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Financial Management Concepts and Applications, Lecture notes of Mathematics

Greenwich Vietnam Mathematics

A wide range of financial management topics, including capital budgeting, capital structure, asset valuation, risk and return, and financial markets. It provides an in-depth analysis of key concepts and their practical applications in the business world. Structured around multiple-choice questions and short answer questions, allowing readers to test their understanding of the material. It delves into topics such as the goal of financial management, the differences between book value and market value, the components of the cost of capital, the evaluation of investment projects using techniques like npv and irr, and the characteristics of various financial instruments and markets. Likely to be useful for university students studying finance, accounting, or related disciplines, as it covers a comprehensive set of foundational financial management principles and their real-world implications.

Typology: Lecture notes

2023/2024

Uploaded on 06/11/2024

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SECTION A: MULTIPLE CHOICE QUESTIONS (3 MARKS)

Answer ALL questions. Each question carries 0.15 marks.

1. Which one of the following terms is defined as the management of a firm's long- term investments?

A. working capital management B. financial allocation.

C. agency cost analysis D. capital budgeting

E. capital structure

2. Which one of the following is a capital budgeting decision?

A. determining how many shares of stock to issue

B. deciding whether or not to purchase a new machine for the production line

C. deciding how to refinance a debt issue that is maturing

D. determining how much inventory to keep on hand

E. determining how much money should be kept in the checking account

3. Which one of the following statements is correct?

A. A general partnership is legally the same as a corporation

B. Both sole proprietorship and partnership income is taxed as individual income

C. Partnerships are the most complicated type of business to form

D. All business organizations have bylaws

E. Only firms organized as sole proprietorships have limited lives.

4. Which one of the following is classified as an intangible fixed asset?

A. accounts receivable B. production equipment

C. building D. trademark

E. inventory

5. The book value of a firm is:

A. equivalent to the firm's market value provided that the firm has some fixed assets.

B. based on historical cost

C. generally greater than the market value when fixed assets are included

D. more of a financial than an accounting valuation

E. adjusted to the market value whenever the market value exceeds the stated book value.

6. Shelley won a lottery and will receive $1,000 a year for the next ten years. The value of her

winnings today discounted at her discount rate is called which one of the following?

A. single amount B. future value

C. present value D. simple amount

E. compounded value

7. Which one of the following transactions occurs in the primary market?

A. purchase of 500 shares of GE stock from a current shareholder

B. gift of 100 shares of stock to a charitable organization

C. gift of 200 shares of stock by a mother to her daughter

D. a purchase of newly issued stock from AT&T

Partial preview of the text

Download Financial Management Concepts and Applications and more Lecture notes Mathematics in PDF only on Docsity!

SECTION A: MULTIPLE CHOICE QUESTIONS (3 MARKS)

Answer ALL questions. Each question carries 0.15 marks.

1. Which one of the following terms is defined as the management of a firm's long- term investments? A. working capital management B. financial allocation. C. agency cost analysis D. capital budgeting E. capital structure 2. Which one of the following is a capital budgeting decision? A. determining how many shares of stock to issue B. deciding whether or not to purchase a new machine for the production line C. deciding how to refinance a debt issue that is maturing D. determining how much inventory to keep on hand E. determining how much money should be kept in the checking account 3. Which one of the following statements is correct? A. A general partnership is legally the same as a corporation B. Both sole proprietorship and partnership income is taxed as individual income C. Partnerships are the most complicated type of business to form D. All business organizations have bylaws E. Only firms organized as sole proprietorships have limited lives. 4. Which one of the following is classified as an intangible fixed asset? A. accounts receivable B. production equipment C. building D. trademark E. inventory 5. The book value of a firm is: A. equivalent to the firm's market value provided that the firm has some fixed assets. B. based on historical cost C. generally greater than the market value when fixed assets are included D. more of a financial than an accounting valuation E. adjusted to the market value whenever the market value exceeds the stated book value. 6. Shelley won a lottery and will receive $1,000 a year for the next ten years. The value of her winnings today discounted at her discount rate is called which one of the following? A. single amount B. future value C. present value D. simple amount E. compounded value 7. Which one of the following transactions occurs in the primary market? A. purchase of 500 shares of GE stock from a current shareholder B. gift of 100 shares of stock to a charitable organization C. gift of 200 shares of stock by a mother to her daughter D. a purchase of newly issued stock from AT&T

