UNISEMINAR
UNISEMINAR
Theory
Practice
Exams
Extras
Sem
inar
Introduction
Finance & Accounting Academic Year 2012/2013, Block 1
Uniseminar – Finance & Accounting Introduction
Welcome to Uniseminar!
IInnttrroodduuccttiioonn
Uniseminar offers EExxaamm PPrreeppaarraattiioonn SSeemmiinnaarrss,, SSuummmmaarryy SSccrriippttss aanndd
LLeeaarrnniinngg CCaarrddss for students of the Maastricht University. It is our goal to
optimally prepare you for your exams and to make your own exam preparation as
efficient as possible. In order to achieve this goal, we have developed a system of
seminars in combination with an extensive summary script, which is proven for
several years by now.
In university it is often the case that there is a lot of material available for a
course and that the importance of this material is hard to evaluate. Since we, as
students, have made this experience as well, you are provided with a Uniseminar
Summary Script of the corresponding course. This folder contains all exam-‐
relevant material and it gives you a good summary of all course topics. The
content of the folder is created by experienced Master or PhD students, who have
taught this course already several times. As a consequence, it is possible for you
to concentrate on the actual exam preparation, rather than spending hours
searching and printing the right material.
At the end of week 7 of your block, normally during the weekend, our EExxaamm
PPrreeppaarraattiioonn SSeemmiinnaarrss take place. These seminars are taught by above-‐
average students, who have already mastered their studies at the Maastricht
University and have a great deal of experience in tutoring. Since they have studied
and taught at the Maastricht University they know exactly where potential
problems may lie and are therefore able to optimally teach you the whole theory
of the course and practice perfectly tailored examples with you. Furthermore you
can bring in your own questions during the seminar and discuss individual
problems during the breaks.
You are able to pick up your SSuummmmaarryy SSccrriipptt aanndd LLeeaarrnniinngg CCaarrddss in
advance of the Seminar in order to already start preparing so that you can
discover your own difficulties early enough. Later in the Seminar you will then
know what your weaknesses are and be able to pay special attention to these
Introduction Uniseminar – Finance & Accounting
sections or ask questions about it. Our Summary Script and Learning Cards are
updated every year according to the current course’s content and we are always
trying to optimize the folder as much as possible.
AAbboouutt UUss
Uniseminar was founded 5 years ago by two students at the University of
St.Gallen in order to make Exam Preparation more efficient and coherent. Since
2005 we have expanded our vision and are now offering seminars and material
for an efficient exam preparation in Switzerland, the Netherlands, Italy and
Germany.
Thanks to this longstanding experience, we were able to build up a team of highly
qualified tutors and editors and are therefore able to guarantee high quality of
exam preparation.
The team of Uniseminar is grown strongly over the years and comprehends
several mathematicians, statisticians and economists, who all bring a great
didactical experience. All tutors of Uniseminar have been teaching their field for
years and know exactly what is important in order to optimally prepare and pass
the exam.
Theory
Practice
Exams
Extras
Sem
inar
T
Theory
Finance & Accounting Academic Year 2012/2013, Block 1
Theory Uniseminar – Finance & Accounting
TThheeoorryy
The Theory Script summarizes the whole theory of the course in a simple and
understandable way. Concepts are explained with the help of demonstrative
examples. It is structured according to the seven weeks of the course and is one of
the most important parts of your exam preparation. Although practice is very
important, it is even more crucial to understand the basic concepts of the course
in order to be able to calculate and understand all different kinds of exercises and
exam questions.
TTaabbllee ooff CCoonntteennttss
FFiinnaannccee 11
1 Capital Markets – Risk & Return 1
2 Capital Structure 11
3 Payout Policy 24
4 Capital Budgeting and Valuation 34
5 Options 41
AAccccoouunnttiinngg 5577
1 Organizations 57
2 Financial Statements 61
3 Transaction Analysis 67
4 Accrual Accounting 71
5 Short-‐Term/Trading Investments 73
6 Receivables 75
7 Inventory & Cost of Goods Sold 81
8 Plant Assets and Intangibles 88
9 Current Liabilities 92
10 The Cash Flow Statement 97
11 Financial Statement Analysis 103
Uniseminar – Finance & Accounting Theory - Finance
1
Finance
1 Capital Markets – Risk & Return
The fundamental principle regarding investments of any kind (stocks, bonds,
options, etc.) is that investors are risk averse and thus demand a risk premium for
bearing risk. Consequently, the basic capital market model (CAPM) establishes a
positive relationship between risk and return. As the risk increases, the
associated premium that investors demand increases, which in turn raises the
required return on the investment.
1.1 Risk – Common vs. Independent Risk
In order to understand how the risk of an individual security differs from the risk
of a portfolio composed of different securities, one needs to understand that there
are two types of risk:
• Common risk: risk that is perfectly correlated (such as an earthquake
affecting all houses in an entire city at the same time)
• Independent risks: risks that do not share correlation (such as the risk of
burglary affecting one house without affecting all other houses at the same
time)
Diversification entails the averaging out of independent risks in a large portfolio
and will be defined more extensively below when applied to securities.
Over a given time period, the risk of holding a stock is that the dividends plus the
final stock price will be higher or lower than expected, which makes the realized
return risky. Stock prices fluctuate due to two types of risk:
• firm-specific risk – risk due to firm-specific news. Risk that does not affect
the whole market, but only one firm or a small number of firms. It is also
called idiosyncratic, unsystematic, unique or diversifiable risk.
• systematic risk – risk due to market-wide news. Risk that affects all
companies to some degree. It is also called undiversifiable or market-risk.
Theory - Finance Uniseminar – Finance & Accounting
2
As the names already suggest, firm-specific risk can be diversified away in a
(large) portfolio. Contrary systematic risk can not be diversified in a portfolio,
because it affects all firms that are publicly traded. Whereas investors are not
compensated for holding firm-specific risk, they expect a risk premium for
holding systematic risk. The risk premium is also known as the excess return,
which can be defined as the difference between the average return for the
investment and the average return for Treasury bills, a risk-free investment.
