Ch.

1: INTRO TO FINANCE Corporate Finance is the study of the relationship between business decisions and the value of the stock of business. Capital Budgeting is what assets (investments) one should take on. Capital
Structure is the combination of debt and equity used to finance the firm’s operations. Capital Structure decisions include determining the number of shares of stock to issue. Working Capital Management is planning and managing the firm’s CA’s
and CL’s, which can also include inventory. The primary goal of financial management is to maximize the current value of each share of outstanding stock. Stakeholders are the suppliers, customers, and employees of a corporation. Agency
Costs are the costs of the conflict of interest between shareholders and management. Offering stock options is a form of management compensation that’s designed to eliminate the agency problem. Financial Markets bring buyers and sellers
together. They are driven by the supply and demand for money (banks + investment dealers are examples) MARKET TYPES: Money Markets issue ST debt. Include Primary markets which involve the sale of new securities on an exchange, also
includes Private and Public Markets. Capital Markets issue LT debt. Include Secondary Markets which involve the RESALE of securities on an exchange. Also includes Dealer Markets is over the counter, electronically, and Auction Markets, the
physical location of a market (NASDAQ). A Value Manager has a focus on LT cash flow returns, and takes an outsider’s view. A Corporation is a business created as a distinct legal entity owned by one or more individuals or entities. Ownership
of shares are easily transferred, has a limited liability, and easy to raise financing. However, they are due to double taxation, and more expensive and complex to form. A Partnership is a business owned by 2 or more people, where owners keep
all profits, have access to more human and financial capital than sole prop., and limited partners have limited liability. It’s hard to grow the business though. Income Trust holds the debt and equity of an underlying business and distribute the
income generated to unit holders. Co-operative is an enterprise that is equally owned by members, share the benefits of a co-op based on how much they use the co-op’s service. Fin. Institutions act as intermediaries between investors and
firms raising funds.
Ch. 2: FIN. STATEMENTS, CASH FLOWS & TAXES Net Working Capital is the difference between a firm’s CA’s and CL’s. The Balance Sheet is a snapshot taken at a single point in time. 3 things to keep in mind
when examining a Balance Sheet: Liquidity, Debt vs. Equity, and MV vs. BV. Liquidity is the speed and ease w/ which an asset can be converted into cash. A/R are generally more liquid than inventory. Book Value is the accounting value of a
firm’s assets. It is based off of historical costs. Market Value is the price at which willing buyers and sellers trade the assets. Impairment Losses is the amount by which the carrying (book) value of an asset exceeds its recoverable amount. The
Income Statement contains non-cash items which is a primary reason that accounting income differs from cash flow. It reflects a summary of activity that occurs over some period of time. 3 things to keep in mind when examining an Inc.
Statement: IFRS, Non-Cash items, and Time and Costs. Non-Cash Items are expenses charged against revenues that do not directly affect cash flow. Average Tax Rate is the percentage of income that goes towards paying taxes. ATR = Total
taxes paid / Total Taxable Income. Marginal Tax Rate is the extra tax you pay if you earned 1 more dollar. Most relevant to decision making. Dividend Tax Credit is the formula that reduces the effective tax rate on dividends. It encourages
Canadian Investors to invest in Canadian firms. Capital Gains arise when an investment increases in value above the purchasing price. Loss Carry Back, and Loss Carry Forward can be used to offset the consequences. Capital Cost Allowance
is the depreciation for tax purposes, uses the half year rule for Yr 1. Basically, depreciation we are allowed to deduct. Recapture is when you sell an asset for more than the ending UCC. The difference would be added to taxable income.

CASH FLOW IDENTITY: Cash Flow from Assets = (Operating Cash Flow) – (Net Capital Spending) – (Changes in Networking Capital) [[[CFA = Cash flow to Cred. + Cash Flow to Shareholders]]]
OCF = EBIT + depr. – taxes | Net Cap. Spending = End F.A – Beg. F.A + depr. | Change in NWC = (CAF – CAI) – (CLF – CLI) | CFC = Interest Paid – Net New LT debt | CFS = Div. paid – Net New Equity. |
Gross Profit = Sales – COGS | EBIT = Gross Profit – operating exp. | Net Income = EBIT – taxes | Retained Earnings = Net Income – Div. | EPS = Net Income / Common Stock |

