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Corporate Finance Final Exam Review
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Gravity
Combo of sets from Chapters 5,6,7,8,9,10,12
Terms in this set (209)
Future Value
the amount an investment is worth after one or more periods
Compounding
the process of accumulating interest on an investment over time to earn more interest
Interest on Interest
interest earned on the reinvestment of previous interest payments
Compound Interest
interest earned on both the initial principal and the interest reinvested from prior periods
Simple Interest
interest earned only on the original principal amount invested
Present Value
the current value of future cash flows discounted at the appropriate discount rate
Discount
calculate the present value of some future amount
Discount Rate
the rate used to calculate the present value of future cash flows
Discounted Cash Flow (DCF) Valuation
calculating the present value of a future cash flow to determine its value today
Incremental Cash Flows
the difference between a firm's future cash flows with a project and those without the project
Stand-Alone Principle
the assumption that evaluation of a project may be based on the project's incremental cash flows
Sunk Cost
a cost that has already been incurred and cannot be removed and therefore should not be considered in an investment decision
Opportunity Cost
the most valuable alternative that is given up if a particular investment is undertaken
Erosion
the cash flows of a new project that come at the expense of a firm's existing projects
Pro Forma Financial Statements
financial statements projecting future years' operations
Operating Cash Flow
= earnings before interest and taxes + depreciation - taxes
Accelerated Cost Recovery System (ACRS)
a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications
Depreciation Tax Shield
the tax saving results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate
Equivalent Annual Cost (EAC)
the present value of a project's costs calculated on an annual basis
Risk Premium
the excess return required from an investment in a risky asset over that required from a risk-free investment
Variance
the average squared difference between the actual return and the average return
Standard Deviation
the positive square root of variance
Normal Distribution
a symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation
Geometric Average Return
the average compound return earned per year over a multi-year period
Arithmetic Average Return
the return earned in an average year over a multi-year period
Efficient Capital Market
a market in which security prices reflect available information
Efficient Markets Hypothesis (EMH)
the hypothesis that actual capital markets, such as NYSE, are efficient
Net Present Value (NPV)
the difference between an investment's market value and its cost
Discounted Cash Flow
the process of valuing an investment by discounting its future cash flows
Payback Period
the amount of time required for an investment to generate cash flows sufficient to recover its initial cost
Discounted Payback Period
the length of time required for an investment's discounted cash flows to equal its initial cost
Average Accounting Return (AAR)
an investment's average net income divided by its average book value
Internal Rate of Return (IRR)
the discount rate that makes the NPV of an investment zero
Net Present Value Profile
a graphical representation of the relationship between an investment's NPVs and various discount rates
Multiple Rates of Return
the possibility that more than one discount rate will make the NPV of an investment zero
Mutually Exclusive Investment Decisions
a situation in which taking one investment prevents the taking of another
Profitability Index (PI)
the present value of an investment's future cash flows divided by its initial cost. Also called the benefit-cost ratio
coupon
stated interest payment made on a bond
face value
the principal amount of a bond that is repaid at the end of the term. also, par value.
coupon rate
the annual coupon divided by the face value of a bond
maturity
date on which the principal amount of a bond is paid
yield to maturity (YTM)
the rate required in the market on a bond.
current yield
a bond's annual coupon divided by its price
indenture
the written agreement between the corporation and the lender detailing the terms of the debt issue
registered form
the form of bond issue in which the registrar of the company records ownership of each bond: payment is made directly to the owner of record
bearer form
the form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond
sinking fund
an account managed by the bond trustee for early bond redemption.
security
collateral - secured by financial securities, mortgage - secured by real property (normally land or buildings)
seniority
...
subordinated
...
bond ratings
...
interest rate risk
the risk that arises for bond owners from fluctuating interest rates
debenture
an unsecured debt, usually with a maturity of 10 years or more
premium bond
a bond that pays more than the going (market) rate
discount bond
a bond that pays less than the going (market) rate
note
an unsecured debt, usually with a maturity of under 10 years
debt
not an ownership interest, no voting rights, interest is tax-deductible, creditors have legal recourse if interest or principal payments are missed, can lead to financial distress & bankruptcy
term
...
protective covenants
a part of the indenture limiting certain action that might be taken during the term of the loan, usually to protect the lender.
call provision
an agreement giving the corporation the option to repurchase the bond at a specific price prior to maturity
call premium
the amount by which the call price exceeds the par value of the bond
deferred call provision
a call provision prohibiting the company from redeeming the bond prior to a certain date
call protected bond
a bond that currently cannot be redeemed by the issuer
zero coupon bond
a bond that makes no coupon payments and thus is initially priced at a deep discount
bid price
the price a dealer is willing to pay for a security
asked price
the price a dealer is willing to take for a security
bid-ask spread
the difference between the bid price and the asked price
clean price
the price of a bond net of accrued interest; this is the price that is typically quoted
dirty price
the price of a bond including accrued interest, also known as the full or invoice price. this is the price the buyer actually pays.