• Diversification - refers to the reduction of firm-specific risk. It is achieved
by investing in a variety of assets with different characteristics. The lower
the correlation between the assets the higher is the diversification
potential (exception: correlation of 1 no diversification at all!). The
example below illustrates the effect that diversification has on firm specific
(unsystematic) risk:
Example:
There are two companies. (1) a car producer (e.g. VW) who´s return (revenue)
and consequently its share price will go down if the prices for steel increase
(higher steel prices = higher production costs).
(2) a steel producer (e.g. AcelorMittal), who´s return (and share price) will
increase as the price for steel increases (i.e. AcelorMirral returns are negatively
correlated with VW´s returns).
Now think about what happens if you invested an equal amount of money in both
companies and the price for steel increases: The share price of VW will decrease
due to higher production costs. However, the decrease in VW´s share price will be
offset by the increase in the price of AcelorMittal. As a result, a portfolio
containing both firms will effectively reduce the firm specific risk that is related
to an increase in the price of steel.
A portfolio that contains only systematic risk (where all unsystematic risk is
diversified) is called an efficient portfolio. A natural candidate for an efficient
portfolio is the market portfolio, which is a portfolio of all stocks and securities
Theory - Finance Uniseminar – Finance & Accounting
8
Exhibit 1.2.1: Capital Market Line
The CAPM assumes an efficient market portfolio, which means that the market
portfolio does not contain any firm-specific risk. Since investors are only
compensated for systematic risk in terms of risk premia (because firm-specific
risk is diversified away), the appropriate measure of risk to determine a
security’s risk premium is its beta. The beta is a measure of sensitivity of an
asset´s returns to market returns.
Beta
• 𝛽𝑖 = 𝑆𝐷(𝑅𝑖)∗𝐶𝑜𝑟𝑟(𝑅𝑖,𝑅𝑀𝑘𝑡)𝑆𝐷(𝑅𝑀𝑘𝑡)
= 𝐶𝑜𝑣(𝑅𝑖,𝑅𝑀𝑘𝑡)𝑉𝑎𝑟(𝑅𝑀𝑘𝑡)
The slope of the CML is the Sharpe Ratio which is a measure of a securities excess
return per unit of risk (reward-to-variability ratio). Consequently, it serves as a
good measure to compare different investment opportunities.
Sharpe Ratio
• Sharpe Ratioi = 𝑅𝑖 − 𝑟𝑓
𝜎𝑖
Standard deviation (σ)
0 20% 40%30%
Exp
ecte
d R
etu
rn (
%) Market Portfolio
=efficient Portfolio
Capital Market
Line
Efficient frontier
Inefficient frontier
Min. Variance
*Slope: Sharpe Ratio
10%
5%
10%
15%
Volatility due to diversifyable risk
Volatility dueto undiver-sifyable risk
Exxon
Uniseminar – Finance & Accounting Theory - Finance
9
1.4.2 The security market line
The security market line (SML) shows the required return for each security as a function
of its beta with the market. The security market line relates a securities expected return
to its beta. If all securities are correctly priced they lie exactly on the security market line
(as depicted in Exhibit 1.2.2.1).
Exhibit 1.2.2.1: Security Market Line
If securities are mispriced they do not lie on the security market line. Securities that
yield a lower (higher) return than predicted by the CAPM equation are said to be
overpriced (underpriced) and have a negative (positive) alpha. This is illustrated in
Exhibit 1.2.2.2.
• Overpriced security: given the securities level of risk, it provides a lower return
than it should according to the CAPM equation
• Underpriced security: given the securities level of risk, it provides a lower return
than it should according to the CAPM equation
Beta (β)0 0.2 1.0 1.80.6 1.4 2.2
Exp
ecte
d R
etu
rn (
%) Security
Market Line
*Slope: Risk Premium
IBM
NOK
Edison
Apple
5%
10%
Beta of Nokia
15%
Market Portfolio
Theory - Finance Uniseminar – Finance & Accounting
24
3 Payout Policy
The decision of a firm, how free cash-flows are paid out to its investors is called
payout policy. As depicted in the figure below, a firm has four options to
distribute cash: (1) retain the cash, using it to undertake new investments and
thereby increasing the future growth potential and thus future cash flows.
(2) Retain cash and increase cash reserves which might be important if the firm
has a large amount of short term liabilities or needs a lot of cash to keep
operations running (e.g. grocery stores need lots of change money). (3)
Repurchase shares thereby changing the capital structure of the company. This is
especially favorable if the company thinks that their shares are currently
undervalued! (4) Pay a dividend to investors thereby increasing investors Return
on Equity (ROE).
Retain Pay Out
Invest in New Projects
Increase Cash
Reserves
Repurchase Shares
Pay Dividends
Free Cash Flow
Uniseminar – Finance & Accounting Theory - Finance
25
Tim
e3.1 Dividends (No taxes)
A company’s board determines the amount of the firm’s dividend. Below you find
the official procedure for dividend payments.
• declaration date – the date on which the board authorizes/declares the
dividend
• ex-dividend date – buyers of stock on or after this date do not receive the
dividends (two before the record date)
• record date – shareholders recorded on this date receive the dividend
• payable date – the date when the dividend is actually paid out to the
shareholders
In a perfect capital market, when a dividend is paid, the share price drops by
the amount of the dividend when the stock begins to trade ex-dividend (Just
before the stock is traded “cum-dividend” - with the dividend)
3.2 Share repurchases (no taxes)
The firm uses cash to buy shares of its own outstanding stock. In a perfect capital
markets, an open-market share repurchase has no effect on the stock price, and
the stock is the same as the cum-dividend price if a dividend were paid instead.
Open Market Repurchase - A firm announces its intention to buy its own shares in
the open market and then proceeds to do so over time like any other investor.
