book 2.5 1.18

Excalibur’s Investors are not willing to pay as much per dollar of earnings or

per dollar of book value as they are for shares in other firms in the industry.

This signals that they consider the firm’sprospects to be worse than the average.However, the firm is still selling for more

than its accounting book value.

Relationships Among Ratios:The Du Pont System

• Ratio Analysis generally involves an examination of related ratios.

• Comparison of these relationships over time helps to identify the company’s strengths and weaknesses.

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83

Net Inc. Net Inc. Sales Assets Sales Assets

= x

The Du Pont Equation

Net ProfitMargin

Total AssetTurnover

Return onAssets

= x



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The Modified Du Pont Equation

Net Inc. Net Inc. Sales AssetsEquity Sales Assets Equity = x x

Net ProfitMargin

Total AssetTurnover

Return onEquity

EquityMultiplier

= x x

Homework Questions & Problems:

85

Use the following information to answer the questions. Elton CorporationIncome Statementfor the year ending 12/31/XX(in thousands of dollars)

Net sales $ 2,700Operating Costs (2,350)Depreciation ( 150)Interest Expense ( 70)

EBT 130Income Tax (40%) ( 52)

Net Income $ 78

Dividends to Common Stock = $ 58


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Elton CorporationBalance Sheet

12/31/XX(in thousands of dollars)

Cash $ 150

Accounts Payable $100Accounts Receivable 250

Notes Payable 250Inventory 600 Other Current Liabilities 50Total Current Assets $1,000 Total Current Liabilities $400 Total Fixed Assets 1,500 Long Term Debt 1,100

Common Stock 800 Retained Earnings 200

Total Assets $2,500 Total Liab. & Equity $2,500 Number of shares outstanding = 10,000 sharesPrice per Share = $100


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1. Calculate each of the following ratios. Be sure to give the complete equation as well as the solution:

a. Current ratiob. Quick ratioc. Total Debt/Total Asset Ratiod. Inventory Turnover Ratioe. ROEf. TIEg. EPSh. Net Profit Margini. Market to Book Ratioj. Total Assets Turnover Ratio

2. Show the Modified DuPont Equation for the company.


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3. Given these industry ratios:Net Profit Margin 4.3%Debt/Asset 40%Total Asset Turnover 1.1

ROA 4.73%

Use the DuPont equation to compare the performance of Elton Corp to the industry average. What can you say about their(a) profitability, (b) expense control, (c) asset management, and (d) debt management.

4. A firm expects to have net income of $85,000. If preferred dividends paid are 42,000, common stock dividends paid are $20,000, and shares of common stock outstanding are 10,000, what is the EPS?


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5. Fill in the missing data based on the information provided for years 2009 and 2010.

ABC CORPORATIONBalance Sheet Changes and ClassificationOf Key Accounts between 2009 and 2010

Account 2009 2010 Change Source/UseLong-term debt $960 $800Accounts receivable $640 $500Common stock $200 $300Cash $640 $500Retained earnings $960 $800Accruals $50 $200Inventory $840 $600Accounts payable $1,150 $1,000Net fixed assets $1,800 $2,000

90

Forecasting forFinancial Planning

Learning Objectives:

• The importance of forecasting to business success.

• The financial forecasting process.• Preparation of pro forma financial

statements.• The importance of analyzing forecasts.

91

Why is forecasting important?

– If you produce too much of a product, or a product that no one wants to buy, you still must pay for materials, labor, and storage.

– If you produce too little of a product, you will lose sales and possibly market share.

92

Mistakes are costly:

Forecasting Approaches

• Experience• Probability• Correlation

93

Financial managers concentrate on

three general approaches to financial

forecasting:

Experience

• Managers who have been in the business for a long time have developed a sense for the patterns in sales, expenses, consumer demand factors, etc.– Example: Editors who work for book

publishers regularly read submitted manuscripts and make judgments about whether their company should buy the rights to publish the books.

94

Probability

• Past history often tells us a lot about what will happen in the future.

• Managers can use this information to estimate the future.– Example: In the past, a 7-11 manager has

found that she will lose 1% of candy inventory to shoplifters. She can use this information to estimate future losses and also to design better controls.

95

Correlation

• Correlation is a measure of the relative movement of two variables relative to each other. – Example: If interest rates go up, a real estate agent

knows that home sales will tend to fall (because the higher cost of financing makes it harder for buyers to qualify for mortgages).

