Alan Cring Productions in association with Emergent Light Studio presents the
Illinois State Collegiate Compendium, academic lectures in business and economics.
This is business finance, FIL 341 for Autumn Semester 2024.
Today review for the final exam. The final exam will be held on, when will the final
exam be held here? Next Wednesday I believe it is. Let me make sure of that.
Yeah the exam will be held on Wednesday December the 11th from 1210 until 210
p.m. and you will have the full time. A couple of just the minor markers for the
exam. You are, I'm going to let you use your notes for the final exam. You can
use all your notes. I would not rely on those to be able to take the exam
because then you'll burn up all your time looking for things in your notes.
But certainly you can get a summary put together and that will help at least to
some extent with the final exam. Let me look at the number of questions. It's a
hundred points but of course it counts for more than that as a percentage of
your grade. And as it stands now, now this is actually only an estimate, there
will be approximately 57 questions on it. Now some of those are multiple part
questions like two drop-down menus or check mark all that apply, that kind of
thing. And of course there's a matching in there as well and that matching is a
total of 12 different possible matches and there are approximately eight
distractors. In other words, there are terms that don't match to anything. The
left you're matching something that's on the right but there are seven extras on
the right that don't go to anything. So there are distractors, seven or eight
of those. Those are all definitional words and terms, descriptions, you
know, financial intermediation or something along that line or debenture or
spot forward, those kinds of terms. Now in your files folder you have a ginormous
list of terms but you also have a short, I'm putting up a shorter list of terms
as well. That giant list is like 280 or 300 terms that I bring up during a
course and I shrink that down to what's relevant for you to know that it's not
just something way out there that I wouldn't ask a question on. But that's a
good place for just making sure that you're solid on how, what kinds of terms
that I could throw at you on the final exam. Now let me go kind of backwards. The
last part of the final exam and I could put it up, actually I could put the final
exam up here but he probably wouldn't want to see it. Okay, let me, the
numerical questions on the exam. They are, the quiz, that last quiz was most of the
numericals but there will be a few more of numericals than what were on the
quiz. So in other words, I'm going to, let me give you a breakdown and the first
ones are pretty much what you saw on quiz eight or a quiz before that maybe
even. But you're going to have a question on present value of an annuity. Future
value of an annuity.
Bond price, bond yield.
We'll have just basic bread and butter, meat and potatoes kind of questions like
final loan payment. Nothing difficult. Now remember, get your Excel spreadsheets up
and running before the quiz, before the, rather the final. Have them up there, use
them and make sure that you download a fresh copy. I usually encourage that, just
make sure that you didn't accidentally delete a formula cell or something like
that so that you've got the latest and in a couple of cases I've done a quick
little enhancement to help you out a little bit. So make sure that you've got
the latest download of those spreadsheets. Now let me go on here.
Stock price with dividends and a selling price.
Stock price with a constant growth rate dividend.
And stock price with a horizon value.
Now those will all be in your stock valuation spreadsheet.
Now net present value, internal rate of return, and a modified internal rate of
return. Now you didn't see an MIRR before now but it's just plug, it's one of
the worksheets in the net present value, the NPV and IRR. There is an NPV sheet
and IRR and then there's one for MIRR, modified internal rate of return.
And all you have to do is just the same as you've done for the other
ones, just put in the numbers and in that one you have both a financing rate and a
reinvestment rate. So you put those in and out comes your MIRR.
Now also you'll have a breakeven and those are real, those are gimmies, the
breakeven. I will not ask you for a payback period. Now there'll be a just a
classic meet the objective capital asset pricing model. There's a CAPM
spreadsheet, you work sheet, you can spreadsheet, you can download. It's not
that hard to do it by hand but I've got a spreadsheet for you to do it anyway.
Now also you will have a weighted average cost of capital problem. That's
that's a difficult one in terms of time. Just make sure you fill in all of the
white cells from the narrative and out will come your weighted average cost of
capital.
Now that's about it, that's it for numericals.
You should be able to clean those up relatively quickly. It's just make sure
that you check your numbers again, make sure you put in the right numbers before
you commit to sending the exam up closing the exam. Just make sure that you
double check your numbers. Okay now on to the rest of the exam. First thing first, I
will go back to the early part of the semester and again what we're doing in a
course like this as much as anything else is absolutely solidifying your
understanding of fundamentals of corporate finance and finance in
general so that we can be assured that there are no questions like that when
you go on to the courses after me that you know what a corporation is, what it
means to be what stockholders and bondholders, just those fundamentals.