Terminal Loss is when you sell an asset for less than the ending UCC. The difference would be deducted from taxable income. A use of cash can be defined as any activity that diminishes the cash balance of a firm.
Ch. 3: WORKING W/ FIN. STATEMENTS Sources of Cash are a firm’s activities that generate cash. A decrease in an asset account, or an increase in a liability or equity acct., is a source of cash. Selling a product, asset
or security. Uses of Cash are a firm’s activities in which cash is spent. An increase in assets, or a decrease in a liability or equity acct., is a use of cash. Purchasing assets, or paying for materials/labour. Statement of CF is a firm’s financial
statement that summarizes its sources and uses of cash over a specific period. Common Size Statements are standardized financial statements presenting all items in %. BS is shown by dividing Total Assets, IS is shown by Total Sales.
Common Base Yr. Statements is presenting all items relative to a base year amount; such as a ratio. Combination Method is dividing yr. 2 % by yr. 1 % to get a ratio. Problems w/ Financial Statement Analysis include: 1) many firms are
conglomerates whose combined operations don’t fit any neat industry classification. 2) The financial statements of firms outside US and CAN do not nec. conform to GAAP, making it hard to compare. 3) Firms may use different accounting
procedures for inv. 4) If 2 firms w/ seasonal operations end their fiscal year at different times, their fin. results can be hard to compare.

Current Ratio = CA / CL Total Debt Ratio = (Tot. A – Tot E.) / (Tot. A) Inventory Turnover = COGS / Inventory Profit Margin = NI / Sales Price-Earn. Ratio (PER) = PPS / EPS
Quick Ratio = (CA – Inv.) / CL D/E Ratio = Tot. Debt / Tot. E Days’ Sales in Invent. = 365 / Inv. Turnover ROA = NI / Total Assets Price-Earn Growth Ratio = (PER) x
Cash Ratio = Cash / CL Equity Multiplier = Tot. A / Tot. E Receivables Turnover = Sales / AR ROE = NI / Total Equity (expected future earnings growth) x 100
Intrvl Measure = CA / avg. daily oper. costs LT Debt Ratio = (LT D) / (LT D + Tot. E) Days’ Sales in Rec. = 365 / Rec. Turnover ROE2 = (Prof. Marg.) x Market to Book Ratio = MVS / BVS
ROE measures/how
ST Solvency shareholders fared during
Liquidity Times Interest/ Earned
LT Solvency = EBIT / Interest
Fin. Leverage NWC
AssetTurnover = Sales
Utilization / NWC
Turnover Ratios Profitability
(TAT) x (Fin.Ratios
Leverage) Market
Du ValueisRatios
Pont Identity the expression of breaking ROE into 3
the year. Total Asset Turnover = Sales / Tot. Assets parts. It’s a convenient way of systematically approaching
Cash Coverage Ratio = (EBIT + depr.) / Intrst Fin. Leverage = Ass. / Eq. financial statement analysis.

Ch. 5: TIME VALUE OF MONEY Future Value (Compounding) is the amount an investment is worth after one or more periods at a given interest rate. Present Value (Discounting) is the current value of future cash flows
discounted at the appropriate discount rate. Present values become smaller as time increases. The higher the discount rate, the lower the PV. Compounding is the accumulating interest in an investment over time. The greater the number of
years, the greater the compounding effect. Interest-On-Interest is the interest earned on the reinvestment of previous interest. Compound-Interest is interest earned on both the principal and prior invested interested. Simple Interest is the interest
earned on only the original principle. Interest Rate is the exchange rate between present value and future value. Many Financial Calculators require that either the present value of the future value be entered as a negative number when solving
for the number of periods, t. The Rule of 72 is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. R72 = 72 / (annual rate of return). A dollar today is worth more than a dollar in the future

