Term
| What are the four parts to a Strategic Plan and what it means? |
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Definition
1) Statement of Purpose: " Our mission is to maximize shareholder's value"
2) Corporate Scope: defines firm's line of business and geographic area of operation
3) Statement of corporate objectives: sets specific goals to guide managment
4) Corporate Strategies: broad approach to achieve these goals |
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Term
| What is the Operating Plan? |
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Definition
- it provides a detailed plan to meet corporate objectives
- usually a 5 year plan
- detail planning for the first year |
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Term
| What are the five steps to a Financial Plan? |
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Definition
1) Project financial statements to analyze the effects of the operating plan on projected profits and financial ratios
2) Determine the funds to support the five- year plan
3) Forecast funds to be generated internally and funds obtained from external sources
4) Establish a performance based management compensation
5) Monitor operations and take corrective actions |
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Term
| A sales forecast is a review of sales for how long? |
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Definition
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Term
| A sales forecast estimates future sales from or for: |
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Definition
1) economy
2) industry's prospects
3) company's current product line
4) proposed products
5) marketing |
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Term
| The Percentage of Sales Method assumes what and has what steps: |
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Definition
it assumes that costs are proportional to sales
1) Calculate the ratios for several past years
2) Forecast the income statement
3) Forecast the balance sheet
4) Raising the additional funds needed |
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Term
| What are the 3 limitations to The Percentage of Sales Method? |
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Definition
1) Economies of Scale
2) Lumpy assets
3) Excess capacity adjustments |
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Term
| What are the 3 sources of capital? |
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Definition
1) Common Stock
2) Preferred Stock
3) Debt |
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Term
| What 3 questions does capital structure bring up? |
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Definition
1) Do firms have target capital structure?
2) Do firms prefer internal to external financing?
3) Is firm's capital structure just a cumulative outcome of timing equity markets? |
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Term
| True or False: The required rate of return to debtholders (rd) is not equal to the firm's cost of debt |
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Definition
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Term
| After tax cost of debt is: |
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Definition
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Term
| True of False: Preferred dividends are not tax deductible. Therefore the company bears their full cost |
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Definition
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Term
| True or False: Common dividends must be paid before preferred dividends |
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Definition
| False; preferred dividends comes first |
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Term
| The cost of preferred stock is: |
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Definition
| rps= Dps/ Pn, where Dps= preferred dividends and Pn is the price the firm receives after deducting the flotation costs |
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Term
| What are the two ways that a company can raise common equity? |
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Definition
1) by issuing new shares (seasoned offering)
2) by retaining earnings |
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Term
| What are three effects of issuing new shares of common stock? |
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Definition
1) expensive
2) negative signal to the market
3) increase in supply of stock puts pressure on the stock price |
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Term
| Fact: The firm should earn on its retained earnings at least as much as its stockholders themselves could earn on alternative investments of equivalent risk (rs). |
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Definition
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Term
| How to estimate the cost of equity? |
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Definition
1) The CAPM Approach
2) The discounted cash flow method
3) The bond-yield plus risk-premium approach |
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Term
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Definition
1) Estimate the risk free rate (rf)
2) Estimate the current expected market risk premium: E(rm) - rf
3) Estimate stock's Beta
4) Estimate the required rate of return according to the CAPM: rs= rf +Beta(E(rm) - rf) |
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Term
| Problems with the CAPM Approach: |
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Definition
- hard to estimate future Beta
- difficult to estimate market risk premium |
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Term
| What are the three inputs to the Discounted Cash Flow Approach? |
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Definition
1) Current Stock price Po
2) Current dividends
3) Expected Growth Rate g: historical growth rate or analyst's forecast |
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Term
| The Bond- yield plus growth rate Approach: |
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Definition
- it is an ad hoc procedure used by some analysts
- add a judgemental risk premium of 3 to 5% to the interest rate on the firm's own long-term debt:
- rs= Bond yield + Bond risk premium |
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Term
| Which method is used the most to provide estimates of firm's cost of equity? |
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Definition
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Term
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Definition
| the weighted average cost of capital is a weighted average of the various component's costs |
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Term
Facts about WACC:
- The WACC is the current weighted average cost of capital the company would face for a new or "marginal" dollar of capital- it is not the average cost of capital raised in the past
- The percentages of each capital component should be based on management's target capital structure |
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Definition
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Term
| Factors the firm cannot control involving WACC: |
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Definition
- the level of interest rates
- the market risk premium
- the tax rate |
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Term
| Factors the firm can control involving WACC: |
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Definition
- its capital structure
- its dividend policy
- its investment policy |
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