CMA 2-Sec B_ Corporate Finance

What is Weak-Form Efficiency of the Efficient Market Hypothesis (EMH)?

Weak-Form Efficiency is when securities prices reflect all past information but not all private or public information from the future. Under this form, investors could not earn returns greater than market averages based on historical patterns in security prices, but rather only by trading based on public or private information.

Why does higher leverage lead to higher firm value?

When firms have higher leverage (i.e., more debt), it can lead to higher firm value because the tax-deductible interest payments reduce the amount of income reported for tax purposes. This leads to lower tax payments and higher after-tax free cash flow.

What is the Accounts Receivable Turnover Ratio?

Accounts Receivable Turnover Ratio = Annual Net Credit Sales ÷ Average Receivables Balance

When will a bond sell at par value, a discount, or a premium?

*A bond will sell at par value when the market interest rate and a bond's coupon rate are the same. *A bond will sell at a discount when the coupon rate is below the market interest rate. *A bond will sell at a premium when the coupon rate is higher than the market interest rate.

What three factors does the Dividend Discount Model (DDM) consider?

1. Cash flow—dividends paid to stockholders 2. Expected holding period of the stock 3. Pattern of dividend growth: a. Constant dividend (zero growth) b. Constant growth of dividend c. Variable growth of dividend

What are three commonly used swaps?

1. Currency swap: Currency swaps occur when two organizations contract to exchange or "swap" currencies at some future date and assume the foreign exchange risk associated with the other party's home currency. 2. Interest rate swap: an agreement to exchange cash flows from one type of interest rate structure for cash flows in another type of interest structure. 3. A credit default swap: an agreement that requires one party to indemnify (or reimburse) the other party in the event of default by a third party.

What five factors affect the value of an option prior to the expiration date?

1. Current price of the underlying asset 2. Exercise price 3. Volatility of the value of the underlying asset 4. Time until the option expires 5. Risk-free rate of interest

What are four reasons why a firm can benefit from going public?

1. Firms can raise larger amounts of equity capital in the public equity market than from private sources. 2. Once a firm's stock is publicly listed, it becomes easier for the firm to raise additional capital through equity offerings. 3. Firms can determine the proportion of ownership shares they would like to make available to the public. 4. Going public allows a firm's stock to trade on secondary market exchanges.

Describe three common alternatives for financing working capital needs.

1. Maturity Matching: matching the maturities of liabilities to the assets that they fund 2. Long-term Funding: using long-term debt and equity to fund working capital and fixed assets 3. Short-term Funding: using short-term debt to finance working capital, and at times, a portion of fixed assets

What are three of the most common valuation ratios?

1. Price-to-earnings (P/E) ratio 2. Market-to-book (M/B) ratio 3. Price-to-sales (P/S) ratio

Describe some financing agreements available from banks.

1. Term loans, which are payable by a certain date 2. Informal line of credit, which is a verbal agreement that a firm can borrow an agreed amount 3. Formal line of credit, which is an agreement with legal obligation for the bank to lend an agreed amount 4. Secured loans, which are backed by collateral

The common stock account on the balance sheet is comprised of what two accounts?

1. The Common Stock account, listed at the par value of the stock issued. 2. The Additional Paid-in Capital account is the amount of money received from issuing stock above and beyond the par value.

What are three reasons firms maintain large cash balances?

1. The transaction motive: to make payments related to their business operations 2. The precautionary motive: for unexpected or emergency cash needs 3. The compliance motive: to comply with cash balance requirements from loans and other bank services

Define the below important terms related to Options: The Underlying Asset A Call Option A Put Option A Short Position A Long Position The Strike (exercise price) Exercise date In the Money Out of the Money

1. The underlying asset of an option is the asset upon which the value of the option is based. The underlying asset may be tangible (such as a building or stock) or intangible (such as an interest rate or the value of a stock index). 2. A call option allows the owner to buy the underlying asset at a specified price. In the Money if Strike< Asset's Market Price, b/c paying less 3. A put option allows the owner to sell the underlying asset at a specified price. In the Money if Strick > Asset's Market Price, b/c receiving more 4. A short position is taken when an investor expects the price of an underlying asset to fall. 5. A long position is taken when an investor expects the price of an underlying asset to rise. 6. The strike (or exercise) price is the fixed value at which the owner can buy or sell the underlying asset. 7. Exercise date is the last day on which the buyer can exercise the option. An American option contract allows the owner to exercise the option at any time during the option period. In contrast, a European option is allowed to be exercised only on the maturity date. Most options that are traded on exchanges are American options. 8. In the money means that an owner of an option will benefit from exercising the option. 9. Out of the money means that an owner of an option will not benefit from exercising the option. Ex: Strike> Market so receiving more

From what sources can a firm receive short-term credit to finance working capital requirements?

