FINC 201 TUTORIAL TEST STAY UPDATED FOR EVENTS - PowerPoint Presentation

1. FINC 201 TUTORIALTEST

2. STAY UPDATED FOR EVENTS Facebook Page: The Investment SocietyInstagram: the_investmentsocietySIGN UP FOR FREE QUESTIONS AND FEEDBACKEmail: tutorials@ucinvestmentsociety.com

3. OVERVIEWGoal of the FirmFinancial Statements & Ratio AnalysisTime Value of Money (TVM)Practicing Approach and Method to Answering QuestionsContinuous CompoundingAnnuity DueInflation AdjustmentsEffective Annual Rate (EAR)Bond ValuationPracticing Approach and Method to Answering QuestionsStock ValuationKey Formulas and VariablesPracticing Approach and Method to Answering QuestionsNPVProjects with unequal lengthFinding IRR

4. About the TestREMEMBER, you must write down the relevant formula and plug in correct numbers before using financial calculatorWhen using financial calculator, state what you are doing and write down variables inputted eg. N= ____ , I/Y = ____ etc…If you do not have a financial calculator, you must rearrange and solve mathematically

5. Goal of the FirmMaximise shareholder value! Usually through maximising returns to shareholders through dividends and capital growth (appreciation in the share price). Also related to the goal of the firm is agency theory which says that there is a misalignment of interests between those managing the firm and those who own the firm (shareholders). However, shareholders have an indirect power over the managers as they elect the Board of Directors who elects the CEO who determines secondary management.

6. QUESTION 1

7. Question 1What would you do first?

8. Age 22 62 Year 0 40 $ 0 FVQuestion 1NI/YPVPMTFVThese are the key variables we need – can you find them all?NEED TO IDENTIFY WHICH OF THE 5 KEY VARIABLES BELOW WE NEED FOR OUR ANSWER

9. Finding N (Number of Periods) NI/YPVPMTFV480These are the key variables we need – can you find them all?    Calculation:     

10. Finding PMT (or CF – per period) NI/YPVPMTFV480420These are the key variables we need – can you find them all?  Calculation:    

11. Finding Required Rate of Return (I/Y, OCC, r) NI/YPVPMTFV4800.83333333420These are the key variables we need – can you find them all?   Calculation:   NOTE: Enter percentages as whole numbers in financial calculator! e.g. enter 10% as 10, NOT 0.10

12. Calculating Future Value (FV) These are the key variables we need – can you find them all?INPUT FIGURES INTO FINANCIAL CALCULATORTHEN COMPUTE FVNI/YPVPMTFV4800.83333330420=???

13. Find FV - Financial Calculator (Texas)      VariableInputN480I/Y0.83333PMT420PV0Calculator Key(s)CPTFVNI/YPVPMTFV4800.83333330420=$2,656,113.42Gives FV = $2,656,113.42

14. Final Answer These are the key variables we need – can you find them all?INPUT FIGURES INTO FINANCIAL CALCULATORTHEN COMPUTE FVNI/YPVPMTFV4800.83333330420= $2,656,113.42

15. Question 2

16. Question 2 NI/YPVPMTFVNEED TO IDENTIFY WHICH OF THE 5 KEY VARIABLES BELOW WE NEED FOR OUR ANSWERWhere do we start?

17. NI/YPVPMTFVThese are the key variables we need – can you find them all?Age 22 62 82Year 0 40 60$ 0 PV FVCreate A Timeline

18. Finding the Present Value (PV)NI/YPVPMTFV2,656,113.4These are the key variables we need – can you find them all?KEY:OUR FV from (b) is now our PV in (c)Age 22 62 82Year 0 40 60$ 0 PV FV

19. Finding the Remaining VariablesNI/YPVPMTFV2400.833333332,656,113.4=???$0These are the key variables we need – can you find them all?Age 22 62 82Year 0 40 60$ 0 PV FV $2,656,113.42 $0• I/Y remains the same as in (b)• N Calculation:   

20. Gives PMT = $25,632.07So monthly income while retired will be $25,632.07Find PV - Financial Calculator (Texas)      VariableInputN240I/Y0.83333PV2,656,113.4FV0Calculator Key(s)CPTPMTNI/YPVPMTFV2400.833333332,656,113.4=$25,632.070

21. Final Answer (PMT)NI/YPVPMTFV2400.833333332,656,113.4=$25,632.07$0These are the key variables we need – can you find them all?Age 22 62 82Year 0 40 60$ 0 PV FV $2,656,113.42 $0NOTE: THIS IS MONTHLY!