The time interval is not specified and the firm has no obligation to repurchase the
amount it originally stated.
Tender offer - A firm repurchases shares through a tender offer, offering to buy
shares at a prescpecified price during a short time period (usually 20 days). The
price is usually set at a substantial premium to the current market price. If not
enough shareholders are willing to tender their shares, the offer will be canceled.
A related method is the Dutch auction share repurchase, in which the firm lists
different prices at which it is prepared to buy shares, and shareholders in turn
Uniseminar – Finance & Accounting Theory - Finance
35
4.1 Calculations of Free Cash flows [FCF & FCFE]
In order to understand the income statement items each of the three valuation
methods is based on, it is essential to understand how the different free cash
flows are computed.
Calculation Free Cash flow to the Firm [FCF] Calculation Free Cash Flow to Equity [FCFE]
𝑺𝒂𝒍𝒆𝒔 𝑺𝒂𝒍𝒆𝒔
− 𝐶𝑂𝐺𝑆 − 𝐶𝑂𝐺𝑆
𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕 𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕
− 𝑆𝐺&𝐴 − 𝑆𝐺&𝐴
− 𝑜𝑡ℎ𝑒𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑜𝑡ℎ𝑒𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
𝐸𝐵𝐼𝑇𝐷𝐴 𝐸𝐵𝐼𝑇𝐷𝐴
− 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
− 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛
−𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
− 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛
𝑬𝑩𝑰𝑻 (earnings before interest and Tax) 𝑬𝑩𝑰𝑻 (earnings before interest and
Tax)
− 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
− 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥 [𝐸𝐵𝐼𝑇 ∗ (1 − 𝜏𝐶)] − 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥
EBI (unlevered net income) Net Income
+ 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
− 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒
− 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 − 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
+ 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑁𝑒𝑡 𝐵𝑜𝑟𝑟𝑜𝑤𝑖𝑛𝑔 (𝑑𝑒𝑏𝑡)
𝑭𝑪𝑭 𝑭𝑪𝑭𝑬
The free cash flow to the firm [FCF] takes all payments (cash flows) to all
stakeholders (debt and equity holders) into account. As a result, interest
Theory - Finance Uniseminar – Finance & Accounting
36
payments are not deducted from EBIT, because interest payments are cash flows
that go to a company´s debt holders. Depreciation is added back because it is not
a real cash expense2. The change in NWC refers to the change between short term
assets and liabilities (NWC=current assets - current liabilities). It shows how
much money the company has for its operation in the short term. If the change in
NWC is positive, the amount is subtracted from EBI/net income, and vice versa.
The free cash flow to equity [FCFE] only takes payments (cash flows) to equity
holders into account. Therefore, interest is deducted from the EBIT as interest
payments are made before shareholders are served. Furthermore, increases in
net borrowings are added back, since this represents additional cash
shareholders can use to pay as dividends or invest in projects. It is simply new
debt that is taken on by the company which can be used for any purpose (if you
take out a loan you can decide what to do with the money so it represents an
increase in the amount you can spend).
4.2 The Weighted Average Cost of Capital (WACC) Method
The WACC method determines the firm value to all stakeholders (equity and debt
holders) of a company. The appropriate cash flows to use are the Free Cash Flow
to the Firm (FCF or FCFF) and the discount rate applicable is the WACC.
Procedure:
Step 1 - Compute the free cash flow (FCF) of the company/investment
Step 2 - Compute the weighted average cost of capital, 𝑟𝑊𝐴𝐶𝐶:
• 𝑟𝑊𝐴𝐶𝐶 = 𝑬𝑬+𝑫
𝒓𝑬 + 𝑫𝑬+𝑫
𝒓𝑫 ∗ (𝟏 − 𝒕𝒄) with 𝑟𝐸 = 𝑟𝑓 + 𝛽(𝑅𝑚𝑘𝑡 − 𝑟𝑓)
𝐸 = 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
2 When machinery is bought this is recorded as "Capital Expenditure" on the balance sheet. Depreciation only serves as the function to spread the cost of such an investment over its useful life. That is, when the machinery is bought, cash actually goes out of the company´s pocket, but the depreciation deductions happen only on paper!
Uniseminar – Finance & Accounting Theory - Finance
51
5.5 Option Pricing
5.5.1 Binomial Pricing Model
The price of an option depends on the fact if the stock will go up or down in the
next period. From the stock price movements the price of an option can be
calculated. The figure below depicts the basic steps for call and put options. Cu
(Pu) and Cd (Pd) stand for the value of a call (put) option if the price goes up or
down, respectively.
Option Price (for call and for put options):
• ∆= 𝐶𝑢−𝐶𝑑𝑠𝑢−𝑆𝑑
• 𝐵 = 𝐶𝑑−𝑆𝑑∆1+𝑟𝑓
• 𝑂𝑝𝑡𝑖𝑜𝑛 𝑝𝑟𝑖𝑐𝑒 (𝐶 𝑜𝑟 𝑃) = 𝑆∆ + 𝐵
Example: Binomial Option Pricing Model You own a European call option with strike price (K) of €32! The current stock price of the
underlying is €30. During the next period, the stock price can either go up or down by €5.
The risk free interest rate (rf ) is 5%. What is the value of the option today?
• ∆= 𝐶𝑢−𝐶𝑑𝑠𝑢−𝑆𝑑
= 3−035−25
= 0.3
• 𝐵 = 𝐶𝑑−𝑆𝑑∆
1+𝑟𝑓= 0−25∗0.3
1.05 = −7,143
• 𝐶 = 𝑆∆ + 𝐵 = 30 ∗ 0.3 − 7.143 = €1.86
This example is a simplification. Usually there are more than two possible and more than
one period.