1. Trade credit 2. Short-term bank loans 3. Commercial paper 4. Accounts receivable financing

In what situations can you use WACC for firm projects?

1. WACC should only be used if the new project has a similar risk profile as the firm's current projects upon which the calculation of WACC was based. 2. WACC should only be used if the new project has the same capital structure—financing mix—as the firm as a whole.

What is preferred stock?

Preferred stock is a unique financial instrument that has characteristics of both common stock and debt. It has a fixed dividend amount which companies are not required to pay in a given financial period, but the dividends are cumulative. Preferred stockholders do not have voting rights. In the event of a liquidation, preferred stockholders are paid after bondholders but before common stockholders. Preferred stock often has provisions to convert shares of preferred stock into shares of common stock.

What are Eurodollar deposits?

Eurodollar deposits are typically nonnegotiable dollar-denominated time deposits held by banks outside the United States. May be purchased through most large U.S. banks Maturities range from overnight to several years; most are 6 months or less.

When firms have high inventory turnover ratios, they incur fewer overhead expenses in what areas?

Fewer employees required to handle and move material. Lower utility costs because the firm requires less space to store inventory. Less depreciation expense or rent expense related to handling equipment, such as forklifts.

What role do financial institutions play in the flow of cash through the financial system?

Financial institutions provide cash from debt and equity issuances in the primary exchange market while also facilitating secondary exchange markets where debt and equity holders trade securities.

Why do financial markets exist?

Financial markets exist to facilitate the flow of money from investors (those looking for a return on capital) and users (those seeking to fund business operations). 1. Transferring funds—from depositors to investors 2. Providing liquidity—giving investors a means of converting securities into cash 3. Providing economic signals—security sales can signal a change in the economy

What is the difference between a highly rated bond and a low-rated bond?

Highly rated bonds are perceived to be safer because the bond issuer is highly likely to pay interest payments and ultimately repay the bond principal. However, low-rated bonds (also known as junk bonds) have a higher default risk. Junk bonds have higher interest rates to compensate investors for the increased likelihood that the bond issuer may not be able to make interest payments or repay the bond principal.

What is the discounted cash flow (DCF) method? And, What steps are taken to value any asset using the DCF method?

The DCF method is a valuation method based on the value of any asset being the present value of its future cash flows. DCF takes into account the time value of money and the risk involved with investing a dollar. The discount rate used in the DCF method compensates investors for their time and risk. 1. Estimate the expected future cash flows. 2. Determine the discount rate to be used. 3. Calculate the present value of the future cash flows.

When are option values easily determined?

Option values are readily and easily determined when the option expires. The value is simply the difference between the exercise price and the value of the underlying asset.

In the event of the company liquidating, what is the order of precedence on claim for assets?

Order of precedence is as follows: 1. Corporate bonds 2. Convertible bonds 3. Preferred stock 4. Convertible preferred stock 5. Common stock

What are tracking stocks?

Ownership shares that are issued by a parent company to monitor the performance of one strategic business unit (SBU). Tracking stocks typically have limited or no voting rights. Companies use a tracking stock to measure the performance of a high-growth SBU held inside of a parent company. While the parent company maintains control of the SBU, the creation of a tracking stock provides a mechanism for investors to invest in a portion of the company. All financial results from the SBU are tracked separately from the parent company's overall financial results, which creates greater transparency for market participants to evaluate the SBU performance.

What is the Economic Order Quantity (EOQ) model and how is it calculated? What are some key assumptions?

The EOQ is the least amount of inventory that should be ordered given the various costs involved. *It minimizes the ordering and carrying costs in the aggregate (individual cost components may not necessarily be at their minimum) *Ordering Costs are in the numerator/ Carry costs are in the denominator Key assumptions: (1) Same quantity order on each order (2) Demand, ordering costs, and carrying costs are known, and constant (no qty discounts) (3) purchase order lead time is known. 4) stock outs will not occur EOQ = √ [(Cost per order × Units demanded per period × 2) ÷ Unit carrying cost] Cost per unit is the Purchase price * Carry cost, which is is expressed as a percentage of inventory cost.