Who has a prior claim, who has a residual claim,
and all of that kind of thing.
What do I mean by a dividend? Does the company have to pay a dividend? Does it
not have to? Basic knowledge of stocks, common stocks, you should know what it
means to what common stock means, preferred stock. I mean there's also
classified stock and tracking stock.
Now on the other side, debt instruments. You know the difference between a
mortgage bond and a debitor.
Know the difference between a bill, a note, and a bond.
Who is the issuer, who is the borrower, who's selling the bond, who is buying
the bond as far as the lender and the borrower go. Make sure you know
that, you understand that.
Now I'm not going to hit you. There are a lot of different things about
bonds like callable and puttable bonds. I won't hit you with that. Just I told
about it, the book told about it, and that's about it. I won't check you on
callable and puttable bonds. Make sure you do know about foreign bonds. What do
I mean by a foreign bond?
Now make sure you know about financial intermediation. Matching of surplus and
deficit economic units based on level timing and risk.
Okay, interest rates.
Now what the structure of an interest rate is, what is the risk-free rate, what
is the risk premium, default maturity and liquidity,
what I mean by nominal versus real.
Going on here to other matters. Risk and return, our biggest, most important
concept in finance. And be sure you understand know that the technically
correct definition is the greater the non-diversifiable or systematic risk, the
greater the expected return. Now we say greater the greater the risk, the greater
the return. That's sloppy. The technically it's the greater the
systematic or non-diversifiable risk, the greater the expected return.
I will expect you to show me that you know the difference between systematic
and non-systematic risk
and total risk. How do we measure total risk? What's the classic for that? That's
of course standard deviation, sigma. But in our business a lot of the time what
we are not we're not interested in sigma. We're interested in a tighter measure of
the part of the risk, of a part of the risk. What's the metric that we use for
systematic risk?
How do you read it? If I see that this number is 1.5, what does that tell us
about the investment?
Related to that, leading to a little bit tighter question, why do we care in
responsible professional finance? Why do we care so much about adding stocks to a
portfolio? What's the purpose of this? Just so we have a lot of different
letters to brag about or is there a purpose to it?
Moving on with that, CAPM of course you'll do a CAPM calculation but I also
anticipate that you'll understand that what capital asset pricing model is
telling us. What do we mean by the risk of the market premium over risk-free?
Now moving over to component cost of capital. We went through the formulas to
find the cost of debt after taxes, the cost of equity which is broken
down into three different equity parts. The cost of preferred stock, the cost of
common stock as the book says the cost of retained earnings, and the cost of
new common stock. There's a binding, I'm trying to
telegraph a question to you but if you look at the formulas for the cost of
equity, there's something that comes shining through in every one of those.
You see a relationship between the price of the security and the cost of the
component capital, a component. There's a relationship and it's showing through in
all the different formulas. Make sure you know that. It's a question that if I
telegraph as much as I can about the question because it could sort of lead
you blindside you if you just hit it on the exam. There's also a relationship
between the cost of equity and the growth rate of the dividends. Make sure
you know those relationships. Just look at the formulas for all three of those
pieces and you'll see that come shining through those relationships which is why
a company cannot pretend that it doesn't care about its stock price. I told, I may
have, I think I told you, I had companies that I consulted for and I would go to
we'd have a meeting I said well the stock price is following and their
immediate reaction was well so what? You know it'll go down you know and someday
they'll see how great our company is. Why is that a wrong attitude? Why is that
fundamentally wrong to think that the price isn't something that we should
worry about? Especially on a long-term basis. I'm trying to think I'm not gonna
go beat it beat that course anymore. Just make sure that you understand that those
relationships between the cost of equity and the price of the equity and the cost
of the equity and the growth rate of the dividends. Just as a quick mention
also going back make sure that you understand corporate governance. Now I
first passed a passed over corporate governance early in the semester
talking about the executives, the C-suite, and the board of directors and all of
that and I would certainly that's fair game to ask you something about board of
directors versus the executive officers of the corporation and then I passed
over it again late in the course corporate governance in a more formal
fashion aiming to deepen the understanding of the corporate
governance framework and also about ethics and how that is tied in to the
governance and the management of the corporation. So in that regard agency at
the agency question or two could show up. You could also see something about
ethical frameworks that have been considered historically and we now
settle on some version of the agency approach. Who's the agent, who's the
principal, what are the costs agency costs that can be extracted that kind of
thing.