real rates
interest rates or rates of return that have been adjusted for inflation.
nominal rates
interest rates or rates of return that have not been adjusted for inflation.
fisher effect
the relationship between nominal returns, real returns, and inflation.
term structure of interest rates
the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money.
inflation premium
the portion of a nominal interest rate that represents compensation for expected future inflation.
interest rate risk premium
the compensation investors demand for bearing interest rate risk.
treasury yield curve
a plot of the yields on treasury notes and bonds relative to maturity
default risk premium
the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default
taxability premium
the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status
liquidity premium
the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity
twice a year
How often do bonds issued in the US usually make payments?
price risk
change in price due to changes in interest rates
long-term bonds
which bonds have more risk? long or short term?
low coupon rate bonds
do low or high coupon rate bonds have more price risk?
reinvestment rate risk
uncertainty concerning rates at which cash flows can be reinvested
short-term bonds
which bonds have more reinvestment risk? short or long-term?
high coupon rate bonds
which bonds have more reinvestment rate risk? high or low coupon rate bonds?
yield to maturity
the market required rate of return implied by the current bond price
equity
ownership interest, common stockholders vote to elect board, dividends are not tax deductible, dividends are not a liability of the firm until declared, stockholders have no legal recourse if dividends are not declared, firm cannot go bankrupt
bond indenture
contract between issuing company and bondholders
bond indenture includes
basic terms of bonds, total amount of bonds issued, secured vs. unsecured, sinking fund provisions, call provisions, details of protective covenants
treasury securities
federal government debt
treasury bills
purse discount bonds, original maturity of one year or less
treasury notes
coupon debt, original maturity between one and ten years
treasury bonds
coupon debt, original maturity greater than ten years
zero coupon bonds
make no period interest payments (coupon rate = 0%) and entire YTM comes from the difference between the purchase price and the par value (capital gains)
treasury bills and U.S. Savings bonds
two examples of zero coupon bonds
dividend growth model
a model that determines the current price of a stock as its dividend next period divided by the discounted rate less the dividend growth rate
dividend yield
a stock's expected cash dividend divided by its current price
capital gains yield
the dividend growth rate, or the rate at which the value of an investment grows
cumulative voting
a procedure in which a shareholder may cast all votes for one member of the board of directors
common stock
equity without priority for dividends or in bankruptcy
straight voting
a procedure in which a shareholder may cast all votes for each member of the board of directors
proxy
a grant of authority by a shareholder allowing another individual to vote that shareholder's shares.
dividends
payments by a corporation to shareholders, made in either cash or stock.
preferred stock
stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights.
primary market
the market in which new securities are originally sold to investors.
secondary market
the market in which previously issued securities are traded among investors.
dealer
an agent who buys and sells securities from inventory
broker
an agent who arranges security transactions among investors
member
as of 2006, a member is the owner of a trading license on the NYSE
commission brokers
NYSE members who execute customer orders to buy and sell stock transmitted to the exchange floor
specialist
an NYSE member acting as a dealer in a small number of securities on the exchange floor; often called a market maker
floor brokers
NYSE members who execute orders for commission brokers on a fee basis; sometimes called $2 brokers.
SuperDOT system
an electronic NYSE system allowing orders to be transmitted directly to the specialist
floor traders
NYSE members who trade for their own accounts, trying to anticipate temporary price fluctuations
order flow
the flow of customer orders to buy and sell securities
specialist's post
the fixed place on the exchange floor where the specialist operates
inside quotes
the highest bid quotes and the lowest ask quotes for a security
electronic communications networks (ECNs)
web sites that allow investors to trade directly with one another
stock price
the dividend growth model makes the implicit assumption that the _________ ________ will grow at the same constant rate as the dividend. if cash flows on an investment grow at a constant rate through time, the value of that investment grows at the same rate as the cash flows.
No. Investors who don't like the voting features of a particular class of stock are under no obligation to buy it.
is it unfair or unethical for corporations to create classes of stock with unequal voting rights?
stock value
the current_________ ________ reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term.
capital budgeting
what long term investments should we make?
value
we create _____ by choosing an investment which is worth more in the market place than it costs to acquire.
net present value (NPV)
the difference between an investment's market value and its cost
net present values
the capital budgeting process can be described as a search for investments with positive ____ _______ _______.
discounted cash flow (DCF)
the process of valuing an investment by discounting its future cash flows
net present value
an investment should be accepted if the _____ ______ _____ is positive and rejected if it is negative
payback period
the amount of time required for an investment to generate cash flows sufficient to recover its initial cost
average accounting return (AAR)
an investment's average net income divided by its average book value
internal rate of return (IRR)
the discount rate that makes the NPV f an investment zero
IRR
an investment is acceptable if the ____ exceeds the required return. it should be rejected otherwise.