What is the Efficient Market Hypothesis (EMH)?

The Efficient Market Hypothesis (EMH) is an underlying theory about how well markets are able to reflect information in security prices. The degree to which this theory applies is often described in three forms (Strong-Form Efficiency, Semistrong-Form Efficiency, Weak-Form Efficiency)

What does 2/15, net 60 mean? And How can a company decrease it's collection period? What is the formula to calculate the cost of not taking a discount?

Two ways to decrease the collection period: reduce a company's average collection period is to offer a larger discount for paying within a discount window (3/15 instead of 2/15) and to reduce the allowable time for customers to pay their balance (net 30 instead of net 60). Taking both of these steps increases the likelihood that the average collection period will decrease. {[(Discount %) ÷ (100% − Discount %)] × (Days in Year)]} (Total Payment Period − Discount Period)

What is unsystematic risk?

Unsystematic risk is a broad term that encompasses any type of risk which may affect the returns of a company's stock. Unsystematic risk comes from company-specific factors.

What are warrants?

Warrants are long-term options for the holder to purchase stock directly from the issuing corporation. A warrant contract allows the holder to purchase stock at a specified price, quantity, and future time.

What is permanent working capital?

Permanent working capital is the minimum level of working capital that a firm will always have on its books. Fluctuations in working capital above that amount need to be financed and managed. Three common alternatives for financing working capital needs are (Maturity matching, Long-term funding, Short-term funding)

How is preferred stock valued?

Preferred stock can be valued using the DCF method, similar to bond valuation because it has a fixed cash flow. P0 = Dividend ÷ Required Rate of Return

The amount of accounts receivable a firm has is affected by what four factors?

1. Credit screening 2. Credit terms 3. Monitoring of collections 4. Default risk

What are stock repurchases?

Stock repurchases, also known as treasury stock, take place when a company buys shares of its own stock on the open market.

What's the difference between a horizontal merger, a vertical merger, and a conglomerate merger?

*A horizontal merger is when two firms in the same industry combine. *A vertical merger is when two companies that make parts for a finished good combine. *A conglomerate merger is when two companies combine from different industries.

What is an equity carve-out?

*A carve-out is similar to a spin-off, however, a spin-off is when a parent company transfers shares to existing shareholders as opposed to new ones. *In a carve-out, the parent company sells some of its shares in its subsidiary to the public through an initial public offering (IPO), effectively establishing the subsidiary as a standalone company. *Since shares are sold to the public, a carve-out also establishes a new set of shareholders in the subsidiary. *A carve-out allows a company to capitalize on a business segment that may not be part of its core operations as it still retains an equity stake (Controlling interest) in the subsidiary.

What is a divestiture?

*A divestiture is when a company or government disposes of all or some of its assets by selling, exchanging, closing them down, or through bankruptcy. *As companies grow, they may become involved in too many business lines, so divestiture is the way to stay focused and remain profitable. *Divestiture allows companies to cut costs, repay their debts, focus on their core businesses, and enhance shareholder value.

What protective actions can an acquisition target implement to protect against acquisition?

*A golden parachute *Staggered board of directors *The white knight *Poison pills *A leveraged recapitalization

What is the difference between a risk-adverse investor, a risk-neutral investor, and a risk-seeking investor?

*A risk-adverse investor is someone who tries to limit risk exposure and has lower expectations for returns. *A risk-neutral investor is someone who is indifferent about trying to limit or seek out risk and has balanced expectations for returns. *A risk-seeking investor is willing to take on greater risk exposure in the hopes of gaining greater returns.

When determining whether to refinance debt, what should organizations consider?

*Credit rating *Macroeconomic conditions *Cash position *Covenants *Earnings *Risk

What are the declaration date, ex-dividend date, record date, and payable date in regards to dividends?

*Declaration date: when the company announces that the board has approved a dividend. *Ex-dividend date: the first day the stock will trade without rights to the declared dividend. *Payable date: when the dividend is distributed. *Record date: two business days after the ex-dividend date. Shareholders at that date are determined to receive the dividend.

Why is the determination of cash flows more complicated internationally?