CU max(S-K,0)
CD max(S-K,0)
SSU
SD
PU max(K-S,0)
PD max(K-S,0)
Call Option Put Option
SSU
SD
CU max(35-32, 0) = 3
CD max(25-32, 0)= -7 = 0
30
35
25
Theory - Finance Uniseminar – Finance & Accounting
52
5.5.2 Black-Scholes Model
The Black-Scholes Model is an alternative model that can be used to price options
on non-dividend paying stocks. It is derived from the Binomial option pricing
model and requires five input variables:
(1) 𝑆 = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒
(2) 𝑇 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠
(3) 𝐾 = 𝑒𝑥𝑒𝑟𝑐𝑖𝑠𝑒 𝑝𝑟𝑖𝑐𝑒
(4) 𝑟𝑓 = 𝑡ℎ𝑒 𝑟𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑟𝑎𝑡𝑒 �𝑡𝑜 𝑐𝑜𝑚𝑝𝑢𝑡𝑒 𝑃𝑉(𝐾)�
(5) 𝜎 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑣𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦
The price of a call options is computed as follows:
• 𝐶 = 𝑆 ∗ 𝑁(𝑑1) − 𝑃𝑉(𝐾) ∗ 𝑁(𝑑2) 3| ∆ = 𝑁(𝑑1);
𝐵 = −𝑃𝑉(𝐾) ∗ 𝑁(𝑑2)
𝑑1 = ln[𝑆/𝑃𝑉(𝐾) ]𝜎∗√𝑇
+ 𝜎∗√𝑇2
𝑑2 = 𝑑1 − 𝜎 ∗ √𝑇
The Price of a put option is computed as follows:
• 𝑃 = 𝑃𝑉(𝐾) ∗ [1 − 𝑁(𝑑2)] − 𝑆 ∗ [1 − 𝑁(𝑑1)] 4| ∆ = −[1 −
𝑁(𝑑1)];
𝐵 = 𝑃𝑉(𝐾) ∗ [1 − 𝑁(𝑑2)]
The advantage of the Black-Scholes Option Pricing Model is that the only variable
input is the volatility. All other variables are known. Therefore, it is easy to
implement and much quicker than the procedure of the Binomial Option Pricing
Model.
3 From the Binomial Option Pricing Model it is known that 𝐶 = 𝑆 ∗ ∆ + 𝐵 4 From the Binomial Option Pricing Model it is known that 𝑃 = 𝑆 ∗ ∆ + 𝐵
Uniseminar – Finance & Accounting Theory -‐ Accounting
65
22..55 RReellaattiioonnsshhiipp bbeettwweeeenn FFiinnaanncciiaall SSttaatteemmeennttss
It is of great importance that you understand the processes between the financial
statements. Understanding this will give you a general understanding of the
accounting procedures and make other things way easier:
IInnccoommee SSttaatteemmeenntt BBaallaannccee SShheeeett Asset 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 100,000 Current assets − 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 25,000 Cash & Cash equivalents 40,000 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 75,000 Accounts Receivable 5,000 − 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆,𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 & 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅, 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆
30,000 Inventories 10,000 Total current assets 55,000
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 45,000 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 5,000 Non-‐current Assets − 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 0 Property, Plant, Equip. 20,000 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 40,000 -‐ Acc. Depreciation 5,000 − 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 5,000 Total Non-‐current Assets 15,000 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 35,000 − 𝑇𝑇𝑇𝑇𝑇𝑇 15,000 TToottaall AAsssseettss 7700,,000000 𝑵𝑵𝑵𝑵𝑵𝑵 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰 20,000 Liabilities SSttaatteemmeenntt ooff CChhaannggeess iinn EEqquuiittyy Current Liabilities
Accounts payable 8,000 𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩 𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆 2,500 Short term borrowing 2,000 + 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 20,000 Total current Liabilities 10,000 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 -‐5,500 𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞 17,000 Non-‐current Liabilities Long-‐term Debt (rD=10%) 50,000 Other L-‐T Liabilities 3,000 CCaasshh FFllooww SSttaatteemmeenntt Total Non-‐current
Liabilities 53,000
𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴. 10,000 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴. 5,000 Shareholders' Equity 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴. 0 Share capital 1,000 𝐍𝐍𝐍𝐍𝐍𝐍 𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐅𝐅𝐅𝐅𝐅𝐅𝐅𝐅 15,000 Retained Earnings 16,000 Cash balance beginning year 25000 Total Sh. Equity 17,000 Cash balance end of the year 40000 TToottaall LLiiaabbiilliittiieess aanndd SShhaarreehhoollddeerrss'' EEqquuiittyy 7700,,000000
55
55
33
33
11
11
66
66
44
22
22
44
Uniseminar – Finance & Accounting Theory -‐ Accounting
77
EExxaammppllee:: AAggiinngg ooff RReecceeiivvaabblleess MMeetthhoodd
You were asked by your manager to set up an allowance account for your company. The Table below depicts the outstanding accounts receivables of your customers.
Customer 1 – 30 Days 31 – 60 Days Over 60 Days
X € 2,000 € 1,000
Y € 500
Z €300
Estimated % of
default
1%
2%
3%
Furthermore, your current allowance account shows the following entries:
AAlllloowwaannccee ffoorr UUnnccooll lleeccttiibbllee ((CCoonnttrraa EExxppeennssee AAccccoouunntt))
Debit Credit OOppeenniinngg
BBaallaannccee
5500
In period P2 one of your customers, Mr. Z defaults.
How do the respective journal entries look like? What are the most important steps you have to consider?
