FINANCE 3403 - 3404: Lecture Notes

Raymond H. Digge! "r.! CFA

College of Business
University of Central Florida
TEXT: Keown, Scott, Martin & etty
Basic Financial Manage!ent
"
t#
$ edition
T#is wor%&oo% is a co!'ilation of class #andouts$
(t #as &een 're'ared to #el' you understand conce'ts
and do well on e)a!inations$ lease &ring t#is wor%&oo%
to eac# class wit# your financial calculator$
E*M+(, +--.ESS (S /0 S1,,+BUS +0- M1 2EB S(TE
( +M 3E.E T/ 3E,$ 3/ME TE, 4/r!ond Beac#5 678* 9:;*7<77
,E+SE C+,, #EF$RE 6 M on nig#ts w#en ( a! not teac#ing
/FF(CE TE,: -+1T/0+ B,-= >9 ?77B 678*?;8*88:? X 87>7
B.E@+.- .//M >8; 9>?*:::: X 9;;<9
$FFICE H$%R& AND CLA&& &CHED%LE ARE '$&(ED $N $FFICE D$$R
IN(R$D%C(I$N
T#is wor%&oo% #as &een designed to consolidate all lecture notes and #andouts$ (t #as &een 're'ared to
#el' you study for e)a!s and to cover %ey conce'ts$ (t a!'lifies !any conce'ts in t#e te)t and
su!!ariAes %ey for!ulas and 'oints$ (t is not a 'ro&le! wor%&oo%$ ( will 'rovide sa!'le 'ro&le!s fro!
t#e te)t wor%&oo% for e)a! review in t#e li&rary and &y #andout$ T#ere will &e 'ro&le! assign!ents
fro! 'ro&le!s at t#e end of eac# c#a'ter$ T#ese assign!ents will &e su''le!ented wit# class #andouts
and over#ead slides$ 3o!ewor% assign!ents are designed to #el' you do well on e)a!inations$
Solutions will &e 'rovided$ 3o!ewor% is c#ec%ed &ut not graded$ T#is &oo% will &e referred to
e)tensively during t#e course so )ring it to eac* cass EACH cass meeting$ (t is also designed to #el'
you do well on e)a!s so )e sure and study it care+uy$ So!e e)a! Buestions are ta%en fro! t#is &oo%$
(A#LE $F C$N(EN(&
T/(C +=E 0UMBE.
FIN 3403 AND 3404
Course notes >*8
=rou' 'roCect notes ;*9
Using E)cel and ower'oint <
E)a! study ti's 6

Ti!e value of !oney conce'ts 6*::
Use of a financial calculator :?*:;
T@M #o!ewor% 'ro&le!s and solutions :9*??
Financial .atio analysis and tea! 'roCect ti's ?>*?9 ,aso see a--endi. -. 4/0
Cost of ca'ital conce'ts ?<*?"
Ca'ital &udgeting conce'ts ?6*>>
Ca'ital Structure and ,everage >8*>9
FIN 3404 ($'IC& ><
Financial Forecasting and !odeling >"*8:
Financial !ar%ets and instru!ents 8?*8> ,IN(R$D%CED IN FIN 34030
@aluation of &onds and stoc%s 88*89,IN(R$D%CED IN FIN 34030
Converti&le Securities and 2arrants 8<
Co!!on stoc% valuation conce'ts 8"
-ividend -iscount Model sa!'le 86
ut and Call /'tions ;7*;:
A--endi.
Ti's on ta%ing e)a!s in t#is course ;?
.ead t#e 2SD ,i%e a ro ;>*;8
Career o''ortunities in finance ;;*;9
re'aring an effective resu!e ;<
(nterviewing ti's ;<
For!ulas ;"
Financial ratio for!ulas ;6
Business Mat# ** co!!on e)a! errors 97
+(M. and t#e CF+ designation 9:
R. H. Diggle, Jr., CFA. All rights reserved. 1998.
&1LLA#%& &%22AR1 DA(A
FIN 3403 #%&INE&& FINANCE
FIN 3404 IN(ER2EDIA(E FINANCE
(0ST.UCT/. .$ 3$ -(==,E, D., CF+
/FF(CE 3/U.S /STE-EC3ECK /FF(CE -//.
/FF(CE 0UMBE. B,-= >9 ?77B -+1T/0+ C+MUS TE,: 678*?;8*88:?
?
?
.//M >8; B.E@+.- C+MUS TE,: 678*9>?*:::: X 9;;<9
TE,E3/0E: 3/ME 678*9:;*7<77 0/T +FTE. 6 M
E*M+(, C3ECK 2EB S(TE 23(C3 3+S +0 E*M+(, (C/0
C$%R&E DE&CRI'(I$N&:
FIN 3403 is entitled FBusiness FinanceGand deals wit# funda!ental cor'orate finance
issues including ti!e value of !oney, use of a financial calculator, cost of ca'ital, ca'ital
&udgeting, financial !ar%ets and instru!ents and valuation issues$
.E.EHU(S(TES +CC ?7?:, ?7<:, EC/ ?7:>, ?7?>
FIN 3404 4(nter!ediate Finance5 is a continuation of t#e F(0 >87> for finance !aCors$
+dditional to'ics covered include financial structure and leverage, financial forecasting
and !odeling, !ore advanced valuation and ratio analysis, o'tions and derivatives$
.E.EHU(S(TES F(0 >87> 4not to &e ta%en concurrently5
(E3(#$$4& AND IN&(R%2EN( ,#$(H C$%R&E&0:
RE5%IRED (E3(: #asic Financia 2anagement! 6
t*
edition! 7//8! 4eo9n! &cott!
2artin : 'etty.
(*e (I #A II;. (e.as Instruments #usiness Anayst II 'us. (*e 9or<)oo<!
ectures! and t*e te.t are <eyed to t*is instrument. 1ou 9i )e at an e.treme
disad=antage in e.ams i+ you attem-t to use anot*er +inancia cacuator.
HI>HL1 REC$22ENDED

(*e ?a &treet "ourna ,student su&scri'tion sign u' will &e t#e second wee% of class$ Students
!ay s#are su&scri'tions$ T#e 2SD is 3(=3,1 reco!!ended5
'LEA&E REFER ($ (HE C$%R&E &1LLA#%& F$R
:$ =rading, e)a!, and attendance 'olicy
?$ /ffice #ours$ 3ours will also &e 'osted on office door$
>$ +ssign!ents
8$ /t#er current infor!ation
T#e instructor reserves t#e rig#t to c#ange t#e order of !aterial and to c#ange class assign!ents$
Bot# F(0 >87> and >878 are Buantitative courses$ Students w#o too% &asic accounting !ore t#an ? ter!s
ago s#ould &rus# u' on accounting$ Knowledge of &asic accounting is assu!ed$ T#is course will use t#e
'ersonal co!'uter$ T#ere are assign!ents using MS E)cel and ower'oint$ ( will &riefly de!onstrate
t#ese tools in class$
>ENERAL C$%R&E N$(E&

=eneral %nowledge of accounting is assumed$ T#e instructor will &e availa&le to assist students &efore
class$ /ffice #ours will &e 'osted$ T#is is a Buantitative course$ (t is i!'ortant t#at you do assigned
'ro&le!s and &ring your te)t and financial calculator to eac# class$
+ccounting .eview: (t #as &een !y e)'erience t#at if you #ave not #ad accounting wit#in t#e 'ast ?
years, you !ay need to &rus# u' on conce'ts$ ( will 'rovide li&rary !aterials to
#el' you$ .ead C#a'ter ? of t#e te)t and do 'ro&le!s at t#e end of t#at
c#a'ter$ See instructor early if you are confused$ Finance is a cu!ulative
disci'line$ (f you are unclear on a conce't, s'end t#e ti!e to understand it$
T#e &est way to do t#is is usually &y doing 'ro&le!s$
>
>
My Co& is to #el' you and to si!'lify te)t !aterial$
Financial Calculator: 1our first assign!ent is to &eco!e fa!iliar wit# t#e assigned financial
calculator$ .ead t#e !anual$ Test t#e T@M %eys w#ic# are descri&ed later in
t#ese lecture notes$ T#e calculator will &e used in &ot# F(0 >87> and >878 (t
will also #el' you in real life calculate t#e cost of an auto loan or lease, figure a
!ortgage and even 'rice a &ond$ ( #ave !ade arrange!ents wit# local retailers
to stoc% t#is calculator$ Cost is ty'ically under I87$

E)a!inations: B.(0= 1/U. F(0+0C(+, C+,CU,+T/. +0- SE@E.+, E0C(,S$
T#ere will &e t#ree e)a!s 'lus a cu!ulative final e)a!$ 1ou can dro' t#e
lowest e)a! score$ (f you do well in E)a!s :, ? and >, you #ave t#e o'tion of
not ta%ing t#e final$
Coverage: assigned c#a'ters, #o!ewor% assign!ents and 'ro&le!s
,ectures will e!'#asiAe i!'ortant to'ics$
For!at: !ulti'le c#oice, 'ro&le!s and s#ort answer
Ti!e: Ma)i!u! of : #our 8; !inutes
Formula sheets provided with all exams.
There will be a lecture after each of the exams (1 to 3)
Ma%e u' e)a!s: /nly granted to students w#o can 'rovide docu!entation of illness or 'ersonal
e!ergency$ Students !ust see instructor +S+ regarding a !issed e)a!$
3o!ewor% assign!ents: +ssign!ents s#ould &e turned in after class on t#e due date$ 3o!ewor%
'ro&le!s are designed to #el' you do well on t#e e)a!s$
$
T#e two lowest #o!ewor% grades will &e dro''ed$ +ssign!ents !ar%ed in
)od ty-e are to &e #anded in$ /t#er 'ro&le!s will &e assigned in class to #el'
clarify conce'ts and #el' you use calculator s'reads#eets$
For students w#o #ave trou&le wit# Buantitative 'ro&le!s, t#e Study =uide is
reco!!ended for review as are t#e Buestions at t#e end of eac# c#a'ter$
+ttendance 'olicy: ,ectures are designed to #el' you understand conce'ts and to #el' you wor%
'ro&le!s$ STU-E0TS 2(T3 M/.E T3+0 > U0EXCUSE- +BSE0CES
2(,, 0/T +SS T3(S C/U.SE$
3o!ewor%: re'are and turn in #o!ewor% 'ro&le!s on date assigned$ lease ST+,E all
#o!ewor%$ +,, 3/ME2/.K MUST BE M+.KE- +S F/,,/2S in
UE. .(=3T corner of '$ :: 1our na!e, date, F(0 >87> and ca!'us,
c#a'ter and 'ro&le!s assigned$ lace na!e on all 'ages
C$%R&E N$(E& C$N(D.
Co!'uter use: 1ou s#ould #ave an active student nu!&er at t#e University Co!'uter Center$
+ssign!ents !ay &e !ade using software loaded on t#e server$ See instructor
you #ave Buestions or 'ro&le!s in accessing assigned software or data&ases$

S'ecial needs: See instructor during office #ours if you #ave s'ecial needs$
(f you #ave trou&le seeing t#e screen, see !e and #ave your seat c#anged$
Seating c#art: ( will set u' a seating c#art early in t#e ter!$ ( as% t#at tea!s sit toget#er$
.ecording lectures: 1ou !ay !a%e ta'e recordings of lectures if it will #el' you review !aterial$ (
will wor% on !a%ing co'ies of ower'oint lecture slides availa&le in
t#e
li&rary$
8
8
>R$%' 'R$"EC( N$(E&
Bot# F(0 >87> and F(0 >878 will &e divided into grou's to analyAe a real co!'any and 'erfor! ratio
analysis$ T#is e)ercise is designed to en#ance t#e learning e)'erience$ T#e F(0 >878 analysis will &e
!ore advanced and will include a sales and earnings forecast$ eer evaluations will &e !ade$ Eac#
student will &e as%ed to co!'lete a for! at t#e end of t#e ter!$ T#e 'ur'ose of t#is is to assure t#at all
tea! !e!&ers contri&ute to t#e tea!$ 3ow you !anage t#is is u' to you$ Tea!s will &e given ti!e to get
organiAed in class$ 1ou !ust attend tea! !eetings$ &ee instructor 9it* any -ro)ems $
Most wor% in co!'anies today is done in tea!s$ (t is i!'ortant t#at you get e)'erience wor%ing in a tea!
environ!ent$ T#e goal of t#is e)ercise is to give you #ands on e)'erience in analyAing a real co!'any$ (t
is li%ely t#at you will encounter accounting treat!ents t#at !ay vary fro! t#ose you #ave encountered in
te)t&oo%s$ T#is is nor!al$ 1ou are as%ed to !eet wit# instructor as a TE+M eit#er during office #ours or
&y a''oint!ent wit# any and all Buestions on t#is 'roCect$
(EA2 C$2'AN1 CHEC4LI&(:
:$ /rganiAe your tea!s eary in t*e term$ 1ou s#ould tea! !eetings at a convenient ti!e for all
!e!&ers$ 1ou will &e given so!e class ti!e to sign u' and e)c#ange '#one nu!&ers$ +ll tea!
!e!&ers s#ould &e involved in 're'aring your co!'any analysis$ 1our tea! can function as a study
grou' as well$
?$ Co!'anies s#ould &e selected &y t#e T3(.- class !eeting 4second wee% in su!!er5$ T#e instructor
will a''rove all co!'anies to avoid du'lication and to !a%e sure data is availa&le on your co!'any$
(T (S (M/.T+0T t#at you do t#e following in selecting your co!'any:
See t#at t#ere is infor!ation on your co!'any in t#e li&rary$ 1ou MUST li!it your c#oice to
a UB,(C (0-UST.(+, co!'any wit# at least :7 years of o'erating #istory$ T#is is so t#at
infor!ation will &e easier to find$ T#e co!'any !ust #ave sales of at least I;77 !illion$
T#e co!'any !ust &e 'rofita&le$ -/ 0/T select a co!'any wit# a loss$
See if t#ere are current financials availa&le in t#e li&rary or elsew#ere suc# as t#e internet
1ou s#ould call, fa) or write your co!'any +S+ reBuesting co'ies of t#e !ost recent
annual re'ort and :7K$ Try and get t#e !ost recent 'ro)y, :7Hs 4Buarterly re'orts5 and
recent 'ress releases$ lease try and wor% wit# original docu!ents and not E-=+. co'ies
or su!!aries fro! t#e internet$ I cannot over stress the importance o o!taining
inormation on "o#r compan" immediatel".
(EA2 C$2'AN1 ANAL1&I& CHEC4LI&( C$N(D.
>$ -efine res'onsi&ilities for eac# tea! !e!&er in t#e written and oral re'ort$ T#is is +.T(CU,+.,1
i!'ortant for tea! : & ? since your 'resentation is due i!!ediately after e)a! ?$ T#e oral
'resentation on your co!'any s#ould include slides for t#e over#ead 'roCector andJor #andouts and
!ust &e T(ME- to last :; !inutes$ +llow anot#er ; !inutes for Buestions$
8$ + tea! re'resentative s#ould see t#e instructor eac# wee% wit# a 'rogress re'ort and Buestions on
ratios and s'ecific issues relevant to your co!'any$ ( strongly suggest you let !e review as !uc# of
your 'resentation !aterials as 'ossi&le &efore t#e due date so ( can !a%e suggestions$
;$ Begin filling in data on t#e E)cel s'reads#eet 'rogra!$ + dis% will &e 'rovided eac# tea!$ Ma%e
9$ sure t#at you follow instructions and enter data consistently in I!illions 4e)ce't 'er s#are data5$
See instructor wit# Buestions as a team or send one team mem)er 9it* a team @uestions.
Begin &y transferring t#e E)cel s'reads#eet to a flo''y dis% and entering na!es of all tea!
!e!&ers, your tea! nu!&er, and t#e co!'any na!e in t#e yellow s'aces$
,oo% in t#e 2all Street Dournal for current 'rice, annualiAed dividend 'er s#are and JE
ratio$ By dividing 'rice &y t#e JE you can deter!ine ,ast :? !ont# 4,TM5 E$$S$ or
earnings 'er s#are$ 1ou !ay need to u'date t#is Cust 'rior to your 'resentation$ +lso find
your co!'any tic%er sy!&ol and w#ere it is traded$
;
;
Enter t#e !ont# and year of t#e last 'u&lis#ed annual re'ort$ Use t#is data since Buarterly
data is not audited$ 1ou are encouraged to u'date earnings to t#e last Buarter in your
re!ar%s es'ecially if trends are different &ut your analysis uses only audited annual data$
Enter inco!e state!ent and &alance s#eet data in s'aces indicated$ T#ere !ay &e ga's$ -o
as !uc# as you can &efore seeing instructor$
Using @alue ,ine, MoodyKs 3and&oo% or (nternat sources, enter t#e 3( and ,/ stoc% 'rices
for t#e 'ast ; years$
<$ C#ec% co!'aratives on ot#er fir!s in t#e sa!e industry using t#e S& Co!'ustat data&ase$
Im-ortant: Re=ie9 t*is 9it* instructor.
"$ ,oo% at your out'ut and c#ec% for any in'ut errors$ Begin analyAing t#e ratios and co!'aring your
co!'anyKs 'erfor!ance wit# its 'eers$ T#is is called F&enc#!ar%ing$G
,oo% at trends in growt#$
+re ratios of your co!'any &etter or worse t#an t#e co!'etitionL 2#yL
FIN 3404 0NL1
Co!'lete t#e Forecast section after t#e ratio analysis$ 4SEE $ >6 BE,/25
Co!'lete t#e -uont Model and --M$ 4SEE (0ST.UCT/.5
.ead t#e CE/ letter for t#e 'ast several years$ -id t#e co!'any do w#at t#ey said t#ey
would doL 2#at are t#eir strategic o&CectivesL
6$ Begin develo'ing your 'resentation outline$ .e!e!&er ti!e your re!ar%s to last :; !inutes so it is
i!'ortant t#at your re!ar%s &e scri'ted$ 1ou !ay organiAe t#e 'resentation in any way you want $
:7$ Begin develo'ing your Microsoft ower'oint slides$ 1ou will use t#e ,C- syste! for t#e over#ead
'roCector to 'roCect your 'ower'oint 'resentation on t#e screen$ USE ,+.=E F/0TS so slides can
&e seen in rear of classroo!$ Ma%e co'ies of t#e s'reads#eet, slides and re!ar%s for instructor$
::$ /0 T3E -+TE /F 1/U. .ESE0T+T(/0
(M/.T+0T: Bring !ulti'le co'ies of your ower'oint co!'uter dis% so if one tea!
!e!&er is delayed or if dis% is da!aged you can 'roceed$ +rrive early$ ,oad your
'resentation on t#e C drive of t#e C &efore class and test it$
Tea! !e!&ers s#ould &e dressed in a''ro'riate &usiness attire
rovide a one 'age outline for your class !ates and instructor to use to ta%e notes$
.eview w#at eac# tea! !e!&er will do 'rior to class$ Use a scri't$

I2'$R(AN(: #e+ore -resentation! -ease gi=e t*e instructor a co-y o+ ast annua
re-ort! *andouts and ratio E.ce s*eet -rintout and o=er*eads. 'ace t*e names o+ eac*
team mem)er! t*e date! name o+ t*e com-any and course on t*e co=er -age.
E3CEL AND '$?ER'$IN(
E3CEL
/ne of t#e i!'ortant s%ills t#at you need to !aster to increase your !ar%eta&ility is effective use of E)cel
or ,otus :*?*> to do s'reads#eet analysis, MS 2ord to 're'are written te)t and ower'oint to 're'are
visual 'resentations$ T#is is a s%ill t#at you can and s#ould 'ut on your resu!e$ Knowledge of E)cel is
assu!ed$ (f you do not %now #ow to use t#is software, ta%e ti!e to go to t#e co!'uter la& and learn it$
1ou do not need to &e an e)'ert$ /ne of your tea! !e!&ers or a la& ad!inistrator can #el' you$ ,+B
+-M(0(ST.+T/.S +.E 0/T res'onsi&le for teac#ing you t#is software, #owever$
Financial s'reads#eets using E)cel are a 'art of financial !odeling and financial decision !a%ing today$
+s a UCF &usiness sc#ool graduate you will &e e)'ected to understand t#ese tools$ T#is course will #el'
you in understanding s'reads#eet analysis t#roug# your tea! 'roCect$ Eac# tea! will also &e 'rovided
wit# a co!'uter dis% wit# several ot#er assign!ents and 4'ossi&le5 e)tra credit 'roCects$ 1ou will not &e
reBuired to use E)cel on any e)a! in t#is course$ T#at is w#at t#e financial calculator is for$ (t is
9
9
reco!!ended t#at finance !aCors consider a financial case course to a''ly conce'ts learned in t#is course
using 'refor!atted s'reads#eets$
'$?ER'$IN(
ower'oint is t#e standard for &usiness gra'#ics today$ ( will de!onstrate t#is software in class a&out one
t#ird of t#e way t#roug# t#e ter!$ 3ere are so!e ti's in t#e use of ower'oint:
:$ 2e use MS 0T in t#e Business Sc#ool$ Be sure and save all your wor% in MS 0T for!at on a flo''y
dis% in t#e co!'uter la&$ ,ower versions !ay not wor% or will need to &e converted to MS 0T to
function 'ro'erly$
?$ Be sure and re#earse your 'resentation$ ( encourage as !any !e!&ers of t#e tea! as you want to
'artici'ate in t#e re!ar%s &ut t#e way you decide to organiAe your tea! is co!'letely your call$
>$ /n t#e day of your 'resentation, ( reco!!end you save your 'resentation on t#e #ard drive on t#e
'orta&le C in t#e classroo!$ lan to get to class early to do t#is$ So!e c#arts and ta&les !ay not
wor% 'ro'erly fro! a flo''y or !ay delay your 'resentation due to slow res'onse$
8$ ower'oint #as a notes ca'a&ility t#at allows you to ty'e our t#e Fscri'tG of your 'resentation$ (
reco!!end t#at you use a scri't and t#at you ti!e your 'resentation$ Consider t#is a dres re#earsal
for your first 'resentation in a cor'orate &oard roo!$
;$ 3ave one !e!&er of t#e tea! follow t#e scri't and wor% t#e co!'uter to advance t#e slides$ T#e
'resenter s#ould %e' eye contact wit# t#e audience$
9$ ower'oint is funMMM E)'eri!ent wit# various sound effects and icons$ 3owever re!e!&er t#at t#e
'ri!ary Co& you are to do is to evaluate your co!'any using t#e financial ratio analysis$ Begin wit#
t#at$ Use t#e ratios in your s'reads#eet$
<$ 1ou !ay use gra'#ics, c#arts, and ta&les$ Dust &e sure t#at fonts are large enoug# to &e seen at t#e
&ac% of t#e roo!$ 1ou !ay wis# to download t#e cor'orate logo fro! t#e internet$ Dust re!e!&er to
&e sure and de&ug your dis% for any viruses BEF/.E using t#e server or loading anyt#ing on t#e
classroo! C$
"$ 1ou are .EHU(.E- to !a%e a class #andout of t#e %ey 'oints of your 'resentation$ ,i!it t#is to one
'age$ Ma%e enoug# co'ies for eac# of your class!ates$
lan to use t#e ,C- screen for your 'resentation$ T#is will ena&le you to use !otion and sound and color
effectively$ Be sure and 'rint all slides for t#e instructor$
&(%D1 (I'& F$R (HI& C$%R&E
T#ese suggestions are &ased on wor%ing wit# students over t#e years$
&%>>E&(I$N 7: >E( IN($ A &(%D1 >R$%' N$?$ T#is is 'articularly
i!'ortant if you #ave not #ad accounting recently, or you #ave
difficulty wit# Buantitative courses$ 1our 'roCect tea! is designed
to &e a study grou'$ Be sure !e!&ers of your tea! live in t#e
sa!e area so it is easy to set u' !eetings$
&%>>E&(I$N A: D$ (HE H$2E?$R4 F$R EBER1 CLA&&. Students w#o
are not 're'ared &eco!e confused$ T#ere is a great deal of
!aterial covered in class$ (f you #ave not studied t#e lecture notes
and te)t and atte!'ted to do t#e 'ro&le!s, t#e odds increase
greatly t#at you will not do well on e)a!s$
&%>>E&(I$N 3: ?RI(E $%( 5%E&(I$N&$ +s% Buestions in class$ -o not
#esitate to see !e if you are 3aving 'ro&le!s$ (t is nor!al to &e
confused in t#e &eginning$ (t ta%es a w#ile for t#e Nlig#t &ul&N to
co!e on and !y e)'erience is t#at everyone sees t#e lig#t at a
different sc#edule$
<
<
&%>>E&(I$N 4: (A4E ACC%RA(E N$(E&$ E)a!s focus on lecture !aterial
&ecause ( try and #ig#lig#t t#ings ( consider i!'ortant$ T#e &est
way to ta%e notes is to -/20,/+- t#e 'ower'oint lecture slides
in slide s#ow for!at ** > * 8 slides 'er 'age wit# roo! on t#e rig#t
for notes$
&%>>E&(I$N C: IN &(%D1IN> F$R E3A2& D$ (HE F$LL$?IN>:
+$ -o 'ro&le!s in your study grou'$ (f you are unsure a&out an
area, do !ore 'ro&le!s suc# as t#e ST 4self test 'ro&le!s5$
T#ese 'rovide t#e solutions at t#e end of t#e c#a'ter$
B$ Study lecture notes and T slides wit# class notes$ ay
attention to definitions of ter!s$
C$ Be sure and &eco!e t#oroug#ly fa!iliar wit# your financial
calculator 2E,, BEF/.E t#e e)a!$
-$ + for!ula 'age will &e 'rovided$ 1ou need to %now w#ic#
for!ulas a''ly to t#e 'ro&le! at #and$
E$ (f you are rusty on accounting &e sure and review C#$ ? and
ot#er !aterial suggested &y instructor$
F$ 2atc# out for si!'le !at# !ista%es$ -o you %now #ow to
calculate O c#ange &etween two 'ointsL C#ec% your wor%$
&%>>E&(I$N 8: D$ N$( 'ANIC$
1ou are allowed to dro' one e)a!$ Ta%e advantage of e)tra credit
o''ortunities$ (f you do 'oorly on an e)a! -/ 0/T get
discouraged$ .eview w#at you did wrong and wor% to understand
t#e !aterial$ E)a! !aterial is cu!ulative$
&%>>E&(I$N D: &ee me -U.(0= /FF(CE 3/U.S if you are #aving 'ro&le!s$
(HE (I2E BAL%E $F 2$NE1
T#e saying is F+ &ird in #and is wort# two in t#e &us#$G T#e value of a dollar received
today is wort# !ore t#an a dollar received a year fro! now$ 2#yL Money received now
can &e invested and earn interest, or it could &e consu!ed$ (nvesting is trading dollars
today for dollars in t#e future$ Borrowing is trading future dollars for dollars today$
4ey conce-ts:
Ti!e line 1E+.S 7 : ? > 1E+.S
PPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPP
@alue I: I:$:7 I:$?: I:$>> 70E Com-ound return
T#e ti!e line s#ows t#at &y compo#nding I: today it will grow to I:$?: in ? years and
I:$>> in > years$ T#is is called finding +uture =aue$
Disco#nting is t#e o''osite of co!'ounding$ -iscounting t#e future value of I:$>> in
year > to 'eriod Aero of I: is called finding a -resent =aue.
T#e interest rate r is t#e rate at w#ic# a cas# flow grows in t#e future$ Co!'ound interest
is earning interest on interest$ (n t#e a&ove e)a!'le, si!'le interest of :7O would
'rovide an investor wit# a return of :7 cents 'er 'eriod$
"
"
T#e for!ula to e)'ress t#e conce't of co!'ounding and future value is:
FVn = PV (1 r)
n