*Foreign countries have different tax codes and financial reporting standards. *Foreign governments place restrictions on the amount of cash that can be moved out of a country, commonly referred to as repatriation of earnings restrictions. *Estimating future cash flows in a foreign currency requires an estimate of future exchange rates. *The stability of a country's political environment is often unknown. A number of assumptions are made in the DCF formula and these assumptions become even harder to estimate/predict if the political environment is instable!

What quantitative factors should be considered when evaluating a business combination?

*Increased revenue from new products or markets *Increased margins from better pricing or lower costs of goods due to quantity discounts *Reduced costs from identifying duplicate departments or processes *Increased return on assets because of decreased duplicate assets

What are some factors that influence foreign currency exchange rates?

*Inflation rates Interest rates Public debt *Current account deficits *Ratio of imports to exports, also called terms of trade or balance of trade *Political and economic stability

What is lead time, safety stock, and reorder point?

*Lead time is the time between when a firm places an order with a supplier and when the goods arrive at the business. *Safety stock is extra inventory on hand to protect against increased demand. *The reorder point is when to order more inventory and is calculated as: (Average Daily Demand in Units × Lead Time) + Safety Stock

What rights do common stockholders have?

*Right to vote -Common stockholders can vote on corporate matters such as election of board of directors, approving mergers or acquisitions, and approval of executive compensation plans. *Preemptive right -If a company issues additional shares to raise capital, current common stockholders are allowed to purchase new shares proportional to the shares they currently own. This allows owners to maintain the same ownership percentage. *Dividends -Common stockholders have the right to receive dividends, if they are paid. Unlike bondholders who hold a contractual obligation to receive interest payments, common stockholders do not have a contractual right for dividends to be paid. In other words, companies do not have to pay dividends. *Residual claim-In the event a company is liquidated, the common stockholders have the right to all remaining assets after creditors and preferred stockholders have been paid.

Why is valuation of common stock using the DCF method more complex?

*The expected cash flows from stock, dividends, are less certain both in size and timing. *Common stock does not have a final maturity date as with bonds. *The discount rate used in a DCF for common stock is not directly observable.

What are the formulas for the Zero-Growth Dividend Model, Constant Growth Dividend Model, and Variable Growth Dividend Model?

*Zero-Growth Dividend Model: P0 = Constant Dividend ÷ Discount Rate *Constant Growth Dividend Model: P0 = Dividend 1 ÷ (Discount rate - Dividend Growth Rate) *Variable Growth Dividend Model: P0 = [D1 ÷ (1+R)] + [D2 ÷ (1+R)2] + ...+ [D3 ÷ (1+R)3] + [Pt ÷ (1+R)t] Where: Pt can be determined by [Dt+1 ÷ R - g]; D = Dividend; R = Discount rate or required rate of return; g = Dividend growth rate

Leases, for financial accounting purposes, come in what two forms? Briefly describe each form.

1. With operating leases, the lessor transfers only the right to use the property to the lessee, and the lessor retains most of the risks and benefits of ownership. 2. Finance leases transfer the risk of ownership to the lessee. The lessee pays for maintenance, insurance, and other costs of ownership.

The value of a business is estimated as the sum of what three factors?

1.Present value of future cash flows over three to five years 2. Present value of all future cash flows thereafter (terminal value) 3. Present value of nonoperating assets

Will a country benefit more from importing when their currency is more or less valuable than the currency of the exporting country?

A country with a more valuable currency will benefit more from importing from other countries with a less valuable currency.

What is a diversified portfolio?

A diversified portfolio is one with a mix of investments from different industries where the only risk of an individual asset comes from systematic risk. Diversified portfolios are typically less risky for a given level of expected returns than an individual asset because the unsystematic risk associated with an individual asset is eliminated.

Why should the marginal cost of capital be used instead of the historical cost of capital when making decisions about the future?

A firm's marginal cost of capital is the cost of each new dollar in capital raised. Firms change over time with regards to their capital structure, profitability, growth, risk, and more. Historical cost of capital rates may not adequately reflect changes in these factors. As such, a future decision and evaluations of future projects and investments should be made using the marginal cost of capital. The basic calculations remain the same, but are made with future projections rather than relying on historical rates and calculations.

What is the difference between a forward, future contract?