SIMPLE CASH FLOWS: FV = PV x (1 + r) t PV = FV / (1 + r) t r = (FV / PV) 1/t - 1 t = [ ln (FV / PV)] / [ ln (1 + r)] FV interest factor = (1 + r) t

because 1) Risk of not receiving the dollar in the future. 2) Inflation of the dollar. 3) Could invest the dollar and earn interest.
Ch. 6: DISCOUNTED CASH FLOW VARIATION Annuity is a level stream of cash flows for a fixed period of time. Car loans and mortgages (mortgages are always csa). When the cash flows of an annuity are the same,
we use a variation of finding PV. W/ an ordinary annuity, the cash flows occur at the end of each period. Annuity Dues are annuities in which the cash flow occurs at the beginning of the period, and not end. Leases and investments. Perpetuities
are annuities in which the cash flows continue forever. Examples include trust funds, endowment funds, and preferred stock. A Consol is a type of perpetuity. Growing Perpetuity is a constant stream of cash flows w/o end that is expected to rise
forever. Growing Annuity is a finite number of growing annual cash flows. Effective Annual Rate (EAR) is the interest rate expressed as if it were compounded once per year. Quoted Interest Rate (APR) is the interest rate expressed in terms of
the interest payment each period. It is the interest rate which lenders must report to borrowers as required by law . Pure Discount Loans are the simplest of loans. The borrower receives money today and repays a single lump sum at some time in
the future. Interest-only-loans are set up for the borrower to pay interest each period and repay the whole principal at some point in the future. Amortized Loans are specified which the lender may require the borrower to repay parts of the
loan over time. When comparing investments it’s best to not solely rely on APR rates.
Ch. 7: INTEREST & BOND VALUATION Coupons are the stated interest payment made on a bond. Face (Par) Value is the principal amount of a bond that is repaid at the end of the term. Coupon Rate is the annual
coupon divided by the face value of the bond. Maturity is the specified date at which the principal amount of a bond is paid. Discount Bonds are bonds that sell for less than face value. They are caused by an increase in interest rates. Premium

C = Dollars per period ANNUITY DUE PVA / FVA: PVA or FVA x (1 + r)

PRESENT VALUE FOR ANNUITY CASH FLOWS: PVA = C x

1−1/ ( 1+r )t C = [PVA x r] / [1 – 1/(1+r) ] t = (-1) x ln [(-1) x (PVA x r/C – 1)] ANNUITY DUE ‘C’:
t
C / (1 + r)
PERPETUITIES: PVP = (C) / (r) PVP = (C) / (r – g) g
r C
t GROWING ANNUITY:
FUTURE VALUE FOR ANNUITY CASH FLOWS: FVA =
C x [ ( 1+r ) −1] C = [FVA x r] / [(1+r) - 1 ] t
t = { ln [ (FVA x r) / (C) + 1] } / { ln [1 + r] }
PV =
r−g
[

r
Bonds are bonds that sell for more than face value. They are caused by falling interest rates. Yield To Maturity (r) is the rate of return required by investors in the market for owning a bond. Market Price of a bond is equal to the present value of
the face value, plus the present value of annuity payments. Interest Rate Risk arises for bond owners from fluctuating interest rates. The longer the time to maturity, and the lower the coupon rate, the HIGHER THE INTEREST RATE RISK. Bond
Indebture is a written agreement between the corporation and the lender detailing the terms of the debt issue. Includes basic terms of the bond, the amount of the bonds issued, repayment arrangements, etc. DEBT VS EQUITY: Debt is not an
ownership interest in the firm, interest payments on debt are tax deductible, and unpaid debt is a liability that must be paid. Equity is an ownership interest in the firm, dividends are not tax deductible, and dividends do not have to be paid. BOND
TYPES: Registered Form has the owner of the bond’s name, Bearer Form does not have record of the owner’s name. Debenture is unsecured debt (10+), Notes are secured debt (<10). Call Provision is an agreement giving the corporation the
option to repurchase the bond at a specified price before maturity. Protective Covenant is that part of the indebture that limits certain actions a company might otherwise wish to take. Negative Covenants limits the actions that the company may
take, and Positive Covenants are actions the company agrees to take. Clean Price is the price of a bond net accrued interest; this is the price that is typically quoted. Dirty Price is the price of a bond including accrued interest, this is the price the

YTM = [(Annual Coupons) + (FV – MV) / Yrs Remaining] / [(FV + MV) / 2] BV = [C] x [(1 – 1/(1 + r) t) / r] + [FV x 1/(1 + r) t ] C = [BV – (FV x (1/(1 + r) t )] / [(1 – 1/(1 + r) t) / r] Cr = FV x r x (1/m)
Fischer Effect: The relationship between the nominal returns, real returns, and inflation. Exact: (1+R) = (1+r) x (1+H)Approximate: R = r + H [R=Nom, r=Real, H=Infl.]