F@> Q I: 4:$:754:$:754:$:75 Q I:$>> or I:4:$:75
>
w#ere n Q > years
1our financial calculator will #el' you solve for any of 8 varia&les: future value 4F@5,
'resent value 4@5, ti!e 'eriods 4n5 and t#e interest rate r$ T#ere is anot#er factor to
consider in addition$ T#is is t#e nu!&er of co!'ounding 'eriods !$ T#e financial
calculator reBuires you to set t#e nu!&er of 'eriods using t#e %ey J1$ 1ou %now t#at
daily co!'ounding will 'roduce a #ig#er future value t#an annual co!'ounding for
e)a!'le$
2e will loo% at t#e use of a financial calculator in t#e ne)t section$
C/0@E0T(/0 (n using a calculator, /UTF,/2S are a negative nu!&er and
(0F,/2S are 'ositive$
'RE&EN( BAL%E (A#LE&: lease &eco!e fa!iliar wit# Ta&les B, C , -, and E in t#e
&ac% of your te)t$ 2#ile e)a!s will use t#e calculator, we will do 'ro&le!s using t#e
ta&les to #el' you understand w#at t#e calculator is doing$
(I2E BAL%E $F 2$NE1 C$N(D.
FB C$NCE'(&: :$ T#e #ig#er t#e interest rate r t#e hi!her t#e future value
?$ T#e longer t#e ti!e 'eriod n t#e hi!her t#e future value
>$ T#e !ore freBuent t#e co!'ounding ! t#e hi!her t#e F@
+s noted a&ove, "iscountin! is t#e 'rocess of ta%ing a Future @alue 4F@5 and 'lacing it in
resent @alue ter!s$ (n finance t#is conce't is used in a variety of a''lications t#at we
will study in t#is course$ For e)a!'le:
T#e value of an office &uilding is t#e discounted 'resent value
of t#e rents received for n years$
T#e value of a co!!on stoc% 4using a dividend discount !odel5
is t#e e)'ected future dividends 'aid for n years into t#e future$
'B F FBn
,7 ; r0
n
2e saw a&ove t#at I: grew to I:$>> in > years at :7O co!'ounded$ Conversely, t#e @
of I:$>> received > years fro! now is I:
'B C$NCE'(&: :$ T#e #ig#er t#e interest rate r t#e lower t#e 'resent value
?$ T#e longer t#e ti!e 'eriod n t#e lower t#e 'resent value
>$ T#e !ore freBuent t#e co!'ounding t#e lower t#e 'resent value
So far we #ave dealt wit# a si!'le e)a!'le of single 4or lump sum5 cas# flows
2#at a&out !ulti'le cas# flowsL
+ constant cas# flow over ti!e is called an A$$%I&'. T#is contrasts wit# a lu!' su!$
6
6
T#e 'resent value of an annuity 4@+5 can &e derived fro! t#e following for!ula:
'BA Q F@ R F@ R F@
4 : R r5: 4: R r5? 4 : R r5>
,et us say you receive a 'ayc#ec% of I;77 'er wee%$ T#at is an annuity w#ic# 'ays you a
total of I?9,777 'er year 4;? wee%s5$
T#e future value of an annuity FBA can &e derived using t#e MT %ey on your financial
calculator$ T#e MT is a recurring cas# flow of t#e sa!e siAe received over ti!e 4n5$ ,et
us say you can save I>77 'er !ont#$ +t an interest rate r of :;O 'er annu!
co!'ounded, #ow !uc# !oney would you #ave in >7 yearsL (n ?; yearsL
n Q >7 ) :? Q >97 !ont#s 52it# t#e financial calculator, you will learn #ow to set t#e
calculator for !ont#ly co!'ounding &y setting J1 to :?$ /n t#e calculator you will set
J1 to :? !eaning t#is is a !ont#ly 'ay!ent 4:? ti!es 'er year5$
MT Q I>77$ T3(S (S E0TE.E- +S + 0E=+T(@E 0UMBE. *I>77
r 4(J1 on your calculator5 Q :; 4note t#is nu!&er is entered wit# 0/ deci!al5
(I2E BAL%E $F 2$NE1 C$N(D.
S/,@E F/. F@: QI ?,:7?,689 4T#is is t#e F@ of I>77 'er !ont# for >7 years at :;O$
S/,@E F/. F@ 23E.E T(ME E.(/- (S ?; 1E+.S 4>77 !ont#s5$ SET 0 Q >77
F@ Q I6";,???$ 4+,M/ST + M(,,(/0+(.E5$
0otice t#at t#e !oney !ore t#an dou&led &etween ?; and >7 years$
+s we will learn in a''lying t#e F.U,E /F <?G at a co!'ound rate of :;O
!oney dou&les every 8$" years$
-ivide t#e nu!&er <? &y t#e interest rate :; Q 8$"
+t :7O !oney dou&les every <$? years 4<?J:75
+s we #ave learned: (f r increases t#e F@ increases$
+ foot&all 'layer is offered a > year contract w#ic# will 'ay I; today 4lu!' su!5 or I :
!illion at t#e end of year :, I? !illion at t#e end of year ?, and I> !illion at t#e end of
year >$ +ssu!ing an interest rate r of ;O, w#ic# offer s#ould #e acce'tL
T#e @ of t#e I; !illion lu!' su! is I; !illion since it is received today$ 2#at is t#e @
of > uneven cas# flows totaling I9 !illion over > yearsL T#e answer is I;,>;<,6;?$
&E((IN> %' A (B2 'R$#LE2 $N AN E3A2
:$ .ead t#e Buestion carefully$ 2#at are you solving for$
?$ -raw a ti!e line neatly$ Be careful$ (0 M/ST ./B,EMS 1/U 0EE- T/ M+KE
SU.E T3+T T3E S/,UT(/0 (S 1E+. 7$
>$ #ist data inputs$ (s t#is an annuity 'ro&le! or a lu!' su! or &ot#L
:7
:7
8$ 2#at is t#e nu!&er of co!'ounding 'eriods 'er year 4J15L
;$ 2#at is t#e discount rate 4(J15L
$%& '&(T #)(T *## )+P&T( +,*T#$ T% -,T P*.T)*# /.,")T %+ *+ ,0*'
1e will illustrate these simple concepts with a series of problems. &his (ill !e done in
class and in pro!lems. I also ma" provide a video and other li!rar" materials to help
"o#.
First, #owever, we need to &eco!e fa!iliar wit# a financial calculator$
%&IN> A FINANCIAL CALC%LA($R
(*e (I #A II -us
:$ ST+.T(0= /UT
(t is i!'ortant t#at you read t#e !anual carefully &efore atte!'ting to use your calculator$
:$ Clear all registers using ?
nd
CT, ?
nd
C,E+. T@M and ?
nd
clear 2or% %eys
?$ C#ec% J1 %ey$ For annual calculations set it for : 'ay!ent 'er year$ For &onds 4unless ot#erwise
s'ecified5 it is ?Jy since &onds 'ay se!iannually, for &an% loans it !ay ty'ically &e set at :?J1 4i$e$
one 'ay!ent 'er !ont# 4t#e default setting5$
>$ 3ow !any deci!al 'oints do you needL (n so!e calculations you !ay want ; digits to t#e rig#t of
t#e deci!al$ E0TE. ?
0-
F/.M+T ; 4E0TE.5 T#is sets calculator to needed accuracy$
?$ T(ME @+,UE /F M/0E1 KE1S4learn t#is first5
T#ese %eys are located t#e t#ird row fro! t#e to'$ T#ere are ; %eys:
N 0UMBE. /F T(ME E.(/-S 4J1 X 05 (F J1 Q ? +0- T3E T(ME (S ; 1E+.S 0 Q :7
IG1 +00U+, (0TE.EST .+TE E0TE. +S + 23/,E 0UMBE. 4"$<;O is entered as "$<;5
'B 0ET .ESE0T @+,UE 4lu!' su!5 Enter outflows as a negative nu!&er
'2( +1ME0TS 4'eriodic 'ay!ents S annuity5 Enter outflows as a negative nu!&er
FB FUTU.E @+,UE
(n addition to t#ese five %eys, you !ust c#ec% J1:
'G1 ?
nd
$ and (J1 %ey E0TE. T3(S F(.ST BEF/.E E0TE.(0= -+T+ /0 +01 ./B,EM
J1 is t#e nu!&er of co!'ounding 'eriods$ J1 Q : Q annual, J1 Q >9; Q daily etc$
1ou can enter data in > or 8 %eys and solve for t#e re!aining varia&le$ T#ere is no 'reset order in w#ic#
you !ust enter data$ Dust &e sure to clear registers and c#ec% J1 &efore entering data$
+ny of t#ese %eys can &e t#e de'endent varia&le$ For e)a!'le, say you want to deter!ine #ow !any years
it will ta%e for you to accu!ulate I:,777,777 &y saving I;77 'er !ont# at :7O E$ growt# 'er annu!$
::
::
E0TE. J1 Q :? E0TE.
(J1Q :7
MTQ *;77 4F(0+0C(+, C/0@E0T(/0: /UTF,/2S +.E + M(0US 0UMBE.5
F@ Q :777777
E0TE. CT , 0 Q >8;$76?? M/0T3S
-(@(-E B1 :? Q?"$<;" 1E+.S
(f you stand to in#erit I:77,777 in :7 years, w#at is it wort# now at a :7O discount rateL
E0TE. J1 Q : E0TE.
0 Q :7
(J1Q :7
F@Q:77777
E0TE. CT, @ Q >;:<8$"?
>$ B/0- 2/.KS3EET 4we will use t#is later in t#e course5
./B,EM: 2#at is t#e yield to !aturity of a "$<;O &ond due in ?7 years selling at :7;
E0TE. ?
nd
B/0-
C,. 2/.K
Enter settle!ent date 4T#is is t#e date t#e &ond would &e 'aid for in a trade:
I2'$R(AN( N$(E: Cor'orate settle!ent is > &usiness days fro! trade
date$ Settle!ent on U$S$ Treasury issues is ne)t day 4trade date R :5
E0TE. S-T 4settle!ent date5: Use Dune >7, :66<
E0TE. T3(S -+TE +S: 9$>76< .ESS E0TE. +0- -/20 +../2
C'N: T#e !enu 'ro!'ts you for cou'on in 'ct "$<;O Q "$<; E0TE.
E0TE. RD( 4rede!'tion date5: T#is is t#e date t#e &ond !atures or is called$
(n t#is 'ro&le! !aturity is ?7 years fro! now 4Dune >7, ?7:<5 Q 9$>7:<
.ESS E0TE.
.ESS -/20 +../2 KE1
RB Q E0TE. +. 4:775 +ll &onds !ature at I:777$ #onds are
@uoted as a -ercent o+ -ar$ Enter I:777 as :77O or :77$
AC( ,eave calculator set at +CT w#ic# !eans a >9; day year 4actual5
AG1 ,eave calculator set at se!iannual interest 'ay$ T#is is true of all
cor'orate &onds we will &e studying$
'RI: SK( /@E. 1,- +0- scroll down to .(CE and enter :7;$
:7;QI:7;O 7f 'ar or a dollar 'rice of I:7;7$
1,- Scroll U +../2 to 1,- and enter CT
&$L%(I$N I& 6.A3E T3(S (S T3E 1(E,- T/ M+TU.(T1
8$ C+S3 F,/2 2/.KS3EET 42e will use t#is in ca'ital &udgeting5
T#is wor%s#eet is used in solving ca'ital &udgeting 'ro&le!s$ 1ou can also do !any 'ro&le!s wit# T@M
%eys and use t#is to C3ECK 1/U. +0S2E. in an e)a!$
E0TE. ?
nd
CF
C+0E0TE. -/,,+. /UTF,/2 /F (0(T(+, (0@ESTME0T
C/0@E0T(/0: /utflows are a 0E=+T(@E nu!&er
C07 E0TE. C+S3 (0F,/2 (0 1E+. : $$ n
F$7 E0TE. F.EHUE0C1 4for even cas# flow strea! enter years of cas# flows5

C$A $$ C0n Enter as a&ove
N'B co!'uter will as% for ( (Q2+CC in ca'ital &udgeting 'ro&le!s
2+CCQ weig#ted average cost of ca'ital
4also called F#urdle rateG5
Enter ( 4i$e$ :7O is entered as :7 wit# no deci!al5
USE -/20 +../2$ 0@ +E+.S +=+(0$ 3(T CT KE1
:?
:?
T#is 'rovides t#e 0@ of cas# flows discounted at ( (..
(.. is a 'ercentage t#at eBuates t#e cas# outflows wit# t#e inflows
(f (.. were used as t#e discount rate in a 0@ calculation t#e answer
would &e Aero$
N'B I& C$NCE'(%ALL1 (HE 2$&( ACC%RA(E 2E(H$D
;$ /T3E. 2/.KS3EETS
2e !ay e)a!ine ot#er wor%s#eets on your calculator in an effort to solve s'ecific 'ro&le!s suc# as
leasing, !ortgage a!ortiAation or co!'ound rate of return$ T#e calculator !anual will e)'lain use$
;$ US(0= 1/U. C+,CU,+T/. (0 +0 EX+M
E)a! : will 'ri!arily focus on your a&ility to do ti!e value of !oney calculations$
+T ,E+ST 97O of t#is e)a! will involve T@M 'ro&le!s using your financial
calculator$ (n E)a! : you will use t#e >
rd
row of %eys only$
2#en solving a T@M 'ro&le! do t#e following eac# ti!e:
:$ -ETE.M(0E T3E T(ME ,(0E$
?$ C,E+. +,, .E=(STE.S
>$ E0TE. J1
'G1 ay!ents 'er year T#e default setting of your calculator is J1 Q :?$
8$ E0TE. (0-EE0-E0T @+.(+B,ES (0 +01 /.-E.
N nu!&er of ti!e 'eriods$ 4J15 ) 4years5 $ >7 years of !ont#ly '!ts: 0 Q >97
IG1 annual interest$ Enter as a nu!&er wit# no deci!al 4:7O is entered as :75
'B resent value$ T#is is for ,UM SUMS
C$NBEN(I$N: /utflows are entered as a negative nu!&er
'2( ay!ents ** +n +00U(T1 strea! of E@E0 cas# inflows or outflows$
FB Future value$ T#is could re'resent t#e value of a 'ortfolio for e)a!'le w#ere
you invested a lu!' su! 4@ entered as an outflow5 andJor a series of MTS
4also entered as outflows5$
;$ S/,@E F/. -EE0-E0T @+.(+B,E
9$ C3ECK 1/U. 2/.K$ -/ES (T M+KE ,/=(C+, SE0SEL
&(E'& IN D$IN> (B2 'R$#LE2& IN AN E3A2
:$ Cear registers
?$ Dra9 t*e time ine on t*e )ac< o+ t*e e.am -age. ?*at are you so=ing +orH
>$ &*o9 a in-uts on your cacuator NEA(L1 starting 9it* 'G1. IF 1$% ?AN(
'AR(IAL CREDI( &H$? 1$%R ?$R4 AND #E NEA(.
8$ C*ec< your 9or< 9it* rue o+ DA or ot*er 9or<s*eet register$
T#e only way to learn t#e calculator is to do 'ro&le!s$
(HE R%LE $F DA: (*is rue 9i *e- you c*ec< your 9or<.
-ivide (J1 into <?$ T#is will tell you t#e nu!&er of years
it will ta%e for a su! to -/UB,E$
E)a!'le: :7O 4<?J:75 Q <$? 1E+.S
:;O 4<?J:;5 Q 8$" 1E+.S
?7O 4<?J?75 Q >$9 1E+.S
T#is a''ro)i!ation #el's you solve si!'le lu!' su! future value 4F@5 'ro&le!s$
(t is i!'ortant to understand C/0CETU+,,1 w#at t#e calculator is doing to see if
your answer !a%es sense$ For e)a!'le, if you invest I:7,777 at :7O interest for < years
you %now fro! t#e rule of <? t#at t#e answer s#ould a''ro)i!ate I?7,777 since !oney
dou&les in <$? years at :7O co!'ounded annually$
T#e ta&les in t#e te)t will not &e used in an e)a!$ 3owever, it is i!'ortant t#at you
understand w#at t#ey !ean$ ,et us &riefly loo% at t#e! now in t#e &ac% of your te)t:
:>
:>
(A#LE # F%&%R) *A+%) ,F A +%-. /%- ,F 01 1C,-.,%$D /%-2
T#is ta&le tells you t#e value of I: for n 'eriods at interest rates of :O to >9O
+ssu!e you invest a lu!' su! I:777 at :;O for ?7 years$
=o to ?7 year line and over to :;O colu!n$ T#e ta&le value is :9$>99
Multi'ly ta&le value ti!es @ 4lu!' su! outlay5: 4I:777 ) :9$>995 Q I:9,>99
T#is is t#e value of your lu!' su! savings at t#e end of t#e 'eriod 4?7 years5
%&IN> (HE FINANCIAL CALC%LA($R C$N(D.
(A#LE D F%&%R) *A+%) ,F A$ A$$%I&' 1/%- ,F A$ A$$%I&'2
T#is ta&le is t#e future value of an annual 'ay!ent 4MT5$ For e)a!'le, let us
say you save I:777 'er year for :? years at 6O$ =o to t#e :? year line and
t#e 6O colu!n$ T#e ta&le value is ?7$:87$
Multi'le ta&le value ti!es MT 4:777 ) ?7$:8:5 Q I?7:8:$
T#is is t#e F@ 4future value5 of your savings
(A#LE C .R)/)$& *A+%) ,F A +%-. /%- ,F 01 R)C)I*)D I$ &H) F%&%R)
T#e value of I: received in :; years at a :?O discount rate is $:"?<$
(f t#e value at t#e end of t#e 'eriod 4:; years in t#is e)a!'le5 is I:777, t#e
'resent value is I:"?$<7 discounted at :?O$ T#is !eans t#at if you invested
I:"?$<7 for :?O for :; years it would &e wort# I:777 at t#e end of t#e 'eriod$
(A#LE E .R)/)$& *A+%) ,F A$ A$$%I&' ,F 01 F,R n .)RI,D/
+ssu!e you invest I;77 'er year for :; years$ T#e ta&le value at a :;O
discount rate is ;$";<8$ 2#at does t#is !eanL 4I;77 ) ;$"8<8 Q
?6?>$<7$ T#is is t#e 0@ of I;77 'er year for :; years at :;O$