E. IBM's purchase of GE stock

8. The length of time a firm must wait to recoup the money it has invested in a project is called the: A. internal return period B. payback period C. profitability period D. discounted cash period E. valuation period 9. The internal rate of return: A. may produce multiple rates of return when cash flows are conventional B. is best used when comparing mutually exclusive projects C. is rarely used in the business world today D. is principally used to evaluate small dollar project E. is easy to understand 10. The expected return on a stock given various states of the economy is equal to the: A. highest expected return given any economic state B. arithmetic average of the returns for each economic state C. summation of the individual expected rates of return. D. weighted average of the returns for each economic state E. return for the economic state with the highest probability of occurrence 11. Unsystematic risk: A. can be effectively eliminated by portfolio diversification B. is compensated for by the risk premium C. is measured by beta D. is measured by standard deviation E. is related to the overall economy 12. Which one of the following indicates a portfolio is being effectively diversified? A. an increase in the portfolio beta B. a decrease in the portfolio beta C. an increase in the portfolio rate of return D. an increase in the portfolio standard deviation E. a decrease in the portfolio standard deviation 13. Total risk is measured by and systematic risk is measured by _____. A. beta; alpha B. beta; standard deviation C. alpha; beta D. standard deviation; beta E. standard deviation; variance 14. Which one of the following is the primary determinant of a firm's cost of capital? A. debt-equity ratio

20. Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public. The underwriters charged a fee of 8 percent and paid Blue Stone Builders $16.40 a share on 40,000 shares. Which one of the following terms best describes this underwriting? A. best efforts B. shelf registration C. direct right D. private placement E. firm commitment SECTION B: SHORT ANSWER QUESTION (2.2 MARKS) Answer ANY TWO questions. Each question carries 1.1 marks

According to CAPM, the expected return on a risky asset depends on three components. Describe each component and explain its role in determining expected return.
Explain the differences and similarities between net present value (NPV) and the profitability
Using the dividend growth model, explain why a firm would be hesitant to reduce the growth rate of its dividends. SECTION C: PROBLEM SOLVING QUESTIONS (4.8 MARKS) Answer ANY THREE questions. Each question carries 1.6 marks.
What is the standard deviation of the returns on a $30,000 portfolio which consists of stocks S and T? Stock S is valued at $21, State of Economy Probability of State of Economy Returns if State Occurs Stock S Stock T Boom 5% 11% 8% Normal 85% 8% 6% Recession 10% -5% 8%
Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14.3 percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company's tax rate is 37 percent. What is the firm's weighted average cost of capital?
An investment project costs $21,500 and has annual cash flows of $6,500 for 6 years. If the discount rate is 15 percent, what is the discounted payback period?
You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. Project A Project B Year Cash Flow Year Cash Flow

Required rate of return 9 percent 14 percent Required payback period 2.5 years 2.5 years Required accounting return 10 percent 11 percent Should you accept or reject these projects based on net present value analysis? SHORT-ANSWERS

How does the net present value (NPV) decision rule relate to the primary goal of financial management, which is creating wealth for shareholders?
Using the dividend growth model, explain why a firm would be hesitant to reduce the growth rate of its dividends.
Discuss the difference between book values and market values and explain which one is more important to the financial manager and why.
The NPV rule states that a project should be accepted if the NPV is positive and rejected if the NPV is negative. This aligns with the goal of creating wealth for a firm's shareholders as only projects which create wealth are approved for acceptance. Managers are indifferent to projects with zero NPVs, which is okay because such projects neither create nor destroy shareholder wealth. 1. Which one of the following is defined as a firm’s short-term assets (Tài sản ngắn hạn) and its short-term liabilities (Nợ ngắn hạn)? A. Working capital B. Debt C. Investment capital D. Net capital E. Capital structure 2. Which one of the following is an agency cost( Chi phí đại lý)? A. Accepting an investment opportunity that will add value to the firm B. Increasing the quarter dividend C. Investing in a new project that creates firm value D. Hiring outside accountants to audit the company’s financial statements. E. Closing a division of the firm that is operating at a loss 3. Shareholders’ equity A. Increases in value anytime total assets increases B. Is equal to total assets plus total liabilities C. Decreases whenever new shares of stock are issued D. Includes long-term debt, preferred stock, and common stock E. Represents the residual value of the firm. 4. Interest earned on both the initial principal and the interest reinvested from prior periods is called:

E. Payback is focused on the long-term impact of a project

12. Which two methods of project analysis were the most widely used by CEO’s as of 1999? A. Net present value and payback. B. Internal rate of return and payback C. Net present vlaue and average accounting return D. Internal rate of return and net present value 13. Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the: A. Compound rate. B. Current yield. C. Cost of debt. D. Capital gains yield E. Cost of capital. 14. A firm’s overall cost of equity is: A. is generally less than the firm’s WACC given a leveraged firm. B. unaffected by changes in the market risk premium. C. highly dependent upon the growth rate and risk level of the firm. D. generally, less than the firm’s after-tax cost of debt. E. inversely related to changes in the firm’s tax rate. 15. Lester’s Frozen Foods just paid out $0.50 a share to its shareholders. The cash for these payments came from a large sale of assets, not from any earnings of the firm. What are these payments to shareholders called? A. Dividends B. Distributions C. Repurchases D. Payment-in-kind E. Stock splits 16. An investor is more likely to prefer a high dividend payout if a firm: A. has high flotation costs. B. has few, if any, positive net present value projects. C. has lower tax rates than the investor. D. has stock price that is increasing rapidly. E. offers substantial gains on its equities, which are taxed at a favorable rate. SECTION B: SHORT ANSWER QUESTION Answer ANY TWO questions. Each question carries 15 marks.

As long as the firm maintains a positive cash balance, why is it essential to review the firm’s cash flows?
How does the net present value (NPV) decision rule relate to the primary goal of financial management, which is creating wealth for shareholders?
List and briefly describe the three general areas of responsibility for a financial manager. SECTION C: PROBLEM SOLVING QUESTION Answer ANY THREE questions. Each question carries 13 marks.
Soo Lee imports issued 17-year bonds 2 years ago at a coupon rate of 10.3 percent. The bonds make semiannual payments. These bonds currently self for 102 percent of par value. What is the yield to maturity? Verify that your answer is correct. (the yield to maturity is r)

Jen’s Fashions is growing quickly. Dividends are expected to grow at a 19 percent rate for the next 3 years, with the growth rate falling off to a constant 8 percent thereafter. The required return is 12 percent and the company just paid a $3.80 annual dividend. What is the current share price?
Scott is considering a project that will produce cash inflows of $2,100 a year for 4 years. The project has a 12 percent required rate of return and an initial cost of $6,000. What is the discounted payback period?

SHORT ANSWER (1 QUESTION- CHAPTER 1,2,7,8,9)

TOPIC 1 – INTRODUCTION TO FINANCIAL MANAGEMENT (CHAPTER 1)

1. List and briefly describe the three general areas of responsibility for a financial

manager.

The three basic areas are:

1. capital budgeting: the identification of investment opportunities that have a positive net value

2. capital structure: the mix of long-term debt and equity used to finance a firm's operations

3. working capital management: the daily control of a firm's short-term assets and short-term

liabilities

2. Describe the key advantages associated with the corporate form of organization.

The advantages of the corporate form of organization are the ease of transferring ownership, the

owners' limited liability for business debts, the ability to raise large amounts of capital, and the

potential for an unlimited life for the organization.

3. Why are so many businesses structured as sole proprietorships when the corporate form

of business offers more advantages?

A significant advantage of the sole proprietorship is that it is inexpensive and easy to form. If

the sole proprietor has limited capital to start with, it may not be desirable to spend part of that

capital forming a corporation. Also, limited liability for business debts may not be a significant

advantage if the proprietor has most of his or her personal assets tied up in the business already.

Finally, for a typical small firm, having an unlimited life for the business has no real advantage

since the heart and soul of the business is the person who founded it, thereby effectively limiting

the life of the business to that of its founder.

4. What concerns might a loan officer have when loaning funds to a sole proprietorship

that he or she might not have when loaning funds to a corporation?

The existence and viability of a sole proprietor is dependent upon one individual. Should that

individual die, the entity would cease to exist. Likewise, should the owner lose interest in the

business or become ill, the business might also cease to exist. With a corporation, the company

ownership could be sold in any one of those situations such that the business entity would

continue to exist.

5. From a liability point of view, what is the difference between investing in a sole

proprietorship and a general partnership?

that should be raised. The managers have asked you to explain the effects that both of these

forms of financing would have on the cash flows of the firm. Write a short response to this

request.