buyer actually pays. A financial market is TRANSPARENT if it is possible to easily observe its prices and trading volume.
Ch. 8: STOCK VALUATION Interest Payments are promised in bonds, while dividend payments are not in stocks . Preferred Stock has no voting priviledgs generally, pays out dividends. Common Stock has voting rights, but no
dividend priority. 3 types: Multiple classes, voting vs. non-voting, company control. Pre-Emptive Rights refers to the right of shareholders to share proportionately in any new stock issues sold. Dividend Yield is a stock’s next expected dividend
divided by the current stock price (D1/P0). The Dividend Yield on a common stock is most similar to the current yield on a bond. Dividends become a liability of the corporation at the time they are declared. Dividend Growth Model is the stock
valuation model that determines current stock price as the next dividend divided by (discount rate less the dividend growth rate). Shareholder’s Rights include 1. The right to share proportionately in dividends paid, 2. The right to share
proportionately in assets remaining after liabilities have been paid, 3. The right to vote on shareholder matters of great importance. Capital Gains Yield can be defined as g, the growth rate. An increase in the required return on a stock will
decrease it’s market value, all else the same. Valuing stock can be more difficult than bonds, as the timing and amount of future cash flows is not known, the maturity is essentially forever, and no way to find mkt rate of return.
Ch. 9: NPV + OTHER INVESTMENT CRITERIA NPV is the difference between the discounted (market) value of an investment and its cost. NPV is a sum of discounted cash flows. Invest in projects that have a +NPV.
Advantages include no serious flaws, and preferred decision criteria. NPV RULE: The principle that an investment should be accepted if the difference between the investment’s cost and MV is +, and rejected if negative. IRR is the discount rate
that makes NPV=0. IRR RULE: invest in projects when the IRR exceeds the firm’s required rate of return. Advantages include closely related to NPV, leads to same decision for conventional cash flows. However, it cannot be used to rank

COMMON STOCK 0 GROWTH: PT = DT+1 / r COMMON STOCK CONSTANT GROWTH: PT = DT+1 / (r-g) P0 = D1 / (r-g) DT = D0 x (1+g)T DT = DT+1 / (1+g) DT+1 = DT x (1+g) r = (D1/P0) + g
COMMON STOCK NON-CONSTANT GROWTH: PT = [DT(1+g) / (r-g)] P0 = [DT / (1+r) T] + [DT+1 / (1+r) T+1] + [DT+2 / (1+r) T+2] ….. + [PT / (1+r)T]

The capital budgeting process involves: generating LT investment proposals, reviewing + analyzing + selecting from them, and implementing and following up on those selected.
mutually exclusive projects (MEP). IRR ANALYSIS METHOD may produce multiple rates of return for a single project. May lead to incorrect decisions when comparing MEP. Profitability Index is the ratio of present value to cost. Also known as
the benefit/cost ratio. PI RULE: Invest in projects when index exceeds 1. Advantages are that it is similar to NPV. However, cannot be used to compare MEP. Payback Period is the length of time until the sum of an investment’s cash flows
equals its cost. PP RULE: Invest in projects w/ payback period less than cutoff point. Easy to use, however, ignores risk, time value of money, and cash flows beyond cutoff pt. Discounted Payback Period is the length of time required for an
investment’s discounted cash flows to equal it’s initial cost. DPP RULE: investment is acceptable if its DPP is less than some pre-specified # of years. Mutually exclusive describes 2+ events that cannot occur at the same time. Average
Accounting Return is a measure of accounting profit relative to Book Value. AAR RULE: Invest in projects if their AAR exceeds a benchmark AAR. Easy to calculate but not a true rate of return. Ignores TVM, Cash flows, and market values.