22. Continuous Compounding

23. Method NI/YPVPMTFV=???5/12$1$0$2If you are receiving an annual return of 5% per annum, continuously compounding monthly, how long will it take to double your money?Use Financial Calculator:N = 166.7 monthsN = 13.89 years

24. Annuity Due

25. Year 0 1 2 3 4 5$ CF1 CF2 CF3 CF4 CF5$ CF1 CF2 CF3 CF4 CF5Annuity Due v Ordinary AnnuityDifference between Ordinary Annuity and Annuity DueSo which would we expect to have a higher NPV?Ordinary AnnuityAnnuity DueCalculation:  SO WE CAN SOLVE LIKE AN ORDINARY ANNUITY, THEN AT THE VERY END WE JUST ADJUST BY ONE (1) PERIOD (USING THE RATE)

26. QUESTION 3Inflation Adjustments

27. Question 3You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%.(a) What is the present value of the proceeds from the bond?(b) If the inflation rate over the next few years is expected to be 3%, what will the real value of the $100 payoff be in terms of today’s dollars?(c) What is the real interest rate?(d) Show that the real payoff from the bond [from part (b)] discounted at the real interest rate [from part (c)] gives the same present value for the bond as you found in part (a).

28. Year 0 1 2 3CF $100Answer to 3(a)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%.(a) What is the present value of the proceeds from the bond?Calculation:  

29. Question 3(b)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%.(b) If the inflation rate over the next few years is expected to be 3%, what will the real value of the $100 payoff be in terms of today’s dollars?

30. Answer to 3(b)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%.(b) If the inflation rate over the next few years is expected to be 3%, what will the real value of the $100 payoff be in terms of today’s dollars?Calculation:  

31. Question 3(c)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%. The inflation rate over the next few years is expected to be 3%.(c) What is the real interest rate?

32. FormulaThe key is to change the nominal rate to a real rateCalculation:Where i is the rate of inflation  

33. Answer to 3(c)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%. The inflation rate over the next few years is expected to be 3%.(c) What is the real interest rate?Calculation:Where i is the rate of inflation  

34. Question 3(d)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%. The inflation rate over the next few years is expected to be 3%.(d) Show that the real payoff from the bond [from part (b)] discounted at the real interest rate [from part (c)] gives the same present value for the bond as you found in part (a).

35. Answer to 3(d)You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8%. The inflation rate over the next few years is expected to be 3%.(d) Show that the real payoff from the bond [from part (b)] discounted at the real interest rate [from part (c)] gives the same present value for the bond as you found in part (a).Calculation:$91.51 is answer from (b)0.048544 is answer from (c) THIS SHOWS THAT YOU SHOULD ARRIVE AT THE SAME ANSWER WHETHER YOU USE NOMINAL OR REAL

36. QUESTION 4

37. Question 4BNZ is loaning money at 6.2% compounded semi-annuallyANZ is loaning money at 6.0% compounded monthlyWhat is the best option?