zero NPV
the IRR on an investment is the required return that results in a ______ ___ when it is used as the discount rate
net present value profile
a graphical representation of the relationship between an investment's NPV and various discount rates
multiple rates of return
the possibility that more than one discount rate makes the NPV of an investment zero
mutually exclusive investment decisions
a situation where taking one investment prevents the taking of another.
stand-alone principle
the assumption that evaluation of a project may be based on the project's incremental cash flows.
sunk cost
a cost that has already been incurred and cannot be recouped and therefore should not be considered an investment decision.
opportunity cost
the most valuable alternative that is given up if a particular investment is undertaken.
erosion
the cash flows of a new project that come at the expense of a firm's existing projects.
pro forma financial statements
financial statements projecting future years' operations.
how do we mitigate forecasting risk?
scenario analysis, look at options.
forecasting risk
the possibility that errors in projected cash flows will lead to incorrect decisions. also estimation risk.
scenario analysis
the determination of what happens to NPV estimates when we ask what-if questions
sensitivity analysis
investigation of what happens to NPV when only one variable is changed.
risk premium
all premium that is above and beyond the risk free rate
beta coefficient
amount of systematic risk present in a particular risky asset relative to that in an average risky asset.
systematic risk principle
the expected return on a risky asset depends only on that assets systematic risk
principle of diversification
spreading an investment across a number of assets will eliminate some, but not all, of the risk.
systematic risk
which type of risk
sunk costs
already paid costs
opportunity cost
what else could we be doing right now? _________ vs. ___________
net working capital
current assets - current liabilities
sensitivity analysis
pick one variable and change it
payback period
when the investment pays for itself
payback period
"when do I get my money back?"
accept project
NPV > 0
reject project
NPV < 0
capital structure
"how do we finance the investment?"
working capital management
"how will we manage the day-to-day financial activities?"
capital budgeting
"what long term investments should the firm make?"
capital budgeting
the process of planning and managing a firm's long-term investments.
debt & equity
what two ways can a company raise capital?
capital budgeting
"should we invest?"
EAR
which is more likely to be higher, EAR or APR?
effective annual rate (EAR)
the interest rate expressed as if it were compounded once per year
noncash expenses
expenses charged against revenues that do not directly affect cash flow, such as depreciation.
earnings before interest and taxes (EBIT)
sales - COGS - depreciation
market value
Current value, today's price, what it's worth today, what are you willing to pay today
compounding
the growth of a dollar amount through time via reinvestment of interest earned. It is also the process of determining the future value of an investment.
discounting
is the process of determining the value today of an amount to be received in the future.
Future values grow (assuming a positive rate of return)
as you increase the length of time involved, what happens to future values?
compounding
the process of accumulating interest in an investment over time to earn more interest.
simple interest
interest earned only on the original principal amount invested.
Earnings before interest and tax
Sales - Cost of goods sold - Operating expenses
market value
the goal of financial management is to maximize the ________ _________ of the stock, not its book value.
bonds
long-term debt
debenture
an unsecured debt, usually with a maturity of 10 years or more
indenture
the written agreement between the corporation and the lender detailing the terms of the debt issue
face value
the principal amount of a bond that is repaid at the end of the term. also, par value.
coupon rate
the annual coupon divided by the face value of a bond
coupon
stated interest payment made on a bond
premium bond
a bond that pays more than the going (market) rate
yield to maturity (YTM)
the rate required in the market on a bond.
annuity due
when payments occur at the beginning of a period
working capital management
how will we manage the day-to-day financial activities?
capital structuring
how will this investment be financed?
capital budgeting
what long term investments should the firm make?
capital budgeting
the process of planning and managing a firm's long-term investments.
capital structure
the mixture of debt and equity maintained by a firm
capital budgeting
the process of planning and managing a firm's long-term investments.
agency problem
the possibility of conflict of interest between the owners and management of the firm
net working capital
current assets - current liabilities
net working capital
what is the term for the money you have for daily operating?
depreciation
_________ does not affect cash flow.
no, because the agent is the principal
would there be an agency problem in a sole proprietorship?
noncash expenses
expenses charged against revenues that do not directly affect cash flow, such as depreciation.
generally accepted accounting principles (GAAP)
the common set of standards and procedures by which audited financial statements are prepared.
OCF
earnings before interest and taxes (EBIT) + depreciation - taxes
operating cash flow
cash generated from a firm's normal business activities
common-size statement
a standardized financial statement presenting all items in percentage terms. balance sheet items are shown as percentage of assets and income statement items as a percentage of sales.
EBIT
...
profit margin
net income/sales
income statement
what financial statement do you need to figure out your profit margin?
how much profit is generated for each dollar in sales
what is a profit margin?
compounding
the process of accumulating interest in an investment over time to earn more interest.
compound interest
interest earned on both the initial principal and the interest reinvested from prior periods.
simple interest
interest earned only on the original principal amount invested.
Earnings before interest and tax
Sales - Cost of goods sold - Operating expenses
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