SStteepp 11:: Check the current Allowance Account for its opening balance
AAll lloowwaannccee ffoorr UUnnccooll lleeccttiibbllee ((CCoonnttrraa EExxppeennssee AAccccoouunntt))
Debit Credit OOppeenniinngg
BBaallaannccee
5500
Uniseminar – Finance & Accounting Theory -‐ Accounting
85
77..22 FFIIFFOO aanndd LLIIFFOO iinn PPrraaccttiiccee
What is the impact of iinnccrreeaassiinngg or decreasing unit ccoossttss for the FIFO and LIFO
respectively? As the figure below illustrates, increasing costs (prices) result in
lloowweerr CCOOGGSS uunnddeerr FFIIFFOO and hhiigghheerr CCOOGGSS uunnddeerr LLIIFFOO. Thus, with
increasing prices the FIFO method will provide a higher profit figure (due to
lower COGS), while the LIFO method would result in higher COGS → lower profit
→ lower tax payments! For this reason LIFO is not allowed under IFRS (since
prices generally increase over time → inflation!).
With decreasing costs the FIFO method yields higher COGS and the LIFO yields
lower COGS. Thus, the FIFO (LIFO) yields higher (lower) COGS.
EExxhhiibbiitt 77..22..11:: FiFo and LiFo cost structures for increasing/decreasing prices
LLIIFFOO LLiiqquuiiddaattiioonn -‐ occurs when inventory levels fall below the levels of the
previous year. If the quantities fall below the level of the previous year the
company has to use (even) older inventory prices to compute COGS. Assuming
that due to inflation, prices usually increase, older and consequently lower costs
are shifted into the COGS calculation, which results in higher net income and
higher tax payments. As a result, managers try to avoid LIFO liquidation.
Time
Cost €
FIFO
Time
Cost €
Time
Cost €
Time
Cost €
A) Increasing Cost
B) Decreasing Cost
LIFO
Practice
Exams
Extras
Sem
inar
P
Practice Exercises
Finance & Accounting Academic Year 2012/2013, Block 1
Uniseminar – Finance & Accounting Practice
PPrraaccttiiccee EExxeerrcciisseess
This part contains practice exercises to each week and therefore to each chapter
of the theory script. By this, you can deepen your theoretical knowledge with
practical exercises and you can go through the exercises of these topics again,
which you have not understood so well until now. Although you may think that
you already have done enough exercises during the weeks, these exercises are
tailored specifically to your needs and try to teach you the most important topics
of the exam in a practical manner.
TTaabbllee ooff CCoonntteennttss
FFiinnaannccee 11
Exercises 1
Solutions 16
AAccccoouunnttiinngg 4433
Exercises 43
Solutions 56
Uniseminar – Finance & Accounting Practice -‐ Finance
1
FFiinnaannccee -‐-‐ EExxeerrcciisseess
11 CCaappiittaall MMaarrkkeettss –– RRiisskk && RReettuurrnn
This topic deals with the basic principle of capital markets: the risk-‐return
relationship of securities. The two most important aspects are the CAPM model
and the Security Market Line (SML).
EExxeerrcciissee 11..11
The table below shows the quarterly stock prices of Apple, Inc. (AAPL) and
Microsoft, Inc. (MSFT) during June and July 2011 (Weekly data, closing prices).
Based on these data, calculate
DDaattee AAAAPPLL SS&&PP 550000
24. Jun. 11 317 1272 01. Jul. 11 328 1268 08. Jul. 11 343 1340 15. Jul. 11 356 1343
aa)) the mean weekly return for the two stocks and the market (round to three
digits)
bb)) the variance for the two stocks and the market (round to six digits)
cc)) the standard deviation for the two stocks and the market (round to four
digits)
Furthermore, calculate AAPL´s
dd)) correlation assuming that the covariance of AAPL with the market is
0.000184 and (round to three digits)
ee)) beta
ff)) sharpe ratio (assume a risk free rate of 2.5%)
Practice -‐ Finance Uniseminar – Finance & Accounting
2
EExxeerrcciissee 11..22
aa)) Explain the difference between the Security Market Line (SML) and the
Capital Market Line (CML). In this regard, elaborate on the different axes
labels.
bb)) Explain where the market portfolio is positioned on each line.
cc)) Regarding the CAPM model
ii .. What is the efficient frontier?
iiii .. Explain the difference between Total risk, systematic risk, and
unsystematic risk. How can you measure each risk type?
iiiiii .. What is the CAPM equation? In this regard, explain what kind of return
relationship is represented by this equation? What is meant by market risk
premium? How does it differ from an individual's risk premium?
dd)) Regarding the SML
ii .. What does "alpha" mean and when is a security over-‐ or undervalued?
Explain the phenomenon of mispricing from a risk-‐return perspective.
ii ii .. What does a securities beta imply?
EExxeerrcciissee 11..33
Assume that in 2007 the rate of return on short-‐term government securities
(perceived to be risk-‐free) was about 4.5%. Suppose the expected rate of return
required by the market for a portfolio with a beta of 1 is 11%. According to the
CAPM:
aa)) What is the expected rate of return on the market portfolio? What is the
market risk premium?
bb)) What is the risk premium for a security with a beta of 0.8 and 1.2?
cc)) The rate of return on Skodia's was 16% in the first quarter of 2007 and
currently Skodia has a beta of 1.5. According to the CAPM, is the stock over-‐
or undervalued? Is the alpha positive or negative? Does it lie above or
Uniseminar – Finance & Accounting Practice -‐ Finance
9
44 CCaappiittaall bbuuddggeettiinngg aanndd vvaalluuaattiioonn
EExxeerrcciissee 44..11
In table a) below you find the modified financial statements of Apple Inc. for the
last three years. Furthermore, some balance sheet items have also been reported
in table b) below. For the following exercise, assume a corporate tax rate of 35%
and a cost of debt of 10%.