9$ C+0 1/U BEC/ME + M(,,(/0+(.EL 1ES 1/U C+0MMMM
Financial 'lanning is a !atter of starting early and stic%ing to it$ For t#ose students w#o
are interested we will give you an o''ortunity to do a financial 'lan on yourself as an e)tra
credit 'roCect to illustrate t#ese 'rinci'les and, #o'efully, to start you on t#e road to
financial inde'endence$
Can you save I>77 'er !ont#L +ssu!e a return of :;O co!'ounded annually$
Clear registers$
Set J1 for :? .ESS ?
0-
J1 E0TE. :? 4.ESS E0TE.5
E0TE. *I>77 +0- .ESS MT 4t#is is an outflow so it is negative5
E0TE. I:777777 .ESS F@
E0TE. :; .ESS (J1 4+00U+, .ETU.0 /F :;O5
S/,@E F/. 0 0 Q >7:$:9 M/0T3S Q?;$76 1E+.S +0-
<$ US(0= M(C./S/FT EXCE, T/ S/,@E T@M ./B,EMS
(n financial !odeling te!'lates can &e develo'ed in MSJE)cel to solve T@M 'ro&le!s$
T#e Q0@ function will ena&le you to solve co!'le) !ulti'le cas# flow 'ro&le!s$ See t#e dividend
discount !odel on '$ >> of t#is wor%&oo%$ FN'B ,I.1! ces o+ cas* +o9 stream0$ E)cel will also do (..
&ut it esti!ates t#e discount rate using an iterative !et#od starting wit# :7O$
:8
:8
(B2 'R$#LE2& CH C H$2E?$R4 &$L%(I$N&
0/TE: &A3+)/ A$D CA+C%+A&,R /,+%&I,$/ 4I++ *AR' /+I5H&+'. C+,CU,+T/. /,+%&I,$
I/ -,R) ACC%RA&). &A3+)/ CA$ ,$+' 3) %/)D 4H)$ .6' I/ 1. ,%&F+,4/ AR) $)5A&I*).
N%2#ER IN #$LD AND I(ALIC& I& &$L%(I$N
CH)C7 4,R7 &4, 4A'/8 &A3+) A$D CA+C%+A&,R I$ .R,3+)-/ 4H)R) .6' 9 1
+)AR$ 4HICH &A3+) &, %/) F,R )ACH &'.) ,F .R,3+)-
#>NG
'R$#LE2 (A#LE BAL%E END 'G1 N IG1 'B '2( FB
;*:+ B ?$;68 B=0 : :7 :7 *;777 12343
;*:B B :$<:8 B=0 : < " *"777 13516
;*:C B >$"69 B=0 : :? :? *<<; 3613
;*:- B :$?<9 B=0 : ; ; *?:777 24761
;*?+ B :7>6J;77Q?$7<6 B=0 : 18 ; *;77 :7>6$;
;*?B B :$;>6 B=0 : C 6 *>; ;>$"<
;*?C B ?$6"9 B=0 : 4 ?7 *:77 ?7"$97
;*?- B :$8"9 B=0 : ?7 ? *;> <"$<9
;*>+ B >$"69 B=0 : :? 12 *;77 :68"
;*>B B :$87< B=0 : < 8 *>77 8??$:
;*>C B ;$978 B=0 : ?7 3 *;7 ?"7$?
;*>- B ?$8"" B=0 : ; 26 *?77 86<$9
;*8+ C $>"9 B=0 : :7 :7 9367 "77
;*8B C $<"8 B=0 : ; ; 9238 >77
;*8C C $$<"6 B=0 : " > 9573 :777
;*8- C $?>> B=0 : " ?7 9233 :777
;*;+ - :?$;9" E0- : :7 ; *;77 4273
;*;B - 9$:7; E0- : ; :7 *:77 416.8
;*;C - :?$;9" E0- : < < *>; 363
;*;- - :?$;9" E0- : > ? *?; 54.8
(B2 'R$#LE2& H$2E?$R4 &$L%(I$N& C$N(D
:;
:;
#>NG
'R$#LE2 (A#LE BAL%E END 'G1 N IG1 'B '2( FB
;*9+ E <$7?8 E0- : :7 < 15883 *?;77
;*9B E ?$"?6 E0- : > > 137 *<7
;*9C E ;$;"? E0- : < 9 1843 *?"7
;*9- E 9$:8; E0- : :7 :7 3652 *;77
;*<+ B :$>>" ; 1.S B=0 : ; 9 *:7777 13376
;*<B B :$9:: ; 1.S B=0 : ; :7 *:7777 14116
;*"+ 0+ 0+ ,/=+0 B=0 : :? :7 *:777 2833
;*"+ 0+ 0+ ./B(0S/0 B=0 8 " " *:?7777 1:6833
;*:7+ 0+ +00U(T1 + E0- : :? 13.13 *;7777 ";77
;*::+ :;777 T 4:$?5 1. : Q :"777 1. ?Q ?:977 1. >Q ?;6?7
;*:?+ 8: T 4:$:77 : 8; ? ;7 > ;; 8 97
./U0- T/ 0E+.EST 23/,E 0UMBE.
;*:>a ,//K +T T3E -(FFE.E0CE BET2EE0 B=0 +0- E0- (0 T3(S ./B,EM
B=0 : ?; 6 *97777 846:
E0- : ?; 6 *97777 4167
;*:8a E0- : :; 9 4:: :;777
;*:;+ B=0 : :7 7.6 *;77 :7<6$;
US(0= T3E .U,E /F <?, 1/U K0/2 +0S2E. (S +B/@E BUT C,/SE T/ <$?O
S(0CE <$?O C/M/U0-E- 2(,, -/UB,E (0 :7 1E+.S
;*:6+ (n t#is %ind of 'ro&le! w#ic# we will study in art (( of t#e course, you will use t#e
cas# flow s'reads#eet$ 2e will learn #ow to use t#is later
;*?7+ T#is %ind of security is called a FAero cou'on &ond$ F Since t#ere is no cou'on,
t#e 'rice is eBual to t#e 0@ of t#e 'ar value of t#e &ond at !aturity 4I:7775
E0- : < :7 813.17 :777
;*?:+ 2#at is t#e !eaning of a 'er'etuity + 'referred stoc% is an e)a!'le
since t#ere is no !aturity$ F/.MU,+ 4using calc$ Keys5: 'B F '2( G IG1
300G.06 F 3DC0 ,use cacuator and set N to 700! IG1 F 6 I
AND '2( F 300 to ac*ie=e same
resut
7000G.7A F 6333
FIN 3403 'R$F DI>>LE (B2 'R$#LE2&
Solve t#ese .E+, 2/.,- 'ro&le!s F/. 0EXT C,+SS using your T( B+((R financial calculator$ (n (n
%se t*e +oo9ing ste-s: 1$,&)8 &his is re:#ired on the e;am so practice doing it $,42
:$ -raw t#e ti!e line
?$ ,ist calculator in'uts in t#e following order: B=0 /. E0-
J1 4 default Q :? 4M/0T3,15
0/TE: 2it# outflows, enter 0
:9
:9
0u!&er and t#en enter !inus (J1 Enter actual 'ct$ "O Q "
Sign 4lower rig#t %ey5 @ /utflow is entered as a negative nu!&er
F@
MT
>$ Clear +,, T3.EE calculator !e!ory registers
8$ Solve 'ro&le! &y entering in'uts listed a&ove$ 2#at are you solving forL
;$ C#ec% results$ (s it logicalL Use ta&les$ Use .ule of <? w#ere a''lica&le$
'R$#LE2&
:$ 1ou want to lease a new Taurus$ T#e stic%er is I?7,777$ Ta) and title is I:?;7$ T#e lease ter! is >
years$ T#e loan +. interest rate is 9O$ T#e de'reciation is :"O in year :, :?O in year ? and :7O
in year >$ T#e ca' cost reduction 4increase in cost5 is I;77$ C+,CU,+TE ,E+SE +1ME0T
$,&)8 Depreciation is comp#ted !" ta<ing the acc#m#lated = depreciation over the least term 1>
"ears in this case2 and m#ltipl"ing it times net investment 1cost ? ta; @ title ? dealer prep ? reight2
?$ +ssu!e you negotiate t#e 'rice on 'ro&le! : to I:6777$ Ta) and title are I:?77$ Ca' cost is I;77$
1ou get financing at a good rate of ?$6O$ C+,CU,+TE 0E2 +1ME0T$
>$ ,ease a new Ca!ry$ Stic%er I?7,;77$ 1ou negotiate 'rice of I:6;77$ Ta) and title Q I:>77$
-e'eciation Q :;O yr :, :7O yr$ ? and "O yr$ >$ (J1 Q ?$6O$ Ca' cost reduction is I;77$
C+,CU,+TE ,E+SE +1ME0T$
8$ ,ease a Ca!ry$ Sa!e facts as U > e)ce't (J1 Q "O$ S/,@E F/. MT$
;$ Sa!e as 8$ 1ou trade in your old car for I;777$ S/,@E F/. MT$
9$ 1ou need retire!ent inco!e of I?;77 'er !ont#$ 1ou 'lan to retire at age ;;$ 1our actuarial life
e)'ectancy is ";$ 3/2 MUC3 M/0E1 2(,, 1/U 0EE- +T +=E ;; T/ FU0- T3(S
.ET(.EME0T +00U(T1 +SSUM(0= +0 "O (0@ESTME0T .ETU.0 -U.(0=
.ET(.EME0T$ SET E0-$
<$ 3ow !uc# will you need to save E+C3 M/0T3 in 'ro&le! 9 a&ove assu!ing an invest!ent return
BEF/.E .ET(.EME0T fro! age ?; to age ;; 4>7 1E+.S5 +SSUM(0= + :7O (0@ESTME0T
.ETU.0 .(/. T/ .ET(.EME0T$ SET E0-$
"$ 1ou #ave a c#ild age 8$ 1ou need to save for college$ T#e cost of college in a 'u&lic university if
I6777 'er year in current dollars$ 1our esti!ated invest!ent return is "O$ College costs are rising at
9O$ C+,CU,+TE T3E T/T+, C/ST /F + C/,,E=E E-UC+T(/0 (0 + UB,(C
U0(@E.S(T1 F/. T3(S C3(,- BE=(00(0= +T +=E :" F/. 8 1E+.S$
6$ 1ou want to &uy a #o!e costing I?77,777$ 1ou 'lan to 'ut ?7O down$ T#e loan cost includes ?
/(0TS w#ic# ar added to 'rinci'al at closing$ T#e rate is <$?;O for a >7 year !ortgage and 9$";O
for a :; year !ortgage$ C+,CU,+TE +1ME0T F/. + >7 +0- :; 1E+. ,/+0$
:7$ 1U(E M/.T=+=E$ Use t#e facts of t#e 'ro&le! 6 a&ove for a >7 year !ortgage$ +ssu!e
'ay!ents are !ade every ? wee%s 4?9 ti!es 'er year S ;?J? Q ?95$ Solve for 0 and divide &y ?9 to
deter!ine t#e years to 'ay off t#is F>7 yearG !ortgage$
::$ 1ou want to retire in :; years$ 1ou need an annual inco!e of I<;777 in inco!e at retire!ent and do
not wis# to touc# 'rinci'al$ 1ou 'lan to save I;77 'er !ont#$ 1ou currently #ave a s!all 'ortfolio
wort# I:77,777$ 2#at annual interest return 4(J15 !ust you ac#ieve in order to reac# t#is goalL
3(0T: F@ Q I<;,777 J $;O$
:?$ US(0= B/0- S.E+-S3EET 4covered later in course5$ 1ou want to &uy an + rated &ond t#at
!atures in :; years$ T#e cou'on rate is "O$ T#e yield on + rated &onds in t#e sa!e !aturity range
is <$;O$ 2#at 'rice would you 'ay for t#is &ondL
FIN 3403 DI>>LE: (B2 'R$#LE2& -- &$L%(I$N&
T#ese 'ro&le!s and solutions cover a variety of scenarios$ (t is vital t#at you wor% t#ese
answers out and understand #ow to get answer$ +s% Buestions if you are unclear on
anyt#ing.
:$ 1ou #ave decided to lease a new Taurus$ T#e ter!s are:
Stic%er 'rice: I?7,777 Ca' cost reduction 4add to 'rice5: I;77
Ta) and title: I:?;7
Ter!: > years
:<
:<
+. interest: 9O
-e'rec Q :"O in yr :, :?O yr ? and :7O yr >
.esidual value in > years: I:?777 4stic%er less accu!$ de'r5
F(0+0C(+, C+,CU,+T/. (0UTS: clear registersMM
set B=0 J1 Q :? 0 Q >9 (J1 Q 9
@ Q *I?:<;7 F@ Q :?777 S/,@E F/. MTQ J3C4.64
A. &A2E 'R$#LE2. Many 'eo'le fail to realiAe t#at you
can negotiate t#e 'rice and interest rate in a lease$ +ssu!e
you get t#e 'rice down to I:6777 wit# ta) and title eBual to
I:?77, I;77 ca' cost V FMCC offers ?$6O +. lease$
@ Q *I?7<77 (J1 Q ?$6 F@Q:?777 0Q>9
S/,@E F/. MT Q JA60./4
T3(S (S + S+@(0=S /F I<>$67 /. ?7$"O
>$ C$2'ARI&$N &H$''IN>: Ne9 Camry
Stic%er Q I?7,;77 your -riceFJ7/!C00 Ta) & title Q I:>77
-e'reciation: :;O yr :, :7O year ? and "O year >
.esidual Q I:><>; (J1 Q ?$6
Ca' cost reductionQ I;77 @ Q *I?:>77 F@ Q I:><>;
T#e Ca!ry costs I;77 !ore &ut t#e residual is I::<8 #ig#er 4Foreign cars do not
de'reciate as !uc# as U$S$ cars5
MT Q JACA.AC 4S+@(0=S /F :7O even t#oug# t#e Ca!ry cost !ore u' front$5
(B2 'R$#LE2& C$N(D.
8$ Ca!ry wit#out factory financing
S+ME F+CTS +S U ? EXCET (J1 Q "
@ Q *?:>77 F@ Q :><>; 0 Q >9
S/,@E F/. MT Q J3A8.44
;$ Ca!ry wit#out factory financing &ut you trade in your
old car for I;777
@ Q *:9>77 F@ Q :><>; 0 Q >9
S/,@E F/. MT F J7D0.67
(B2 'R$#L&2& C$N(D.: INBE&(IN> %&IN> (B2
9$ 1ou need retire!ent inco!e of I?;77 'er !ont#$ 1ou 'lan to retire at age ;;$
1our actuarial life e)'ectancy is age ";$ 3ow !uc# !oney will you need at
age ;; to fund t#is annuity assu!ing an "O invest!ent return
SET E0- S +,, +00U(T(ES USE E0-
J1 Q :? (J1 Q "
MT Q I?;77
0 Q >7 X :? Q >97
F@ Q 7 S/,@E F/. @ Q *I>88,?>9
@ is negative since it is considered an outflow
<$ 3ow !uc# !ust you save eac# !ont# starting at age
?; 4>7 years5 in order to save t#e su! a&ove assu!ing
:"
:"
an invest!ent return of :7O$ 40/TE: T#e return is #ig#er w#en you are
young and declines to "O w#en you are retired$5
J1 Q :? 0 Q >97 (J1 Q :7
F@ Q I>88,?>9 4do not enter t#is as negative5
S/,@E F/. MT Q -J7C7.03 T#is is negative
(B2 'R$#LE2& KC$LLE>E F%NDIN>
"$ Saving for a c#ild reBuires 'lanning$ +ssu!e funds are
'laced in an FU=M+G account and accu!ulate at t#e c#ildKs
ta) rate w#ic#, for our 'ur'oses, is assu!ed to &e Aero$ 1our c#ild is
8 now and will enter college at age :"$ 1ou #ave :8 years to save$ College
cost in current dollars is I6777 'er year$ Costs are rising &y 9O 'er year$
&(E' $NE: Calculate annual cost in 1E+. :8 +T 9O inflation$ &E( #>N:
NF74 'G1 F 7
IG1 F 8
'B F -/000
&$LBE F$R FB. (*is is coege cost in year 74.
FB FA0346.73
&(E' (?$: Calculate annual cost of college 4year :8*:<5
FRE&H2AN 1R 74 JA0346.73
&$'H$2$RE 1R 7C JA7C8/.0A ,1R 7 . 7.080
"%NI$R 1R 78 JAA683.7D ,1R A . 7.080
&ENI$R 1R 7D JA4A34./8 ,1R 3 . 7.08
($(AL C$&( K 4 1EAR& J6/07C.A6
&(E' (HREE: Calculate #ow !uc# you need to save eac# !ont# to accu!ulate
enoug# funds to !eet total dollar need in ste' two$ Use (J1 of "O$
J1 Q :? 0 Q :9" (J1 Q "
@ Q 7 F@ QI 6/07C.A6 S/,@E F/. MT
MT Q *I A6D.0D S+@(0=S J M/0T3 **: C3(,-
Save for :8 years 4:9" !ont#s5 at assu!ed return of "O
/. (B2 'R$#LE2&: &ABIN> $N A 2$R(>A>E
C$2'ARE 7C AND 30 1EAR 2$R(>A>E
3/ME .(CEQI?77,777 WC,/& 9 .RIC) 11A D$ .-&2 ? .,I$&/ A$D
C+,/I$5 C,/&/X Q M/.T=+=E ,/+0 Q I:97,777 1this is an o#tlo(2
-/20 +1ME0T Q ?7O /(0TS Q ? Q ?O 7F ,/+0
'G1 F 7A 4 : oint is :O of ,/+05 ? 'oints Q I>?77$
'B F (0(T(+, M/.T=+=E B+,+0CE: -J783!A00
>7 1E+. M/.T=+=E N F 380 IG1 F D.ACE
:; 1E+. M/.T=+=E N F 760 IG1 F 8.6CE
SET B=0
solve for MT: 30 year J7708.8A
7C year J7444.// 4I>>"$>< J !o !ore5
>:O #ig#er 'ay!ent
'aid off ;7O faster
:6
:6
+ si!'le strategy is to 'ay an additional I>>" 'er !ont# 4a''lied to 'rinci'al5
w#en you can to a!ortiAe t#e loan$
70. 1%''IE 2$R(>A>E
USE F+CTS /0 >7 1E+. ,/+0 +B/@E EXCET
+SSUME +1ME0TS +.E M+-E E@E.1 ? 2EEKS
MT Q ::79$9?J? /. I;;>$>: B(*2EEK,1
&et 'G1 to A8 ,CAGA0
Most 'eo'le will not notice t#e difference es'ecially if t#ey get 'aid &i*wee%ly
(J1 Q <$?; @ Q *I:9>?77 MT Q I;;>$>:
S/,@E F/. 0 Q 878.A '2(&
Di=ide )y A8 FA3.D 1ears
.ESU,T: + reduction in ter! of 9$> years or ?:O
(F 1/U T+KE /UT + M/.T=+=E +T +=E >7 (T 2(,, BE +(- /FF 23E0
1/U +.E +,M/ST ;8$
(B2 'R$#LE2& KINBE&(IN> 7
::$ 1ou #ave a 'ersonal goal of retiring in :; years$ 1ou
need a 'ortfolio t#at will 'roduce I<;,777 'er year in
inco!e (0 :; 1E+.S and you do not want to touc#
'rinci'al$ T#e 'ortfolio is assu!ed to yield ;O$ 1ou
'lan to save I;77 'er !ont#$ 1ou #ave a s!all
'ortfolio now of I:77,777$ 2#at annual interest return
4si!'le annual co!'ounding5 !ust you o&tain in order
to reac# t#is goalL
STE :: 2e !uc# calculate t#e siAe of t#e 'ortfolio needed to 'roduce t#e
inco!e$
<;777J$7; Q I:,;77,777 T3(S (S F@
(B2 - INBE&(IN> C$N(D. &$L%(I$N&
STE ?: 2E +.E S/,@(0= F/. (J1
J1 Q:? 0/TE: since you are saving M/0T3,1, you !ust
set J1 to :?
SET B=0 4t#is will always &e given
in e)a! Buestion5
0 Q :; X :? Q :"7
@ Q *:77777
MT Q *;77
F@ Q :;77777
&$LBE F$R IG1 F 78.A0E
$,&)8 %se the same steps in solving all &*- pro!lems in an e;am
1. Read the :#estion CAR)F%++'
B. Dra( a time line on the 3AC7 o the e;am page
>$ Determine (hat "o# are solving or
8$ $)A&+' list "o#r <e"stro<e inp#ts. ,#tlo(s are
negative n#m!ers.
?7
?7
;$ /ho( "o#r ans(er $)A&+'. )ither !o; or
#nderline it.
7A. (B2 'R$#LE2&: C$R'$RA(E #$ND&L)ond s-reads*eet.
/A*) &HI/ .R,3+)- A$D /,+%&I,$ F,R +A&)R I$ &H) C,%R/)C$,& ,$ )DA- 1
Before we solve t#is 'ro&le!, it is i!'ortant to understand a few &asic conce'ts:
Cor'orate &onds !ature at +.$ ar Q I:777
Cor'orate &onds 'ay interest cou'ons SEM(+00U+,,1$ J1 Q ?
T#e stated interest rate on t#e &ond is fi)ed for t#e life of t#e &ond$ T#is is
called t#e FCou'on rate$G
+ll &onds are 'riced to t#e !ar%et yield on &onds of si!ilar ty'e, Buality and
!aturity$ T#is yield is always c#anging and &onds adCust to it &y t#e 'rice
fluctuating$ (f yields in t#e !ar%et go U, &ond 'rices go -/20$
1ou are t#in%ing of &uying a cor'orate &ond t#at !atures in :; years$ T#e cou'on
rate is "O$ 1ields on si!iliar cor'orate &onds in t#e :; year !aturity range is
<$;O$ 2#at 'rice would you 'ay for t#is &ondL
SET B=0 SET J1 Q ?
0 Q >7 4.e!e!&er 0 Q J1 ti!es t#e nu!&er of years5
(J1 Q <$; (n a &ond 'ro&le! (J1 is t#e yield on ot#er si!ilar
&onds$ -/ 0/T use t#e cou'on rate on t#e &ond$
F@ Q :777 +ll &onds !ature at 'ar$ ar Q :777
MT Q 87 Bonds 'ay interest se!iannually$
T#is &ond #as a cou'on rate of "O$
+nnual interest Q "O ) I:777 Q I"7
Eac# cou'on is t#erefore #alf t#e annual
interest of I"7 or I87
S/,@E F/. @ 70D7.3A
FINANCIAL RA(I$ ANAL1&I&--(EA2 'R$"EC(
.+T(/S +.E F/. (0-UST.(+, C/M+0(ES 'o#r presentation sho#ld highlight &R)$D/
+$ #ALANCE &HEE( RA(I$& ,&$2E $F (HE RA(I$& LI&(ED ARE N$( IN (HE (E3(0
,(HU(-(T1 C.Q C+JC,
+C(- TEST or HU(CK .+T(/Q C+*(0@JC, or C+S3 R +. J C,
-S/4days sales outstanding5 Q+.J 4sales J >975 + >97 day year is assu!ed
T3(S .+T(/ (S +,S/ C+,,E- +@= C/,,ECT(/0 E.(/-
/E.+T(0= (nventory turnover Q Cost of goods sold J +verage
./F(T+B(,(T1 inventory 4B/1 R E/15J?
Fi)ed assets turnover R Sales J ro'erty lant and eBui'!ent
,E@E.+=E T/T+, -EBT J T/T+, +SSETS Q Current lia&ilities R ,$T$ de&t J assets
,T -EBT J +SSETS Q de&t Y : year J total assets
,T -EBT J EHU(T1 Q de&t Y : year J 4co!!on stoc% R sur'lus R ret earnings5
0/TE: referred stoc% is 0/T eBuity
X (0T E+.0E-Q EB(T J interest e)'ense fro! inco!e state!ent
EB(T Q Earnings &efore interest and ta)es$ T#is !ay Q o'erating inco!e
X F(XE- C3=S E+.0E-Q 4EB(T R lease '!ts 5J 4interest R rent e)'ense R
?:
?:
sin%ing fund 5 J 4:*ta) rate5
B$ INC$2E &(A(E2EN( RA(I$&
./F(T+B(,(T1 =ross !argin Q 40et Sales * C=S5J net sales
/-( 9 cost o goods sold (-* 9 selling general and admin overhead
/'erating !argin Q 40$ sales * 4C=S R S=+5 J net sales /.
4=ross inco!e * S=+5J net sales
reta) !arginQ reta) inco!e J 0et sales
0et !arginQ 0et inco!e &efore co! divds J 0et sales
Ca' e)'ense J sales Ca'ital e)'enditures as O of revenues
.&- J sales (!'ortant !easure for #ig# tec# fir!s
C$ BAL%A(I$N RA(I$& JE Q Co!!on stoc% 'rice J Earnings 'er s#are
3istorical JE Q avg 'rice in year J ES in t#at year
Current JE Q current 'rice J ,TM ES
1(E,- Q Co!!on -S 4indicated annual rate5J cur$ rice
B@S Q S3 eBuity J co!!on s#s issued +0- outstanding
.(CEJB//KQ current 'rice of co!!on J last Btr B@S
-$ C$2#INA(I$N RA(I$&
./+ Q net inco!e J total assets
R$E F net income G &H e@uity '%(T )'P%.T*+T .*T)%
#istorical ./E Q net inco!e for year J avg S3 eBuity
4B/1 eBuity R E/1 eBuity5J?
E$ (REND& +re !argins increasing or decreasingL (s leverage increasing or decreasingL
+re e)'enses growing faster t#an revenuesL 2#yL
F$ D%'$N( R$E 2$DEL Eac# tea! is 'rovided a si!'lified -uont !odel in MS E)cel on
co!'uter dis%$ T#is !odel s#ows t#e inter'lay &etween financial
leverage, ot#er ele!ents in financial structure and ./E$
(EA2 'R$"EC( (I'&
(n 're'aring your tea! E)cel re'ort, #ere are so!e ti's:
:$ /rganiAe your tea! eary. =et na!es and '#one nu!&ers of tea! !e!&ers$ Set a
.E=U,+. MEET(0= T(ME$ 1ou need to !eet eac# wee%$ 1our tea! will also
function as a study grou'$
?$ (t is vital t#at +,, tea! !e!&ers !a%e tea! !eetings$ (t is @(T+, t#at you see !e
if so!eone on your tea! is not 'ulling t#eir weig#t$
>$ +''oint a tea! secretary to %ee' trac% of all tea! !e!&ers and !a%e sure everyone
#as wor% done for all tea! !eetings$ S#are '#one nu!&ers and E*Mail addresses$
8$ Be sure you are all using t#e sa!e software$ UCF co!'uter la& Cs o'erate on
2indows 0T and t#e latest version of ower'oint, 2ord and E)cel$ (f you #ave an
older version of eit#er 2indows or MS /ffice, you !ay not &e a&le to o'en or save
your wor%$ lease use t#e UCF co!'uter la& w#enever 'ossi&le$ 0ote t#at t#e
-BCC and BCC co!'uters are 0/T necessarily co!'ati&le$ C#ec% wit# t#e
co!'uter la& !anager to &e SU.E you are using a UCF !ac#ine wit# latest software$
;$ -elegate s'ecific Co&s suc# as:
/&taining co!'any re'orts
,oo%ing u' !ar%et data on !y we& site using 1a#oo or Big C#arts
Filling in t#e E)cel s'reads#eet$ +ssign different 'ortions to eac# tea!
!e!&er$
Understanding t#e ratios$ See instructor as a tea! wit# s'ecific Buestions$
-evelo'ing T slides
??
??
9$ Ma%e sure you B+CK U all wor% including t#e s'reads#eet and T slides$ +ll
tea! !e!&ers s#ould !a%e co'ies every wee% so if so!eone is !issing it will not
&ring your efforts to a #alt$
<$ Follow t#e outline in t#e E)cel 'rogra!$ See instructor regarding t#e -uont Model
and t#e --M$
"$ 1ou will &e as%ed to co!'lete a tea! 'eer grou' evaluation$ T#is is for your &enefit$
(t is vital t#at you let instructor %now if so!eone in your grou' is not 'ulling t#eir
weig#t$ Most students #ave Co&s, !any #ave fa!ilies and ot#er res'onsi&ilities$ T#is
class is your Co&$ 1ou are e)'ected to wor% in t#is grou' 'roCect as a TE+M$ T#ose
w#o fail to #eed t#is !essage will receive a Aero on t#e tea! 'roCect$
6$ TE+MS 23/ 2+0T T/ -/ T3E SE=ME0T +0+,1S(S +0- ./DECT(/0**
T#is is an /T(/0+, !odule for F(0 >>7> students$ -o 0/T atte!'t to do t#is on
your own$ 1ou MUST see instructor$ (f you enter any data at all in t#e wor%s#eet it
will affect t#e -ividend -iscount Model$ 1ou !ay do t#is for e)tra credit, &ut do so
only if you #ave ti!e and #ave co!'leted all your slides$
RA(I$ ANAL1&I&: &A2'LE E3A2 5%E&(I$N&
:$ X1Z Cor'$ co!!on is selling at I:77 J s#$ 2#ic# re'resents a JE of :7X$ (f t#e fir! #as :77
co!!on s#ares outstanding, a ./E of ?7O, and a total de&t ratio of 97O, w#at is t#e return on assets
./+L
S/,UT(/0
JE Q .(CE J ES Q:7 T3E.EF/.E E$$S Q I:7 E. S3+.E
0ET (0C/ME Q I:7 X :77 S3ES /UT Q I:777
./E Q :777J S3 EHU(T1 Q ?7O T3E.EF/.E S3 EHU(T1 Q I;777
(F -EBT .+T(/ (S 87O T3E0 EHU(T1 (S 97O$ II;777 Q 97O /F T/T+, C+
T3E.EF/.E: T/T+, ,(+B(,(T(ES +0- S3 EHU(T1 Q I:?,;77
T/T+, +SSETS Q T/T+, ,(+B(,(T(ES R S3 EHU(T1
./+ Q 0ET (0C/ME J T/T+, +SSETS Q :777J:?;77 Q "O
?$ + fir! #as total assets of I:8 !illion and a de&tJeBuity ratio of $<;$ (ts sales are I:7 !illion and it
#as total fi)ed assets of I8 !illion$ (f t#e fir!Ks EB(T is I? !illion, its ta) rate if 8;O, and t#e
interest rate on all de&t is :7O, w#at is t#e fir!Ks ./EL
S/,UT(/0: T/T+, -EBT R T/T+, EHU(T1 Q I:8 MM
T/T+, -EBT Q $<; 4T/T+, EHU(T15
I:8!! Q T/T+, EHU(T1 R$<;
T/T+, EHU(T1 Q I:8MM J :$<; Q I" MM
T3E.EF/.E T/T+, -EBT Q I9 M(,,(/0
-EBT (0TE.EST Q I9MM X :7O Q I977,777
?>
?>
EB(T Q I? MM
.ET+XQ EB(T * ( Q I:$8MM
0ET Q .ET+X 4:*T5 Q I:$8MM X $;; Q I<<7,777
./E Q I<<7,777J",777,777 Q 6$9?;O
>$ =iven t#e following infor!ation, calculate t#e !ar%et 'rice 'er s#are of 2+M (nc$
0et inco!e I?77,777
E$$S$ I?$77
SJ3 eBuity I?,777,777
Mar%etJ&oo% :$;X 4:;7O5
Co!!on s#ares out Q I?77,777 J I? Q :77,777
B@S Q I?,777,777 J :77,777 s#s Q I?7
!ar%et value Q :$;X &oo% value 'er s#are Q I>7 'er s#are

