# Review Ch. 4_ Ch. 12_ Ch. 13 by yurtgc548

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```									Review Ch. 4, Ch. 12, Ch. 13
Chapter 4 Outline
1.   What is financial planning
2.   Financial planning models
3.   The percentage of sales approach
4.   External financing and growth
5.   Caveats in financial planning

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Percentage of sales approach:

COMPUTERFIELD CORPORATION

Financial Statements

Income statement                    Balance sheet

Sales      \$8,000        CA       \$5000      Debt      \$8250

Costs       5,800        FA      \$7000       Equity    \$3750

Net Income \$2,200        Total   \$12000      Total    \$12000

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EFN and Capacity Usage
• Suppose COMPUTERFIELD is operating at 80%
capacity:
1. What would be sales at full capacity? (1p)
2. What is the capital intensity ratio at full
capacity? (1p)
3. What is EFN at full capacity and Dividend
payout ratio is 15%? (1p)
What is EFN to increase sales to 12000 and
Dividend payout ratio is 35%?
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Q 1:8,000/.8=10,000; Full capacity as increase
10,000/8,000 = 1.25 (25%)

•   Income statement
•   Sales \$8,000
•   Costs \$5,800
•   N I \$2,200
• Ret earnings 2,200*.85=1,870
• New Ret earnings 1,870*1.25=2,337.5
• There is no indication that any changes took
place in % cost for the proforma income
statement, we can get the same result by
increasing RE or by creating proforma IS
13-5
New assets needed
•   CA
•   5000*1.25=6,250
•   TA =6,250+7000
•   13,250
• capital intensity ratio at full capacity
• =13,250/10,000 =1.325
• EFN =0 change in TA = 1250 which is less than
the retained earnings, we can fully finance
internally full capacity operation.
13-6
What is EFN to increase sales to 12,000 (50%) and
Dividend payout ratio is 35%?

•   Income statement
•   Sales \$8,000
•   Costs \$5,800
•   N I \$2,200
• Ret earnings 2,200*.65=1,430
• New Ret earnings 1,430*1.5=2,145
• There is no indication that any changes took
place in % cost for the proforma income
statement, we can get the same result by
increasing RE or by creating proforma IS
13-7
Recent Sales 8,000; Proj. Sales 12,000
Increase 50%

• CA 5,000*1. 5=7,500
• FA=7,000+1,400
• TA =15,900

• FA=7000/10000 per unit of sales=.7
• Inv . Need for 2000 more units of sales
=.7*2000=1,400
• EFN=1,755 change in TA = 3,900 from RE=2,145

13-8
EFN=1,755

•   D/E ratio =3/2
•   EFN=1,755
•   How much debt should be issued?
•   How much equity?
• If they issue only debt (all 1,755 in bonds)
what will be the D/E ratio on the proforma BS?
• D=8,250+1,755=10,005
• E=3,750+2,145=5,895 D/E=1.69
13-9
• Internal Growth Rate

• Sustainable Growth Rate
Chapter 12 Overview
• Return of an investment: arithmetic and geometric

• The variability of returns

• Efficiency of capital markets

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Arithmetic vs. Geometric
Averages (1)
• Geometric return = the average compound
return earned per year over multiyear period

Geometric average return =

• Arithmetic average return = the return earned
in an average (typical) year over a multiyear
period
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The Variability of Returns
• Variance = the average squared deviation
between the actual return and the average
return

• Standard deviation = the positive square root
of the variance

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The Normal Distribution (2)

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Z-score
• For any normal random variable:

• Z – z-score
• X – normal random variable
•    - mean

15
Chapter 13 Outline
• Expected Returns and Variances of a portfolio
• Announcements, Surprises, and Expected
Returns
• Risk: Systematic and Unsystematic
• Diversification and Portfolio Risk
• Systematic Risk and Beta
• The Security Market Line (SML)
Portfolios
Portfolio = a group of assets held by an
investor

• The risk-return trade-off for a portfolio is measured
by the portfolio expected return and standard
deviation, just as with individual assets

Portfolio weights = Percentage of a
portfolio’s total value in a particular asset

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Portfolio Expected Returns (1)
• The expected return of a portfolio is the weighted
average of the expected returns for each asset in the
portfolio

• You can also find the expected return by finding the
portfolio return in each possible state and computing
the expected value

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Calculate Portfolio Variance
• Portfolio variance can be calculated using
the following formula:

• Correlation is a statistical measure of how 2 assets
move in relation to each other

• If the correlation between stocks A and B = -1,
what is the standard deviation of the portfolio?

1
Portfolio Diversification

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Measuring Systematic Risk
• Beta (β) is a measure of systematic risk

• Interpreting beta:
– β = 1 implies the asset has the same systematic
risk as the overall market
– β < 1 implies the asset has less systematic risk
than the overall market
– β > 1 implies the asset has more systematic risk
than the overall market

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Portfolio Expected Returns and Betas

Rf
Reward-to-Risk Ratio:

• The reward-to-risk ratio is the slope of the line
illustrated in the previous slide
– Slope = (E(RA) – Rf) / (bA – 0)
– Reward-to-risk ratio =

• If an asset has a reward-to-risk ratio = 8?

• If an asset has a reward-to-risk ratio = 7?

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The Fundamental Result
• The reward-to-risk ratio must be the same for
all assets in the market

• If one asset has twice as much systematic risk
as another asset, its risk premium is twice as
large
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Security Market Line (2)

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