– Example: Sales of umbrellas are higher in rainy seasons.

96

The Sales Forecasting Process

97

Finance Department

Marketing(sales estimate)

Top Management(policy, strategy)

Production(capacity, schedules)

Accounting(financial statements,depreciation, taxes)

SALESFORECAST

Forecast future sales based on past sales growth

98

Time

Sales

Plot of Past Sales

00 01 02 03 04 05 06 07 08 09


99

Time

Sales

Trend Line

00 01 02 03 04 05 06 07 08 09


100

Time

Sales

Growth Rate

Sales Estimates for next 2 years

00 01 02 03 04 05 06 07 08 09

Also include the effects of any events which are expected to impact future sales (new products or economic conditions)

101

Time

Sales


New Product Introduced

00 01 02 03 04 05 06 07 08 09

• Also include the effects of any events which are expected to impact future sales (new products or economic conditions)

102

00 01 02 03 04 05 06 07 08 09Time

Sales


New Product Introduced

Sales Growth Imposes Costs on the Firm

– Current Assets: Inventory, A/R, Cash– Fixed Assets: Plant and Equipment

103

20092010

Will require additional resources

Pro Forma Financial Statements

• Pro forma financial statements are forecasts of the firm’s future financial statements based on a certain set of assumptions about sales trends and the relationships between sales and various financial variables, and between other financial statement variables relative to each other.

104

Producing Pro Formas

Sales will increase from $5million to $8 million.Production is at full capacity (24 hrs. per day).Dividend payout will be 70% of NI.Spontaneous balance sheet accounts. increase in

a constant proportion to sales.

105

Example Data for Marginal Product Inc.


106

Note: The projected saleswill be determined after inputfrom many different units ordepartments of the firm.

Determining Sales Growth

= 60%$8 - $5 $5

Step 1:

Income StatementMarginal Product Inc.

figures in 000s

Sales $5,000 COGS 4,133 EBIT 867Int 200EBT 667Tax (.40) 267NI 400

Current Projected

$8,000


107

Calculate projected Net Income. New COGS =

Old COGS x 1.6 = 6,613

Note: There is no increase yetin the interest charges sinceMarginal Product’s managershave not yet decided how they

will finance the growth.

Step 2:

Income StatementMarginal Product Inc.

figures in 000s

Sales $5,000 $8,000COGS 4,133 6,613EBIT 867 1,387Int 200 200EBT 667 1,187Tax (.40) 267 475NI 400 712

Current Projected


108

Forecast increase in assets (% of sales)

Step 3:

Balance SheetMarginal Product Inc.

figures in 000,000s

Current Assets $2.5 Accounts Payable $1.0 Net Fixed Assets 3.0 Accrued Expenses 0.5 Total $5.5 Notes Payable 0.0

Current Liabilities $1.5 Long Term Debt $2.0 Common Stock 0.5 Retained Earnings 1.5 Common Equity $2.0 Total Claims $5.5

Assets Current Projected Liabilities Current Projected


109


figures in 000,000s

Current Assets $2.5 $4.0 Accounts Payable $1.0 Net Fixed Assets 3.0 Accrued Expenses 0.5 Total $5.5 Notes Payable 0.0



Forecast increase in assets (% of sales). If sales increase by 60%, so too will any asset that remains a constant percent of sales.

Step 3:

$2.5(1+.60) = $4.0


110

Forecast increase in assets (% of sales)

Step 3:


figures in 000,000s

Current Assets $2.5 $4.0 Accounts Payable $1.0 Net Fixed Assets 3.0 4.8 Accrued Expenses 0.5 Total $5.5 $8.8 Notes Payable 0.0



+$3.30

$3.0(1+.60) = $4.8


111

Forecast increase inspontaneous liabilities.

Step 4:


figures in 000,000s

Current Assets $2.5 $4.0 Accounts Payable $1.0 $1.6Net Fixed Assets 3.0 4.8 Accrued Expenses 0.5 Total $5.5 $8.8 Notes Payable 0.0



$1.0(1+.60) = $1.60


112


figures in 000,000s

Current Assets $2.5 $4.0 Accounts Payable $1.0 $1.6Net Fixed Assets 3.0 4.8 Accrued Expenses 0.5 .8Total $5.5 $8.8 Notes Payable 0.0



$0.5(1+.60) = $0.80

Forecast increase inspontaneous liabilities.