RA(I$ ANAL1&I& 'R$#LE2
Fill in t#e &alance s#eet and inco!e state!ent data &elow$ S3/2 1/U. 2/.KMMMM
-e&t ratio: ;7O -ays sales outstanding >9 days
Huic% ratio 7$"X [ =ross !argin ?;O
Total asset turnover :$;X (nventory turnover ;X

Cas# IPPPPPPPPPPPPPPP +ccts$ aya&le IPPPPPPPPPPPPPPP
+ccts$ .eceiva&leIPPPPPPPPPPPPPPP ,$ T$ -e&t I 97,777
(nventories IPPPPPPPPPPPPPPP Co!!on stoc% IPPPPPPPPPPPPPPP
Fi)ed assets IPPPPPPPPPPPPPPP .etained earnings I 6<,;77
Total assets I >77,777 Total lia&ilities and
SJ3 eBuity IPPPPPPPPPPPPPPP
Sales IPPPPPPPPPPPPPPP Cost of goods sold IPPPPPPPPPPPPPPP
S/,UT(/0
T/T+, ,(+B(,(T(ES +0- EHU(T1 Q T/T+, +SSETS Q I>77,777
T/T+, -EBT Q T/T+, +SSETS X ;7O Q I:;7,777
+ Q T/T+, -EBT * ,T -EBT Q I:;7,777 * I 97,777 Q I67,777
C/MM/0 ST/CK Q 4T/T+, ,(+B R EHU(T15 * .ET E+.0(0=S * T/T+, -EBT
Q I>77,777 * 4I6<;77 R I67,777 R ;7,7775 Q I;?,;77
S+,ES Q :$; ) T/T+, +SSETS Q I8;7,777
C=S Q sales 4:*$?;5 Q <;O /F S+,ES Q I>><,;77
(0@E0T/.(ES Q S+,ES J ; Q II67,777
-S/ Q +CCTS .ECE(@+B,E J 4+00U+, S+,ES J >975
-S/ Q >9
T3E.EF/.E +CCTS .EC Q 8;7,777J>97 X >9 Q I8;,777
?8
?8
C+S3 R +. Q HU(CK .+T(/ Q "7O /F CU..E0T ,(+B
Q 67,777 X 7$" Q I<?,777
S(0CE +. Q I8;,777 T3E.EF/.E C+S3 Q I<?,777 * I8;,777 Q I?<,777
F(XE- +SSETS Q T/T+, +SSETS * CU..E0T +SSETS 4C+S3 R +. R (0@5
Q I>77,777 * 4I?<,777 R I8;,777 R I67,7775 Q I:>",777
C$&( $F CA'I(AL C$NCE'(&
+$ (ECHNI5%E
L$N> (ER2 %&E& F$R CA'I(AL #%D>E(IN> K%&E L( &$%RCE&
(n t#is course we will li!it our discussion to long ter! de&t, 'referred and co!!on stoc%$
T#ese t#ree e)ternal long ter! financing sources s#ould &e evaluated on an after ta) &asis$
/nly interest on de&t is deducti&le for Federal inco!e ta) 'ur'oses$
2eig#ted average cost of ca'ital 42+CC5 evaluation tec#niBues
+t cost 4as s#own on financial state!ents w#ic# are #istorical5$
(n t#is course we will use #istorical or &oo% values in co!'uting 2+CC$
+t !ar%et 4'articularly i!'ortant for a''reciated eBuity5
(t is i!'ortant to understand, #owever, t#at &oo% values can &e !isleading and t#at
!any analysts atte!'t to assign current !ar%et values in co!'uting 2+CC$
Marginal or 'ros'ective cost 4current rates5 vs$ e!&edded costs$ Focus on current !ar%et
costs 4i$e$ w#at would it cost to go 'u&lic wit# a de&t issue or eBuity issue now5
Floatation costs Susually included &ut a!ortiAed over life of issue$ Underwriting
cost of floating de&t 4'articularly 'rivate 'lace!ents5 is less t#an eBuity
-ifference &etween Fno!inalG FeffectiveG costs is usually ignored$
0ew issue costs are constantly c#anging$ T#e !easure of a de&t issue is t#e rate of
&onds of si!ilar ty'e, Buality 4including su&ordination5 and !aturity$
For!ulas used in co!'uting cost of ca'ital co!'onents:
?ACC F ?d4d,7-(0 ; ?-s4-s ; ?ce4s
4d ,7-t0 4-s F D-s 4 s F D7 ; g 4 e F D7 ; g ,ne9 e@uity0
'n ' 0 ' 0,7-F0
4d F cost o+ de)t 4d,7-t0 is t*e a+ter ta. cost o+ de)t
4-+ F current yied o+ a -re+erreds F '+d. Di=idend G -+d. 'rice
4s F cost o+ e@uity F D7 ,annua D.'.&. ,year 7 in t*e +uture00G -rice ; E
gro9t* in di=idends g.
g may )e estimated using *istorica com-ound gro9t* in E.'.&. or D.'.&.
N F num)er o+ years 'G1 F 7
'B F +irst year ,negati=e0 FB F ast year in time series o+ E'& or D'&
&$LBE F$R IG1 ,t*is is t*e com-ound annua gro9t*0
?ACC F ?EI>H(ED ABERA>E C$&( $F CA'I(AL &(E'&
7. Com-ute t*e -ercentage mi. on t*e )aance s*eet o+ de)t! -re+erred and
?;
?;
e@uity ca-ita. (a<e eac* item and di=ide )y t*e sum o+ t*ese items 9*ic* is
caed Mtota ca-itaiNation.O $ne or more items may )e e.cuded. &ome
com-anies do not use -re+erred stoc< +or e.am-e.
A. Com-ute a+ter ta. cost o+ de)t! -re+erred and e@uity.
3. 2uti-y eac* com-onent a+ter ta. cost time t*e -ercentage mi..
?eig*ted costLe.-ressed as a -ercent.
4. Add eac* 9eig*ted cost in -ercent. (*e sum is ?ACC.
E3A2'LE:
lease use t#e &alance s#eet &elow to calculate t#e after ta) 2+CC for +BC Cor'$
T#e cor'orate ta) rate is 87O$ T#e co!!on dividend is I>$77 and e)'ected to grow at "O$ T#e
stoc% is selling at I?; w#ic# is eBual to &oo% value$
+SSETS ,(+B(,(T(ES +0- EHU(T1
Cas# I:?7
+ccts receiva&le I?87
(nventories I>97 ,$T$ de&t :>O cou'on I::;?
lant & eBui'!ent net I?:97 SJ3 eBuity I:<?"
PPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPP PPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPPP
T/T+, +SSETS I?""7 T/T+, ,(+B & EHU(T1 I?""7
&(E' 7: Kd 4:*T5 Q :>O T4:*$85 <$"O after ta) cost of de&t
K'f 0/T (0 T3(S ./B,EM **use -'f J rice 'fd$
Ks Q -:J7 Rg 23E.E -: Q is t#e -$$S$ ne)t year 4an esti!ate5
Q -7 T 4:Rg5 Q >$77 T4:R$7"5Q 4>$?8J?;5R$7":?$69O R "O Q ?7$69O

&(E' A: 2uti-y cost o+ eac* com-onent times 9eig*t in ca- structure
?ACC F ?d4d,7-(0 ; ?-s4-s ; ?ce4s
I::;? J I?""7 Q 87O 4,T de&t is 87O of total ca'italiAation5
I:<?"J?""7 Q 97O 4eBuity is 97O of ca'italiAation5
<$"O 4after ta) cost of de&t5 T(MES 87O weig#t Q >$:?O
?7$69O cost of eBuity T(MES 97O weig#t Q :?$;<O
?ACC F 7C.8/E
B$ CA'2 CA'I(AL A&&E( 'RICIN> 2$DEL
(*is is an aternate met*od +or determining 9eig*ted a=erage cost o+ ca-ita
T#e Ca'ital +sset ricing Model is a !ar%et driven !odel$ (t is &ased on a Fris% freeG rate$
For situations wit# so!e level of ris%, investors de!and a Fris% 're!iu!$G T#e ris%
're!iu! #as several co!'onents:
-efault or &usiness ris% 're!iu!$ T#is is &ased on siAe of enter'rise and
Ftrac% record$G @enture ca'ital and (/s are t#e !ost ris%y$ T#e nature of
t#e co!'etition and tec#nological c#ange are also i!'ortant #ere$
,iBuidity ris% 're!iu! 4increases wit# ter!5
(nterest rate ris% 4're!iu! for uncertainty of !acroecono!ic conditions5
(nflation ris% 're!iu!
/t#er: regulatory ris%, tec#nological o&solesence, currency ris% (!'ortant
for !ultinational co!'anies5, la&or ris% 4i!'ortant w#en la&or contracts
are in renewal5, environ!ental ris% 4to)ic waste du!' on t#e &ac% 87,
nuclear reactors for utilities5 etc$
EX+M,E: .is% free rate %se (-noteQ !aturity of new issue C.7CE
?9
?9
R Business ris% Co!'any well esta&lis#ed :$77O
R ,iBuidity ris% @aries wit# !aturity
:$77
R (nterest rate ris% Uncertainty ?$77
R (nflation ris% 're!iu! ?$77
Total ris% 're!iu! 8.0E 3 #E(A 7.3 D.60E
($(AL 7A./CE
C+M is a t#eoretical !odel t#at #as draw&ac%s$ Two of t#ese are &eta w#ic# researc# #as not 'roven to
&e relia&le in all cases and t#e fact t#at t#e C+M !odel reBuires an esti!ate of FUTU.E !ar%et returns
or interest rates$ (f we could do t#at we would all &e ric#$
$
Most co!'anies #ire an outside co!'any suc# as invest!ent &an%ing fir! to evaluate ca'ital costs$ T#e
'rocess of e)a!ining t#e condition of t#e fir!, its co!'etitive environ!ent and ris% 'osture, !ar%et
conditions 4re!e!&er new de&t or eBuity issues can &e floated anyw#ere in t#e world for !ultinationals5
and &alance s#eet co!'onents at cost and !ar%et 4re'lace!ent cost5 is called MDue Diigence.O +
docu!ent su!!ariAing t#ese factors is called a MFairness $-inion.O
CA'I(AL #%D>E(IN>
Ca'ital &udgeting is t#e analysis of 'roCects or invest!ents suc# as new 'lant &
eBui'!ent$ Every enter'rise !ust evaluate ca'ital invest!ents$
F(.ST T3E =//- 0E2S: Ca'ital &udgeting is an a''lication of a tec#niBue you #ave
already !astered: 0et resent @alue analysisM
2e will also use 0@ in t#e valuation of &onds and stoc%s$ (t is t#e !ost 'ervasive
conce't in finance$ 1ou will learn t#at t#ere are several tec#niBues used in ca'ital
&udgeting$ +et present value is considered the best &ecause it directly relates to t#e %ey
o&Cective we learned in C#a'ter :: !a)i!iAing s#are#older value$
2e will e)a!ine t#ree tec#niBues used in ca'ital &udgeting:
7. 'ay)ac<
A. Interna Rate o+ Return ,IRR0
>$ Net 'resent Baue ,N'B5
(ER2IN$L$>1: Net in=estment Q cost R ta) R installation R addition to
net wor%ing ca'ital Q C0
De-recia)e )asis F 0et invest!ent less Y in 02C
Net cas* +o9s Q
C
7P.n
Even Cas# flows: T#is is w#ere all cas# flows are t#e sa!e
Can use freBuency %ey on calculator
F
7
etc$
Uneven cas# flows: More nor!al case$ Eac# cas# flow !ust
&e evaluated individually$
?<
?<
-EF(0(T(/0S:
'A1#AC4 T#e nu!&er of years w#ere flows C7
P..
Cn
F
C0
E@E0 C+S3 F,/2S Q C7 J +00U+, C+S3 F,/2
U0E@E0 Q C7 * SUM /F +00U+, CF U0T(, +0S2E. Q 7
ay&ac% #as t#e advantage of &eing conce'tually easy
to understand 4i$e$ ( get !y !oney &ac% in say ; years5$
(*e -ro)ems 9it* t*e -ay)ac< a--roac* are:
:$ T#e nu!&er of years to recou' t#e initial invest!ent is
ar&itrary and is not co!'ared wit# any standard !easure
or &enc#!ar%$
?$ ay&ac% ignores cas# flows &eyond t#e 'ay&ac% 'eriod$
ay&ac% ignores t#e ti!e value of !oney$
CA'I(AL #%D>E(IN> C$N(D$
IRR T#at discount rate w#ere @4inflows5 Q @ 4outflows5
(.. is t#e interest rate t#at sets 0@ Q 7

C
E
?
CF
1
?
CF
B
?F? CF
n
9 E
11 ? IRR2
1
11?IRR2
B
(1)..)
3
(n order for a 'roCect to &e acce'ted, t#e (.. !ust usually
&e larger t#an a F#urdle rate$G T#is is usually defined
as t#e weig#ted average cost of ca'ital 42+CC5$
&(E' 7 in (.. analysis is to solve t#e (.. eBuation using
your financial calculator$
&(E' A in (.. analysis is to co!'are t#e co!'uted (..
wit# t#e reBuired rate of return 4usually 2+CC5$ (f t#e
(.. e.ceeds t#e reBuired rate of return, t#e 'roCect s#ould
&e acce-ted. (f it is ess! t#e 'roCect s#ould &e reQected$
0@ Calculates t#e net 'resent value of all cas# flows
4outflows and inflows5 discounted at t#e 2+CC$
N'B I& C$NCE'(%ALL1 (HE 2$&( C$RREC(
MET3/-$ (F C/MET(0= MET3/-S =(@E
-(FFE.E0T .ESU,TS, T3E 0@ S/,UT(/0 (S
T3E /0E T/ USE$
+PV Q .* ,F 3)$)FI&/ A .* ,F C,/&/
?"
?"
T#is difference is t#e net 'resent value of t#e 'roCect$
(f t#e 0@ is -ositi=e, &enefits e)ceed costs and 'roCect
would &e acce-ted$ + negati=e 0@ !eans costs e)ceed
&enefits and 'roCect would &e reQected$ T#e disount rate
used is t#e 2+CC or Re@uired rate o+ return$
/T3E. TE.MS MUTU+,,1 EXC,US(@E ./DECTS roCects w#ere
acce'tance of one 'roCect forces reCection of anot#er 'roCect$
(0-EE0-E0T ./DECTS: roCects w#ere acce'tance
of one does not lead to reCection of ot#ers$
C+(T+, .+T(/0(0=: Ty'ical situation w#ere li!ited
&udget li!its nu!&er of 'roCects wit# 'ositive 0@s t#at
can &e acce'ted$ (n ca'ital rationing, a fir! !ust ran% w#ic#
'ositive 0@ 'roCects to acce't$
2+CC Q WO in eBuity at &oo% ) cost of eBuity after ta)X R
WO in de&t at &oo% ) after ta) cost of de&tXR
WO in 'fd$ Stoc% ) after ta) cost of 'fdX
0/TE: /nly interest on de&t is ta) deducti&le$
'R$#LE2& IN CA'I(AL #%D>E(IN>

CA&H FL$? Q 0ET (0C/ME +FTE. F(T R -E.EC,
$'ERA(IN> CA&H FL$? Q 0ET (0C/ME R T+X S+@(0=S /0 -E.$
DE'RECIA#LE #A&I& 4-B5Q -irect cost of eBui'!ent, ta)es and set u' &ut
e)cluding wor%ing ca'ital reBuire!ents$
NE( INBE&(2EN( Q EBui'!ent or 'roCect cost including set u', ta)es, delivery and
wor%ing ca'ital needs$ 40( Q -B R C3+0=E (0 2C5
C/. + C/. B
.ET+X (0C/ME I:77 I:77
F(T .+TE 87O >7O
0ET (0C/ME I97 I<7
-E.EC(+T(/0 I:77 I7
CA&H FL$? I:97 I<7
CF Q net inco!e or net savings 'lus de'reciation
DE'RECIA(I$N C$NCE'(&:
?*at a++ects de-reciation:
7. De-recia)e )asis F net outay ; s*i--ing! ta.! instaation
A. Asset i+e +or accounting -ur-oses
3. De-reciation accounting met*od used
&.L. I& 2$&( C$N&ERBA(IBE. De-reciation is a N$N CA&H
c*arge. Com-anies -re+er acceerated de-reciation )ecause it resuts
in more ra-id ta. sa=ings.
I::77 (0@ESTME0T 2(T3I:77 s#i''ing cost
; 1E+. ,(FE and I:77 salvage value
-E.EC(+B,E B+S(S Q I:?77 Basis is 0/T adCusted for salvage value
?6
?6
4straignt line5 S$,$ -E.EC I?87 oer year
C/0@E0T(/0: +ssu!e asset is 'laced in service in !iddle of year :
M+C.S Modified accellerated cost recovery syste! 4re'laces --B and
M+C.S C,+SS -e'reciation sc#edule as O of -e'recia&le &asis
M+C.S T+B,E 2(,, BE =(@E0 (0 +0 EX+M
; 1E+. ./DECT
1E+. :?7O 3alf year convention
1E+. ?>?O
1E+. >:6O
1E+. 8:?
1E+. ;::
1E+. 9 9
DEFINI(I$N&
.E,+CEME0T Q -ecision to totally re'lace an e)isting asset t#at is still
'roductive wit# a new asset$

S+,@+=E @+,UE Q esti!ate of value of asset as scra' at end of useful life$
(nclude -EC/MM(SS(/0(0= C/STS $ Salvage value
ma; be ne!ative suc# as in t#e case of a !ining co!'any w#o !ust restore
land to for!er condition$
'R$#LE2& IN CA'I(AL #%D>E(IN> C$N(D$
-EF(0(T(/0: (ncre!ental cas# flowsQ t#ose !arginal returns t#at directly
i!'act decision to acce't or reCect 'roCect
-EF(0(T(/0: SU0K C/STS /utlay t#at #as &een incurred and cannot
&e recovered
3ow do you co!'are a 'roCect suc# as a new s#o''ing center w#ere site
'lans and surveys #ave &een conducted vs a FgreenfieldG locationL
-EF(0(T(/0: /''ortunity costs Q return on BEST +,TE.0+T(@E use
of an asset
EXTE.0+,(T(ES: Effects of decision on ot#er 'arts of t#e fir!$
(0-(.ECT C/STS 4S3((0= +0- (0ST+,,+T(/0, T+X, ETC5 Q
+ny cost included in de'recia&le &asis
(0@ESTME0T (0 0ET 2/.K(0= C+(T+, 2C 4C+*C,5 Q s#ort ter!
funds needed to su''ort 'roCect 4inventory, accounts receiva&le financed
etc5$ T#is is a C/ST 4 'art of net invest!ent5 and !ay &e recovered as a
/S(T(@E cas# flow at t#e end of 'roCect life$
S/,@(0= + C+(T+, BU-=T(0= ./B,EM 23E.E C+S3 F,/2S MUST BE C+,CU,+TE-
&(E' $NE: -ETE.M(0E -E.EC(+B,E B+S(S
T#is is &asis for de'reciation$ (t includes net cost R installation R ta)
&(E' (?$: -ETE.M(0E 0ET (0@ESTME0T. $I on &I3AB? cash lo( (or<sheet is CF0
S/ME ./B,EMS 2(,, C/0S(-E. T+0=(B,E +0- (0T+0=(B,E C+(T+, /UT,+1 C/STS 4if
Buantifia&le5$ S/ME /F T3ESE C/STS +.E EST(M+TES$
F/. +0 EX+0S(/0 ./DECT S t#ere are > ele!ents in net outlay
F/. + .E,+CEME0T ./DECT T3E.E +.E 8 ele!ents
&(E' (HREE: REBEN%E $R &ABIN>& F$RECA&( ,usuay gi=en in -ro)em0
Use a s'reads#eet to esti!ate S+,ES for life of 'roCect
.evenues Q 'rice ti!es esti!ated volu!e
+n e)a! Buestion !ay give you S+@(0=S fro! a 'roCect or !ac#ine$
>7
>7