Ch. 10: CAPITAL BUDGETING Capital Budgeting Process is determining what products or services will be offered, in what markets will we compete in, and what new projects should be introduced/ pursued. Future cash flows
are key in capital investment decisions. Always choose the decision that maximizes the firm’s value. Only current assets/liabilities need to be considered when making a decision. Only relevant cash flows for a project are considered. B/c relevant
cash flows are defined in term of changes to the firm’s existing cash flow, they are called incremental cash flows. Stand Alone Prinicple is calculating future total cash flows to the firm with and without a project. This approach allows us to
evaluate a projects on its own merits. Erosion in a financial sense is defined as, the negative impact on the current cash flows from an exisiting product when a new product is introduced. The cash flows of a new project that come at the expense
of a firm’s existing product. Opportunity Cost is the most valuable investment given up if an alternative investment is chosen. Government Intervention are also relevant costs. Ex: taxes, grants, CCA. Sunk Costs are costs that we have already
paid or have already incurred the liability to pay. If Inflation in cash inflow estimation is ingnored, there may be a bias against accepting capital budgeting projects.. Financing Costs are irrelevant in capital budgeting. It will not affect the
accept/reject decision. Depreciation Tax Shield is the cash flow tax savings generated as a result of a firm’s tax-deductible depreciation expense. Pro-Forma Financial Statements project future year’s operations. Developing a Pro Forma: 1)
Prepare: estimate unit sales, selling price, variable cost per unit, relative fixed costs, investment in NWC. 2) Forecast: project cash flows from operations, changes in NWC, changes in investment. 3) Evaluate: Using NPV and other criteria, we
can project to determine if we reject or accept the project. OTHER CONSIDERATIONS: Accrual Vs. Cash Numbers: in CB, we need to convert IS values from accrual to cash. Depreciation & CCA: accounting depreciation is a non-cash item and
is added back to NI to get cash flows from operatios. It reduces the firm’s tax. C = Original Cost (Total CCA) D = Depreciation Rate T = Tax Rate r = Discount Rate S = Salvage Value n = years remaining. Use the Effective Annual Cost when
evaluating equipment with different lives. ALWAYS choose the option with the lower EAC. In EAC, we are not required to find when NPV=0. DISCOUNTING = (Cash Inflow / (1+r)n)
PVCCATS = [(CxDxT) / (D+r)] x [(1+0.5r) / (1+r)] – [(SxDxT) / (T+r)] x [(1) / (1+r)n] NPV = (OCF (DISCOUNTED)) – (C) – (PVCCATS) EAC = (PV of Costs (DISCOUNTED)) / [(1 – 1/(1+r) n) / r]

Ch. 11: PROJECT ANALYSIS, EVALUATION & ETHICS Forecasting Risk is the possibility that errors in projected cash flows will lead to incorrect NPV estimates. 4 WAYS TO FORECAST RISKS: 1) Sources of
Value 2) Scenario Analysis is taking into account what happens to NPV estimates when we ask what-if questions. If many scenarios are negative, we should investigate. 3)Sensitivity Analysis investigates what happens to NPV when only 1
variable is changed. Helps us isolate the sources of forecasting risks 4) Simulation Analysis is a combination of scenario analysis is a combination of scenario analysis and sensitivity analysis where many simulations are run and analyzed. Law
is the clearly defined set of enforceable rules that applies to everyone and represents a level of expected conduct that everyone must observe. Ethics addresses situations not covered by law. Ex: relationships. Ethics can contribute to the
formation of laws. Justice Ethics asks if the harms and benefits are fairly distributed across the affected stakeholders. Utilitarian Analysis asks if the benefits outweigh the harms. Rights’ Analysis asks if human rights are protected. Includes:
Liberty Rights: things I have that nobody else should take from me, and Welfare Rights: things that I do not have that someone else should give to me. CFAI strives to treat members as shareholders.

