Financial Decision Making and Capital Optimization
Capital Structure and Share Valuation
First, I check the shares mentioned.
| Debt Ratio | Asset | Debt | Equity | NS Shares |
|---|---|---|---|---|
| % Provided | $ Finance Your Company | Ratio x Asset | Asset – Debt | Equity / Shares |
Earnings and Return Metrics
| Interest | Interest Expense | EPS | Expected EPS | Expected Return |
|---|---|---|---|---|
% Provided. Examples:
| Interest x Debt | NPAT / N Shares | Same as EPS | % Provided |
Risk and Variance Calculations
| Price per Share | Standard Deviation | Coefficient of Variation |
|---|---|---|
| EPS / Expected Return | EPS 1 + EPS 2 EPS 3 – EPS 2 They must be equal. Result² x 0.25 Square root of (Result + Result) | Standard Deviation / EPS |
Price per share is also called Estimated Share Value.
Debt Ratio Percentage Analysis
| 0.25 | 0.50 | 0.25 | |
|---|---|---|---|
| EBIT | 0 | Stated in the problem table | Stated in the problem table |
| Interest Expense | From the first | From the first | From the first |
| NPBT | EBIT – Interest Expense | EBIT – Interest Expense | EBIT – Interest Expense |
| Tax (40%) | NPBT x 0.40 | NPBT x 0.40 | NPBT x 0.40 |
| NPAT | NPBT – Tax. Subtract without signs, but add a minus to the result. | NPBT – Tax | NPBT – Tax |
| EPS | NPAT / N Shares | NPAT / N Shares | NPAT / N Shares |
Financial Management Principles and Problems
- Estimated Share Value = Expected EPS / Estimated Return. The higher value is chosen.
- Beta Coefficient: Higher beta indicates more risk.
- Portfolio Risk Reduction: You plan to invest in two businesses and would like to lower the risk of your portfolio. From the following list, choose the best possible combination that would decrease your risk: A. An iPad manufacturing business and a car dealer business.
Why? Because they do not affect each other. If one fails, the other can stand. - Weighted Portfolio Return: You have a portfolio investment totaling $352,000 invested as follows: A: $52k, B: $65k, C: $56k, D: $53k, E: $67k, F: $59k. Expected returns are: A: 15%, B: 12%, C: 10%, D: 25%, E: 20%, F: 14%. Calculate the weighted portfolio return. If you have an expectation of 13%, is this combination desirable?
Total: $52k + $65k + $56k + $53k + $67k + $59k = $352,000Asset Investment ($) Weight A 52,000 52,000 / 352,000 = 0.1477 B 65,000 65,000 / 352,000 = 0.1847 C 56,000 56,000 / 352,000 = 0.1591 D 53,000 53,000 / 352,000 = 0.1506 E 67,000 67,000 / 352,000 = 0.1903 F 59,000 59,000 / 352,000 = 0.1676
Rp = (0.1477 × 0.15) + (0.1847 × 0.12) + (0.1591 × 0.10) + (0.1506 × 0.25) + (0.1903 × 0.20) + (0.1676 × 0.14)- A: 0.02216
- B: 0.02216
- C: 0.01591
- D: 0.03765
- E: 0.03806
- F: 0.02346
Expected portfolio return: 15.94%. Required expectation: 13%.
YES, this portfolio combination is desirable because 15.94% > 13%. - Asset Selection: Choose the best option based on Coefficient of Variation (CV = SD / Expected Return). Choose the lowest CV.
- Asset A: Return 15%, SD 2.3%
- Asset B: Return 14%, SD 2%
- Asset C: Return 18%, SD 2.9%
- Asset D: Return % (missing), SD 1.8%
- Internal Rate of Return (IRR): If the IRR of Project A is 12%, it would be logical that: c) It would be indifferent only if another project offers the same IRR.
- Retirement Planning: You are 25 and wish to deposit $200 monthly into a retirement account at 5% interest until age 65.
- r = 0.05 / 12 = 0.0041667 per month
- n = 40 × 12 = 480 months
- FV = PMT × [(1+r)^n – 1] / r
- FV = 200 × [(1.0041667)^480 – 1] / 0.0041667
- (1.0041667)^480 ≈ 7.36; 7.36 – 1 = 6.36
- FV = 200 × 6.36 / 0.0041667
- FV = 200 × 1526 = $305,200
- Capital Structure Optimization: This allows us to: c) Get the best possible EPS, finding the lowest possible number of shares and the highest possible earnings considering the risks.
- Risk and Return Relation: Risk will always have an inverse relation with return: b) False.
- Net Present Value (NPV): If the NPV of a project analysis is negative, you should reject it: YES.
- Projected Costs: If previous sales were $300k and costs were $200k, with future sales of $350k, what are the projected costs?
- Cost Ratio = 200 / 300 = 0.6667
- Projected Costs = 350,000 × 0.6667 ≈ $233k