Theory of finance EXAM

University of Guelph Gordon S. Lang School of Business and Economics

Department of Economics and Finance ECON*2560DE: Theory of Finance Summer Semester 2019 Key Concepts for Theory of Finance The following is a list of some of the major concepts that have been covered during the course that you should make sure you understand in your preparation for the final exam. Ch. 1 – Goals and Governance of the Firm

The goal of managers is to maximize firm value Advantages and disadvantages of a corporation The difference between real and financial assets Ch. 2 – Financial Markets and Institutions Functions of financial markets and institutions Ch. 3 – Accounting and Finance Balance sheet, Income statement, statement of Cash flows Market value vs. book value Ch. 5 - Time Value of money

Single cash flow: future value, present value, how to find discount rate Annuity: present value, how to find cash flow, annuity due, growing annuity, multiple payments

per year, amortization Perpetuity: present value, how to find cash flow, how to find discount rate, growing perpetuity

Relationship between discount rate and PV Inflation – real vs. nominal interest rates Compounding (EAR) Ch. 6 – Valuing Bonds Calculate PV with annual or semi-annual coupons How bond prices vary with interest rates

Relationships between - coupon rate, YTM, current yield, rates of return, and prices Relationships between risk and maturity, risk and coupon rate

Yield curve Bond ratings and default premium You will not be asked to calculate Yield to Maturity Ch. 7 – Valuing Stocks

Dividend discount model: no growth, constant growth, non-constant growth, sustainable growth rate

Relationship between price and growth rate, ROE, plowback ratio, discount rate Market efficiency Ch. 11 – Introduction to Risk and Return and the Opportunity Cost of Capital

Relationship between risk and return Unique vs market risk Benefits of diversification Ch. 12 – Risk, Return, and Capital Budgeting (CAPM) Beta - market risk Portfolio Betas Security market line and CAPM relationship Company risk vs. Project risk Ch. 13 – The Weighted-Average Cost of Capital and Company Valuation (WACC)

Calculation of WACC Calculations – Market values of debt and equity, costs of debt and equity (note that you did

these calculations in your project) Uses of WACC You do not need to know how about levered and unlevered betas Ch. 8 – Net Present Value and Other Investment Criteria

How to calculate NPV, payback, discounted payback, IRR (Note: you will not be asked to calculate IRR for anything more than a single cash flow), profitability index

Shortcomings of payback, discounted payback, IRR, profitability index Equivalent annual cash flows - projects with unequal lives, replacement

Ch. 9 – Using Discount Cash flow Analysis to Make Investment Decisions What constitutes an incremental cash flow How to calculate a cash flow Treatment of net working capital Treatment of depreciation in cash flows (Note: you will not be asked to calculate CCA depreciation, but you should know what it is) Ch. 10 - Project analysis Sensitivity/scenario/simulation analysis Break-even analysis - accounting vs. NPV Degree of Operating Leverage (DOL) Project options - decision tree analysis Ch. 14 – Introduction to Corporate financing and Governance Common Stock – ownership, voting procedures, classes of stock Preferred Stock Corporate Debt – repayment provisions, seniority, security Similarities and differences between different securities Different types of preferred stock and debt Ch. 15 – Venture Capital, IPOs, and Seasoned Offerings Venture capital

IPOs, underpricing Underwriting process General cash offers

Rights issues Private placements Ch. 16 – Debt Policy No taxes - capital structure irrelevant Taxes - VL = VU + PV(interest tax shield) VL = VU + TCD - if debt is permanent Costs of financial distress - VL = VU + PV(interest tax shield) - PV(costs of financial distress)

Relationships between firm value and rE, rD, rA, and WACC for each situation Trade-off Theory, Pecking-Order Theory

Ch. 18 - Payout policy How dividends are paid

Stock splits/stock dividends/reverse splits Share repurchase vs cash dividend How do companies decide on dividends Irrelevance of dividend policy Dividends as signals Clientele effect