Ch. 18: ST FINANCE & PLANNING Contingency Planning is taking into account the managerial options implicit in a project. The A/R Turnover would increase if the cash cycle was shortened. The Accounts Payable Period is
the lenth of time between the acquisition of inventory and payment. Operating Cycle is the length of time between the acquisition of inventory and the collection of cash from receivables. Op. Cycle has two distinct components: Inventory Period:
the time it takes to acquire and sell the inventory, and the Accounts Receivable Period: the length of time between the sale of inventory and the collection of cash from receivables. Letter of Credit is issued by a bank, promises to make a loan if
certain conditions are met. An agreement by a bank which guarantees payment on the prompt arrival of a shipment of goods from an overseas supplier. Commerical Paper are ST notes ussued by large and highly rated firms. Trust Receipt lists
items and it’s registered serial numbers. Chattel Mortgages are used when the inventory consists of large equipment or large moveable assets. Cash Cycle is the number of days that pass until we collect cash from the sale, measured from the
time we actually pay for the inventory. The longer the cash cyle, the more financing required. A lengthening cash cycle may indicate unsalable inventory or problems collecting A/R. Financial Decision Makers can influence the lengths of the cash
and operating cycle by adjusting credit terms and making payments at different points, as well as, from a LT perspective, investing in equipment that utilizes different production technique (and, therefore, different production times.) Factoring is
the process that transfers the responsibility of collecting A/R from a firm to a bank in exchange for a percent of the A/R value. Carrying Costs are costs of the firm that rise with the increased levels of investment in its CA. Shortage Costs are the
costs of the firm that are caused by running out of inventory or chooses not to extend credit. Sources of Cash / activities that increase cash include increasing CL, LT debt, Equity, & decreasing CA (other than cash) and Fix. assets. Uses of Cash
/ activities that decrease cash are opposities of increasing cash. Flexible Policy is a company procedure whereby the firm maintains a relatively high ratio of CA to sales. Involves keeping large cash and security balances, large amounts of
inventory, and granting credit. Benefits include customers will be willing to pay more, allows for fewer production stoppages with the increased inventory, and stimulates sales with allowing credit sales. Restrictive Policy involves keeping low cash
and securities balances, keeping small amounts of inventory, and allowing few credit sales if any. Deciding what policy is better can be influenced by a number of things: 1) Cash Reserves, 2) relative interest rates, 3) Maturity Hedge –
attempting to match the maturities of assets and liabilities. Short-Term Financial Plan includes any cash flows from new equity, debt, and debt repayment. Cash budgeting is a planning exercise because it forces the financial manager to think
about future cash flows. In addition forecasting risks is important in a financial plan to consider unexpected things. Cash Balance is the difference between the cash inflows and cash outflows. Cash inflows include sales and cash collections,
while Cash outflows include payments on A/P, LT Financing expenses, or other general operating expenses. EAR is the effective interest rate. It is often calculated on factoring conditions. EAR = (1 + r) T - 1 T is determined by taking 365, and
dividing by the payment due date less the cash discount date. I.E (2/10, N/30) would be 20 days. T = 365/20 = 18.25
Ch. 19: CASH & LIQUIDITY MGMT. Basic objective is to find BALANCE (Trying to find an optimal point between carrying costs and shortage costs). The opportunity costs of holding cash is low if the firm holds little cash. The
Opportunity cost increases as cash holdings increase b/c the firm gives up potential gains (interest, dividends) that could have been earned. A firm is more likely to borrow to cover an unexpected cash outflow the greater its cash flow variability
and the lower its investment in marketable securities. Trading Costs are increased when the firm must sell securities to establish a cash balance. Reasons for holding Cash: Speculative Motive, Precautionary Motive, Transaction Motive. Float is
the net effect of cheques in the process of clearing. My balance vs. the bank’s balance for my account. Float consists of 3 components: 1) Mail Float caused by Mail Delay, 2) Processing Float caused by Processing Delay, 3) Availability Float
caused by Clearing Delay. Understanding the float depends on customer locations and how efficient the firm is at collecting cash. An opportunity cost can arise for not being able to use cash from receivables. Cheques written generate
Dispursement Float, while cheques received create Collection Float. The Net Float is important when a business makes payments, and receives payments primarily with cheques. A positive net float makes the bank think your firm has more
money than it really does, while a negative net float thinks your firm has less. A positive float is good news for the firm, since it can invest the excess cash and earn interest income. Investing Idle Cash:These temporary cash surpluses can be
caused by: a) Seasonal/ Cyclical Activities – some firms cash flows are expected, and take advantage of that for purchasing marketable securities during times of surplus’, and sell marketable securities during defecits. b) Planned or Possible
Expenditures – a firm may accumulate temporary investments, such as issuing bonds and stocks before cash is needed, investing the cash in ST investments, and sell these investments when the cash is needed. Related Points: a)
Characterstics of ST securities – low risk offers a low return; preserving capital is the primary goal. B) Maturity – the shorter the time to maturity, the lower the expected return. The longer the time to maturity, the greater the interest rate risk,
hence; a higher expected return. Matching the time to maturity of a marketable security to the time the funds are needed eliminates interest rate risk. C) Default Risk – the probability that interest and principal will not be paid in the promised
amounts on the due date. Firms avoid investing in marketable securities with high default risk, given the purposes of investing idle cash. D) Marketability – the ease of converting an asset to cash. Some money markets, such as Treasury Bills,
are more liquid than others. E) Taxes – corporate tax on interest income is higher than dividend income from preferred or common stock. However, the prices fluctuate often on CS/PS, making them too risky.
A firm should not pay more than the total value of the collection float to eliminate the collection float.
Average Daily Float = (Avg dollar value of cheques received per day) x (Avg # of days delayed) / (# of days in 1 month) Collection Float = (Avg dollar value of cheques received per day) x (Avg # of days delayed)
Maximum Daily Charge (Savings) = (Collection Float) x (Daily Interest Rate) Simple Interest Earned = [(Payment Amount) x (1 + RT] – [(Payment Amount)] Compound Interest Earned = [PV + (1 + R)T] – PV