IInnccoommee SSttaatteemmeenntt AAppppllee IInncc.. ((iinn ´́000000)) 2010 2009 2008
Sales − 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶
65,000 32,000
43,000 25,500
32,000 21,000
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 −𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 & 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 −𝑅𝑅&𝐷𝐷 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸
33,000 2,000 5,500
17,500 4,000 1,500
11,000 3,000 1,000
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 & 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
25,500 3,500
12,000 1,000
7,000 0
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 2222,,000000 1111,,000000 77,,000000
TTaabbllee aa))
BBaallaannccee SShheeeett IItteemmss
2010 2009 2008 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 20,000 10,000 0 Change in NWC +2,000 −500 +1500 Capital Expenditures 7,000 3,000 3,500
TTaabbllee bb))
aa)) Calculate the Free Cash Flow to the Firm in 2010
bb)) Calculate the Free Cash Flow to Equity in 2009 and the increase in net
borrowing for 2010
Practice -‐ Finance Uniseminar – Finance & Accounting
22
22 CCaappiittaall SSttrruuccttuurree,, MMooddiigglliiaannii aanndd MMiill lleerr
SSoolluuttiioonn ttoo EExxeerrcciissee 22..11
aa)) Modigliani and Miller Proposition I: In perfect capital markets, the total
value of a firm iiss equal to the market value of the total cash flows generated by its
assets and iiss nnoott affected by its choice of capital structure.
bb)) In perfect capital markets, homemade leverage iiss not a good example that
a firm's choice of capital structure does not affect its overall value.
cc)) (iii) A firm´s financing decision ccaannnnoott alter the cash flows generated by
its investments. Investors can alter their portfolio individually and thus replicate
any capital structure choice themselves.
dd)) SSoommeettiimmeess. It is only called leveraged recapitalization if the issuance of
new leverage is used to repurchase shares. It can also be financed, by using excess
cash of a company's cash reserves..
ee)) In perfect capital markets, an increase in a firms leverage (everything else
constant) iinnccrreeaasseess its cost of levered equity.. Leverage increases the riskiness
of a firm's cash flow to its equity holders as they only have a residual claim on a
firm`s assets (due to the seniority of debt).
ff)) In perfect capital markets, the cost of equity eeqquuaallss the cost of unlevered
equity only when the firm does not has any leverage. Because the unlevered cost
of capital is the cost of capital of a hypothetical all equity (completely unlevered)
firm, the unlevered cost of capital has to be the same as the cost of equity of a
completely unlevered firm.
Uniseminar – Finance & Accounting Practice -‐ Finance
23
gg)) FFiirree ssaallee ooff aasssseettss is an indirect cost of bankruptcy.
hh)) When a firm faces financial distress it mmaayy file for chapter 7 or 11 of the
U.S. bankruptcy code. Chapter 7 ll iiqquuiiddaattiioonn involves appointing a ttrruusstteeee to
oversee the ll iiqquuiiddaattiioonn of a firm's assets. Chapter 11 rreeoorrggaanniizzaattiioonn allows
for rreessttrruuccttuurriinngg of firm´s assets and eennaabblleess a firm to keep its operations
running.
ii)) Due to the high costs associated with financial distress, firm´s facing
financial distress ccaann directly negotiate with their creditors and thus avoid the
high costs of filing for bankruptcy; this is called a workout.
jj)) Another approach that minimizes the ddiirreecctt costs associated with
bankruptcy is called prepackaged bankruptcy. In this process a firm facing
bankruptcy, first develops a reorganization plan to which all creditors agree and
then files for CChhaapptteerr 1111 of the U.S. Bankruptcy Act.
kk)) FFaallssee.. It is the present value of agency-‐ and distress costs that is
subtracted, not just the costs themselves!
SSoolluuttiioonn ttoo EExxeerrcciissee 22..22
aa)) You were given a debt-‐to-‐equity ratio of 40%. First, let´s clarify the
different nomenclatures of different capital ratios:
= Debt-‐to-‐equity ratio
= = Debt-‐to-‐value ratio
= = Equity-‐to-‐value ratio
Practice -‐ Finance Uniseminar – Finance & Accounting
34
SSoolluuttiioonn ttoo EExxeerrcciissee 44..22
a) In order to perform a WACC analysis, the following steps must be
completed:
Step 1: Calculate the Free Cash Flow to the Firm
Step 2: Calculate the debt-‐to-‐value ratio (or alternatively the debt-‐to equity ratio)
Step 3: Calculate the cost of equity using the CAPM model.
Step 4: Calculate the 𝑟𝑟
Step 5: Discount the FCF at the 𝑟𝑟
The procedure is illustrated below.
Step 1: FCF
WWeeiigghhtteedd AAvveerraaggee MMeetthhoodd 2012 2013 2014 2015 2016 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 10 15 15 25 30 − 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑡𝑡𝑡𝑡𝑡𝑡 (30%) + 3 4.5 4.5 7.5 9 𝐸𝐸𝐸𝐸𝐸𝐸 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 ∗ 1− 𝜏𝜏 − 7 10.5 10.5 17.5 21 + 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 0 10 10 10 5 −𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 35 0 0 0 0 − 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑁𝑁𝑁𝑁𝑁𝑁 0 0 0 0 0 FCF (42) 20.5 20.5 27.5 26
Step 2: Debt-‐to-‐value ratio
Next, the cash flows need to be discounted at the WACC in order to determine the
NPV of the project. For that purpose the debt-‐to-‐value ratio needs to be
estimated. From the introduction it is known that the company has 500 million in
equity and 330 million in debt plus an additional 30 million in cash and cash
equivalents. Its nneett ddeebbtt can therefore be calculated as:
330 − 30 = 𝟑𝟑𝟑𝟑𝟑𝟑 𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎.
As a result the ddeebbtt-‐-‐ttoo-‐-‐vvaalluuee rraattiioo is equal to = 0.375.
Uniseminar – Finance & Accounting Practice -‐ Accounting
45
22 FFiinnaanncciiaall SSttaatteemmeennttss
EExxeerrcciissee 22
Complete the financial statements below. Hint: Start with the Income Statement
(hint: you will need some Balance Sheet items to complete this statement).
