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Course Materials on BungeeLink Midterm 1 09-09 ● Risk, Opportunity, and Inflation enforce each other ○ What makes a dollar worth more today than a year from now

09-11 ● Perpetuities ○ PV = PMT / i ● Ordinary Annuity vs. Annuity Due ○ Annuity: gets present value one period before the first payment; gets future value at the last payment ○ Annuity Due(begin mode): gets PV at the time of first payment; gets FV one period after the time of the last payment ■ The cash flows occur at the beginning of each year, rather than at the end of each year ● Effective yield 09-16 ● Characteristics of Bonds ○ Bonds pay a fixed coupon (interest) payments at fixed intervals and pay the par value at maturity. ● The value of any asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return ● Tip: enter PV as a negative ● Yield To Maturity: the average annual rate of return investors expect to receive on a bond if they hold it to maturity ○ = The promised yield ○ = discount rate ○ Not the same as the current yield ● Debentures - unsecured bonds ● Subordinated debentures - unsecured “junior” debt

● Mortgage bonds - secured bonds ● Zeros - bonds that pay only par value at maturity; no coupon interest payments ● Junk bonds - rated BB and below ○ AAA, AA, A, BBB are great investment bonds ○ BB, B, C, D are junk bonds/high yield 09-18 ● If the coupon rate = discount rate, the bond will sell for par value. ● If the coupon rate > discount rate, the bond will sell for premium. ● If the coupon rate < discount rate, the bond will sell for a discount. ● There is an inverse relationship between prices and yields. ○ If interest rates increase, the price of existing bonds will fall ○ If interest rates fall, the price of existing bonds will increase ● Yield of maturity and coupon rate are always stated annually ● Interest Rate Sensitivity ○ Time to maturity ■ High = high sensitivity ■ Short = low sensitivity ○ Coupon rate ■ High = low sensitivity ■ Low = high sensitivity ○ Duration Impact (Duration captures both effects) ■ higher duration = greater sensitivity

Midterm 2 09-30 ● What is the required rate of return for a Treasury security? ○ Required rate of return = Risk-free rate of return (it includes inflation) ■ Since Treasury’s are essentially free of default risk, the rate of return on a Treasury security is considered the “risk free” rate of return ● For a corporate stock or bond

○ Required rate of return = risk-free rate of return + risk premium ● Risk ○ The possibility that an actual return will differ from our expected return ○ Upside risk & downside risk ● If two stocks are perfectly positively correlated, diversification has no effect on risk ● Negatively correlated

10-02 ● Lower correlation --> higher diversification ● Lower correlation --> Lower standard deviation ● If perfectly positive, standard deviation = 0.5 * SD1 + 0.5 * SD2 ● Not perfectly positive, standard deviation is less than average ● By definition, the market’s beta = 1 ● Aggressive asset, beta > 1 10-07 ● ROA: return on assets ● C of C: cost of capital ● ROA > C of C → increase value ● ROA < C of C → decrease value 10-16 ● EPS = Net income / amount of outstanding shares ● Test Review 2 ○ 1. Expected return < required return, the stock is overvalued ○ 3. If perfectly correlated, it’s 23. Not perfectly correlated < +1, it’s less than 23. ○ Do question 5!!!!

Midterm 3 heavy on chap. 3 & 4

10-21 Financial Statements ● Exam 2 ○ Question 1 ■ Mistakes: accept bad projects or reject good projects ■ Low risk r10.4% ■ High risk acceptable at 15%, it looks better at 10.4%. We would accept it (risk: the possibility that the actual return differs from what we expect. It was 15% chance that it differs, but now it’s only 10.4% possibility that it differs. Therefore, we accept it. ) ■ Low risk division is bad at 10.4%, we would reject it which is a mistake ■ Use 10.4% to evaluate, high risk seems to have lower risk so we accept it, but low risk seems to have higher risk so we may reject the good potential investments. ○ Question 14 ■ Beta less than 1 ● Balance Sheet ○ Assets = liabilities + owners equity ○ Financing by your own money or others money ○ Assets stated in order of liquidity (from most to least) ■ Cash is the most liquid asset ● Net income can be ○ Paid out as dividends or ○ Retained in the firm as retained earnings ● You can’t use retained earnings to pay bills. Need cash to pay bills.