&(E' (HREE C/M,ETE + ./*F/.M+ &,
:$ Fro! sales or savings SUBT.+CT
?$ costs
>$ de'reciation 40/TE: Use M+C.S ta&le if needed to co!'ute de'r$5
8$ -eter!ine 'reta) inco!e and co!'ute ta)es
0et inco!e Q net inco!e after ta)es and all e)'enses including de'reciation
Esti!ate /E.+T(0= C+S3 F,/2 for esti!ated life of 'roCect
%/F = +,T )+/%', T*0 (*V)+-( %+ ",P.,/)*T)%+
&(E' F$%R: -eter!ine additional cas# flow in last year fro! sale of !ac#ine 4Salvage @alue5
:$ Fro! salvage value 4given in 'ro&le!5 SUBT.+CT any re!aining &asis
4O unde'reciated a!ount on M+C.S ta&le ti!es de'r$ Basis5
?$ Co!'ute ta) on net recovery 4S@ * re!aining &asis5 X F(T rate
>$ Su&tract ta) fro! S@$ T3(S (S +--(T(/0+, CF (0 ,+ST 1E+.
8$ +dd additional cas# flow fro! salvage to /CF in last year
&(E' C: -.+2 T(ME ,(0E +0- C+,CU,+TE 0@ +0- (.. F/. ./DECT
Use cas# flow wor%s#eet on T(B+?R$ (nclude +,, cas# flows including net salvage
CA'I(AL #%D>E(IN> 'R$#LE2
T#e CE/ of your fir! #as as%ed you to evaluate t#e acBuisition of a new co!'uter$ T#e 'rice is
I>7,777 and it falls into t#e M+C.S > year class$ Ta) and installation costs are I:7,777 and
esti!ated increase in new wor%ing ca'ital 402C5 is I?777$ 1ou esti!ate t#e co!'uter would
increase revenues &y I?7,777 'er year &ut would also increase o'erating costs &y I;,777 'er year$
T#e co!'uter will &e used for > years and sold for I?;,777$ T#e fir!Ks ta) rate is 87O and its
2+CC is :8O
Calculate t#e net invest!ent and de'recia&le &asis in year t Q 7:
2#at is t#e o'erating cas# flow in year ?L
&$L%(I$N:
C/ST /F EHU(ME0T I>7,777
T+X R (0ST+,,+T(/0 I:7,777
DE'RECIA#LE #A&I& J40!000
R 0ET (0C.E+SE (0 02C ?,777
NE( INBE&(2EN( J4A!000 T3(S (S CF7
2ACR& DE'RECIA(I$N ,(A#LE ?ILL #E >IBEN IN AN E3A20 ''. 3C-3D A--endi. 7A
1E+. O of de'$ Basis -E.EC(+T(/0T+X S+@(0=S 487O5
: >>O I:>,?77 I;,?"7
? 8; I:",777 I<,?77
> :; I 9,777 I?,877
8 < I ?,"77 USE- (0 S+,@+=E @+, BE,/2
'R$-F$R2A INC$2E &(A(E2EN(
1E+. : ? >
.E@E0UES I?7,777 I?7,777 I?7,777
LE&& -(.ECT EXE0SES I ;,777 I ;,777 I ;,777
EB-(T
LE&& -E.EC(+T(/0 I:>,?77 I:",777 I 9,777
.ET+X I :,"77 I4>,7775 I 6,777
,ESS F(T 87O I <?7 I :,?77 C. I >,977
0ET I :,7"7 I4:,"775 I ;,877
you were as%ed to calculate o'erating cas# flow w#ic# was defined on for!ula 'age as net inco!e 'lus
ta) savings on de'reciation: 1E+. : 1E+. ? 1E+. >
>:
>:
0ET ,US S+@(0=S /0
-E. 4-EF (0 F/.MU,+S5 I 9,>97 I ;,877 I <,"77
S+,@+=E 4>
rd
year cas# flow5 S+,@ @+,UE I?;,777
,ESS: T+X /0 S$@$ 487O5 4 ","775 TT 4I?;,777*I?,"775 ) 87O
,US: (ncrease in 02C ?,777
C+S3 F,/2 (0 1E+. > I:",:?7
C+S3 F,/2S
net invest!ent CF0 *I8?,777 4T3(S (S + 0E=+T(@E 0UMBE.5 231L
C$7 F$7 F 7 9,>97
C0A F$A F 7 ;,877
C03 F$3 F 7 ?;,6?7 4/CF R salvage and 02C Y5
&$LBE F$R N'B ,I F 740 Enter as :8, not $:8 Q I4:8,<<:5
CA'I(AL &(R%C(%RE AND LEBERA>E
Ca'ital structure loo%s at ways to /T(M(ZE ca'ital structure 4de&t vs eBuity5
&I3 I2'$R(AN( (ER2&:
:$$EB(T Earnings &efore interest and ta)es
reta) inco!e R interest e)'ense on de&t
?$ /E.+T(0= ,E@E.+=E #ig# fi)ed costs -/, Q O C3= (0 EB(T J O C3= (0 S+,ES
>$ F(0+0C(+, ,E@E.+=E T#e degree to w#ic# t#e use of de&t and 'fd 'laces additional
financial ris%s on co!!on s#are#olders$
E CH> IN E'& G E CH> IN E#I(
Conce't: USE /F -EBT M+=0(F1(ES C3+0=ES (0 S+,ES
(T C+0 M+=0(F1 E$$S$$ +0- ./E (0 =//- T(MES
(T C+0 3+@E @E.1 0E=+T(@E C/0SEHUE0CES
(f interest is reduced or eli!inated t#is goes to t#e &otto! line
8$ T/T+, ,E@E.+=E -T, Q -/, T -F,
3ow !uc# increase in ES will result fro! a O increase in Sales
3(=3,1 ,E@E.+=E- F(.MS SE,, +T ,/2E. JE .+T(/S
T3+0 ,/2E. ,E@E.+=E- F(.MS$ 231L
;$ BUS(0ESS .(SK @aria&ility, cyclicality, 'rice sensitivity
F+CT/.S @+.1 B1 (0-UST.1
:$ -EM+0- @+.(+B(,(T1
?$ .+2 M+TE.(+, C/ST @+.(+B(,(T1
>$ .(C(0= F,EX(B(,(T1
+&ility to !aintain !argins in face of Y costs
8$ ,E@E, /F F(XE- C/STS & /E.+T(0= ,E@E.+=E

Utilities #ave steady de!and and fuel adCust!ent clauses$
Even t#oug# t#ey #ave #ig# fi)ed costsE&usiness ris% is low
Steel !ills #ave very #ig# o'erating leverage and &usiness ris%
+ '#ar!aceutical !anufacturer tends to #ave low &usiness ris%
>?
>?
9$ /T(M+, C+(T+, ST.UCTU.E T#at !i) of de&t and eBuity t#at !a)i!iAes 'rice of stoc%
/. M+X(M(ZES S3+.E3/,-E. @+,UE
o-erating e=erage R +inancia e=erage
/'erating leverage is a ter! in finance t#at refers to t#e cost structure of t#e fir!$ Ty'ically, fir!s wit#
#ig# o'erating leverage #ave #eavy fi)ed costs suc# as electric utilities$ T#e rule of t#u!& is t#at fir!s
wit# #ig# o'erating leverage MUST #ave low financial leverage$
FINANCIAL &(R%C(%RE AND LEBERA>E contd .
'ease see C* 73 and accom-aning *andout. Learn +ormuas on -. 4/3. Formuas can )e at one
-oint o+ out-ut or )et9een t9o -oints.
#E' ,)rea<e=en -oint0 is t*at e=e o+ out-ut ,in doars or units0 9*ere Nero -ro+it or oss is reac*ed
Financia e=erage is t*e use o+ de)t in t*e +inancia or ca-itaiNation structure.
$-erating e=erage is t*e e++ect o+ *ig* +i.ed costs. Hig* +i.ed costs resut in a *ig* )rea<e=en -oint.
DCL ,Degree o+ Com)ined e=erage0 F Financia Le=erage 3 $-erating e=erage
F$R2%LA& F$R $'ERA(IN> AND FINANCIAL LEBERA>E
/'erating and financial leverage M+=0(F1 t#e i!'act of a c#ange in sales or EB(T$ T#is e)'ressed as a
!ulti'le or 'ercentage$
F$R2%LA& see te.t '. 4/3 F$R2%LA& >IBEN $N E3A2. 1ou must <no9 9*ic* one to use.
#E(?EEN A '$IN(& A( $NE '$IN( $F $%('%( 5
BE 4in units5 H& Q F J 4 * @5
-/, 4degree of o'erating leverage5 O c#ange in EB(T .BFC
O c#ange in Sales EB(T
-F, 4degree of financial leverage5 O c#ange in E$$S$ EB(T
O c#ange in EB(T EBT
-C, 4degree of co!&ined leverage5 O c#ange in E$$S$ .BFC
O c#ange in Sales EBT
(n solving any leverage 'ro&le!s t#e F(.ST STE is to construct an inco!e state!ent si!ilar to t#at
given on 8"6 of your te)t and on t#e ne)t 'age of t#ese lecture notes 4'$ >95 &elow$
RA(I$& DEALIN> ?I(H LEBERA>E:
T(E .+T(/ 4!argin of safety5 EB(T J ( ( Q (0TE.EST C/STS /0 (0C ST+TEME0T
X F(XE- C3+.=ES EB(T R ,E+SE MTS
( R ,E+SE MTS R SF MTS +FTE. T+X SEE $ ";
,//K +T C+(T+, ST.UCTU.ES F/. -(FFE.E0T (0-UST.(ES
-.U=S ,/2 -EBT 3(=3 ./E
E,ECT./0(CS 3(=3E. -EBT +@= ./E
.ET+(,(0= 3(=3 -EBT +@= ./E
UT(,(T(ES @E.1 3(=3 -EBT ,/2 ./E
>>
>>
23(C3 (0-UST.1 2/U,- 1/U ,(KE T/ /20 +S +0 (0@EST/.L
C$NCE'( $F FINANCIAL FLE3I#ILI(1
:$ .ating agencies S& and MoodyKs rate cor'orate de&t 4+++ to C5
Ban%s and ot#er !oney !ar%et lenders also evaluate ris% and 'rice loans accordingly$
($E$ 3(=3E. .(SK Q 3(=3E. (0TE.EST .+TE /0 ,/+0S
?$ 3ig# ratings !ean lower Kd 4cost of de&t5 and lower 2+CC
FIN 3403 LEBERA>E 'R$#LE2
Facts: F(T rate ;7O
T/T+, -EBT I?7 M(,,(/0
+@= -EBT C/ST <$;O
F(XE- C/STS I8 M(,,(/0
@+.(+B,E C/STS I ? E. U0(T
.(CE I8 E. U0(T
C/MM/0 S3+.ES /UT :,777,777
'RE'ARE A 'R$ F$R2A ':L A( 4 2ILLI$N %NI(& $F $%('%(

&ALE& 4units ) 'rice 'er unit Q I8 ) 8MM5 I:9,777,777
,ess @+.(+B,E C/STS ",777,777 I? ) 8 MM units
Q R#FC 4revenue &efore fi)ed costs5 ",777,777 C,$&RI3 -AR5I$ 9 GE=
* F(XE- C/STS 8,777,777
Q E#I( 4earnings &efore int and ta)es5 8,777,777
* (0TE.EST EXE0SE :,;77,777 <$;O of I?7 MM
F 'reta. income ,E#(0 A!C00!000
* FI( 'AID 1$,&) 12 :,:;7,777 ;7O F(T rate
Q 0ET (0C/ME NI :,?;7,777
Earnings J s#are 4E$$S$5 0( J s#s out I:$?;
0/TE :: (f EBT is negative 4a loss5 t#e convention we use in t#is course is t#at ta)es are
a C.E-(T 4ta) rate ti!es EBT5$ (n t#e real world, co!'anies can a''ly ta) loss
carryforwards$ lease see Te)t '$ ::$
+$ -/, Q rev &ef fi)ed costs J EB(T QI"MM J I8MM Q ?X
B$ -F, Q EB(T J 4EB(T S (5 Q I8MM J I?$;MM Q :$9X
0/TE: EB(T S ( Q .ET+X /. EBT
C$ -C, +T I:9MM /UTUT Q 4?5 4:$95 Q >$? X
-$ ?7O (0C.E+SE (0 S+,ES X >$? Q 98O (0C.E+SE (0 E$$S$ Q I?$7; E.
S3+.E
E$ STQ BE (0 -/,,+.S Q F J C/0T.(B M+.=(0 Q I8 MM J $; Q I" MM
C,$&RI3%&I,$ -AR5I$ I/ R3FC 6 /A+)/
>8
>8
FIN 3404 ($'IC&
Material in t#is section is 'ri!arily covered in t#e F(0 >878 course$
Fin >878 will review t#e following !aterial:
Ti!e @alue of Money conce'ts
Use of t#e T(B+((R Financial Calculator$
1ou !ay #ave used anot#er calcualtor in F(0 >87>
( a! sorry &ut you will need to get a T(B+((R calculator for t#is course
since all lectures, t#is wor%&oo% and t#e te)t are %eyed to it$
Ca'ital &udgeting
Cost of Ca'ital
Financial state!ent analysis
F(0 >87> will cover so!e of t#e ele!ents included &elow on an introductory &asis:
Stoc% and Bond @aluation
Financial Mar%ets and (nstru!ents
/'tions and Futures 4ti!e 'er!itting5
F(0 >878 will e)'lore t#e following new !aterial:
Financial forecasting using s'reads#eet !odels
Cas#, receiva&les and inventory !anage!ent and &udgeting
Merger and +cBuisition analysis
(nternational finance issues
Converti&le securities
+dditional !aterial in use of derivatives$ 0/TE: Students interested in
e)'loring derivatives in !ore de't# s#ould consider ta%ing t#e S'eculative
Mar%ets course
2e will see% to introduce current events on t#e a&ove to'ics into class discussion$
#ot* courses 9i utiiNe a team E.ce &-reads*eet Anaysis o+ a
com-any o+ your c*oice --,must )e a--ro=ed )y instructor0.
>;
>;
FINANCIAL F$RECA&(IN>
/ne of t#e !aCor differences &etween accounting and finance is t#at accounting tends to loo% in t#e rear
view !irror and 're'are #istorical state!ents fro! 'ast results w#ereas finance is constantly engaged in
doing w#at is called F'ro for!a analysisG or Fw#at if scenarios$G
Forecasting and 'lanning is covered in C#a'ter 8 of your te)t$
Financial !odeling is an e)citing area of finance$ Using tools ranging fro! E)cel S'reads#eets suc# as
t#at you will wor% on in your co!'any re'ort to so'#isticated su'er co!'uters using artificial
intelligence, financial !odeling see%s to evaulate !ar%ets, !a%e 'roCections and assist t#e !anager,
trader or analyst in decision !a%ing$
/n 2all Street, !uc# of t#e for!er drudgery in t#e for! of nu!&er crunc#ing is now eli!inated t#roug#
so'#isticated !odels$ 3ig#ly 'aid securities analysts &uild industry !odels to #el' t#e! %ee' trac% of t#e
i!'act of varia&les on t#eir co!'anies$ + si!'le e)a!'le would &e a crude oil 'rice !odel t#at would &e
%eyed into individual oil stoc% inco!e state!ent 'roCections$ Since oil de!and is relatively inelastic,
decreases in 'rice do not translate into a !eaningful volu!e gain$ Crude is a volatile co!!odity$ rice
c#anges i!'act t#e inco!e state!ent al!ost i!!ediately de'ending on t#e ty'e of inventory accounting$
Most U$S$ fir!s use ,(F/, so t#e i!'act is felt rig#t away$
(f you are rusty on accounting, you need to &rus# u' on ratios 4see Te)t '$ :79 and a''endi) to t#is
wor%&oo%5, t#e difference &etween a cas# flow state!ent and an inco!e state!ent and funda!entals
covered in C#a'ter >$ (t is i!'ortant t#at all students carefully review and understand t#e -uont Model
on '$ :7<$ T#is !odel s#ows t#e i!'act of various &alance s#eet and inco!e state!ent ele!ents on
.eturn on EBuity w#ic# is t#e !ost i!'ortant financial ratio since it !easures #ow well !anage!ent is
!a)i!iAing s#are#older value$
(t is i!'ortant to understand t#at Earnings er S#are can &e influenced &y a variety of forces$ So!e of
t#ese are under t#e direct control of t#e financial !anager$ /t#ers are inde'endent of t#e fir! suc# as t#e
econo!ic environ!ent, foreign currency translation i!'act, govern!ent ta)es and regulation etc$ ,et us
e)a!ine so!e of t#e ways ES can increase$
:$ .evenue increases$ Two ele!ents influence revenue increases:
rices are #i%ed
Unit volu!e is increased
?$ rofit !argins widen 4gross !argin, o'erating !argin, 'reta) and net !argin are influenced &y
different forces$5
>$ T#e Ta) rate is cut eit#er &y t#e =overn!ent or &y 'lanning, ta) incentives, etc$$
8$ Financial leverage is used to !agnify s!all c#anges in revenues to t#e &otto! line$
;$ T#e 'roduct !i) c#anges wit# a greater e!'#asis on #ig#er !argin 'roducts or services$
9$ + co!!on s#are re'urc#ase is effected$ .educing t#e s#are count increases E$$S$
<$ Costs are reduced$ T#e 'rocess of F-ownsiAingG is a !aCor recent trend$ Cost cutting falls into !any
categories so!e e)a!'les include:
.educing 'ersonnel t#roug# reduction in force 4.(F5
Cutting s'ecific internal co!'onent costs suc# as inventory t#roug# &etter !anage!ent suc#
as FCust in ti!eG tec#niBues, or new tec#nology suc# as ro&otics$
Cutting costs fro! outside su''liers
Ta) strategies suc# as &uilding a 'lant in an enter'rise Aone or ta) #aven
Sale * lease&ac%s of assets to increase return on assets and ./(
"$ oor 'erfor!ing su&sidiaries are sold w#ic# reduces costs and i!'roves !argins$
>9
>9
6$ + non*dilutive acBuisition is !ade$ 2e will discuss w#at dilution is later$ Basically it refers to t#e
return earned on an acBuisition is vs$ t#e cost of funds$
F$RECA&(IN> %&IN> AN E3CEL &'READ&HEE(
(n your co!'any E)cel s'reads#eet after t#e ratio 'age, t#e co!'uter 'rovides for a si!'ly &,
forecasting !odel to 'roCect E$$S$ for t#e ne)t ; years$ Enter data only w#ere indicated$
+%T,< )n this model= enter data in ;ellow cells onl;. *ll ;ellow cells must be filled in for the model to
wor>. )f ;ou onl; have : se!ments but the model as>s for 8= enter 6s on row five in the ;ellow cells.
1ou are reBuired to enter seg!ent data for sales, !argins and growt# rates$ Most co!'anies 'rovide sales
&rea%down data &y 'roduct line or in geogra'#ic seg!ents$ So!e 'rovide !argin data$ @irtually none
'rovide esti!ated growt# rates &y seg!ent and you will #ave to esti!ate t#is$
Financial forecasting is an educated guess$ (t is not roc%et science$ T#e ele!ents in your forecast are:
:$ -evelo'ing a sales !i) &y 'roduct line, division, or geogra'#ic !i)$ T#is !ay &e 'rovided in t#e
:7K or you !ay need to !a%e so!e assu!'tions and engage in educated guesswor%$
?$ Esti!ating t#e o'erating or gross !argin &y 'roduct line or division$
>$ Esti!ating t#e revenue growt# rate 4units X 'rice c#ange5 for eac# seg!ent in 'ercent$
8$ Ma%ing sure t#at t#e &otto! lines for #istorical data agree wit# actual results$ For e)a!'le, t#e total
of seg!ent sales MUST eBual actual cor'orate sales for t#e 'receeding fiscal year$ T#e total gross or
o'erating inco!e MUST eBual actual data$ T#e growt# rate s#ould &e &ased on 'ast trends$ Be
conservative$ T#e !odel forecasts ES$ T#is s#ould &e close to recent results fro! :7H data$
T#e co!'uter will !a%e a 'roCection &ased on t#ese ele!ents$ +s a !anager, you need to (0TE..ET
t#is out'ut$ -oes is !a%e senseL 3ere is #ow you do t#at:
:$ ,oo% at t#e current year forecast$ 3ow !uc# did sales and ES increaseL -id ES increase !ore
t#an salesL 2#yL 4See all t#e ele!ents listed on t#e 'revious 'age t#at can !agnify ES relative to
sales5
+re your !argins roug#ly t#e sa!e as last year or did t#ey increase !aterially$ Can you
Custify t#e increase$ (f not, go &ac% to t#e to' of t#e !odel and reduce your !argin esti!ates
&y division or growt# rates for #ig#er !argin divisions$
C#ec% t#e ta) rate$ 3as it c#angedL -oes t#is !a%e senseL
?$ (f you are near t#e end of t#e fiscal year, #ow does your nu!&er co!'are wit# actual Buarterly data$
(f you too% a trend line forecast of t#e re!aining Buarters in t#e year would your 'roCection &e closeL
>$ Co!'are your nu!&ers wit# a forecast of a 'rofessional analyst or @alue ,ine 4if availa&le5
Eac# tea! s#ould #and in your !odel$ Try different assu!'tions$ T#is is called Fsensitivity analysis$G
2#at are your conclusions$
F$RECA&(IN> %&IN> HI&($RICAL RA(I$&
lease refer to 'ro&le! 8*; B in your te)t$ Co!'ute t#e &alance s#eet$
lease refer to 'age :< 4a&ove5 in t#is wor%&oo%$ 2e will wor% t#is in class$
T#ese %ind of 'ro&le!s are ty'ical e)a! Buestions$
2:A ,2ER>ER AND AC5%I&I(I$N0 ANAL1&I& ,(E3( CH. A70
.estructuring and M&+ is a s'ecial su&set of t#e forecasting !odel$ T#is is covered in C#$ ?: of your
te)t$
+s #ead of t#e Ca'ital Mar%ets =rou' at a &ro%erage fir!, ( su'ervised researc# and FCor'orate FinanceG
activities$ Cor'orate Finance analysts were engaged in M&+ and new issues 4(/s or initial 'u&lic
2:A ,2ER>ER AND AC5%I&I(I$N0 ANAL1&I& ,(E3( CH. A70
><
><
offerings and secondaries5$ T#eir Co& 4for w#ic# t#ey are e)tre!ely #ig#ly co!'ensated, is to develo' 'ro*
for!a 'roCections and Fw#at ifG scenarios$
(n C#a'ter 8 and in your 'roCect, t#e !ain !et#od of forecasting is called t#e F'ercentage of salesG
!et#od$ (t is si!'ly a trend line 'roCection$ MS E)cel #as &uilt in functions t#at will do least sBuares
trend line 'roCections$ T#is wor%s well for co!'anies and industries w#ic# are non*cyclical and w#ere
growt# is &ased on de!ogra'#ic factors rat#er t#an .&- or new 'roduct develo'!ent$ T#is !et#od does
0/T wor% for cyclical enter'rises, co!'anies engaged in acBuisition or divertiture or fir!s suc# as #ig#
tec# enter'rises de'endent on new 'roducts$
M&+ analysis is an MB+ level analytical 'roCect$ (t is &eyond t#e sco'e of t#is course$ M&+ can &e a
relatively si!'le !atter #owever$ (f Co!'any + &uys Co!'any B using 'urc#ase and not 'ooling of
interest accounting, in general t#e co!&ined &alance s#eet and inco!e state!ents will &e t#e su! of t#e
two inde'endent &alance s#eets 'lus =oodwill$ Co!'uter software is availa&le t#at will co!&ine t#e
state!ents into a si!'le 'ro*for!a$
(n t#e late Si)ties and early Seventies, a 'ro!inent sc#ool of t#oug#t in M&+ was du&&ed t#e
FConglo!erateG !erger$ T#is !erger co!&ined entities t#at were see!ingly unrelated$ T#is was in star%
contrast to t#e !ergers driven &y vertical integration see%ing to control t#e entire distri&ution c#annel
fro! raw !aterial to t#e custo!er or t#e #oriAontal deal see%ing to do!inate a given seg!ent or !ar%et
across 'roduct lines$ T#e &uAAword for t#e conglo!erate deal was:
A ; A F C T#is is called FSynergy$G
-oes it wor%L T#e results are !i)ed$
T#e Eig#ties focused on t#e ,B/ or leveraged &uyout using !assive a!ounts of de&t$ T#is was M&+
using financial leverage to t#e !a)$ (t wor%ed until interest rates rose and forced !any fir!s into C#$ ::$
T#e 0ineties concentrated on undoing t#e e)cesses of t#e Eig#ties$ T#e 0ineties #ave focused on
divestitures of acBuisitions !ade during t#e conglo!erate era$ T#e o&Cective now is to return t#e co!'any
to its FcoreG &usiness or co!'etency$ T#is #as seen =M sell off its 3ug#es Electronics and E-S divisions
for e)a!'le$ er#a's t#e 0ineties s#ould &e la&elled 8 * ? Q >$ Conglo!erates 'osed a 'ro&le!$
Managers did not understand t#e %ey 'roduct or service$ T#ere were so !any divisions in large
co!'anies t#at to' !anage!ent often did not %now w#at &usiness t#ey were in$ T#e era of FdownsiAingG
now see%s to return to a co!'anyKs roots$
?HA( I& A FIR2 ?$R(HH
2e #ave studied valuation of stoc%s and &onds$ 1ou understand ter!s li%e B@S 4&oo% value 'er s#are5,
rice to &oo% and JE 4'rice J earnings 'er s#are5$
3ow do you value a fir!L See Te)t '$ ":<*">7
Consider 2eyer#auser or =eorgia acific$ T#ese are ti!&er co!'anies w#ere t#e assets are rig#t t#ere
growing &efore your eyes$ T#e &alance s#eet reflects #istorical cost$ =eorge 2eyer#aeuser 'urc#ased
'ri!e acific 0ort#west #ardwood forest land for a song$ T#is is true for co!'anies li%e Britis#
etroleu! w#ic# 'urc#ased Standard /il of /#ioKs 4t#e original Standard /il5 +las%an 0ort# Slo'e oil
fields$ Clearly &alance s#eet value for !any fi)ed assets is not useful in deter!ining !ar%et value$
0or!ally current assets are !ar%ed to !ar%et so t#eir values are /K$
?HA( I& A FIR2 ?$R(HH contd.
C# ?: loo%s at so!e ways to develo' a fair !ar%et value for an enter'rise:
:$ #oo< Baue 4stated s#are#olderKs eBuity 'er s#are5$ T#is wor%s for so!e enter'rises li%e &an%s$
>"
>"
?$ A--raisa. T#is would wor% for a real estate fir! or even 2eyer#aeuser$ /&viously if t#e forest
&urns, t#is a''raisal would &e adCusted$ (f 'rices for ti!&er decline t#is would also affect valuation$
>$ &toc< 2ar<et Baue. T#eoretically, in a 'erfectly efficient !ar%et w#ere all infor!ation is %nown,
t#e !ar%et ca'italiAation of a co!'any reflects its value$ 2#y t#en are ot#er co!'anies willing to
'ay &ig re!iu!s in an acBuisitionL T#e answer can include t#at old conce't: synergy 4econo!ies of
scale5, assu!'tions a&out future earnings etc$ 0evert#eless, a !ar%et w#ere assets are freely traded is
t#e &est ar&iter of value since it re'resents fair !ar%et transactions &etween willing &uyers and sellers$
8$ &egment or c*o- s*o- =aue$ T#e 'arts !ay &e wort# !ore t#an t#e w#ole$ T#e 'arts in a used car
are wort# > ti!es t#e value of t#e car itself$ T#is is w#y car t#ieves usually avoid new cars and
concentrate on ?*; year old cars$ T#e sa!e is true of co!'anies$
;$ Cas* +o9 =aue. 2#at is cas# flowL (t is 0/T t#e sa!e as accounting 'rofit$ (n Da'an, +,,
co!'anies are !anaged &ased on cas# flow$ + co!'any wit# su&stantial de'reciation, de'letion or
a!ortiAation e)'ense 'ays less ta)es$ T#is can &e valua&le to an acBuiring co!'any 'aying t#e
!a)i!u! cor'orate ta) &rac%et$ Co!'anies wit# large loss carryforwards !ay co!!and 're!iu!
'rices in an acBuisition for si!ilar reasons$
CHALLEN>E& AND LI2I(A(I$N& IN FINANCIAL F$RECA&(IN>
My 2all Street analysts &elieved everyt#ing could &e si!ulated in a !odel$ (f co!'uters could accurately
forecast our co!'le) environ!ent we would not need educated, t#in%ing !anagers li%e you$ Models are
valua&le tools$ 3owever t#ey #ave t#eir li!itations:
:$ T#e world is a co!'le) 'lace and it is constantly c#anging$ Events in +sia can affect your &usiness$
=overn!ent regulations can i!'act you in une)'ected ways$ Models si!'ly cannot &e large enoug#
to antici'ate all t#ese varia&les$ 3owever as we &uild !ore and !ore so'#isticated financial and
econo!etric !odels we do get &etter at understanding %ey interrelations#i's$
?$ (n a cor'oration !anagers are e)'ert !odel &uilders$ Most financial e)ecutives ( #ave %nown are
e)'ert at designing !odels to !a%e t#e!selves loo% good$ ,et us assu!e you are t#e C#ief Financial
/fficer at a large co!'any and you #ave ; vice 'residents re'orting to you$ Eac# @$$ 'resents
ca'ital &udgeting 'roCects to you for consideration$ Eac# #as a vested interest in getting #isJ#er
'roCect a''roved since it !eans !oney, 'restige and 'ro!otions$ 1our c#allenge is to dig t#roug#
t#e assu!'tions in t#e !odel to sort out #y'e, fuAAy t#in%ing and forecasts and to standardiAe %ey
assu!'tions so all of your ; @$$s are on a level 'laying field$ T#is is a difficult tas%$
>$ My e)'erience is t#at so!e !anagers &eco!e suc# slaves to t#eir !odels t#at t#ey fail to e)ercise
good Cudg!ent$ + good &attlefield !ilitary co!!ander suc# as atton or .o!!el %nows w#en to say
Fenoug#G and !a%e a %ey decision &ased on li!ited infor!ation$ (f you wait for all t#e data to fill u'
t#e !odel, t#e co!'etition will &eat you to t#e 'unc#$ Entre'reneurs 4du&&ed FgunslingersG in t#e
invest!ent arena5 tend to &e good in t#is area$ Unfortunately t#ey often !anage &y t#e fa!ous
!a)i!G F.eady, Fire, +i!$G
8$ Models need to &e easy to use or t#ey will &e ignored$ + good e)a!'le is t#e new Morgan Stanley
trading syste! for foreign currency w#ic# s#ows a !atri) on t#e C.T$ Eac# swa' is colored .E-,
=.EE0 or 1E,,/2$ T#e =reen swa' is a =/$ T#e .ed swa' 'rovides unacca'ta&le ris% J reward
tradeoffs and s#ould &e avoided and t#e 1ellow swa' is a Cudg!ent call$ (t is si!'le$ (t allows for t#e
%ind of instantaneous decisions t#at ty'ify a trading des%$
;$ Forecasts need to &e fle)i&le$ + si!'le e)a!'le of t#is conce't is w#at is called +, B, C &udgeting$
T#e + &udget is t#e &est guess$ T#e B &udget is often !ore conservative version and t#e C is t#e
worst case scenario$ (n event of a .ecession or ot#er e)ternal event, !anage!ent can instantly
switc# to t#e B or C &udget w#ic# includes cost reduction strategies, reduced revenue goals etc$
Being a slave to a fi)ed &udget #as s'elled doo! for !any co!'anies 4and careers5$
FINANCIAL 2AR4E(& AND FINANCIAL IN&(R%2EN(&