IInnccoommee SSttaatteemmeenntt BBaallaannccee SShheeeett 22001122 22001111 Assets Revenue 100,000 Current assets − 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 25,000 Cash & Cash equivalents 25,000 Gross profit 75,000 Accounts Receivable 5,000 12,000 − 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆,𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 & 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺
30,000 Inventories 8,000 Total current assets 55,000 45,000
EBITDA − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 Non-‐current Assets − 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 0 Property, Plant, Equip. 30,000 EBIT -‐ Acc. Depreciation 10,000 − 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒
Total Non-‐current Assets 15,000
Pretax Income − 𝑇𝑇𝑇𝑇𝑇𝑇 15,000 TToottaall AAsssseettss 𝐍𝐍𝐍𝐍𝐍𝐍 𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈 Liabilities SSttaatteemmeenntt ooff CChhaannggeess iinn EEqquuiittyy
Current Liabilities Accounts payable 8,000 5,000
𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩 𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆 2,500 Short-‐Term borrowing 2,000 1,000 + 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 Total current Liabilities 10,000 6,000 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 -‐5,500 𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞 Long-‐Term Liabilities Long-‐term Debt
(rD=10%) 50,000 55,000
Other L-‐T Liabilities 3,000 1,500 CCaasshh FFllooww SSttaatteemmeenntt Total Non-‐current
Liabilities 53,000 56,500
𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝐴𝐴𝐴𝐴𝐴𝐴 10,000 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 5,000 Shareholders' Equity 𝑁𝑁𝑁𝑁𝑁𝑁 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑏𝑏𝑏𝑏 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐴𝐴𝐴𝐴𝐴𝐴 0 Share capital 1,000 1,000 𝐍𝐍𝐍𝐍𝐍𝐍 𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐅𝐅𝐅𝐅𝐅𝐅𝐅𝐅 Retained Earnings 1,500 Cash beginning year 25000 Total Sh. Equity 2,500 Cash end year TToottaall LLiiaabbiilliittiieess aanndd SShhaarreehhoollddeerrss'' EEqquuiittyy 7700,,000000 6655,,000000
Extras
Sem
inar
E Exams
Extras
Sem
inar
Exams
Finance & Accounting Academic Year 2012/2013, Block 1
Exams Uniseminar – Finance & Accounting
EExxaammss
You should start early with the calculation of exams, because you need to get a
general feeling of how the exams are built up. You will soon discover how the
exams are constructed and that there are general tendencies, which repeat from
exam to exam. In this part you will find old exams of the Maastricht University, as
well as two practice exams constructed by Uniseminar. During the seminar you
will then receive a third practice exam.
TTaabbllee ooff CCoonntteennttss
PPrraaccttiiccee EExxaamm 11 ((iinnccll .. ssoolluuttiioonnss)) 11
PPrraaccttiiccee EExxaamm 22 ((iinnccll .. ssoolluuttiioonnss)) 2255
OOlldd EExxaammss 3399
09/10 Resit
08/09 First Sit
Trial Exam
Uniseminar – Finance & Accounting Practice Exam 1
1
PPrraaccttiiccee EExxaamm 11
FFiinnaannccee
1. Bondholders are always served before shareholders are served. Therefore,
shareholders are said to have a residual claim on the assets of a company.
2. For a levered company (<100% debt financing), the cost-‐of-‐debt is always
smaller than the weighted average cost of capital and the cost-‐of-‐equity is
always larger than the weighted average cost of capital.
[Question 3 & 4]
Assume that the risk free rate in 2011 is 5% and the return on SchnitzelStock´s
share is 15.5%. Furthermore, the variance of the stock during 2011 has been
calculated as 0.2345. The covariance with the market is 0.00323 and the markets
standard deviation during 2011 was 11.55%.
3. The Sharpe Ratio of SchnitzelStock is larger than 1.75.
4. The correlation of SchnitzelStock with the market is smaller than 0.5.
5. In the world of Modigliani and Miller absent taxes, dividends do determine
share prices but a firm´s choice of dividend policy does not.
6. Assume that WirelessCab Inc. has a cost-‐of-‐equity of 12%, a cost-‐of-‐debt of
5%, and a debt-‐to-‐value ratio of 30%. Given that it is subject to a 35%
corporate tax rate, its unlevered cost of equity must be smaller than 11%.
Practice Exam 1 Uniseminar – Finance & Accounting
2
7. Tradeoff theory predicts that the value of a levered firm can be expressed as
the sum of its unlevered value, the value of the interest tax shield less any
cost of financial distress.
[Questions 8 & 9]
Assume that the company McBurger has a beta of 1.2 and the risk premium of the
market is 4% and the risk free interest rate is 3%. Furthermore, it currently has a
debt-‐to-‐equity ratio of 40%. McBurger´s cost-‐of-‐debt of 6% and a corporate tax
rate of 35%.
8. Given the information above, McBurger´s cost of equity is equal to 7.8%.
9. Given the information above McBurger´s weighted average cost of capital is
larger than 7.00%.
10. Given that a firm faces financial distress, it may not choose to invest in
positive NPV projects because most of the benefits will go to debt holders.
This problem is referred to as the underinvestment problem.
11. Assume that in 2011 the company WatchTube Inc. faced a corporate tax rate
of 38%, and tax on interest income and capital gains tax were 20% and
22%, respectively. As a result, the effective tax advantage of debt is equal to
39.55%
12. By minimizing the WACC one can determine the optimal capital structure
for a company.
Uniseminar – Finance & Accounting Practice Exam 1
3
13. In a world of Modigliani and Miller with corporate tax a firm’s WACC
decreases as the debt-‐to-‐value ratio increases.
14. All investors who hold shares on the ex-‐dividend date are entitled to receive
the dividend payment that was declared in the preceding declaration date.
15. In an open market repurchase a firm exactly states how many shares it
intends to buy back. As soon as the number is announced the firm has to
purchase back the declared number of stocks, since otherwise non-‐
tendering shareholders would be harmed.
16. Management entrenchment theory states that managers' tend to take on
excessive leverage to fund operations that benefit themselves but not the
company.