But moving on from there I better look at this before I just start
flapping my jowls a bit.
Capital structure, make sure you know what I mean by capital structure and what
constitutes the optimal capital structure.
Now as far as ratios go, now I've said this before and I'll say it again, I don't
care whether or not you can actually calculate a ratio. Bring your ratio
formula sheet with you because I can ask you questions about ratios and what
relationships among ratios. Well what's the order from largest to
smallest of liquidity ratios or what happens if ROA increases and the
ROE, what will it do? What happens if a company becomes more
leveraged? What does that do to ROE?
Questions like that. In other words, don't show me that you can do the numbers, we
can do those in Excel all day long. Show me that you know what the numbers are
telling us and why they can do the things that they do and what you check
for to see what's going on with a particular ratio. Okay, ROE is going
through the roof. Okay, let's find out why that is. Let's look at the numerator
and the denominator and see which one is driving it upward and is that all good
news or is that maybe even bad news? Whatever.
So the ratios part of it is more interpretive of what they tell us.
Let me look here.
Oh let me see. I'm just trying to make sure that I give you a good overview.
Sources of capital. I won't hit too hard on this and I'd be more focused on you
knowing the kinds of financial institutions that you
could actually end up being, where you might actually end up being employed.
And the big ones are of course the commercial banks and the investment
banks and then probably in that you might run into an opportunity in a hedge
fund or in a private equity fund. Just have a have sort of an understanding of
what the differences are among different types of financial
institutions. What can one do that another can't do and all of that.
Although that's becoming so blurred anymore by financial institutions that do
everything. They do IB, they do commercial banking, they do
in other words regular retail banking. They even have a side that does private
equity or offers hedge funds. So it's all over the place mutual funds. A lot of
banks are now heavily into mutual funds these days.
Just a few other things I'm just kind of cleaning up now and then you can ask me
some questions. Make sure you know about bond price dynamics. What happens to a
bond price as the spread between yield and coupon gets smaller?
What happens to the price of a bond as it approaches maturity?
Questions like that are always fair game. What would happen to the, I mean I might
even throw one at you, what happens to the price of a bond? What happens to the
yield on a bond if a corporation's bonds get downgraded in their credit rating?
In a related, somewhat related vein I will expect you to have watched what I
was doing when I did the let's look at the numbers. I could give you, okay well
which of these numbers is close to the current price of gold or which of these
numbers is closest to the current yield on bonds?
Something like that just to ensure that you did watch and that it did have
meaning to you the current market world out there which is where you'll be very
shortly if you're not already starting to dive into it now. What did I say, what
did we look at, what were the numbers and what did I comment on those numbers?
And it's about what's been going on recently, not historically so much.
Oh, I'll do a, there will be a question where I'll say which is the formula for
something and I'll give you a list of like six or eight and you have to tell
me which one of those it is. It could be something like a stock cost of capital,
it could also be a free cash flow, something like that.
And you just have to identify which formula is the one that you would use
and they'll look quite similar so watch what you're, watch the
additions and subtractions and all that kind of good stuff.
Might not, I'm not above like I did on the midterm something about okay, your
current assets went up faster than your current liabilities, what did that do to
your free cash flow? Or you got brought in additional inventory as a buffer
against supply chain disruptions, what's that going to do to your free cash flow?
Or you have decided that you're going to slow down paying your suppliers, what
would that do to your free cash flow? It's kind of common sense in a lot of
cases.
Okay.
It's your turn, ask me questions.
You got any questions for me? Now I'll be sending out an announcement about some
office hours for Monday and Tuesday of next week if you want to come into my
office where it's warm because I've got my space heater running at full blast
and ask me any last minute questions you have. But again I do encourage you to
download the freshest versions of the spreadsheets that I've given in the
course, that you've used in the course. That's all you have for me, that's all I
have for you now and forever. I thank you for being my students.