+$ F(0+0C(+, (0ST.UME0TS
2$NE1 2AR4E( S 7 1EAR IN D%RA(I$N
T*B(,,S S#ort ter! de&t of t#e Federal =ovt$
(ssued in 67, :"7 and >97 day !aturities
>6
>6
Sold at a -(SC/U0T
T*&ills are Fris% freeG and for! t#e &asis for
all ot#er !oney !ar%et rates
FE-E.+, FU0-S (nter&an% overnig#t loans secured &y de'osits at t#e Fed$
C/MME.C(+, +E. S#ort ter! de&t instru!ent of a large cor'oration or its
finance su&sidiary suc# as FMCC sold t#roug# &ro%ers$
Huality of 'a'er is F.atedG &y fir!s suc# as S&, MoodyKs$
Fitc#, or -uff and #el's$
B+0KE. +CCET+0CES ,etter of credit 4a &an%Ks 'ro!ise to 'ay5 t#at #as &een
sta!'ed FguaranteedG &y anot#er &an%$ ,i%e a 'ost dated c#ec%$
Used widely in international finance$
0E=/T(+B,E C-s -e&t instru!ents issued &y &an%s 'aying a stated interest$
0o 'enalty for early wit#drawal S Can &e resold in secondary
!%t 4unli%e consu!er C-s5 !ay or !ay not &e F-(C insured
(ssued in deno!inations of I:77,777 !ini!u!
MMM FU0-S + 'ortfolio of ot#er MM instru!ents 4i$e$: &ills and co!!ercial
'a'er, etc5$ ortfolio 0et +sset @alue 40+@5 is %e't at I:$77
so t#eoretically t#ere is no 'rinci'al fluctuation$
EU./-/,,+.S U$S$ dollar deno!inated de'osits of U$S$ co!!ercial &an%s wit#
&an%s in foreign countries$ T#ese (/Us are actively traded in all
international e)c#anges &ased on current e)c#ange rates$
C/0SUME. C.E-(T +E. ac%aged grou's of loans t#at are traded in !aCor e)c#anges at a
discount &ased on ris% level of F'ortfolio$G
CA'I(AL 2AR4E( T 7 1EAR IN D%RA(I$N
T.E+SU.1 0/TES U$S$ govern!ent direct o&ligations 4usually ?*:7 years in duration5
0/TE: (nterest on +,, U$S$ treasury 'a'er is e)e!'t fro! state and
local inco!e ta)$
T.E+SU.1 B/0-S U$S$ govern!ent direct o&ligations 4:7*>7years in duration5
M/.T=+=ES + &an% loan secured &y real 'ro'erty 4land, co!!ercial, residential or
industrial5$ (f t#e &uyer defaults, lender forecloses and receives title$
Many varieties: Adusta)e rate or +.M 4reset annually at 67 day
&ill rate or ot#er &enc#!ar% R a set ris% 're!iu!
Fi.ed rate*rate fi)ed for life of loan 4 :;*>7 yrs5
+ctive secondary !ar%et caused &y &EC%RI(IUA(I$N

FINANCIAL 2AR4E(& AND FINANCIAL IN&(R%2EN(& C$N(D.
MU0(C(+, B/0-S Bonds or notes issued &y a state of local govern!ent$
FMU01SG >enera o)igation ,>$0 Bac%ed &y ta)es 4GFull fait# and creditG5
Re=enue: Bac%ed &y tolls or ot#er revenue
Muny issuers !ay &e IDR: (ssued &y a !unici'ality for a cor'oration
a state, city, county,
agency, University etc$ E)e!'t fro! Federal inco!e ta)$ So!e issues !ay also &e
I:777 'ar se!i*annual 'ay e)e!'t fro! state andJor local inco!e ta) 4FTri'le ta) freeG5
C/./.+TE B/0-S ,ong ter! de&t instru!ents of large cor'orations$
2ortgage )onds: :
st
$, ?
nd
$, etc secured &y real 'ro'erty
87
87
I:777 'ar E@ui-ment (rust Certi+icates secured &y c#attels li%e air'lanes
(nterest 'aid se!i*annually De)entures Sunsecured e)ce't &y earning 'ower of cor'oration
nor!ally$ (nterest on cor'orate de&t is ta) deducti&le to U$S$
cor'orations
+.Q I:777
C/U/0Q stated interest rate 4"O Q I"75 aid SEM(+00U+,,1
M+TU.(T1 Q stated rede!'tion date
S(0K(0= FU0-Q 're'ay!ent of issue 'rior to !aturity
,E+SES -e&t o&ligation of individuals or cor'orations$ May &e &undled
into a 'ortfolio and securitiAed suc# as a 'ac%age of leases issued
&y =M+C under standardiAed ter!s$
.EFE..E- ST/CKS + unli!ited !aturity Buasi*de&t instru!ent wit# a fi)ed dividend
ar varia&le +t 'resent <7O of dividend inco!e on 'referred stoc%s owned &y
-ividend fi)ed$ ot#er U$S$ cor'orations is free of inco!e ta) 4T#is is called t#e
intercor'orate$ -ividend e)clusion5
0o !aturity referred dividend 'ay!ents are 0/T deducti&le to t#e issuer
fds are FBuasi de&tG -ividends are fi)ed$ Most issues are CUMU,+T(@E$
C/MM/0 ST/CK F.esidual EBuityG or owners#i' ca'ital of a cor'oration$
-ividends are declared &y t#e &oard and vary wit# 'rofita&ility
co!!on s#are#olders 4earnings 'er co!!on s#are5$
/wn t#e Cor'oration E)cess 'rofits after 'ay!ent of all e)'enses and dividends go to
and vote for directors .etained earnings w#ic# is 'art of s#are#olderKs eBuity ca'ital$
'RI2AR1 B&. &EC$NDAR1 2AR4E(&
+ 'ri!ary !ar%et is new ca'ital suc# as a ne9 stoc< or )ond issue$
+ secondary !ar%et 4suc# as t#e 0ew 1or% Stoc% E)c#angeE01SE or FBig BoardG5 !erely trades
e.isting securities and does not raise new ca'ital$
Mar%ets today are glo&al$ +n issue of a large cor'oration li%e E))on !ay trade on t#e 01SE, To%yo,
3ong Kong or ot#er e)c#anges$
T#ere are !any F-erivativesG of t#ese financial instru!ents suc# as traded o'tion contacts or co!!odity
futures t#at also trade actively$ T#ese are &eyond t#e sco'e of t#is course &ut are covered in F(0 87<$
BAL%A(I$N $F #$ND& AND &($C4&
#$ND BAL%A(I$N
T#e value of a &ond is t#e net 'resent value of t#e cas# flow strea!: interest cou'ons
R rede!'tion value discounted at t#e !ar%et rate of interest for &onds of si!ilar ty'e,
Buality, and !aturity$ Cou'on inco!e is an annuity 'aid se!iannually$ T#e
rede!'tion value is a lu!' su! 4I:777 or 'ar in !ost cases5 and is 'aid at !aturity$
#$ND BAL%E F N'B $F IN(ERE&( C$%'$N& ,an annuity0 ; N'B $F 'AR BAL%E A(
2A(%RI(1 Discounted at yied o+ )onds o+ simiar ty-e! @uaity and maturity N$(E:
ALL C$R'$RA(E #$ND& 2A(%RE A( 'AR F J7000. F$R $%R '%R'$&E& ALL #$ND&
ARE A&&%2ED ($ #E &E2IANN%AL 'A1 ?I(H C$%'$N& EBER1 8 2$N(H&.
8:
8:
#ond time ine
1E+. 7 1E+. 0 4M+TU.(T15
C/U/0S E@E.1 9 M/S F(0+, C/U/0 'lus
+. 4I:777 E. B/0-5
#$ND (ER2IN$L$>1
INDEN(%RE + contract &etween a U$S$ cor'oration and &ond#olders s'ecifying ter!s of
a new &ond issue$ T#is docu!ent is reBuired &y t#e SEC$ T#e indenture s'ecifies cou'on,
trustee, call 'rovisions, !aturity, and ot#er ter!s suc# as converti&ility$
(R%&(EE (nstitution 4usually a &an%5 c#arged wit# enforcing ter!s of indenture$ T#e
trustee would initiate &an%ru'tcy 'roceedings is cou'on interest is not 'aid on ti!e$
C$%'$N T#e stated interest rate on a &ond$ Cou'on is stated in 'ercentage ter!s$
+n "O cou'on is eBual to I"7 'er year 4"O ti!es I:777 'ar5$ T3E C/U/0 (S F(XE-
F/. T3E ,(FE /F T3E B/0-$ +,, C/./.+TE B/0-S 2E 2(,, STU-1 +1
(0TE.EST SEM(+00U+,,1$ Eac# cou'on in t#is e)a!'le would &e I87$ +ll 'ro&le!s
will use se!iannual cou'ons$ &et )ond s-reads*eet +or AG1
C$%'$N IN D$LLAR& "O Q I"7 'aid se!iannually 4I87 and I875
'AR Face value$ I:777 F/. C/./.+TE B/0-S$ +,, B/0-S M+TU.E +T +.$
0/TE: (F + B/0- (S C+,,E- BEF/.E M+TU.(T1 T3E.E (S USU+,,1 +
C+,, .EM(U 4i$e$ :7> call 'rice !eans fir! refunds issue at I:7>7 'er &ond$5
'RICE& $F #$ND& ARE 5%$(ED IN E $F 'AR ** "7O Q I"77$ 1our B/0-
2/.KS3EET is in O of 'ar$ (f you solve a 'ro&le! and t#e 0@ is 6? t#is MUST &e
converted to dollars 4i$e$ I6?75
C%RREN( 1IELD Current 'ercantage return : I C/U/0 J .(CE /F B/0-
1IELD ($ 2A(%RI(1 41TM5 T#is is t#e T/T+, .ETU.0 on t#e &ond:
Current yield R ca'ital gain 4or loss5
ACCR%ED INC$2E (nterest due t#e SE,,E. of t#e &ond &ased on t#e nu!&er of days
since t#e last cou'on date$ T#is is t#e last entry on your &ond calculator 4+(5$ T#e
calculator uses a >9; day year for all cor'orate &onds 4+CT5$ (n U$S$ =overn!ent &onds,
t#e calculator is set for >97 day year &y 'ressing +CT and E0TE.$ Calc s#ould read >97$
0/TE: Since t#is is a cor'orate finance course, leave your calculator set for +CT 4>9; day year5
D%RA(I$N + !easure of sensitivity of a &ond 'rice to c#anging interest rates$ -uration
is a !i) of M+TU.(T1 and C/U/0 (0C/ME$ ,ong !aturity &onds generally #ave
longer duration$ 3ig#er C/U/0 &onds of t#e sa!e !aturity as a lower cou'on issue will
#ave s#orter duration since t#e 0@ of t#e cou'on inco!e is greater$
#$ND C$NCE'(&
+t 'ar Cou'on rate Q current yield Q yield to !aturity 41TM5
(f a &ond is selling +B/@E +. , current yied 9i )e T 1(2$ 231L Because if a
&ond is a&ove 'ar 4over I:7775 and !atures at I:777 you will incur a C+(T+, ,/SS at
!aturity$ T#is loss is incor'orated in 1TM calculations$
(f a &ond is selling BE,/2 +. you will #ave a gain u'on !aturity and 1(2 T current
yied.
I+ interest rates DECLINE! )ond 'RICE& INCREA&E
+ &onds 1(E,- T/ M+TU.(T1 is AL?A1& E5%AL to interest rates on &onds of si!ilar
T1E, HU+,(T1 +0- M+TU.(T1 in t#e !ar%et'lace$ (n order for t#e 1TM to eBual t#e
!ar%et rate, t#e &ond 'rice adCusts to reflect current rates$
8?
8?
T#e 0@ %ey on your calculator is t#e su! of two ele!ents: t#e 0@ of all se!iannual
interest cou'ons 4+0 +00U(T15 and t#e 0@ of t#e 'rice at !aturity or call$ +t !aturity
t#e &ond will &e wort# I:777$ (f t#e &ond is called 'rior to !aturity, t#e cor'oration !ay
#ave to 'ay a call 're!iu! 4say :7>5$ T#is will &e disclosed in t#e indenture$
(f you %now a &ond C/U/0, M+TU.(T1 -+TE, and t#e M+.KET .+TE on &onds of
si!ilar ty'e, !aturity and Buality, you can solve for 0@$ T#is is #ow 2all Street Bond
traders deter!ine t#e 'rice of a &ond 4e)cluding accrued inco!e and co!!ission5
F(0+0C(+, C+,CU,+T/. (0UTS (0 + B/0- @+,U+T(/0 ./B,EM US(0= T@M KE1S:

'G1 F A &E( 'G1 ($ A F$R ALL #$ND 'R$#LE2& AND E3A2
N F 1EAR& ($ 2A(%RI(1
I F IN(ERE&( $N #$ND& $F &I2ILAR (1'E AND 5%ALI(1 (+%T /%&P%+)
'B F C%RREN( 'RICE ,NE>A(IBE N%2#ER0---?E &$LBE F$R (HI&
'2( F D$LLAR BAL%E $F &E2I ANN%AL C$%'$N&
FB F J7000 $R REDE2'(I$N CALL 'RICE ,DI&C%&&ED LA(ER IN LEC(%RE0
EX+M,E &$L%(I$N %&IN> (B2 4E1&
23+T (S (TS T3E/.ET(C+, @+,UEL (T (S T3E 0@ /F +,,
C+S3 F,/2S -(SC/U0TE- +T T3E M+.KET .E@+(,(0= \
(0TE.EST .+TE F/. B/0-S /F S(M(,+. T1E +0- HU+,(T1
T3(S (0TE.EST .+TE (S <$;O
SET J1 Q ? +0- C,E+. +,, .E=(STE.S
M+TU.(T1 (S ?; 1E+.S 0Q;7 4?;T?5
C/U/0 Q "O T3E.EF/.E MT Q I87 4I"7J? 0/ M(0US S(=05
F@ Q I:777 4'ar5 F@ !ay &e C+,, .(CE if &ond is called$
(J1 Q <$; (M/.T+0T: (J1 Q !ar%et rate 0/T cou'on on &ond
S/,@E F/. @ Q I:798$:<
B/0- (S SE,,(0= +T + .EM(UM T/ +.$ 231L
/n t#e ne)t 'age we will loo% at t#e Bond S'reads#eet$ (t is reco!!ended t#at in an e)a! if you are
as%ed to co!'ute t#e t#eoretical 'rice of a &ond 40@5 use B/T3 !et#ods to c#ec% yourself$
(n any e)a! Buestion w#ere you are as%ed to co!'ute 1(E,- T/ M+TU.(T1 or +CC.UE-
(0C/ME you MUST use t#e Bond S'reads#eet$ Be sure and clear all registers after 'ressing t#e CF
%ey$ .EMEMBE. T#at @ in your solution will &e a negative nu!&er since it is a cas# outflow$
#$ND BAL%A(I$N C$N(D.
se!iannual -/,,+. C/U/0 Q (0TE.EST C/U/0 T(MES +. 4I:7775 J ?
"O Q I"7 E. 1E+.
cou'on R I87
&$LBIN> F$R 1(2 %&IN> (HE #$ND ?$R4&HEE( see sec. C-A IN (I #AA 2AN%AL
ro&le!: Co!'ute yield to !aturity and accrued inco!e for a "O de&enture wit# a
trade date of 9*>7*6< and a !aturity of >7 years fro! trade date$ T#e 'urc#ase 'rice on t#is &ond
is :79$;> 0/TEV +,, (0UTS (0 S.E+-S3EET +.E +S + O /F +.
(*is is a ste--)y-ste- soution using your (I #AII ; cacuator:
E0TE.: A
ND
#$ND to enter t#e &ond wor%s#eet
8>
8>
&D( Q SETT,EME0T -+TE 4> days fro! T.+-E -+TE for cor'orate issues5
Duly >, :66< is entered as: <$7>6<$ T#is is w#en you BU1 t#e &ond$
-/20 +../2
C'N Q C/U/0 .+TE (0 E.CE0T Q "O E0TE. "
-/20 +../2
RD( Q .E-EMT(/0 -+TE M+TU.(T1 /. C+,, -+TE
>7 1E+.S F./M 9*>7*6< Q 9*>7*?<
E0TE. as: 9$>7?< T#is is w#en &ond !atures or is called$
T( C+,CU,+T/. 3+0-,ES T3E M(,,E0(UM ./B,EM
-/20 +../2
RB Q .E-EMT(/0 @+,UE +T M+TU.(T1 T3(S (S AL?A1& :77
A/ A .)RC)$& ,F .AR :77 Q :77O /F +.
-/ 0/T enter :777 #ere$ (F B/0- (S C+,,E- .(/. T/
M+TU.(T1 T3(S (S C+,,E- +
FC+,,+B,EG B/0-
.E-EMT(/0 C+,, (S +,2+1S
+B/@E +. **S+1 :7>
SET AC( and forget C/. B/0-S USE +CT 4+CTU+, >9; -+1 1E+.5 +,,
EX+M ./B,EMS 2(,, USE +CT
M+KE SU.E C+,CU,+T/. (S SET F/. SEM(+00U+, C/U/0 Q AG1
SK( S/20 T/ .( ,'RI0 Q :79$;>
(M/.T+0T: BE SU.E +0- C/0@E.T +0S2E. F./M E.CE0T /. +. T/ -/,,+.
.(CE: B/0- .(CE (0 -/,,+. TE.MS (S I:79;$>7
AI Q +CC.UE- (0C/ME Q $79;?
+ccrued inco!e is t#e interest 'aya&le to t#e seller reflecting accrued interest fro! t#e last
cou'on to settle!ent date$
(f you &uy a &ond wit# cou'ons on Danuary : and Dune >7 on Marc# >7 you 4T3E BU1E.5
owe t#e seller #alf your ne)t cou'on 'ay!ent$ T#is is called accrued inco!e and is added to
your cost w#en you &uy t#e &ond$ T#e sales co!!ission is also added$
1/U SETT,E- /0 T3E B/0- > -+1S +FTE. T3E C/U/0 +1ME0T
T#erefore accrued inco!e is > days$ 1our calculator will auto!atically calculate +($
MU,T(,1 T3E +0S2E. (0 +( B1 TE0 T/ =ET T3E -/,,+. @+,UE /F +($
"7J>9;$?; ?:$6 CE0TS E. -+1 X > -+1S Q 99 CE0Ts
C$NBER(I#LE #$ND& 'REFERRED& : ?ARRAN(&
,FIN 34040
Converts are a s'ecial case$ &EE (E3( ''. 600-606
Converti&le securities are covered in F(0 >878$
+ll t#e conce'ts t#at a''ly to fi)ed cou'on &onds a''ly to converts$ T#e &ig difference is t#at a convert is
Buasi eBuity$ +t so!e 'oint t#e &ond will self liBuidate 4disa''ear5 and &eco!e co!!on stoc%$
C$NBER(I#LE (ER2IN$L$>1:
+. B/0-S: +ssu!e 'ar is always I:777
F-: (n any 'ro&le! 'ar !ust &e stated$
88
88
C/0@E.S(/0 .+T(/ 0u!&er of s#ares of stoc% 'er &ond or converti&le 'referred$
EX+M,E: Bond is converti&le into ?7 s#ares of stoc%$
C/0@E.S(/0 .(CE ar J conversion ratio
EX+M,E: Bond 'ar is always I:777 for our 'ur'oses$
T#erefore if t#e Cv$ .atio is ?7, t#e conv$ rice Q I;7 4I:777J ?75
C/0@E.S(/0 @+,UE + %ey conce't in understanding t#at a converti&le &ond only #as value
+,S/ C+,,E- as Buasi eBuity w#en t#e stoc% 'rice e)ceeds conversion 'rice$
T3E/.ET(C+, @+,UE EX+M,E: + converti&le &ond #as a conversion ratio$ T#e &ond is
issued at 'ar 4I:7775$ +t ti!e of issue t#e stoc% is trading at I87$
T#e &ond will not &egin to trade as Buasi eBuity 4in tande! wit#
co!!on stoc%5 until t#e co!!on 'rice rises a&ove I;7
EX+M,E ?: +ssu!e t#e co!!on is trading at I97 J s#are$
T#eoretical value of t#e &ond is I:?77 4I97 ) t#e conv ratio of ?75
Since eac# &ond is wort# ?7 co!!on s#ares, t#eoretical value
!easures t#e eBuity value of t#e &ond w#en t#e stoc% is Fin t#e
!onay$G 4a&ove conversion 'rice5$
.EM(UM T/ + converti&le &ond t#at is in t#e !oney is a uniBue instru!ent$ (t #as
C/0@E.S(/0 safety and 'riority of clai! associated wit# a &ond as well as a yield
@+,UE t#at is usually #ig#er t#an t#e co!!on dividend yield$ 3owever, as
t#e co!!on increases in value, t#e &ond will also go u'$ (t is
o&viously a desira&le invest!ent 'ossessing si!ilar returns &ut lower
ris% t#an t#e co!!on$ +s a result, investors tend to &id converti&le
'rice u' a&ove t#eoretical or conversion value$
.EM(UM Q 4M+.KET .(CE /F B/0- * C/0@E.S(/0 @+,UE5 G
4 =.E+TE. /F C/0@E.S(/0 @+,UE /. B/0- .(CE5
re!iu! is e)'ressed as a 'ercentage a&ove conversion or value$
EX+M,E: (n t#e a&ove e)a!'le, we co!'ute conversion value at
I:?77$ +ssu!e t#e !ar%et 'rice of t#e &ond is I:;77$ Conversion
're!iu! is 4>775J :;77 Q ?7O
F/.CE- C/0@E.S(/0 2#en a cor'oration C+,,S a convert t#at is in t#e !oney
t#is will force conversion to co!!on$ T#e &ond will self liBuidate$
#$ND AND &($C4 BAL%A(I$N C$N(D.
IN(ERE&( RA(E&
% Q K
.F
R -. R , R M.
K
.F
Q .is% free rate Q KT R (
8;
8;
C$NCE'(&:
:$ T#e yield curve is nor!ally u'ward slo'ing to t#e rig#t reflecting t#e ti!e value of !oney 4i$e$ we
e)'ect to &e 'aid !ore for longer !aturities5$
?$ Money !ar%et Q ] : year in duration 4Treasury &ills for e)a!'le are MM instru!ents and !ature in
one year or less$ Bills are -(SC/U0T instru!ents$
>$ Ca'ital !ar%et Q Y : year$ 0otes are &onds due in :*:7 years
Bonds nor!ally !ature in :7 to >7 years
8$ K.F can now &e deter!ined &y new U$S$ Treasury &onds 4See UST listings in 2SD5
;$ U$S$ Treasury &onds, notes and &ills are considered t#e 3(=3EST HU+,(T1 instru!ents &ecause
t#ere is no default ris%$ +ll ot#er &onds #ave 3(=3E. yields t#an treasuries due to t#e -.$
9$ (f inflation Y interest rates F/. +,, (0ST.UME0TS Y due to t#e ($ ,onger !aturity instru!ents
would &e !ore affected t#an s#ort !aturity instru!ents$
<$ +n illiBuid instru!ent li%e a C- #as a #ig#er K t#an a liBuid invest!ent of si!ilar ty'e, Buality and
!aturity$ T#is is due to t#e ,$
Stoc% 'rices tend to ] w#en interest rates K Y$ +s we will see, t#e value of stoc%s is t#e 0@ of
t#e future dividend strea! discounted at so!e rate$ ( reco!!end using t#e :7 year U$ S$
Treasury &ond yield$
&($C4 BAL%A(I$N
T#e value of a s#are of co!!on stoc% is t#e net 'resent value of a strea! of dividend inco!e esti!ated
into t#e future$ T#is dividend strea! in !ost dividend discount !odels is 'roCected for >7 years$ (n !y
!odel on t#e ne)t 'age, t#is cas# flow strea! is discounted at t#e :7 year U$S$ Treasury yield and if t#ere
are no dividends or t#e 'ayout is s!all, t#e 'ayout is assu!ed to &e ?7O 4+1/UT Q -SJES or
-(@(-E0-S J 0ET (0C/ME5
T#e for!ula for valuation of a constant growt# stoc% 4see -. A/65
7
Q -
:
K
cs
* g
2#ere
7
Q 'rice, -
:
Q dividend 0EXT year, g Q analyst esti!ate of -S growt# or ES growt# if t#ere
are no dividends$ Kcs is t#e investors reBuired rate of return$
DIBIDEND DI&C$%N( 2$DEL&
T#e !odel on t#e ne)t 'age is an e)a!'le of a --M$ 1ou #ave t#is !odel in your tea! E)cel co!'uter
dis%$ T#e !odel co!'utes t#e 0@ of dividends over a >7 year 'eriod discounted at t#e :7 year Treasury
yield$ (0UTS T/ T3E M/-E, +.E: Current ES esti!ate, dividend 'ayout ratio, an esti!ated
ES growt# rate over t#e ne)t year and t#e :7 year Treasury yield and t#e current stoc% 'rice$ T#e !odel
will deter!ine a 0@ at current interest rates RJ* :77 &asis 'oints 4R or * :O5 at t#e &otto! of t#e !odel$
E. growth Year
NEOGEN CORP (NEOG)
30.0% 1-5 Neogen is a small diagnostic test kit firm located in Lansing,MI
21.0% 6-10
14.7% 11-20
DIVIDEND DISCOUNT MODEL
10.% 21-0 ISC!L YE!R E.P.S. GRO"T# E P!YOUT E. D.P.S
$ $%&3$&'( ) 0.*0 %0% ) 0.0(
89
89
!"#$% &'I$( % $%&3$&'' ) 0.+% 30.0% %0% ) 0.$0
) $0.00 3 $%&30&00 ) 0.,( 30.0% %0% ) 0.$*
* $%&30&0$ ) 0.(( 30.0% %0% ) 0.$(
+ $%&3$&0% ) $.$* 30.0% %0% ) 0.%3
N&) #* +&! !"'(,M
, $%&3$&03 ) $.3( %$.0% %0% ) 0.%(

N&)-.7/.60
- $%&30&0* ) $.,- %$.0% %0% ) 0.33
)$+.3- ( $%&30&0+ ) %.0% %$.0% %0% ) 0.*0
' $%&3$&0, ) %.*+ %$.0% %0% ) 0.*'
10 1(,' "'(,! $0 $%&3$&0- ) %.', %$.0% %0% ) 0.+'
1I(L+ $$ $%&30&0( ) 3.*0 $*.-% %0% ) 0.,(
,.*% $% $%&30&0' ) 3.'0 $*.-% %0% ) 0.-(
T#IS IS I&Y $3 $%&3$&$0 ) *.*- $*.-% %0% ) 0.('
$* $%&3$&$$ ) +.$3 $*.-% %0% ) $.03
$+ $%&30&$% ) +.(( $*.-% %0% ) $.$(
$, $%&30&$3 ) ,.-+ $*.-% %0% ) $.3+
$- $%&3$&$* ) -.-* $*.-% %0% ) $.++
$( $%&3$&$+ ) (.(( $*.-% %0% ) $.-(
$' $%&30&$, ) $0.$( $*.-% %0% ) %.0*
%0 $%&30&$- ) $$.,( $*.-% %0% ) %.3*
%$ $%&3$&$( ) $3.*0 $*.-% %0% ) %.,(
%% $%&3$&$' ) $*.-- $0.3% %0% ) %.'+
%3 $%&30&%0 ) $,.%' $0.3% %0% ) 3.%,
%* $%&30&%$ ) $-.'- $0.3% %0% ) 3.+'
%+ $%&3$&%% ) $'.(% $0.3% %0% ) 3.',
%, $%&3$&%3 ) %$.(, $0.3% %0% ) *.3-
%- $%&30&%* ) %*.$$ $0.3% %0% ) *.(%
%( $%&30&%+ ) %,.+' $0.3% %0% ) +.3%
%' $%&3$&%, ) %'.33 $0.3% %0% ) +.(-
30 $%&3$&%- ) 3%.3* $0.3% %0% ) ,.*-
THIS IS AN EXCEL SPREADSHEET. A DDM NODEL IS A REAL WORLD TVM PROBLEM.
N20 &31 21 I312 6.40 &M"2 (. +&! $#L4MN--0 $(LL!
WE PROJECT EARNINGS AT A DECLINING GROWTH RATE AND HAVE 30 CASH FLOWS
WE PROJECT DIVIDENDS AT A CONSTANT 20% ASSUMED PAYOUT (Pa!"# $ DPS%EPS&
WE USE THE NPV FUNCTION IN EXCEL' !#L4"I#N/
515.7
NPV (I&Y. /e001 o2 /a1h 20ow 1trea3 4h(5h3-6) $4''(N" !"#$% &'I$(/ 5 10.00
( ),L4( 3 &'I$( 154%
BP$ (a)*) +!*,#
Se718t898t: a7a0:1815 E1t83at87g NPV at ;822ere7t 87tere1t rate 2ore/a1t1
$ -%-00 !. -%
- 100 6.7. - 50 6.7.
8,!(LIN(
9 50 6.7. 9 100 6.7.
I&Y E. rate 5.4% 5.:% 6.4% 6.:% 7.4% As rates
NPV E. NPV 51;.6; 516.: 515.7 51.:; 512.7 rise, NPV
/hg 21.5% 10.2% 0.0% -:.1% -17.2% declines
'%( AND CALL $'(I$N&
'%( F $'(I$N ($ &ELL StandardiAed o'tions are !oney !ar%et instru!ents 4e)'ire in ] : yr5
CALLF$'(I$N ($ #%1
&(RI4E Q /T(/0 EXE.C(SE .(CE$ F(XE- F/. ,(FE /F C/0T.+CT
'RICE Q revious day C,/S(0= 'rice$ Fluctuates daily$
'RE2I%2 Q Cost to &uy or a!ount received to sell$ +ll a!ounts are 'er s#are$
2A(%RI(1 Q Contracts e)'ire on t#e T3(.- Friday of eac# !ont#$ Stoc% 'ut and call
o'tions are usually :*> !ont#s in duration$
8<
8<
C$N(RAC( Q For co!!on stoc% : contract Q :77 s#ares 4round lot5
3 (HIN>& CAN HA''EN ($ AN $'(I$N C$N(RAC(:
:$ 1ou can e)ercise it
?$ 1ou can sell it 'rior to e)'iration
>$ 1ou can let it e)'ire wort#less
A o-tions are 9ort*ess on e.-iration
T#e 'rice of t#e o'tion is 0/T t#e sa!e as t#e 'rice of t#e underlying stoc%$ T#e o'tion 'rice is t#e
're!iu! you would 'ay 4in a 'urc#ase situation5 for : s#are$ T#e !ini!u! 'urc#ase is : contract or :77
s#ares$ T#e stri%e 'rice and t#e 'rice of t#e stoc% !ust &e co!'ared to see if contract is Fin t#e !oney$G
(F + UT ST.(KE Y .(CE /F ST/CK it is IN T3E M/0E1
(F + UT ST.(KE ] .(CE /F ST/CK it is $%( $F T3E M/0E1
(F + C+,, ST.(KE Y .(CE /F ST/CK it is $%( $F T3E M/0E1
(F + C+,, ST.(KE ] .(CE /F ST/CK it is IN T3E M/0E1
-(+=.+M (T: UT /. C+,, ST/CK .(CE /T(/0 .(CE X :77 S3S Q .EM(UM
/T(/0 ST.(KE
-ETE.M(0E (S /T(/0 (S (0 T3E M/0E1 /. /UT /F M/0E1
'R$FI( $R L$&& E5%AL&
:$ .EM(UM +(- F/. /T(/0 C/0T.+CT 4in case of a 'urc#ase5 ,US
?$ ./F(T /. ,/SS +T EX(.+T(/0$ T#is is only t#e case if t#e o'tion is (0 T3E M/0E1
/t#erwise, it e)'ires wort#less
/.
:$ .EM(UM .ECE(@E- F/. /T(/0 C/0T.+CT 4in case of a sale of an o'tion5 ,US
?$ ./F(T /. ,/SS +T EX(.+T(/0 T#is is only t#e case if t#e o'tion is (0 T3E M/0E1
/t#erwise, it e)'ires wort#less
+ C/@E.E- C/0T.+CT is an o'tion t#at is &ac%ed &y stoc% you own$ (f you own :77 s#ares, you can
write :7 covered contracts 4'uts or calls5$ 2#y would you do t#is$
(0 T3(S C/U.SE /U. F/CUS (S /0 /T(/0S .(M+.(,1 T/ 3E-=E .(SK
+ 'ut is a for! is a for! of F'ortfolio insuranceG since it li!its loss to a s'ecific level
Selling a call gives seller 're!iu! inco!e$ Most sales are Fout of t#e !oneyG Seller is &etting t#at
t#e stoc% will not a''reciate to stri%e &efore e)'iration$ (f it is in t#e !oney, seller will #ave #is
stoc% 'urc#ased away at stri%e 'rice$
(0-EX /T(/0S are o'tions &ased on an inde) suc# as t#e /EX 4S& ;775 S;77 stoc%s or t#e /EX
4S& :775*:77 stoc%s or t#e -D(+ 4>7 stoc%s5
,E+S +.E ,/0= TE.M /T(/0 C/0T.+CTS 4:*? years usually5
.E+-(0= UT +0- C+,, /T(/0 HU/TES
+$ (nde) o'tions ** (nde) close !ust &e c#ec%ed in &o) usually on u''er left of 'age or section in 2SD
Huote is c#ec%ed &y loo%ing u' date and stri%e 'rice under a''ro'riate inde) o'tion
Two Buotes are given on se'arate ines CQcall Q'ut
B$ (ndividual stoc% o'tions ** rice in ,EFT C/,UM0 is close on underlying stoc%
Huote is c#ec%ed &y loo%ing for date and stri%e for t#e stoc%
Huotes for 'uts and calls are given in two adCacent coumns
C$ T#e first t#ing you !ust do is deter!ine cost of 'urc#asing one contract 4:77 s#ares5 w#ic# is Buoted
'rice ) :77$
8"
8"
-$ T#e second t#ing is to deter!ine if contract is in t#e !oney or out of t#e !oney$ T#is de'ends on
w#et#er it is a UT or C+,, 4see 'age :5
E$ T#e 'rofit on a contract is eBual to 'rofit or loss ,ESS cost of t#e contract or !ulti'le contracts$
EX+M,E: 1ou &uy ; 'uts wit# a I97 stri%e at a 'rice of I8$;7 'er s#are
(n t#e left colu!n you read t#e closing 'rice of t#e stoc%$ I9?
(n t#e a''ro'riate colu!n you read t#e 're!iu! for one s#are
T#is contract is /UT /F T3E M/0E1$ + UT (S (0 T3E M/0E1
23E0 .(CE ] ST.(KE
(f 'rice is unc#anged at e)'iration, you #ave no 'rofit$ T#e o'tion
e)'ires wort#less$ 1our loss is I8$;7 ) ;77 Q I??;7$ T#is is t#e
're!iu! you 'aid$
(f stoc% is wort# I;; on date of e)'iration you MUST E(T3E.
+$ Sell t#e o'tion or
B$ E)ercise it
(f you e)ercise it &y selling t#e stoc% at I97 4t#e stri%e5 for a I;
=./SS 'rofit of I?;77 ,ESS 1/U. re!iu! of I??;7 for a
0ET ./F(T /F I?;7 for t#e ; contracts
$'(I$N 'R$#LE2&
7. Read t*e @uestion
?$ Diagram it$
3. &*o9 your 9or< NEA(L1
8$ IN (B2 -ro)ems! s*o9 your <eystro<es: J1Q nu!&er of co!'ounding 'eriods J yr
0Q years T J1
(J1 Q stated interest or cou'on
@, F@ or MT
2#at are you solving forL
8$ (*in<$ (t t#is answer logicalL
( s#ould not #ave to searc# all over t#e 'age 4or t#e &ac%5 to see your !ista%e or calculations$ (
will !a%e every effort to give 'artial credit !ust you !ust S3/2 1/U. 2/.K$
Many e)a! -ro)ems will not )e !ulti'le c#oice$ 1ou s#ould s#ow your wor% neatly and circle
or underline t#e answer clearly$ T#e only way to study for T@M, o'tions, &ond 'ro&le!s and
currency translation 'ro&le!s, is to do 'ractice 'ro&le!s$ +s% Buestions if
you are unclear on any conce't$
A''ENDI3
A. &(%D1 (I'& F$R FIN 3403! 3404 E3A2&
Eac# ter! students !a%e C/..ECT(B,E errors using t#eir financial calculator$ T#ese
errors fall into 8 !ain categories:
Si!'le addition or !ulti'lication !ista%es$ C#ec% your wor%$
,ac% of co!'lete understanding of T@M %eys and wor%s#eets$
T#ere is only one way to effectively study: Do -ro)ems. 2or% wit# class!ates$
Re=ie9 ecture notes$ Be sure you fully understand all e)a!'les given in class$
0ot erasing all registers including wor%s#eet registers$ (t is critical t#at you erase all
registers &efore doing eac# 'ro&le!
Failure to as% t#e Buestion: F-oes t#is answer !a%e senseLG
Use T@M %eys and a wor%s#eet to cross c#ec% your wor%$
86
86
Use t#e F.ule of <?G to esti!ate t#e answer$
,ac% of logic$ -o a ti!e line$ ,ist all in'uts 4%eystro%es5 0E+T,1 on t#e e)a!$
Finance is a language$ 1ou must study de+initions o+ terms. 'recision is im-ortant.
Use t#e lecture notes and glossary in t#e &ac% of t#e te)t$ ?RI(E $%( definitions$
+not#er 'ro&le! ( see is fuAAy understanding of &asic accounting$ (f it #as &een a w#ile
since you #ad accounting, it is strongy suggested t#at you &rus# u' on ter!s and
conce'ts$ T#is is i!'ortant in ratio analysis, understanding conce'ts suc# as Fcas# flowG
in ca'ital &udgeting, and &ond and stoc% valuation$ -o all t#e 'ro&le!s in t#e te)t and
wor%&oo% dealing wit# accounting$ (f you are unclear, as% Buestions in class$
(n your e)a! you are encouraged to:
Use 'encil$ -o calculations on t#e &ac% of t#e 'age$ T#in% &efore you &egin writing$
Be neat$ ( will give 'artial credit if ( can discern your logic$ S3/2 1/U. 2/.K
(0C,U-(0= KE1ST./KES$
.ead t#e Buestion carefully$
Be concise and 'recise in your answers$ Be sure and answer all 'arts of t#e Buestion$
Budget your ti!e$ -o t#e 'ro&le!s you can solve easily first$
Use t#e &ac% of t#e e)a! for scratc#$ lease answer 'ro&le! in S+CE ./@(-E-$
Beco!e fa!iliar wit# t#e for!ula 'ages in t#ese notes$ T#ey will &e 'rovided wit#
e)a!s$
2#en you get t#e e)a! &ac% it is i!'ortant for you to:
.eview any !ista%es$ Ma%e sure you %now w#at you did wrong$
See instructor wit# any Buestions (MME-(+TE,1$
#. (I'& $N READIN> (HE ?&" LI4E A 'R$
T#e 2all Street Dournal is 'u&lis#ed in > sections$ Section C is t#e %ey section containing stoc% and &ond
Buotes, o'tions and futures data, international activity, interest rates and ot#er ti!ely data$ Most 'ros read
t#e Dournal &ac%wards starting wit# Section C$
7. &($C4 5%$(E& F$R 1$%R C$2'AN1 ANAL1&I&
N1&E M#I> #$ARDO T#e 01SE is a ?77R year old FauctionG !ar%et$ T#ere is a trading floor and
s'ecialists offer to &uy or sell stoc% at fi)ed 'osts or stations s#a'ed
li%e #orses#oes$ 01SE stoc%s tend to &e older so*called F&lue c#i's$G
01SE ST/CKS 3+@E : T/ > ,ETTE.S (0 T(CKE.
,//K U U$S$ STEE, T(CKE. (S X
/lder co!'anies #ave Tic%ers of one or two letters
,//K U (BM Co!'any na!e is (nternational Busienss Mac#ines
0/TE t#at (BM is 0/T listed at &eginning of ( listings
Koda% 0a!e is East!an Koda% Slisted under E for founder =eorge
East!an
&toc< Daiy Listings: LEF( ($ RI>H(
;? 2K 3( ,/ 0+ME +BB.E@ T(CKE. +00 -(@ 1,- ,TM JE @/, 3( ,/
C,/SE F/. T3+T -+1 /F T.+-(0= +0- C3+0=E F/. -+1
;7
;7
Stoc%s !ay #ave footnotes ne)t to t#e tic%er$ + list of t#ese footnotes is in a &o) near t#e
&eginning of t#e stoc% Buotes$
T/ =ET ,+ST :? M/0T3 E+.0(0=S -(@(-E .(CE B1 ,TM JE
(ER2&:
NE( INC$2E QB/TT/M ,(0E +FTE. +,, EXE0SES BUT BEF/.E C/M -(@-S
E.'.&. ,L(20 Q0ET (0C/ME J C/M S3+.ES (SSUE- +0- /UTST+0-(0=
D.'.&. Q+.T /F E$$S$ +(- T/ S3 (0 C+S3$ 0/.M+,,1 +(- HT.,1$
-S as re'orted in t#e 2SD is t#e ast @uarter annuaiNed 4!ulti'lied &y 85
EX+M,E -$$S$ H: I:$77
H? I:$77
H> I:$:7 Board increases -S &y :7 cents
H8 I:$:7
-(@- F/. ,+ST :? M/0T3S 4a&&reviated ,TM5 Q I8$?7
2SD +FTE. H > 2(,, ,(ST -(@- .+TE +T +00U+, .+TE /F I8$87
T3(S (S 23+T 1/U E0TE. F/. 1/U. C/M+01
'GE Q .(CE J ,TM E+.0(0=S E. S3+.E
EX+M,E ST/CK C,/SE- +T I;7
JE Q ?;)
23+T (S ,TM E$$S$ ;7J?; Q I?$77
E0TE. T3(S F/. 1/U. C/M+01
F/. C+,E0-+. 1E+. F(.MS 2E +.E (0 23+T HT. 0/2L
(I'& $N READIN> (HE ?&" LI4E A 'R$ contd.
2AR4E( CA' QM+.KET C+ /. ca'italiAation Q 'rice ti!es s#ares
outstanding$ + co!'any will a &illion dollar !ar%et ca'
!ay #ave :77 !illion s#ares trading at I:7 'er s#are$
EARNIN>& RE'$R(& C#ec% t#e fiscal year end on your co!'any$
Eac# Buarter will fall > !ont#s fro! t#at date$
Huarterly earnings 4SEC for! :7H5 are usually re'orted ?*>
wee%s fro! t#e end of t#e calendar Buarter T#e annual re'ort
4:7K5 ta%es longer since it is fully audited$