Debt financing will require cash outflows for both interest and principal payments. The interest

outflow will be partially offset by a decrease in the cash outflow for taxes. Should the firm

accept additional debt, the liquidity of the firm might have to be increased to ensure the debt

obligations can be met in a timely manner. On the other hand, equity financing does not create

any requirement for future cash outflows as equity does not need to be repaid nor are dividends

required. However, if dividends are paid, they would not lower the firm's cash outflow for taxes.

2. Discuss the difference between book values and market values and explain which one is

more important to the financial manager and why.

The accounts on the balance sheet are generally carried at historical cost, not market values.

Although the book value of the current assets and the liabilities may closely approximate market

values, the same cannot be said for the rest of the balance sheet accounts. Market values are

more relevant as they reflect today's values whereas the balance sheet reflects historical costs as

adjusted by various accounting methods. To determine the current value of a firm, and its worth

to the shareholders, financial managers must monitor market values.

3. Assume you are a credit manager in charge of approving commercial loans to business

firms. Identify three aspects of a firm's cash flows you would review and explain the type of

information you hope to gain from reviewing each of those five aspects.

Student answers will vary but here are some examples:

1) operating cash flow - Is the firm generating positive cash flow from its current operations?

2) cash flow to creditors - Is the firm currently repaying debt or is it assuming additional debt?

3) net working capital - Is the firm increasing or decreasing its net working capital and what

effect, if any, is this having on the firm's liquidity?

4) cash flow to stockholders - Is the firm currently paying any dividends to its shareholders and

are those shareholders investing additional capital into the firm?

5) net capital spending - Is the firm currently investing in additional fixed assets?

TOPIC 4 – VALUATION OF BONDS (CHAPTER 7)

1. Define liquidity risk, default risk, and taxability risk and explain how these risks relate

to bonds and bond yields.

Liquidity risk is the inability to quickly sell a bond for its full value. This risk exists primarily in

thinly traded issues. Default risk is the likelihood the issuer will default on its bond obligations

and is the basis for bond ratings. Taxability risk reflects the fact that bond interest can be taxed

differently at the federal, state, and local levels and that these tax rates can change. Each of these

risks increase bond yields as investors require compensation in exchange for risk acceptance.

2. Inflation has remained low for the past three years but you have come to the conclusion

that trend is ending and inflation will increase significantly over the next 18 months.

Assume you have reached this conclusion prior to other investors reaching the same

conclusion. What adjustments should you make to your bond portfolio in light of your

conclusions?

Increases in inflation will increase interest rates according to the term structure of interest rates.

Therefore, you should sell any long-term bonds you own and replace them with short-term

bonds. You should also replace lower coupon bonds with higher coupon bonds. These changes

should be done promptly before other investors commence taking the same actions.

3. Explain the conditions that would need to exist for the Treasury yield curve to be

downward sloping.

A downward sloping Treasury yield curve exists when current inflation rates are high but are

expected to decline in the future. The decline in the inflation premium must be significant

enough to overcome the rising interest rate risk premium as the time to maturity increases.

4. Describe the relationships that exist between the coupon rate, the yield to maturity, and

the current yield for both a discount bond and a premium bond. Discount bond: Yield to

maturity > Current yield > Coupon rate

Premium bond: Yield to maturity < Current yield < Coupon rate

TOPIC 5 – VALUATION OF SHARES (CHAPTER 8)

1. What are the primary differences and similarities between NASDAQ and the NYSE?

The NYSE has a physical trading floor in New York City, is primarily a broker market, relies on

specialists for liquidity under a single market maker system, utilizes the SuperDOT system, and

has stricter listing requirements. NASDAQ is an electronic network of dealers and utilizes a

multiple market maker system. NASDAQ is open to ECNs but the NYSE is not. NASDAQ has

no physical trading floor.

2. Using the dividend growth model, explain why a firm would be hesitant to reduce the

growth rate of its dividends.

The dividend growth model states that Pt = Dt+1/(R - g). A reduction in the growth rate will

reduce both Dt+1 and g. Lowering the value of these variables will effectively lower the value of

the firm's stock, which is something firms are hesitant to do.

3. Kelley wants to purchase shares in Classic Kars, Inc., but is torn between buying shares

of common stock or shares of preferred stock. What should he consider before determining

the type of share he should purchase?