A forward contract between two parties requires one party to buy or sell a specified asset on a specified day at a predetermined price. Delivery of the underlying asset occurs on the contract's delivery date. A future contract is an agreement actively traded on organized exchanges and usually does not carry the expectation of actual delivery of a physical asset, but rather parties exchange the monetary value of the contract.

What is a leveraged buyout?

A leveraged buyout is a merger where the buyer uses debt to finance a significant portion of the transaction.

What is a lockbox system?

A lockbox system is an arrangement between a bank and a firm that allows geographically dispersed customers to send their payments to a post office box near them. The payments are then collected and processed by the bank. Because the payment skips the firm's location, the collection float is reduced. In the case of mailed checks, the bank generally provides photocopies or electronic scans of the checks along with payment remittance forms to the firm. The primary drawback of a lockbox system is the cost of administering the system, which can include post office box rental fees, account or deposit fees, and processing fees. The net benefit of a lockbox system is the dollar value of reduced mail and processing float less the costs of the system. A firm benefits from a lockbox by accelerating cash collections, which allow the firm to earn interest on the cash sooner than it otherwise would.

What is a managed floating foreign currency exchange rate?

A managed floating foreign exchange rate system combines features of the fixed and floating exchange rate systems because governments can intervene in markets when required but market forces generally dictate foreign currency exchange rates.

What is a Secondary Public Offering or Seasoned Public Offering?

A secondary public offering or seasoned public offering (3rd, 4th, etc) takes place when a firm that already has publicly traded securities engages in a sale of additional securities. The advantage for firms issuing additional securities is that investors typically will pay higher prices for a second offering as opposed to a first offering. This is because the stock is better known and has higher liquidity. The disadvantage is that there could be some scrutiny of why that firm needs more cash and it could be looked upon negatively.

What is the difference between secured and unsecured debt?

A secured bond means that the principal is backed by the company's assets as collateral. An unsecured bond does not have collateral, but rather is simply backed by the company's promise to repay the debt.

What is an example of a tax shield?

A tax shield is the reduction in income taxes companies can receive by deducting interest payments on debt from their taxes. However, companies cannot deduct dividend payments. This tax shield for interest payments reduces the cost of debt, thus resulting in a lower cost of capital to the firm.

What methods can firms use to control disbursement activities?

A zero-balance account (ZBA) - allows a bank to write checks against an account with no money in it. A daily transfer from the bank's master account covers any checks written. Firms may have multiple ZBAs for supplier payments, tax payments, wages, etc. ZBAs allow for decentralized payables activity and the elimination of excess cash in multiple bank accounts. Centralized payables- allows a firm to use a single bank account and take advantage of economies of scale from a single payment location. A payable through draft (PTD) - requires a bank to present the instrument to the firm for final acceptance (the bank says hey this bill just came in and needs to be paid). The firm then will deposit funds to cover the draft. This service incurs higher charges for the firm but allows the firm greater management over its cash funds. Electronic commerce (e-commerce)- facilitates relationships and transactions digitally. Processing payments online reduces cycle time and has lower error rates.

What is an Initial Public Offering (IPO)?

An Initial Public Offering (IPO) is when a firm offers ownership shares in the firm to the general public for the first time.

What is the difference between an acquisition and a merger?

An acquisition is when one firm buys a controlling interest, that is greater than 50% ownership, in another business. A merger takes places when two firms combine into one.

What is an option?

An option is a contract between parties where the option buyer has the right, but not the obligation, to buy or sell a given amount of the underlying asset. The buyer of an option pays the seller or writer of an option a premium or fee in order to buy the right to exercise the contractual agreement at a future date.

Describe some financing methods for international trade.

Banker's acceptance letters: short-term financing instruments issued by a firm and guaranteed by a financial institution. The letters are traded in secondary markets. A party buying a banker's acceptance can present the letter for payment at the bank issuing the letter. Foreign currency accounts: accounts maintained to pay bills in that foreign currency. Countertrading: exchanging goods and services instead of cash. Forfeiting: the purchaser pays for receivables from an exporter at a discount for immediate cash. (similar to factoring of A/R). A forfeiting transaction usually includes these features: 1. A credit period of at least 180 days 2. The possibility of settling the transaction in most major currencies 3. A letter of credit, promissory note, or other guarantee made by a bank

What are the benefits and risks of Forwards, Futures & Options?