Step 4:


113


figures in 000,000s

Current Assets $2.5 $4.0 Accounts Payable $1.0 $1.6Net Fixed Assets 3.0 4.8 Accrued Expenses 0.5 .8Total $5.5 $8.8 Notes Payable 0.0

Current Liabilities $1.5 Long Term Debt $2.0 Common Stock 0.5 Retained Earnings 1.5 1.7Common Equity $2.0 Total Claims $5.5

Assets Current Projected Liabilities Current Projected New retained earnings =Old retained earnings + additions to ret. earnings=1.5 + [NI x (1-div. payout)]=1.5 + [.712 x (1-.7)] = 1.7

Forecast increase inretained earnings.

Step 5:


114


figures in 000,000s

Current Assets $2.5 $4.0 Accounts Payable $1.0 $1.6Net Fixed Assets 3.0 4.8 Accrued Expenses 0.5 .8Total $5.5 $8.8 Notes Payable 0.0 0.0

Current Liabilities $1.5 2.4Long Term Debt $2.0 2.0Common Stock 0.5 .5Retained Earnings 1.5 1.7Common Equity $2.0 2.2Total Claims $5.5 $6.6


Hold other accounts constant to see how much additional

funds will be needed.

Step 6:


115


figures in 000,000s


AFN = $8.8 - 6.6 = $2.2 mill.

Additional funds needed (AFN) = projected assetsminus projected claims

Step 7:




116


figures in 000,000s


AFN = $8.8 - 6.6 = $2.2 mill.



Raise $2.2 million Using: Notes Payable, and/or LT Debt, and/or Common Stock

Additional funds needed (AFN) = projected assetsminus projected claims

Step 7:

Producing Pro Formas Summary

• Determine sales growth.• Calculate projected net income.• Project assets needed to support the new sales

level.• Project increases in spontaneous asset and

liability accounts.• Project addition to retained earnings.• Determine the difference between projected

assets and projected liabilities & equity.

117

Financing feedback

If outside financing is required, the new debt or equity may affect your original projections of the amount of the addition to retained earnings (due to increased interest or dividends on the income statement).

In this case, the pro forma should be recast with the new information to make final projections of AFN.

118

119

1. Briefly discuss the three general approaches to forecasting.

2. Why is forecasting important?

3. Distinguish between the cash budget and the capital budget.

Homework Questions

120

4. Given the following data on the Sands Corporation, project the balance sheet for the coming year using the percentage of sales technique:

Current Sales: $650,000Next year’s sales: $925,000After-tax profits: 6% of SalesDividend payout ratio: 40%Current retained earnings: $200,000Accounts receivable as a percent of sales: 10%Cash as a percent of sales: 5%Inventory as a percent of sales: 32%Net fixed assets as a percent of sales: 38%Accounts payable as a percent of sales: 6%Accruals as a percent of sales: 12%Next year’s common stock: $200,000

Sands CorporationBalance Sheet

December 31, 2005ASSETS LIABILITIES AND EQUITIESCash (a) Accounts payable (f )Accounts receivable (b) Notes payable (g)Inventory (c) Accruals (h)Net fixed assets (d) Common stock (i )

Retained earnings (j )Total ( e ) Total ( k )

121

Risk and Return

122

Learning Objectives

Define risk, risk aversion, and risk-return tradeoff.

Measure risk. Identify different types of risk. Explain methods of risk reduction. Describe how firms compensate for

risk. Discuss the CAPM.

Expected Return

• Expected return is the mean of the probability distribution of possible returns.

• Future returns are not known with certainty. The standard deviation is a measure of this uncertainty.

123

Expected Return• Expected return is the mean of the probability

distribution of possible returns.• Future returns are not known with certainty• To calculate expected return, compute the

weighted average of possible returns

124

where m = Expected return Vi = Possible value of return during period i Pi = Probability of V occurring during period i

m = (S Vi x Pi)

Expected Return Calculation

125

Example:

You are evaluating Zumwalt Corporation’s common stock. You estimate the following returns given different states of the economy

State of Economy Probability Return

Economic Downturn .10 –5%Zero Growth .20 5%Moderate Growth .40 10%High Growth .30 20%

= – 0.5%= 1.0%= 4.0%= 6.0%

k = 10.5%

Expected rate of return on the stock is 10.5%

Risk and Rates of Return

• Risk is the potential for unexpected events to occur.

• If two financial alternatives are similar except for their degree of risk, most people will choose the less risky alternative because they are risk averse i.e. they don’t like risk.