38. FormulaThis formula is to help with comparing interest ratesThis formula is made to help you “compare apples with apples”EAR = Effective Annual RateCalculation:Where m is the number of periods per year  

39. AnswerBNZ is loaning money at 6.2% compounded semi-annuallyANZ is loaning money at 6.0% compounded monthlyWhat is the best option?BNZ Loan Rate Calculation:  So what does this mean?ANZ Loan Rate Calculation:  

40. AnswerBNZ is loaning money at 6.2% compounded semi-annuallyANZ is loaning money at 6.0% compounded monthlyWhat is the best option?BNZ Loan Rate Calculation:  The EAR of ANZ’s rate indicates that it is cheaper than BNZ.So since we are borrowing, we should choose ANZ.ANZ Loan Rate Calculation:  

41. QUESTION 5Bond Valuation

42. Question 5

43. Year 0 1 20$ ?? PV FVQuestion 5NI/YPVPMTFV=???These are the key variables we need – can you find them all?NEED TO IDENTIFY WHICH OF THE 5 KEY VARIABLES BELOW WE NEED FOR OUR ANSWERWE NEED PRICESO WE ARE CALCULATING PV!

44. Question 5NI/YPVPMTFV=???1000(0.07)=701000These are the key variables we need – can you find them all?INITIAL INFO THAT DOESN’T CHANGE!Year 0 1 20$ ?? PV FV

45. Question 5 NI/YPVPMTFV20-1=196=???1000(0.07)=701000These are the key variables we need – can you find them all?FILL IN NEW INFORMATION THAT HAS CHANGEDYear 0 1 20$ ?? PV FV

46. Gives PV = $1,111.58So the current price of the bonds is $1,111.58Find PV - Financial Calculator (Texas)VariableInputN19I/Y6PMT70FV1,000 Calculator Key(s) NI/YPVPMTFV196=$1,111.58701,000CPTPV    

47. Question 5NI/YPVPMTFV20-1=196=$1,111.581000(0.07)=701000Look over notes so you can explain why price rises with a drop in interest rates...

48. QUESTION 6

49. Question 6Air NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?

50. Question 6NI/YPVPMTFVAir NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?These are the key variables we need – can you find them all?Is this all the information we have?What is a “current yield”?How would you approach this?

51. Question 6NI/YPVPMTFV1,000Air NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?ASSUME: Face Value is $1,000

52. Question 6NI/YPVPMTFV=???7=(0.08)(1,000)=801,000Air NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?But how do we figure out the current price?

53. Finding Current Price, using Current YieldAir NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?What is the “current yield”?Formula:We can re-arrange: 

54. Finding Current Price, using Current YieldAir NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?What is the “current yield”?Formula:We can re-arrange: For Financial Calculator:PMT is CouponPV is PriceCalculation: 

55. Question 6NI/YPVPMTFV=???7-1,070.23=(0.08)(1,000)=801,000Air NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?Now we plug numbers in and CPT for NNOTE: Enter PV as a negative

56. Question 6NI/YPVPMTFV=9.997-1,070.23=(0.08)(1,000)=801,000Air NZ has issued 8% annual coupon bonds that are now selling at a yield to maturity of 7% and current yield of 7.475%. What is the remaining maturity of these bonds?Therefore, 10 years remaining!

57. STOCK VALUATION

58. Key Formulas and Variables

59. Calculate the Current Share Price (P0)  

60. Answer Formulas:       

61. Calculate the Current Share Price (P0)   

62. Answer     Formulas:      

63. Calculate Market Capitalisation 

64. Answer Formulas:     

65. QUESTION 7

66. Question 7

67. Question 7SET IT UP WITH A TIMELINE, AND A TABLE OF FIGURES BELOW

68. Question 7ESTABLISH ALL THE GIVEN FIGURES, THEN CALCULATE THE GAPS

69. Question 7 START WITH EPS, THEN DPS COMES FROM THIS

70. Question 7 Formula & Calculation:  Example (Year 1 Dividend):Note “d” is dividend pay-out ratio NOTE: IN THE TEST, DON’T ROUND UP UNTIL THE VERY END!!!