Benefits: A benefit of using either a forward contract or a futures contract instead of an option is that they do not require any upfront payment. Another benefit of a forward contract is that it is a private contract, so any underlying asset can either be purchased or sold. Futures contracts are negotiable securities that trade on exchanges, so therefore only certain assets can be hedged using futures contracts. With a forward contract all payments occur at settlement date, while settlement of a futures contract occurs on a day-to-day basis as the price of the underlying asset changes making the futures contract less risky. The benefit of an option, as opposed to forward or futures contracts, is that payment of the settlement of the contract is not required. If a better price can be achieved on the spot market, there is no requirement to use the option. Risks: The major risk of using either a forward contract or a futures contract is the opportunity cost. If the company has contracted to purchase Mexican pesos in 30 days at a price of $0.052 using either a forward contract or futures contract, the company is required to settle the contract, even if the spot rate on settlement date is $0.049. Therefore, if the company had not hedged, it could have purchased the currency at a lower rate. The main risk of using an option to hedge risk is the loss of the cost of the option. If the company owns an option to purchase Mexican pesos at $0.052 while the spot price is $0.049, it is free to walk away from the contract and purchase the currency on the spot market. Therefore, using an option, the maximum loss is the cost of the option.

Why would a bond be sold at either a discount or a premium? What is a Zero-coupon bond?

Bonds sold at above par value are premium bonds, which takes place when the market interest rate is below the coupon rate of the bond. In contrast, bonds sold below par value are discount bonds, which takes place when the market interest rate is above the coupon rate. Zero Coupon bond- is a bond in which the face value is repaid at the time of maturity. That definition assumes a positive time value of money. It does not make periodic interest payments or have so-called coupons, hence the term zero coupon bond. When the bond reaches maturity, its investor receives its par value. Zero-coupon bonds must sell for less than similar bonds that make periodic coupon payments. Zero-coupon bonds are mostly issued by new corporations with a high level of risk.

What is capital structure?

Capital structure is the mix of debt and equity that a company uses to finance its activities.

What factors does a firm consider before deciding to offer dividends?

Cash availability Covenant requirements Firm performance The dividend policy of a firm is influenced by a number of factors. The amount of cash the firm generates, the variability of that cash flow, the need to reinvest cash back into the business, and tax considerations are all factors that a firm typically takes into consideration when developing its dividend policy. (Note on taxes: As the dividend income tax rate decreases, firms likely pay more in dividends as the after-tax net cash flow to shareholders increases.)

What is cash management?

Cash management is the process by which a firm collects, invests, and administers its cash. Cash management policies are focused on managing a firm's liquidity needs and are built around the cash conversion cycle.

What is collection float and what is it comprised of?

Collection float is a measure of the time from when a transaction is initiated until the cash is available for use and is comprised of: Mail float—The time from when the check is mailed to when the firm receives the check Processing float—The time from when the firm receives the check to when it is deposited Availability float—The time from when the check is deposited to when the funds are made available to the organization

What do commercial banks do?

Commercial banks are banks that offer financial services such as checking accounts, savings accounts, lines of credit, and term-loans. Government regulations have varied over time as to whether commercial banks could engage in investment banking activities. Investment banking carries higher risk than traditional financial services. To protect the financial system, these two types of banking have been separated at times. However, regulations have also been passed to eliminate the distinction. Following current legislation is the best way to know whether commercial banks are presently allowed to engage in investment banking activities.

What is commercial paper?

Commercial paper is short-term, unsecured notes payable issued by large firms (and bought by big investors) all with high credit ratings. Commercial paper is usually issued in very large denominations (usually exceeding $100,000). Bought by: Pension funds, institutional investors, and insurance companies usually purchase commercial paper as a secure, low-risk investment. Commercial paper is not secured; however, a related financial instrument called bankers' acceptances are short-term notes payable issued by firms yet backed or guaranteed by a commercial bank.

What is credit risk or default risk?

Credit risk or default risk is the risk that a borrower will not repay the investor as promised.

What are currency options?

Currency options give organizations the right, but not the obligation, to buy or sell foreign currency at a contractually obligated price during the option period. Currency options are different than futures because options give the right to execute the transaction but the company is not required to execute the transaction.

What are current assets comprised of?

Current assets (sometimes referred to as gross working capital) are comprised of assets which a firm expects to convert to cash within one year or less.

What are current liabilities comprised of?

Current liabilities are comprised of obligations which a firm expects to pay within one year or less.