Ch. 20: CREDIT MGMT. Trade Credit is credit granted to other firms, while Consumer Credit is credit granted to customers. Granting Credit can stimulate sales, but there are costs: receivables carrying costs, bad debts, and
administration and collection costs. Components of Credit Policy: 1) Terms of Sale – what is the credit period, is there a cash discount and discount period. 2) Credit Analysis – who is being offered credit. 3) Collection Policy – how do we collect
credit. Involves monitoring receivables to spot trouble and obtaining payment on past due accts. CREDIT CYCLE: 1. The credit sale is made & the customer receives an invoice which details transaction information. 2. The firm sends a regular
statement to the customer. 3. The customer sends a cheque to the firm. 4. The firm deposits the cheque. 5. The firm’s acct. is credited for the amount on the cheque. A/R = (Avg value of credit sales) x (Avg collection period). Credit Period is the
length of time for which credit is granted. The invoice date is the beginning of the credit period. The length of the credit period is often dependent on the buyer’s operating cycle (Inventory Period + Receivables Period). The shorter the buyer’s
operating cycle, the shorter the credit period. By extending credit, we finance a portion of a buyer’s operating cycle, and shorten their cash cycle. The following factors influence the credit period: perishability and salvage value, consumer
demand, cost, profitiability, credit risk, size of the account, competition, consumer type. Cash Discount Period is the time during which a cash discount is available. Cash discounts speed up collection, thus reducing the firm’s average collection
period and the investment in receivables. Cash discounts are an incentive for consumers to pay quickly. ANALYZING CREDIT POLICY: Credit Analysis refers to the process of deciding whether to grant credit to a particular customers. Credit
Evaluation and Scoring Criteria: Character, capacity, capital, collateral, conditions. Credit Information is commonly used to assess the creditworthiness of a firm; includes examining financial statements, customer’s payment and credit history
with firms, and bank’s references. Credit Scoring is calculating a numerical rating for a customer based on information collected and then granting or refusing credit. Has the advantage of being an objective measure. Granting credit only makes
sense if the NPV from doing so is positive. We need to consider: revenue effects, cost effects, cost of ST debt, probability of bad debts, and cash discounts. Granting credit involves a trade-off between carrying costs and opportunity costs.
Carrying Costs include the required return on receivables, the losses from bad debts, and the cost of managing credit and credit collections. As credit policy becomes more flexible, carrying costs increase. Opportunity Costs arise if a firm has a
very restrictive credit policy, the potential profit from increased sales is lost because all credit refused. The costs include an increase in the number of sales, and potentially higher selling prices with credit. Optimal Credit Policy is determined
where the incremental cash flows from increased sales are exactly equal to the incremental costs of carrying the increased investment in A/R. AP TurnO = COGS / Avg Payables
1-Time-Sale: NPV = [Expected Return x (1 - % prob. of non-payment)] / [1 + r] – [Variable Cost] Repeat Customer: NPV = [(Expected Return – Variable Cost) x (1 - % prob.of non-payment) / (r)] – [Variable Cost]
Operating Cycle = Invent Pd + AR Pd Invent Pd. = 365 / Invent TurnO AR Pd = 365 / AR TurnO Cash Cycle = Operating Cycle / AP Pd. AP Pd. = 365 / AP TurnO Invent TurnO = COGS / Avg Invent. AR TurnO = Sales / Avg. AR

