Best of Fina What do we know and not know about finance? Why should we care?

Final Exam 25% of your grade 25% of your grade Tuesday, Dec. 1, 3:30-6:30, SEH 328 Tuesday, Dec. 1, 3:30-6:30, SEH open questions 8-10 open questions No multiple choice or true/false questions No multiple choice or true/false questions Most problems will be numerical, but some will be conceptual/essay- type Most problems will be numerical, but some will be conceptual/essay- type About half of the exam will focus on the material covered after the mid- term: About half of the exam will focus on the material covered after the mid- term: Risk and Return Risk and Return Security Issuance Security Issuance Capital structure and firm value Capital structure and firm value Cost of capital Cost of capital In search for sample problems, revisit and make sure that you understand the practice problem sets/exams, homeworks, and examples In search for sample problems, revisit and make sure that you understand the practice problem sets/exams, homeworks, and examples Bring two pages of notes and a calculator (or two) Bring two pages of notes and a calculator (or two)

Important Ideas in Finance VALUE! VALUE! Time Value of Money Time Value of Money Capital Budgeting and Net Present Value Capital Budgeting and Net Present Value Risk and Return and Cost of Capital Risk and Return and Cost of Capital Capital Structure Theory and Cost of Capital Capital Structure Theory and Cost of Capital

Topics Covered 1. Financial Statements Analysis (ratios, sources and used of funds) 2. Present and future values: of a lump sumof a lump sum of annuities, growing annuities, and annuities dueof annuities, growing annuities, and annuities due Compounding more often than once a year; EAR vs. APRCompounding more often than once a year; EAR vs. APR Bond valuationBond valuation Stock ValuationStock Valuation 3. Capital Budgeting and Project Evaluation 4. Risk and Return 5. Security Issuance, Capital Structure and Cost of Capital

Capital Budgeting and Project Evaluation I. Cash Flows vs. Accounting Income 1. Non-cash items: Depreciation, change in NWC 2. Relevant costs vs. non-relevant costs: opportunity cost, sunk costs. 3. Depreciation methods: straight line vs. MACRS 4. Operating CF; CF from Investment (e.g., purchase or sale of capital equipment) 5. Taxes II. Project Evaluation Rules 1. NPV 2. IRR 3. Payback 4. Economic Value Added (EVA ®)

Risk and Return 1. Definition of return: calculation of average and expected return for a single security 2. Calculation of standard deviation of the average and expected return for a single security 3. The concept of risk-aversion; the relation between risk and return 4. Portfolio diversification:  Systematic vs. non-systematic risk  Calculation of average and expected return for portfolio  Calculation of standard deviation of the average and expected return for portfolio 5. Efficient portfolios and the Capital Market Line 6. CAPM and the Securities Market Line (beta as measure of systematic risk)

Example Consider a day on which the Dow Jones Industrial Average (DJIA), an average of 30 large stocks, rose 1.5 percent. However, on the same day, IBM, which is one of the 30 stocks in DJIA, announced that its fourth quarter earnings were below analysts’ expectations, and as a result its stock price declined 15%. Within the context of this example, please discuss systematic risk, unsystematic (idiosyncratic risk), and portfolio diversification. Consider a day on which the Dow Jones Industrial Average (DJIA), an average of 30 large stocks, rose 1.5 percent. However, on the same day, IBM, which is one of the 30 stocks in DJIA, announced that its fourth quarter earnings were below analysts’ expectations, and as a result its stock price declined 15%. Within the context of this example, please discuss systematic risk, unsystematic (idiosyncratic risk), and portfolio diversification.

 Sources of funds to corporations internal vs. external sources (dividends and payout)internal vs. external sources (dividends and payout) debt vs. equitydebt vs. equity private vs. public financing (IPOs, LBOs)private vs. public financing (IPOs, LBOs)  Capital structure and M&M propositions: the effect of financing on: firm valuefirm value riskrisk cost of capital:cost of capital:  Capital Structure and WACC Long-term financing and capital structure of the firm

M&M Propositions Debt and Firm Value Debt and Firm Value Debt and Cost of Equity Debt and Cost of Equity Debt and Beta Debt and Beta Debt and WACC Debt and WACC Assumptions: A world with or without: Assumptions: A world with or without: –taxes –bankruptcy costs

Good luck (in life, and on the exam)! “If a man empties his purse into his head, no one can take it away from him. An investment of knowledge always pays the best interest.” Ben Franklin