• Risk averse investors will require higher expected rates of return as compensation for taking on higher levels of risk.

126

Measurement of Investment Risk

127

Example:You evaluate two investments: Zumwalt Corporation’s common stock and a one year Gov't Bond paying a guaranteed 2%.

100%

Return

Probability of Return

T-Bill

2% Return

10%

Probability of Return

Zumwalt Corp

5%

20%30%40%

10% 20%–5%

There is risk in owning Zumwalt stock, no risk in owning the T-bills

Measurement of Investment Risk• Standard Deviation ( ) s measures the dispersion of

returns. It is the square root of the variance.

128

Example:Compute the standard deviation on Zumwalt common stock. the mean (m) was previously computed as 10.5%

= s SQRT( S P(V - m)2)

State of Economy Probability Return

Economic Downturn .10 5%Zero Growth .20 5%Moderate Growth .40 10%High Growth .30 20%

(- - 10.5%)2 = .24025%

( - 10.5%)2 = .001%( - 10.5%)2 = .27075%

( - 10.5%)2 = .0605%

S= s2 = variance

s2 = .005725 = 0.5725%s = SQRT of 0.005725s = .07566 = 7.566%

= s7.566%


– Firm Specific Risk - Risk due to factors within the firm

129

― Market related Risk - Risk due to overall market conditions

Stock price is likely to rise if overall stock market is doing well.

Risk of a company's stock can be separated into two parts:

Stock price will most likely fall if a major government contract is discontinued unexpectedly.

Diversification: If investors hold stock in many companies, the firm specific risk will be cancelled out.

Even if investors hold many stocks, cannot eliminate the market related risk

Risk and Rates of Return• Risk and Diversification

– If an investor holds enough stocks in portfolio (about 15-20) company specific (diversifiable) risk is virtually eliminated

130

# of stocks in Portfolio

Variability of Returns

Market Related Risk

b


– If an investor holds enough stocks in portfolio (about 20) company specific (diversifiable) risk is virtually eliminated

131



Firm Specific Risk


– If an investor holds enough stocks in portfolio (about 20) company specific (diversifiable) risk is virtually eliminated

132



Total Risk

Risk and Rates of Return• Market risk is the risk of the overall market, so to

measure we need to compare individual stock returns to the overall market returns.

• A proxy for the market is usually used: An index of stocks such as the S&P 500

• Market risk measures how individual stock returns are affected by this market

• Regress individual stock returns on the returns of the market index

133

Risk and Rates of Return• Regress individual stock returns on Market index

134

S&PReturn

PepsiCoReturn

-15% 15%-10% -5% 10%5%

5%

10%

15%

-5%

-10%

-15%

Risk and Rates of ReturnRegress individual stock returns on Market index. Plot ordered pairs every 6

months for ten years starting in January 1999.

135

S&PReturn

PepsiCoReturn

-15% 15%-10% -5% 10%5%

5%

10%

15%

-5%

-10%

-15%

Jan 1999PepsiCo-0.37%S&P -1.99%

Risk and Rates of Return• Regress individual stock returns on Market index

136

S&PReturn

PepsiCoReturn

-15% 15%-10% -5% 10%5%

5%

10%

15%

-5%

-10%

-15%

Plot Remaining Points


137

S&PReturn

PepsiCoReturn

-15% 15%-10% -5% 10%5%

5%

10%

15%

-5%

-10%

-15%

Best Fit Regression Line

Regress individual stock returns on Market index returns


138

Regress individual stock returns on Market index returns

S&PReturn

PepsiCoReturn

-15% 15%-10% -5% 10%5%

5%

10%

15%

-5%

-10%

-15%

Slope = riserun

5.5%5%

= = 1.1

-5%


Market Risk is measured by Beta

139

Beta is the slope of the regression (characteristic) line.

Risk and Rates of Return• Market Risk is measured by Beta

– Beta is the slope of the regression (characteristic) line

140

S&PReturn

PepsiCoReturn

-15% 15%-10% -5% 10%5%

5%

10%

15%

-5%

-10%

-15%

Slope = 1.1 = Beta ( )b

Risk and Rates of Return• Interpreting Beta

141

Beta = 1Market Beta = 1Company with a beta of 1 has average risk

Beta < 1Low Risk CompanyReturn on stock will be less affected by the market

than average Beta > 1

High Market Risk CompanyStock return will be more affected by the market

than average

Investors adjust their required rates of return to compensate for risk.