Ch. 14: COST OF CAPITAL The Cost of Capital is the minimum required associated with a project. It depends primarily on the risk of the investment. Cost of Capital aka. Required Return aka. Discount Rate. Determining the Cost
of Equity can be difficult since there is no way to directly observe the return equity investors require on investments. Required Return is estimated by two approaches: 1) Dividend Growth Model Approach: RE = (D1/P0) + g. RE is the return that
shareholders require on the stock, it can be interpreted as the firm’s cost of equity capital. Advantages of DGM are that it is easy to use, however, the model is really only applicable to cases where steady growth is present, and the company
pays dividends. It also does not consider risk of individual investments. 2) CAPM – Capital Asset Pricing Model: RE = Risk Free Rate + Market Risk Premium x Leveraged Equity. Advantages of CAPM are that it adjusts for risk, and is applicable
to companies other than those with steady dividend growth. Disadvantages include that it uses estimates off of its past in its calculations. The Cost of Debt is the return that the firm’s LT creditors demand on new borrowings. It can be observed
directly or indirectly in the financial markets. USE THE YTM FORMULA FROM CH 7 TO CALCULATE RD; COST OF DEBT. Cost of Preferred Stock: RP = D/P0. The WACC – Weighted Average Cost of Capital is a before-tax cost of capital
(becomes after-tax when considering investments). WACC is the overall return that the firm must earn on its existing assets to maintain the value of the firm. It is also the required return on any investments by the firm that have essentially the
same risks as existing operations. Projects that are intimately The weights may fluctuate with changing market values. The weights may not be available if the firm is not publicly traded. Book Values can be used in replacement of Market Values
if need be. WACC = WDRD(1-T) + WERE + WRRP where E = Market Value of Equity, D = Market Value of Debt, V = D+E; market value of the firm. WE = E/V; percent finance with equity WD = D/V; percent financed with debt. Flotation Costs should
be considered as the required return depends on the risk, not how the money is raised. Weighted Average Flotation Cost; FA = WD(Flotation Cost of Debt) + WE(Flotation Cost of Equity). Dollar Flotation Costs = Dollar Flotation Cost = (Cost of
Project) / (1-FA) – (Cost of Project). To solve for after tax cash flows; take the cash flow and multiply by (1-tax) NPVIGNORING FLOTATION = [after tax cash flows x (1-(1/(1+WACC) t)) / WACC] – [Cost of Project] NPVCONSIDERING FLOTATION = [after tax cash
flows x (1-(1/(1+WACC) t)) / WACC] – [Cost of Project / (1-FA)]. Using WACC for all types of projects can result in the firm incorrectly accepting relatively risky projects, and incorrectly rejecting relatively safe ones. The firm’s overall cost of capital
is really a mixture of several costs of capital. A negative WACC is a relatively low risk, whereas a positive WACC is relatively high risk.
Ch. 12/13: MKT. HISTORY & RISK RETURN Market History allows for a rewards for bearing risk, and the greater the potential reward, the greater the risk. Risk Premiums: Treasury bills have the shortest time to maturity
of the different government securities. Since government can usually raise taxes to pay its bills (within political limits), this debt is virtually free of any default risk over it’s short life. The rate on this debt is called risk-free return and is generally
used as a benchmark in measuring risk premiums. The difference between the nominal return on an investment and the risk-free T-Bill rate is a measure of the risk premium paid to investors. Historical Variability is the reason for different risk
premiums for different investments. The variance and the standard deviation of historical returns are the most commonly used meaures of variability. The higher the variance and standard deviation, the higher the risk. Capital Market Efficiency:
stock and bond prices fluctuate from the reassessment of asset values by investors after new information comes to surface. Prices appear to respond quickly to new information. Future stock prices, particularly in the short term are very difficult
to predict based on publicly available information. If mispricing in stocks exists, there is no obvious means for identifying them. TYPES OF RISKS: 1) Market-Wide-Systematic Risk – the unanticipated events that impact large numbers of assets –
changes in interest rates, GDP, exchange rates, or fuel prices. 2) Asset-Specific-Unsystematic Risk – the unanticipated events that are unique to individual assets – produce failure lawsuits, death of a key executive, a strike, or insider training.
The risks associated with market-wide events cannot be diversified away, however, the risks specific to individual assets are diversifiable. An investor can reduce the risk in an expected portfolio return by holding more than 1 asset, as more
assets added to the portfolio can eliminate or diversify away asset-specific risk. Measuring Systematic Risk is the crucial determinant of an asset’s expected return. This can be done in 3 ways: CAPM, Arbitrage Pricing Model, or Multifactor
models. Capital Asset Pricing Model measures systematic risk using a specific measure called the beta coefficient. The beta coefficient measures the responsiveness of a security’s return on the market as a whole. The market beta is equal to 1.