10-23 ● Any assets that non-current are fixed assets ● Income Statement is like a video, is a statement of a period of time ● Depreciation expense on Income Statement does not represent cash ● There are circumstances we pay interest we don’t put on interest expense, and we don’t pay interest but put on interest expense.

Interest expense on Income Statement does not represent the check the company writes to the government, is not cash. ● In accounting concept, Net Income is not cash after all! ● On Income Statement, nothing represents actual cash flow! 10-28 ● All sales are on credit, unless the questions says otherwise ● Operating income = EBIT 10-30 ● For supermarket, inventory / assets is high ● For utility, P.P.E / asset is high (such as almost 90%) 11-4 ● If a firm experienced an increase in inventory by $500,000, then: ○ answer: D ○ Inventory is an operating ● A firm had revenue of $500,000, COGS of $200,000, net income of….. What was this company’s EBIT last year? ○ Answer: A. $100,00 ○ Add interest expense and tax expense to net income ● A firm had revenue of $500,000, COGS of $200,000, net income of….. What was this company’s operating expenses (including depreciation) last year? ○ Answer: ● 6. Answer: b. CFF cash flow from finance ● 7. Answer: d. $206 ● 8. Answer: d. $252 ● 9. Answer: b. $225 ○ Change in cash = CFO +CFI +CFF ○ New cash = old cash + change in cash 11-11 ● New RE = Old RE + NI - Div ● RE must be independently forecast

● Notes payable, long-term debt, common stock are non spontaneous, so they need specific actions and don’t change as sales change ● If the text doesn’t say anything, spontaneous accounts vary with sales. It it says how it varies, go with what it says. ● Total assets = total financing need, total Liab & Equity = total financing in place, Discretionary or External Financing = Total Financing Need - Total Financing in Place ● Next year sales =5.5 ● Next year current asset = 1.65 ● Next year fixed asset = 1.8 ● Total financing need = 3.45 ● Next year account payable =0.88 ● Next year notes payable = this year = 0.4 ● Next year long-term debt = this year = 0.6 ● Next year net income = 0.66, New RE = 1.36 ● On the equation sheet, DuPont breakdown is at ROE ● ROE = ROA x (A/E)

11-13 ● How to increase sustainable growth rate ○ Issue equity ○ Increase net income ○ Decrease payout ratio ○ Increase ○ Increase total asset turnover ○ Increase assets/equity 11-18 (after exam 3) Capital Budgeting Decision Criteria

11-20 ● Want big NPV not big IRR ○ Higher profit is better than higher profit margin ● Replacement chain

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○ Ex. oven in Pizza Hut is replaced every four years ○ NPVs may not be comparable if we have a replacement chain. Because we have a different point when we reinvest ○ Use EAA ■ Spread the NPV over the life of the project ■ Choose the asset with higher EAA Single throw: one time decision ○ Independent: choose both ○ Mutually exclusive: Choose the higher NPV Replacement chain ○ Independent: choose both ○ Mutually exclusive (only can pick one of two) and unequal lives: compute EAA, and choose the higher EAA Sunk cost: money already spent and can’t get back ○ DON’T MATTER! Opportunity cost ○ MATTER! MACRS: x years asset, have x+1 years of depreciation ○ 3-year machine will be depreciated over FOUR years Straight line: x years asset will be depreciated over x years ○ Ex. 3-year machine will be depreciated over THREE years Working capital is included in the calculation of initial outflow and is reversed at the end of the project ○ Remember inflow in the end

11-25 ● Memorize Figure 12.2 and 12.3 on my Educator ● Depreciation is not a real cash flow, but tax is cash. We will take out the depreciation before tax and then add the depreciation back. ● Initial outlay: -100,000 ● 1. 43200 ● 2. 48000 ● 3. 36000 + 1000 + 2400 (tax shield = (100000 * 7% - 1000) * 4%)