142

kj = kRF + bj ( kM – kRF )Security Market Line

where:Kj = required rate of return on the jth securityKRF = risk free rate of returnKM = required rate of return on the marketBj = Beta for the jth security

The Capital Asset Pricing Model

The CAPM measures required rate of return for investments, given the degree of market risk measured by beta.

CAPM Example

• Suppose that the required return on the market is 12% and the risk free rate is 5%.

143

kj = kRF + bj ( kM – kRF )

Security Market Line

CAPM Example


144

Beta1.51.0.50

15%

10%

5%

Risk Free Rate

kj = 5% + bj (12% – 5% )

CAPM Example• Suppose that the required return on the market

is 12% and the risk free rate is 5%.

145

Beta1.51.0.50

15%

10%

5%

Risk & Return on market

kj = 5% + bj (12% – 5% )

Risk Free Rate

CAPM Example


146

Beta1.51.0.50

15%

10%

5%

SML

Connect Points forSecurity Market Line

Market

CAPM Example

If beta = 1.2 kj = 13.4

147

Beta1.5.50

15%

10%

5%

SML13.4%

1.0 1.2

Suppose that the required return on the market is 12% and the risk free rate is 5%.

kj = 5% + bj (12% – 5% )

Market

Company kj

148

Homework

1. You hold a diversified portfolio of stocks and are considering investing in the XYZ Company. The firm’s prospects look good and you estimate the following probability distribution of possible returns:

Probability Return 70% 15% 20% 9% 10% 20%

The return on the market is 13.5% and the risk free rate is 7%. You have calculated XYZ’s beta from past returns as 1.3 and you believe this will be the future beta.

a. What is the expected return for XYZ? b. What is the required return for XYZ according to the CAPM?

149

Homework

2. Assume your existing portfolio is valued at $9,000 and its beta is 1.0. You plan to buy an additional $3,000 of a particular stock that has a beta of 1.8 (without selling any other stock). What is the beta of the new portfolio?

3. Distinguish between business risk and financial risk.

4. What is risk aversion? How does the assumption of risk aversion affect the risk/return tradeoff?

5. Compare diversifiable and nondiversifiable risk. What are some examples of each type of risk?

The Time Valueof Money

Learning Objectives

• The “time value of money” and its importance to business.

• The future value and present value of a single amount.

• The future value and present value of an annuity.

• The present value of a series of uneven cash flows.

• Money grows over time when it earns interest.

• Therefore, money that is to be received at some time in the future is worth less than the same dollar amount to be received today.

• Similarly, a debt of a given amount to be paid in the future are less burdensome than that debt to be paid now.

The Time Value of Money

1. Future Value of Single Sum

$ ?

PV i N CPT FV

2. Future Value of an Annuity

$ $ $ ?Today

PMT i N CPT FV

155

3. Sinking Fund

? ? ? $

FV i N CPT PMT

Today

156

4. Present Value Single Payment

? $

FV i N CPT PV

157

5. Present Value of the Annuity

? $ $ $

PMT i N CPT PV

158

6. Amortized Loans

$? ? ?

PV i N CPT PMT

Financial Calculator Solution - FV Example: You invest $200

at 10%. How much is it worth after 5 years?

1) Calculator Enter:N = 5I/YR = 10PV = -200CPT FV = ?

2) Using Formula:

FV = $200 (1.10)5 = $322.10

322.10

If you would have bought Berkshire Hathaway stock 20 years ago and spent $10,000 for your investment, how much would you have today if the average annual compounded rate of return was 18%?

How long it will take for $2,500 to become $8,865 if it is deposited and earns 5% per year compounded annually? (Calculate to the closest year).

If you deposit a lump sum of $1,200 today into a savings account offering annual interest of 5% compounded monthly, how much will you have in the account at the end of three years?

If you deposit $100 in the bank today at an annual rate of 5.5% compounded annually, how long will it take to double in value?

Your Aunt Matilda Mae makes you the following offer: $14,000 upon undergraduate graduation now or $15,200 upon MBA graduation in 2 years. Which offer should you take if current rates are 4%.

Do all these homework problems on your overhead homework sheets: use your calculator and show the

keys you would press and circle your answer:

161

Annuities• An annuity is a series of equal cash flows

spaced evenly over time.• For example, you pay your landlord an annuity

since your rent is the same amount, paid on the same day of the month for the entire year.

