·How does intrinsic value compare to stock price?

Intrinsic value is an estimate of the actual true value of a company, regardless of market valueMarket value is the current value of a company as reflected by the company’s stock price. Therefore, market value may be significantly higher or lower than the intrinsic value. Market equilibrium: Intrinsic value=stock price

·How do you use the discounted dividend model?

Value of a stock is the present value of the future dividends expected to be generated by the stock

·How do you use the corporate valuation model?

suggests the value of the entire firm equals the present value of the firm’s free cash flows. is the firm’s after-tax operating income less the net capital investment.

Find the market value (MV) of the firm, by finding the PV of the firm’s future FCFs.

Subtract MV of firm’s debt and preferred stock to get MV of common stock. Divide MV of common stock by the number of shares outstanding to get intrinsic stock price (value).

·What is preferred stock and how is it valued?

Hybrid security. Like bonds, preferred stockholders receive a fixed dividend that must be paid before dividends are paid to common stockholders. However, companies can omit preferred dividend payments without fear of pushing the firm into bankruptcy

Chapter 10

·Calculate weighted average cost of capital and all of its components

WACC = wdrd(1 – T) + wprp+ wcrs

The w’s refer to the firm’s capital structure weights.

The r’s refer to the cost of each component.

rd is the marginal cost of debt capital.

Rp is the marginal cost of preferred stock, which is the return investors require on a firm’s preferred stock.

Rs is the marginal cost of common equity using retained earnings.

Chapter 11

·How do you choose between mutually exclusive projects? independent projects?

Independent projects:  If the cash flows of one are unaffected by the acceptance of the other

Mutually exclusive projects:  If the cash flows of one can be adversely impacted by the acceptance of the other

·Calculate and know how to use NPV, IRR, payback, discounted payback and MIRR

IRR is the discount rate that forces PV of inflows equal to cost, and the NPV = 0:

MIRR assumes reinvestment at the opportunity cost = WACC.  MIRR also avoids the multiple IRR problem. Managers like rate of return comparisons, and MIRR is better for this than IRR

Strengths and weaknesses of payback

Provides an indication of a project’s risk and liquidity

Easy to calculate and understand

Ignores the time value of money (TVM Ignores CFs occurring after the payback Period

No relationship between a given payback and investor wealth

Maximization Discounted payback considers TVM, but other 2 flaws remain

Chapter 17

What is a multinational corporation?

Decision making within the corporation may be centralized in the home country, or may be decentralized across the countries in which the corporation does business

·Why do firms expand into other countries?To seek production Efficiency,To avoid political and regulatory Hurdles,To seek new markets,To seek raw materials and new technology,To protect processes and Products,To diversify,To retain customers

·Calculate indirect quotes and direct quotes

The indirect quotation represents the number of units of a

foreign currency needed to purchase one U.S. dollar.  The

indirect quotation is the reciprocal of the direct quotation

Since they are prices of foreign currencies expressed in dollars, they are direct quotations.

·Calculate cross rates

The exchange rate between any two currencies.

·What is exchange rate risk?

The risk that the value of a cash flow in one currency translated to

another currency will decline due to a change in exchange rates

·What are the types of monetary agreements?

Freely floating

Exchange rate determined by the market’s supply and demand for the currency. Governments may occasionally intervene and buy or sell their currency to stabilize fluctuations. 

Managed floating: Significant government intervention manages the exchange rate by manipulating the currency’s supply and demand. The target exchange rates are kept secret to limit speculation. No local currency

The country uses either another country’s currency as its legal

tender (like the U.S. dollar in Ecuador) or else belongs to a group of countries that share a currency

Currency board arrangement The country technically has its own currency but commits to exchange it for a specified foreign currency at a fixed exchange rate

·What is the difference between spot rates and forward rates?

Spot rates are the rates to buy currency for immediate delivery.

Forward rates are the rates to buy currency at some agreed-upon date in the future

·When is the forward rate at a premium or discount?

If the forward currency is more valuable than the spot currency then the forward currency is selling at a premium.

In the opposite situation, the forward currency is selling at a discount.

The primary determinant of the spot/forward rate relationship is relative interest rates.

·What is interest rate parity?

Interest rate parity holds that investors should expect to earn the same

return in all countries after adjusting for risk.

ft= t-period forward exchange rate

e0= today’s spot exchange rate

rh= periodic interest rate in home country

rf= periodic interest rate in foreign country

·What is purchasing power parity?

Purchasing power parity implies that the level of exchange

rates adjust so that identical goods cost the same amount in

different countries.

What impact does relative inflation have on

interest rates and exchange rates

Lower inflation leads to lower interest rates, so borrowing in

low-interest countries may appear attractive to multinational


However, currencies in low-inflation countries tend to

appreciate against those in high-inflation rate countries, so

the effective interest cost increases over the life of the loan.