12-04 An Orderly Financial House ● Money and Happiness ○ People who are struggling with food and basic levels, money affects their happiness ○ Money has small impact on happiness once we meet the basic income ● President Grant :” If there is any one thing that will bring peace and contentment into the human heart, and into the family, it is to live within our means.” ● Rainy Day Fund: spend less than he earns and puts something away for a rainy day. ○ reserved ○ Without disrupting long term saving: children’s education, retirement…. ○ 3-6 months living expense ○ Insured but low interest rates (not trying to get rich with the funds) ■ Checking account ■ Servings account and money market account ■ Certificates of deposit ● Start Early! ● “Vehicle”: Accounts to invest through ○ IRA ○ 401 K: sponsored by employer ○ These accounts give tax advantages ● We don’t invest in accounts, but through accounts ○ Ex. we don’t invest in 401K. We invest through 401K. ● “Engine”: what to invest in ● What should I invest in? ○ Principle: risk-return trade-off ■ High risk >> high return ■ Low risk >> low return ○ What? ■ Stocks (aka equity) -- ownership in a company (risky)

■ Bonds -- loan to a company/government (less risky) ■ Deposit accounts -- (insured, no risk) ○ How? ■ Mutual funds: get a lot of people together; collectively organization ■ Tax-advantaged investing ● Three kinds of retirement plans ○ Employer funded pension plan (defined benefit plan) ○ Employer sponsored retirement plan (defined contribution plan) ■ A promise that employer and employee each contribute something today ■ Ex. 401K ○ Individual retirement accounts ● Tax Deferred Retirement Plans (IRA and 401k) ○ Traditional ■ Pay taxes when I take out the money in the future ■ Tax deferred ○ Roth ■ Pay taxes today, and no need to pay taxes when taking out the money in the future ■ Tax free investing ○ *also consider SEP, Keogh or SIMPLE plan for self-employed or small business ● Characteristics of traditional IRA ○ Contribution is often tax-deductible ■ Income limits if you participate in ESP (e.g. 401k), $85,000 joint AGI ■ Income limits for spouse of ESP participant, $159,000 joint AGI ○ Choice of investment engine ○ Contributions and gains are taxed when the money is withdrawn (lower rate?) ○ Maximum contribution is currently $5,500 (2018) ■ Indexed starting 2009 ○ Not all are eligible(under 70 ½ w/ earned income or spouse)

● Characteristics of Roth IRA ○ Contributions are not tax-deductible ○ Can contribute if in ESP or over age 70 ½ ■ Income limits apply ○ Contributions can always be withdrawn tax and penalty free (earnings if over 59 ½ and Roth>5 years) ○ Earnings grow tax-free ○ Pass tax-free to heirs (5-year required distribution) ○ Avoids winners curse (70 ½ ) ● Roth vs. Traditional? ○ FVIFA = future value interest factor of an annuity ○ Traditional FV: Pre-tax savings (FVIFA) (1-t) ○ Roth FV: Pre-tax savings (1-t) (FVIFA) ○ If the tax rate is consistent, it doesn’t matter which one to choose, it will be the same. ○ Only difference depends on tax rate forecast! ○ Pay taxes when the tax rate is lower ○ “Soft issues” favor Roth

12-09 ● Managing Stock Risk ○ Diversity across stocks ○ Diversity across time ○ What does this mean? Buy and hold an Index Fund ● Bottom line wisdom for someone under 45 (or 50) ○ Asset allocation--mostly (75-80%) equities ○ Fund: broad index (vanguard total market index or similar) ○ Remainer? Index bond fund ● How? ○ “Match” first (401k, 403B, ect)-- broadest equity option ○ Call provider (vanguard, fidelity, ect)-- open account (IRA) and make allocation decision (80/20) ○ Send them money each month ● If the saver's tax rate is constant, tax issues do not impact the choice of

Roth vs Traditional ● Income - pay the Lord - pay yourself - expenses = other savings 12-11 ●...