71. Question 7NOW SET UP LABELS AND SPACE FOR YOUR FINAL CALCULATIONS

72. Question 7NOW YOU NEED TO DISCOUNT THE FIRST “SET” OF DIVIDENDS BACK TO PV at Year 0Formula & Calculation:  

73. Question 7 THIS IS WHERE YOU USE THE GROWING PERPETUITY FORMULAFormula & Calculation:  

74. Question 7 BE CAREFUL! THIS FIGURE IS THE PV at Year 3! SO WE NEED TO BRING IT BACK to Year 0!Formula & Calculation:  

75. Question 7THEN SIMPLE ADDITION OF THE TWO PV0’s

76. Question 7IF THE CURRENT PRICE IS $65 WHAT DO YOU CONCLUDE? IF THE CURRENT PRICE IS $80 WHAT DO YOU CONCLUDE?

77. How to do this on Financial CalculatorVariableInputCFo0C010.48F011C020.576F021C03= 0.6912 + 93.312 = 94.0032F031 ENTER ENTER ENTER ENTER ENTER Calculator Key(s)ENTER ENTER

78. How to do this on Financial CalculatorVariableInputI10NPV[empty] ENTER CPT Calculator Key(s)AND THIS GETS US THE PRESENT VALUE OF THE STOCK OF $71.54

79. Financial Ratios & Analysis

80. Types of Financial RatiosEfficiency Ratios: how well we are using our assets to generate earningsAsset Turnover, Inventory Turnover, Accounts Receivable Collection PeriodProfitability Ratios: how well we use assets to retain profitsNet Profit Margin, Gross Profit Margin, Return on Equity, Return on AssetsLeverage Ratios: how well we maintain the right mix of debt and equity Debt Ratio, Debt-Equity Ratio, Interest Coverage RatioLiquidity Ratios: how well can we meet our short term debt obligationsCurrent Ratio, Liquid Ratio

81. Question 8

82. Question 8 (a)What are the annual sales for a firm with $400,000 in debt, a total debt ratio of 0.4, and an asset turnover of 3.0?

83. Question 8 (a)What are the annual sales for a firm with $400,000 in debt, a total debt ratio of 0.4, and an asset turnover of 3.0?   What we are given:

84. Question 8 (a)What are the annual sales for a firm with $400,000 in debt, a total debt ratio of 0.4, and an asset turnover of 3.0?   Therefore   

85. Question 8 (a)What are the annual sales for a firm with $400,000 in debt, a total debt ratio of 0.4, and an asset turnover of 3.0?   Therefore    

86. Question 8 (b)Your firm is currently doing very well with a return on equity (ROE) of 25%, so you would like to payout 40% of earnings in dividends next year. What earnings growth rate do you need to have to do that without increasing your profit margins or efficiency ratios?

87. Question 8 (b)Your firm is currently doing very well with a return on equity (ROE) of 25%, so you would like to payout 40% of earnings in dividends next year. What earnings growth rate do you need to have to do that without increasing your profit margins or efficiency ratios?  What we are given:

88. Question 8 (b)Your firm is currently doing very well with a return on equity (ROE) of 25%, so you would like to payout 40% of earnings in dividends next year. What earnings growth rate do you need to have to do that without increasing your profit margins or efficiency ratios?  Therefore 

89. Question 8 (b)Your firm is currently doing very well with a return on equity (ROE) of 25%, so you would like to payout 40% of earnings in dividends next year. What earnings growth rate do you need to have to do that without increasing your profit margins or efficiency ratios?  Therefore 

90. Key Tips for Financial RatiosKnow the different categories of ratios and be able to give a few examples of eachKnow what variables belong in each ratio (they might not ALL be on the formula sheet – check ahead of time and get familiarised)Know how to manipulate, combine and re-arrange ratios and formulas to help solve problemsNeed to know how the different ratios relate to each other (e.g. a common variable)

91. Question 9

92. Question 9So what do we do first?How do we approach this type of question?

93. Question 9Need to compare both projects, so find NPV!Do them separately, find NPV of Toaster A, then NPV of Toaster B.