NA&DA5 National Assn$ $f &ecurities Dealers Auto!ated 5uotation &yste!
T#e 0asdaB stoc% !ar%et is an E,ECT./0(C networ% !ar%et$ T#ere is no
trading floor and no s'ecialist$
8 or ; letters in Tic%er

,//K U M(C./S/FT MSFT I:?7$><;
T#ere is really not a FcloseG for 0+S-+H as t#ere is for listed stoc%s$

C$2'$&I(E
2AR4E( DA(A: A. &($C4&
U$S$ ST/CKS ME+SU.E- SE@E.+, 2+1S
TU.0 T/ +=E C*: /F T3E 2SD
T#e Mar%ets -iary in t#e left colu!n su!!ariAes %ey U$S$
and (nternational Stoc% (ndices, Bond 'rice and interest rate
;:
;:
data and %ey co!!odities$
D"IA >7 ST/CKS SEE $ C*> for co!'onent stoc%s
T#e -ow is t#e oldest inde) and was invented &y t#e
first 'u&lis#er of t#e 2SD * C#arles -ow$ /lder
stoc%s in t#is inde) are called F&lue c#i's$G (t is
i!'ortant to understand t#at an old F&lue c#i'G li%e
U$S$ Steel !ay 0/T &e as good an invest!ent as a
newer co!'any li%e Microsoft$
&:' C00 ;77 ST/CKS B1 M+.KET C+
NA&DA5 S!aller ca' stoc%s$ (n ter!s of trading
volu!e t#e 0+S-+H is slig#tly larger now
t#an t#e 01SE$ T#e 0+S-+H Co!'osite
is an unweig#ted inde) of all stoc%s trading
on t#e 0+S-+H$

#. #$ND& age C*: #ig#lig#ts t#e FBellwet#erG >7
year Treasury recent yield trend in a ta&le$
To get t#e actual Treasury F1ield CurveG
you will need to find t#e Treasury Bonds 0otes
and Bills section$ T#e location !oves around
&ut is at t#e &ac% of Section C
C. CAREER $''$R(%NI(IE& IN FINANCE
So!e of you !ay already &e e!'loyed in finance or accounting and want to learn w#at ot#er o''ortunities
e)ist$ ( #ave s'ent over >7 years as a financial !anager$ ( #ave &een a &an% trust officer, served as CE/
of a !oney !anage!ent co!'any, !anaged a growt# F=o*=oG !utual fund, and &een t#e -irector of
.esearc# of two regional &ro%erage fir!s$ (n !y e)'erience, t#e !ost e)citing as'ects of t#is field are:
(t is dyna!ic$ Every day is different$
1ou are 'itting your s%ills against t#e &est &rains in t#e 2orld$ Finance is
a #ig#ly 'aid 'rofession$ +s suc#, it tends to attract #ig#ly Bualified and
!otivated 'eo'le suc# as yourself$
Finance is t#e #eart of any enter'rise$ Can you i!agine any &usiness,
govern!ental entity, or not*for*'rofit grou' wit#out a cas# or ca'ital
&udget for e)a!'leL
1ou will use conce'ts in t#is course in every day life$ T#e financial
calculator will #el' you evaluate t#e +. on a !ortgage, deter!ine t#e
true cost of an auto lease, and co!'ute #ow !uc# you need to save to #ave
a co!forta&le retire!ent$
3ere are so!e areas for you to consider in your interviewing$ Even if you are currently e!'loyed, it is
suggested t#at you ta%e advantage of t#e UM- 'lace!ent office to gain e)'erience in interviewing, and to
learn !ore a&out career o'tions$ +n interns#i' is an o'tion availa&le to you to see a &usiness or industry
fro! t#e inside and see if it is for you$
+$ C$R'$RA(E (REA&%R1
,arge cor'orations #ire financial analysts and accountants to staff t#eir large treasury functions w#o
engage in credit analysis, cas# !anage!ent, ca'ital &udgeting, and ris% !anage!ent activities$ T#is is
an e)cellent 'lace to gain e)'erience$ ,arger cor'orations tend to use !ore so'#isticated analytical
;?
;?
tec#niBues$ Many students start t#ere or in 'u&lic accounting and t#en !ove to a CF/ role in a larger
enter'rise$
1ou will 'ro&a&ly #ave !ore ca!'us interview o''ortunities in t#is area t#an in any ot#er$ Ta%e
advantage of it$
#. C$22ERCIAL #AN4IN>
Co!!ercial Ban%s are t#e F-e'art!ent Stores of Finance$G /''ortunities for a career are in various
de'art!ents including: Credit
Co!!ercial lending
Trust and invest!ent !anage!ent
,easing
Mortgage lending and ad!inistration
Branc# ad!inistration
Ban%ing is consolidating$ T#is creates o''ortunity$ Ban%s are entering
insurance and financial 'lanning$ T#ere are a&out ";77 &an%s in
t#e U$S$ today$ Many of t#e larger &an%s are overseas$
#. IN&%RANCE T#ere are > 'ri!ary ty'es of insurers$ T#ey are:
,ife insurers including credit life
Fire and Casualty 4also called 'ro'erty and casualty5
Multi*line 4a co!&ination of t#e two a&ove for!s5
CAREER $''$R(%NI(IE& C$N(D.
(nsurance co!'anies are state regulated and !ay &e of !utual or
stoc% for!$ ,ife co!'anies tend to invest in longer ter! instru!ents li%e real
estate and stoc%s$ T#ey tend to do !any F'rivate 'lace!entsG in w#ic# an
entire cor'orate &ond or 'referred issue is 'laced wit# t#e insurer$
&C co!'anies are focused on s#orter ter! instru!ents &ecause t#ey are
i!'acted &y unforseen events li%e a flood or fire$ T#ey still do invest in
co!!on stoc% and #ave large 'ortfolios$ &C co!'anies !a%e use of
derivatives for #edging$
Career o''ortunities for finance students include financial 'lanning, 'ortfolio
!anage!ent, actuarial analysis, and sales !anage!ent$ (nsurance co!'anies
tend to &e sta&le and #ave e)cellent &enefits$
C. INBE&(2EN( #R$4ERA>E AND INBE&(2EN( #AN4IN>
T#ese fir!s are usually categoriAed two ways:
2ire #ouses$ T#ese are large national fir!s li%e Merrill ,ync#$
.egionals li%e +$ =$ Edwards$
-iscount &ro%ers li%e C#arles Sc#wa&
T#e larger wire #ouses are ty'ically located in 0ew 1or%$ T#ere is
consolidation going on in t#is industry a!ong regionals in 'articular$
Co!!ercial &an%s are atte!'ting to enter t#e invest!ent &an%ing industry
wit# t#e de!ise of =lass*Steagall restrictions in t#e U$S$
(nvest!ent &an%ing is t#e activity associated wit# raising new funds in t#e
for! of an initial 'u&lic offering 4(/5 or secondary$ (nvest!ent &an%ing tends
to &e cyclical since activity varies wit# t#e level of t#e stoc% and &ond !ar%ets$
Merger and +cBuisition 4M&+ activity5 tends to &e t#e &read and &utter
revenue source w#en deal flow is lig#t$
;>
;>
.esearc# is anot#er activity for regionals and wire #ouses$ +nalysts tend to
s'ecialiAe in one or two industries and 'u&lis# re'orts wit# s'ecific
reco!!endations$ +n MB+ is generally considered necessary to land a
cor'orate finance or researc# Co&$
D. 2$NE1 2ANA>E2EN(
Money !anagers #andle individual 'ortfolios and e!'loyee &enefit
funds for cor'orations, c#urc#es, and ot#er organiAations$ T#ese organiAations
tend to #ire e)'erienced traders, analysts, and &an% trust officers$ +n e)ce'tion
is !utual funds w#ic# will #ire analysts fro! to' &usiness sc#ools li%e UCF$
+gain an MB+ is necessary$
E$ $(HER ,(*ri+ts! credit unions! non--ro+it organiNations! go=ernment0.
=overn!ental entities need finance !anagers$ So do !any c#urc#
organiAations, 'rivate 'ension funds, unions, casinos, air'orts,
s'orts tea!s, #otels and resorts, etc$ Be creative$ Use your
contacts$ +s in any 'rofession, s'ecialiAation usually is t#e %ey to #ig#er 'ay$
C. 'RE'ARIN> 1$%R RE&%2E
( will &e #a''y to review your resu!e$ T#ere are !any &oo%s on t#e su&Cect of effective resu!e writing$
T#e fact is t#at !any cor'orations are si!'ly inundated wit# resu!es$ =etting yours read in a !aCor
c#allenge$ .e!e!&er t#at a resu!e is a fact s#eet !ar%eting 1/U$ (t s#ould &e concise, 'rofessional,
free of s'elling errors or ty'os, and see% to gra& t#e readerKs attention li%e a good ad$ 3ere are a few ti's:
State your career o&Cective at t#e to' of t#e resu!e$ T#is state!ent can &e !odified to fit your
interview on your C &ut it !ust #ave one c#aracteristic: it s#ould state w#at you can contri&ute to
t#e co!'any$ -o not say you want to learn to &e a financial !anager$
rint your resu!e on Buality &ond 'a'er wit# !atc#ing envelo'e
State s%ills including e)'ertise in MS 2ord, E)cel, ower'oint, and ot#er s%ills e!'loyers are
see%ing$ T#is will set you a'art$
-o not attac# references to t#e resu!e &ut line u' references &efore you interview$
(f you 'lan to !ail resu!es, -/ 0/T send t#e! to 3u!an .esources$ Try and #and deliver one to a
contact in senior !anage!ent$ 0etwor% and use fa!ily contacts$ Failing t#at, try sending t#e
resu!e to t#e CE/ via FedE)$ Co!'anies receive #undreds of resu!es eac# day$ ersonal contact is
t#e &est way to get noticed$
D. IN(ERBIE?IN> (I'&
:$ Use t#e UCF recruiting office$
?$ 2#o is your interviewerL See% to deter!ine w#at t#ey are loo%ing for$ (n
t#e initial interview you 'ri!ary !ission is to get invited &ac% for a second
interview$ Be friendly &ut avoid ra!&ling$ Use ti!e well$ ,oo% t#e
interviewer in t#e eye$
>$ -o a financial state!ent analysis on a cor'oration &efore you go to t#e
interview on t#e co!'any and read t#e annual re'ort$ re'are a list of
Buestions$ re'ared candidates will get invited for a second interview$
8$ -ress 'rofessionally$
;$ -o a few FtrialG interviews &efore you interview wit# your to' c#oice$
E)'erience !a%es you !ore rela)ed$
;8
;8
9$ Ta%e co'ies of your resu!e and co'ies of your wor% t#at you can leave wit#
t#e interviewer$
<$ See% out to' e)ecutives t#roug# networ%ing$ T#is is !uc# !ore
'roductive t#an going t#roug# t#e 3u!an .esources funnel$
"$ Be sure and send a t#an% you letter after every interview and after you
acce't a 'osition$ Courtesy goes a long way$ 1ou will 'ro&a&ly want to
c#ange Co&s so!eti!e in your career so donKt &urn any &ridges$
6$ Kee' a list of contacts as you !ove u'ward in your career$ 3el' 'eo'le$
T#is includes 'eo'le w#o wor% for you$ 0etwor%ing is a two way street$
:7$ -o a 'ersonal assess!ent or review annually$ T#is assess!ent s#ould
evaluate not Cust !oney &ut 'ersonal satisfaction and #a''iness$
( will &e #a''y to 'rovide a reference and #el' you wit# your resu!e$
1ou are strongly encouraged to ta%e advantage of interns#i' o''ortunities$
F$R2%LA&
For!ulas will always &e 'rovided on your e)a!$ (n studying for t#e e)a! you s#ould
concentrate on #ow to use eac# for!ula in different %inds of 'ro&le!s$
Future Baue ,FB0 o+ a um- sum FBn F 'B ,7 ; r0
n (a)e A-3
'resent =aue ,'B0 o+ a um- sum 'B F F B a
,7 ; r0
n (a)e A-7
'resent Baue 'B o+ an annuity 'BA F FB ; FB ; P; FB
(a)e A-A ,7 ; r0
7
,7 ; r0
A
,7 F r0
n
4 F 4r+ ; DR' ; L' ; 2R'
?ACC F ?d4d,7-(0 ; ?-s4-s ; ?ce4s
4-s F D-s 4 s F D7 ; g 4 e F D7 ; g ,ne9 e@uity0
'n ' 0 ' 0,7-F0
N$(E: D0 F current di=idend D7 F ,D0 3 ,7 ; g0
D$L F E c*g E#I( D$L@ F5 ,' - B0 #e sure you <no9 use o+ )ot* D$L +ormuas
E c*g &aes 5 ,' - B0 - F
DFL F E CH> E'&
E CH> E#I(
D(L F ,D$L0,DFL0 5 ,' - B0
5,' - B0 - F - I
2ACR& ALL$?ANCE 'ERCEN(A>E&
1ear Cass o+ in=estment
;;
;;
3 year C year D year
7 33E A0E 74E
A 4C 3A AC
3 7C 7/ 7D
4 D 7A 73
C 77 /
8 8 /
D /
6 4
FINANCIAL RA(I$&
&HI/ 4I++ 3) .R,*ID)D 4I&H )DA-/ A+/,
+$ #ALANCE &HEE( RA(I$&
,(HU(-(T1 C.Q C+JC,
HU(CKQ C+*(0@JC, or C+S3 R +. J C,
-S/ Q +.J 4sales J >975 + >97 day year is assu!ed unless indicated
(nventory turnover Q Sales 4fro! inco!e state!ent5J (nventory
,E@E.+=E -e&t .atio Q S#ort and long ter! de&t J total
assets or total lia&ilities and S3 eBuity ca'ital
,T -EBT J +SSETS Q de&t Y : year J total assets
,T -EBT J EHU(T1 Q de&t Y : year J 4co!!on stoc% R sur'lus R ret earnings5
0/TE: referred stoc% is 0/T eBuity
X (0T E+.0E-Q EB(T J interest e)'ense fro! inco!e state!ent
X F(XE- C3=S E+.0E-Q 4EB(T R lease '!ts 5J 4interest R rent e)'ense R
sin%ing fund 5 J 4:*ta) rate5
B$ INC$2E &(A(E2EN( RA(I$&
./F(T+B(,(T1 =ross !argin Q 40et Sales * C=S5J net sales
/'erating !argin Q 40$ sales * 4C=S R S=+5 J net sales /.
4=ross inco!e * S=+5J net sales
reta) !arginQ reta) inco!e J 0et sales
0et !arginQ 0et inco!e &efore co! divds J 0et sales
Ca' e)'ense J sales Ca'ital e)'enditures as O of revenues
.&- J sales (!'ortant !easure for #ig# tec# fir!s
C$ BAL%A(I$N RA(I$& JE Q Co!!on stoc% 'rice J Earnings 'er s#are
3istorical JE Q avg 'rice in year J ES in t#at year
Current JE Q current 'rice J ,TM ES
1(E,- Q Co!!on -S 4indicated ann rate5J cur$ rice
B@S Q S3 eBuity J co!!on s#s issued +0- outstanding
.(CEJB//KQ current 'rice of co!!on J last Btr B@S
-$ C$2#INA(I$N RA(I$&
./+ Q net inco!e J total assets
./E Q net inco!e J S3 eBuity

E. #$ND& Current yield: dollar cou'on inco!e J &ond 'rice
1TM Use &ond s'reads#eet on fin calculator
1TC F F F
;9
;9
B/0- .(CE EX.ESSE- +S + E.CE0T
Conversion ratio Q 'ar J conversion 'rice
cost of de&t Kd 4:*T5
F. C$22$N -ivd yield +nnual divd J stoc% 'rice
% s Q -: R g
7
>. 'REFERRED Current yield K's -J 4'er'etuity Sno !aturity5
2A(HE2A(IC& IN FINANCE
+$ -E+,(0= 2(T3 0E=+T(@E 0UMBE.S
(n Finance we encounter negative nu!&ers often$ +s !anagers we #o'e t#at t#ere are not too !any
negative nu!&ers on t#e &otto! line$ 1ou !ay encounter negative nu!&ers in your co!'any analysis$ (t
is i!'ortant to &e %now #ow to 'ro'erly #andle negative nu!&ers w#en 're'aring a 'resentation$
:$ -o not !ulti'ly or divide &y a negati=e num)er or )y Nero$
?$ -o not atte!'t to do a 'ercentage c#ange analysis &etween -ositi=e and negati=e nu!&ers$ (t is
!eaningless$
>$ Most ratios do not co!'ute wit# a negative nu!&er$ For e)a!'le consider t#e case of a stoc% selling
at I?7 'er s#are wit# E$$S$ of 4*I?$775$ T#e JE is 0/T *:7)$ T#is does not !ean anyt#ing$ (t is
li%e a T(E of 7 w#en it s#ould &e infinite$
+n e)ce'tion is !argin analysis$ (t is 'ossi&le to #ave a negative net !argin and a
negative ./E$ T#e 'ro&le! wit# ./E is t#at we nor!ally co!'ute an average
&etween two years$ (F one year is 'ositive and t#e ot#er is negative, t#e average is
!eaningless$
8$ +s wit# all ot#er wor% we #ave done, as% yourself t#e Buestion: F-oes t#is !a%e senseLG T#e acid
test of any nu!&er in finance is w#et#er it can serve as a 'redictor or decision !a%ing tool$
Consider t#is ti!e series:
E$$S O c#g$
:66; I?$77
:669 I?$?7 R:7O
:66< I:$"7 *:"O
:66" *I7$;7 (0-ETE.M(0+TE
:666 I:$77 F
T#e only way to analyAe trends using t#is data is to develo' an inde) nu!&er$ Usually t#e lowest nu!&er
4in t#is case *$;75 is set to Aero$
E.'.& T3ESE +.E (0-EX 0UMBE.S
7//6 F 0 1/U C+0 .E+.E + B+. C3+.T US(0= T3EM
:66; ?;7
:669 ?<7
:66< ?>7
:66" 7
:666 :;7
#. DEALIN> ?I(H 'ERCEN(A>E&
(f a nu!&er -/UB,ES t#at is a :77O increase$ + T2/ F/,- c#ange is a :77O increase$
(f a nu!&er tri'les t#at is a ?77O increase 0/T a >77O c#ange$
+ ; fold increase is not ;77O$ (t is a 877O increase$ T3(S (S + C/MM/0 EX+M M(ST+KE$
(n &usiness we use 'ercentages a great deal$ (n t#e Financial ,everage seg!ent of t#e course so!e
for!ulas deal wit# O c#ange$ For e)a!'le -/, &etween two 'oints Q O c#ange in EB(T J O c#ange in
sales$ +ssu!e sales : Q I:;7,777 and sales ? Q I:,777,777$ +ssu!e EB(T : Q I>7,777 and EB(T ? Q
I?;7777$ Co!'ute -/,
;<
;<
O c#ange in EB(T Q 4?;7,777 * >77775 J >7777 Q <$>>X Q 9>>O
O c#ange in S+,ES Q 4:,777,777 * :;7,7775 J :;7777 Q ;$99X Q 899O
D$L F 7.3C63
(HE A&&$CIA(I$N $F INBE&(2EN(
2ANA>E2EN( AND RE&EARCH ,AI2R0
(HE CHAR(ERED FINANCIAL ANAL1&(-
CFA DE&I>NA(I$N
+(M. is a non'rofit 'rofessional society for 'ractitioners wit#in t#e invest!ent !anage!ent
'rofession$ Me!&ers include securities analysts, 'ortfolio !anagers, strategists, consultants,
invest!ent counsellors and acade!ics$
+(M. was founded in :667 t#roug# t#e !erger of t#e Financial +nalyst Federation 4F+F5 and t#e
(nstitute of C#artered Financial +nalysts$ +(M. currently re'resents invest!ent 'rofessionals in
96 countries$ T#is 'ast year, over ;7,777 candidates sat for one of t#ree 'arts of t#e CF+
e)a!ination$ +&out a t#ird of t#ese candidates were outside 0ort# +!erica$
There are a limited number of *)'. scholarships available each ;ear thou!h ;our instructor.
These scholarships provide the course materials for /F* ,0*' 1. )f ;ou thin> this ma; be of
interest see me about this opportunit;.
+(M. is #eadBuartered in C#arlottesville, @irginia and 'u&lis#es !any 'rofessional 'u&lications
including t#e Financial +nalystKs Dournal$ (t also s'onsors conferences and se!inars around t#e
world$ T#ere are constituent local societies in over :7; cities worldwide$ ,ocal c#a'ters in
Florida are in /rlando, Mia!i, Ta!'a Bay and Dac%sonville$
( received !y CF+ designation in :6<: and #ave &een active in t#e society since :699$ ( a!
involved in grading t#e CF+ e)a!s$ ( will &e !ost #a''y to discuss t#is 'rofessional association
wit# anyone$ (f you are conte!'lating a career in t#e invest!ent field, you s#ould consider loo%ing
into t#e CF+$ T#e CF+ consists of > e)a!inations s'aced over > years$ Eac# e)a! is 9 #ours in
duration$ T#e curriculu! is rigorous and consists of advanced reading in accounting, financial and
industry analysis, 'ortfolio !anage!ent, regulation and et#ics$
My e)'erience as -irector of .esearc# for a !aCor &ro%erage fir! is t#at CF+ c#arter#olders earn
:7*;7O !ore t#an t#eir conte!'oraries wit#out t#e designation$
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