17. In a world of Modigliani and Miller without taxes, a firm that lowers its
dividend for one period does not risk that its share price will drop.
18. The free cash flow hypothesis predicts that if managers have excess cash on
hand they tend to waste it for their own benefit. As a result, dividend
payments for instance, are highly valued by shareholders as it reduces
excess cash management can waste.
19. The free cash flow to equity can be calculated by taking the free cash flow to
the firm and subtracting after tax interest expense and adding net
borrowing.
Extras
Sem
inar
E
Extras
Finance & Accounting Academic Year 2012/2013, Block 1
Extras Uniseminar – Finance & Accounting
EExxttrraass
In general, the Extras part will supply you with several extras that will be very
helpful for your exam preparation. In the script of this course, you will find a
formula sheet as well as a glossary. You should try to learn as many as possible
definitions of the glossary, because it is easy to gain many points with this. Note:
The formula sheet we included here does not contain all formulas, which you will
need for the exam, as some formulas only make sense in the context of a
procedure and therefore are only included in the Theory part.
TTaabbllee ooff CCoonntteennttss
FFoorrmmuullaass 11
Finance 1
Accounting 5
GGlloossssaarryy 77
Uniseminar – Finance & Accounting Formula Sheet
1
FFoorrmmuullaa SShheeeett
FFiinnaannccee
11 CCaappiittaall MMaarrkkeettss –– RRiisskk && RReettuurrnn
FFoorr SSttoocckkss
VVaarriiaannccee::
𝑉𝑉𝑉𝑉𝑉𝑉 𝑅𝑅 = 𝑝𝑝 ∗ 𝑅𝑅 − 𝐸𝐸 𝑅𝑅
SSttaannddaarrdd DDeevviiaattiioonn (Volatility):
𝑆𝑆𝑆𝑆 𝑅𝑅 = 𝑉𝑉𝑉𝑉𝑉𝑉 𝑅𝑅
FFoorr PPoorrttffoolliiooss::
CCoovvaarriiaannccee::
𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅 = (𝑅𝑅 . − 𝑅𝑅 ) ∗ (𝑅𝑅 , − 𝑅𝑅 )
(T = number of return observations, R = return, 𝑅𝑅= expected return)
CCoorrrreellaattiioonn::
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅 = ,
∗ → 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅 ∗ 𝑆𝑆𝑆𝑆 𝑅𝑅 ∗ 𝑆𝑆𝑆𝑆 𝑅𝑅 =
𝐶𝐶𝑜𝑜𝑜𝑜 𝑅𝑅 ,𝑅𝑅
VVaarriiaannccee::
𝑉𝑉𝑉𝑉𝑉𝑉 𝑅𝑅 = ∑𝑥𝑥 ∗ 𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅 ,𝑅𝑅
(𝑥𝑥 = weight, amount of j held in the portfolio)
Uniseminar – Finance & Accounting Glossary
7
GGlloossssaarryy
AAccccoouunntt ppaayyaabbllee – A liability backed by the general reputation and credit
standing of the debtor
aabbaannddoonnmmeenntt ooppttiioonn – An option for an investor to cease making investments
in a project. Abandonment options can add value to a project because a firm can
drop a project if it turns out to be unsuccessful.
aabbssoolluuttee rreettuurrnn – see cash multiple
aacccceelleerraatteedd ddeepprreecciiaattiioonn mmeetthhoodd – A depreciation method that writes off a
relatively larger amount of the asset's cost nearer the start of its useful life than
the straight-‐line method does.
aaccccoouunntt – The record of the changes that have occurred in a particular asset,
liability or stockholders' equity during a period. The basic summary device of
accounting.
aaccccoouunntt ffoorrmmaatt – A balance-‐sheet format that lists assets on the left and
liabilities and stockholders' equity on the right.
aaccccoouunnttiinngg – The information system that measures business activities,
processes that information into reports and financial statements and
communicates the results to decision makers
aaccccoouunnttiinngg eeqquuaattiioonn – The most basic tool of accounting: Assets = Liabilities
+ Owners' Equity
Glossary Uniseminar – Finance & Accounting
8
aaccccoouunnttss rreecceeiivvaabbllee ttuurrnnoovveerr – Measures a company's ability to collect cash
from credit customers. To compute accounts receivable turnover, divide net
credit sales by average net accounts receivable.
aaccccoouunnttss rreecceeiivvaabbllee ttuurrnnoovveerr – Net sales divided by average net accounts
receivable.
aaccccrruuaall – An expense or revenue that occurs before the business pays or
receives cash. An accrual is the opposite of a deferral.
aaccccrruuaall aaccccoouunnttiinngg -‐ Accounting that records the impact of a business event as
it occurs, regardless of whether the transaction affected cash.
aaccccrruueedd eexxppeennssee – An expense incurred but not yet paid in cash.
aaccccrruueedd eexxppeennssee – An expense incurred but not yet paid in cash. Also called
accrued liability.
aaccccrruueedd ll iiaabbiill iittyy – A liability for an expense that has not yet been paid by the
company.
aaccccrruueedd ll iiaabbiill iittyy – An liability for an expense that has not yet been paid. Also
called accrued expense.
aaccccrruueedd rreevveennuuee – A revenue that has been earned but not yet received in cash.
aaccccuummuullaatteedd ddeepprreecciiaattiioonn – The cumulative sum of all depreciation expense
from the date of acquiring a plant asset.
Sem
inar
S
Seminar
Finance & Accounting Academic Year 2012/2013, Block 1
Seminar Uniseminar – Finance & Accounting
SSeemmiinnaarr
In the following we have provided you with some notepaper so that you can take
notes during the seminar. Furthermore you will receive a third practice exam
during the seminar, which you can file in here. In case you have not subscribed
for the Finance & Accounting seminar yet, you can do so on our website -‐
www.uniseminar.nl -‐ at any time.
Uniseminar – Quantitative Methods I Notes