Kelley needs to identify the reasons he wishes to purchase this stock. If he is looking for a

steady stream of income and preferential treatment should the company go bankrupt, then he

should purchase preferred stock. On the other hand, if he believes the company has a bright

financial future and wishes to share in that success, then he should buy common stock and enjoy

the benefits of residual ownership associated with high profitability. In addition, if he wishes to

have a voice in company matters, he should purchase common stock to ensure that he will have

voting rights.

4. Explain why small shareholders should prefer cumulative voting over straight voting.

With straight voting, a shareholder must control a majority (50 percent plus one) of the

outstanding shares of stock to gain access to a seat on the board of directors. With cumulative

4. How does the net present value (NPV) decision rule relate to the primary goal of

financial management, which is creating wealth for shareholders?

The NPV rule states that a project should be accepted if the NPV is positive and rejected if the

NPV is negative. This aligns with the goal of creating wealth for a firm's shareholders as only

projects which create wealth are approved for acceptance. Managers are indifferent to projects

with zero NPVs, which is okay because such projects neither create nor destroy shareholder

wealth.

REVISION

1. TYPE 1: Calculate Cash Flow from Asset

Ex1.1: Bonner Collision has shareholders' equity of $141,800. The firm owes a total of $126,

of which 60 percent is payable within the next year. The firm net fixed assets of $161,900. What

is the amount of the net working capital?

Ex1.2: Crandall Oil has total sales of $1,349,800 and costs of $903,500. Depreciation is $42,

and the tax rate is 34 percent. The firm does not have any interest expense. What is the operating

cash flow?

Ex1.3: What is the cash flow from assets for 2011 of M&M Foods

2. TYPE 2: Time value of money (Finding FV, PV of Annuity and Perpetuity)

Ex 2.1: You just won the grand prize in a national writing contest! As your prize, you will

receive $2,000 a month for ten years. If you can earn 7 percent on your money, what is this prize

worth to you today?

Ex 2.2: Alexa plans on saving $3,000 a year and expects to earn an annual rate of 10.25 percent.

How much will she have in her account at the end of 45 years?

Ex2.3: You are planning to save for retirement over the next 35 years. To do this, you will invest

$750 per month in a stock account and $300 per month in a bond account. The return of the stock

account is expected to be 10% per year, and the bond account will pay 6% per year. When you

retire, you will combine your money into an account with a return of 5%. How much can you

withdraw each month from your account assuming a 25-year withdrawal period.

Ex2.3: You borrow $165,000 to buy a house. The mortgage rate is 4.5 percent and the loan

period is 20 years. Payments are made monthly. If you pay the mortgage according to the loan

agreement, how much total interest will you pay?

3. TYPE 3: Bond Valuation

Ex3.1: Grand Adventure Properties offers a 9.5 percent coupon bond with annual payments. The

yield to maturity is 11.2 percent and the maturity date is 11 years from today. What is the market

price of this bond if the face value is $1,000?

4. TYPE 4: Stock Valuation

Ex4.1: How much are you willing to pay for one share of Jumbo Trout stock if the company just

paid a $0.70 annual dividend, the dividends increase by 2.5 percent annually, and you require a

10 percent rate of return?

Ex4.2: Free Motion Enterprises paid a $2 per share annual dividend last week. Dividends are

expected to increase by 20 percent in year 1 and 15% in year two. After that dividends are

expected to increase by 3 percent annually. What is one share of this stock worth to you today if

your required rate of return is 13 percent? (3 points)

Ex4.3: The current dividend yield on Clayton's Metals common stock is 3.2 percent. The

company just paid a $1.48 annual dividend and announced plans to pay $1.54 next year. The

dividend growth rate is expected to remain constant at the current level. What is the required rate

of return on this stock?

5. TYPE 5: Capital Budgeting Techniques

Ex 5.1: You are considering the following two mutually exclusive projects. The required rate of

return is 14.6 percent for project A and 13.8 percent for project B. The management numbers of

payback and discounted payback periods for both projects are 3 years. Which project should you

accept based on NPV/ Payback/ Discounted Payback Analysis.

8. TYPE 8: Dividend Policy

KEYWORDS

Section A: 20 Multiple Choice Questions

capital budgeting/capital structure decision, proprietorship – partnership – corporation, goal of