94. But! There is a problem!Unequal Lives!TOASTER A: 3 yearsTOASTER B: 9 yearsTherefore, NPV isn’t a proper comparison, unless they have the same life (in years). So need to find the Equivalent Annual Annuity   

95. Focus on Toaster AOVERHEADS ARE NOT INCREMENTAL! SO IGNORE THEM!CONSULTANT FEE ($2,500) IS A “SUNK COST”, SO IGNORE!Toaster A:Main Revenue $12,000Additional Revenue $8,000 Total Revenue $20,000Less Cash Costs ($2,368.57)Less Depreciation ($8,000)EBIT $9,631.43 Calculate Annual Depreciation Expense: Depreciation = = $8,000   

96. Focus on Toaster A (continued)Toaster A:EBIT $9,631.43tc 30%EBIT(1 – tc) $6,742.00Dep $8,000OCF $14,742 We know that we need the OCF: OCF = EBIT(1 - tc) + Dep 

97. Focus on Toaster A (continued)Calculation of Year 3 CF’s: CF3 or 6 + Salvage = 14,742 + 1,000 = 15,742

98. Toaster A’s NPV - Financial Calculator (Texas)VariableInputCFo-25,000C0114,742F011C0214,742F021C03= 14,742 + 1,000 = 15,742 With r= 12%, NPV = 11,119.57Equivalent Annual Annuity = NPV/ PV of $1 annuity at n periods. = 11,119.57 / 2.401831 Equivalent Annual Annuity of Toaster A = $4629.62

99. Focus on Toaster BOVERHEADS ARE NOT INCREMENTAL! SO IGNORE THEM!CONSULTANT FEE ($2,500) IS A “SUNK COST”, SO IGNORE!Toaster B:Main Revenue $12,000 Total Revenue $12,000Less Cash Costs ($3,608.10)Less Depreciation ($2,555.56)EBIT $5,836.34 Calculate Annual Depreciation Expense: Depreciation = = $2,555.56   

100. Focus on Toaster B (continued)Toaster B:EBIT $5,836.34tc 30%EBIT(1 – tc) $4,085.44Dep $2,555.56OCF $6,641.00 We know that we need the OCF: OCF = EBIT(1 - tc) + Dep 

101. Focus on Toaster B (continued)NI/YPVPMTFV912=?6,6410These are the key variables we need – can you find them all?Because the cashflows are equal and there is no salvage value, can simply use the below five variables.

102. Focus on Toaster B (continued)These are the key variables we need – can you find them all?NI/YPVPMTFV912=$35,384.916,6410

103. Focus on Toaster B (continued)These are the key variables we need – can you find them all?NI/YPVPMTFV912=$35,384.916,6410We know that we need the NPV:jNPV = PV – IOIO = 23,000NPV = 35,384.91 – 23,000NPV = $12,384.91

104. Focus on Toaster B (continued)With r= 12%, NPV = $12,384.91 Equivalent Annual Annuity = NPV/ PV of $1 annuity at n periods. = 12,384.91 / 5.328250 Equivalent Annual Annuity of Toaster B = $2324.38

105. Equivalent Annual Annuity of Toaster A = $4629.62Equivalent Annual Annuity of Toaster B = $2324.382324.38Therefore Toaster A has the highest value ($4629.62 > $2324.38) , and therefore should be chosen as the project to accept (or in this case, the toaster to purchase)Finally – Answering the Question

106. Final Summary of Key Points for Term TestGet a financial calculator and practice using it – so you can be fast, yet accurate in the testLook over key ratios, definitions and formulas so you can understand what a question is asking and wanting you to doMake sure you can remember some of the key concepts e.g. goal of the firm, as there is likely to be some written answers, also these help you with how you approach some of the long/complex questionsPRACTICE!Even though the test won’t be the exact same, it gets you ready for following the different processes and looking for specific details when question spotting, that you need for the test!

107. THANK YOU AND GOOD LUCK!

108. STAY UPDATED FOR EVENTS Facebook Page: The Investment SocietyInstagram: the_investmentsocietySIGN UP FOR FREE Website: www.ucinvestmentsociety.comQUESTIONS AND FEEDBACKEmail: tutorials@ucinvestmentsociety.com