$500 $500 $500 $500 $500

Jan Feb Mar Dec

162

Future Value of an Annuity

0 1 2 3

$0 $100 $100 $100

You deposit $100 each year (end of year) into a savings account.

How much would this account have in it at the end of 3 years if interest were earned at a rate of 2% annually?

Future Value of an Annuity

Using the Calculator:

Don’t forget to clear your calculator of the previous

problem!

N = 3I/Y = 2PV = -$200CPT FV = $212.24

$212.24



What is the future value of an ordinary annuity of $1,000 each year for 10 years, assuming a 4% compounding rate?

What is the future value of an annuity due of $1,000 each year for 10 years assuming a 4% compounding rate?

Dan plans to fund his IRA with a contribution of $ 200 per month for the next 10 years. If Dan can earn 6% per year on his contributions, how much will he have at the end of the 10th year?

James plans to fund his IRA with a lump-sum today of $10,000 and 20 annual deposits of $2,000 for the next 25 years. If he can earn 5% compounded annually, how much will he have at the end of 25 years?

165

Future Value of an Annuity Due

You deposit $100 each year (beginning of year) into a savings account.

How much would this account have in it at the end of 3 years if interest were earned at a rate of 8% annually?

0 1 2 3

$100 $100 $100 FVA=?

Annuity Due: Calculator Solution

Example: You receive $100 per year for 3 years. How much is it worth after 3 years if you can

earn 4% annually?

N = 3I/Y = 4PMT = -$100CPT FV = $312.16


keys you would press and circle your answer:*NOW ASSUME ALL PAYMENTS ARE AT THE BEGINNING OF THE PERIOD*

What is the future value of an ordinary annuity of $1,000 each year for 10 years, assuming a 4% compounding rate?

What is the future value of an annuity due of $1,000 each year for 10 years assuming a 4% compounding rate?

Dan plans to fund his IRA with a contribution of $ 200 per month for the next 10 years. If Dan can earn 6% per year on his contributions, how much will he have at the end of the 10th year?

James plans to fund his IRA with a lump-sum today of $10,000 and 20 annual deposits of $2,000 for the next 25 years. If he can earn 5% compounded annually, how much will he have at the end of 25 years?

168

Financial Calculator Solution – PV of a Single Sum

You Expect to receive $100 in EIGHT years. If can invest at 3%, what is it

worth today?

Calculator Enter:N = 8I/YR = 3FV = 100CPT PV = ?

-78.94

-78.94

169

N I/Y PV PM FV

Present Value of an AnnuityCalculator Solution

PV=?

Enter:N = 3I/YR = 8PMT = 100CPT PV = ?

0 1 2 3

$100 $100 $100

-257.71

-257.71

-257.71

170

Present Value of an Annuity Due

$92.60$85.73

$278.33

0 1 2 3

$100 $100 $100

How much would the following cash flows be worth to you today if you could earn 8% on your deposits?

$100.00

BGNN = 3PMT = -100I/Y = 8CPT PV = 278.33

278.33

171

Amortized Loans

• A loan that is paid off in equal amounts that include principal as well as interest.

• Solving for loan payments.

172

N I/Y PV PMT FV

0 1 2 3 4 5

$5,000 $? $? $? $? $?

–1,186.98ENTER:N = 5I/Y = 6PV = 5,000CPT PMT = ?

Amortized LoansYou borrow $5,000 from your parents to purchase a used car. You agree to

make payments at the end of each year for the next 5 years. If the interest rate on this loan is 6%, how much is your annual payment?

-1,186.98



1. Calculate the present value of annual payments of $3,000 per year for ten years at 8%:

a. Ordinary Annuityb. Annuity Due

2. How much will you have at the end of the 6th year if you invest $5,000 annually for six years at 7% annual rate, if you:

a. Start one year from todayb. Start today

3. A bank agrees to give you a loan of $12,000,000 and you have to pay $1,309,908 per year (end of year) for 26 years. What is your rate of interest? What would the payments be if this were a monthly payment loan?

4. You have found the perfect burial plot. Of course, you don't plan to need it for 60 years. The plot costs $12,000 today and burial plot prices are increasing at 4% per year. How much do you need to deposit at the beginning of each of the next 60 years to pay for the plot if you can earn 11% on your deposit?

quiz2

Documents

firms value

book value depreciation

market value of liabilities

book values

book valuefactors

book valueliabilitiesas

market price

assets initial