What is the Effective Interest Rate Formula?

Effective interest rate = (Net Interest cost (discount) ÷ Cash received ) x100 Note: With Comp Balances Always subtract out of the "Cash received" figure but if it earns interest then subtract it out of the Interest earned (making the "Net" interest earned). solution to practice problem is in percentages .075 / (1 - .125) discount rate / cash received *

What is residual claim of common stockholders?

In the event that a company is liquidated, the stockholders have the right to all remaining assets after creditors and preferred stockholders have been paid.

What is industry risk?

Industry risk is the risk associated with the factors specific to a given industry.

Why is issuing debt less expensive than issuing stock?

Issuing debt is less expensive because the underwriting fees charged to facilitate raising capital are lower for debt than equity.

What is just-in-time (JIT) inventory management?

Just-in-time (JIT) inventory management is when firms contract with suppliers to deliver inventory only when the firm requires it. JIT can be considered a "pull" inventory system wherein demand is the trigger for inventory ordering rather than predetermined inventory levels. The philosophy behind a JIT system is different from traditional inventory systems in that it regards inventory storage as a non-value-added activity. Thus, JIT attempts to reduce or eliminate the carrying costs of inventory. JIT systems were pioneered by Japanese firms like Toyota Motor Company. Most auto manufacturers now employ a JIT system. Firms with JIT systems benefit from having little to no carrying costs and not having the risk of inventory obsolescence. However, firms with JIT systems are very dependent upon their suppliers and their ability to deliver goods as needed.

How does the return of low-risk investments compare to high-risk investments?

Low-risk investments get a lower rate of return while high-risk investments get a higher rate of return.

Describe the Origination and Underwriting process and the difference between the two. What is the difference between origination and underwriting?

Process: *The firm's management works with an investment bank to determine how much money the firm needs to raise and what shares will be offered. *The firm must register with the SEC by filing a preliminary prospectus. *After approval from the SEC, an investment bank agrees to buy the firm's securities and then resell the securities to investors. *The securities then begin trading as the underwriter re-sells the securities to investors. The difference: Origination is the process by which investment banks ready a security for sale, either debt or equity. Underwriting is the process by which investment banks help a company complete the sale of a security. Typically, this takes place by the investment bank buying the new security from the company and then reselling the security to investors.

What are repurchase agreements?

Repurchase agreements (a type of marketable security) involve the purchase of a security from another party, usually a bank or security dealer, who agrees to buy it back at a specified date for a fixed price.

What is the rate of return formula?

Return = (Capital Appreciation + Income) ÷ Investment Or, Return = [(Investmentt+1 - Investment) + Income] ÷ Investment (*note same as shareholder's return formula)

What three market conditions are used in the calculation of the Capital Asset Pricing Model (CAPM)?

Risk-free rate of return (Rf) Market rate of return risk premium (Rm − Rf) Beta (β) of the investment, which measures the investment's sensitivity to changes in the market

What is Semistrong-Form Efficiency of the Efficient Market Hypothesis (EMH)?

Semistrong-Form Efficiency is when security prices reflect all public information but not all private information. This form is a reasonable representation of how most large stock markets function. For examples, investors & analysts who have private information could acquire such information through analysis of the firm or discussions with a firm's customers.

What type of bond matures at different points in time?

Serial bonds refer to bonds within an issue that mature at different points in time. Generally, serial bonds are retired according to their registration number.

What qualitative factors should be considered when evaluating a business combination?

Strength of the management team Fit of the companies' cultures Brand strength Specialized expertise in a type of technology or in a business process

What is the difference between term to maturity and yield to maturity? And, what does the structure of interest rate mean?

Term to maturity is the amount of time that a debt instrument pays interest while yield to maturity is the interest rate being paid by the debt instrument. A key feature of debt-based financial instruments, such as bonds, mortgages, or business loans, is how the interest rate is structured. Each financial instrument will have a unique structure that is negotiated between the debtholder and the debt issuer. Furthermore, economic factors will influence the interest rate of each debt instrument. The term structure of interest rates refers to the relationship between the time (term to maturity) until the debt instrument's principal balance is due and how much (yield to maturity) the debt instrument pays in interest.

What is the average collection period and how is it measured?

The average collection period measures how much time passes between a sale and the time a customer pays and is measured as a weighted average of the times customers pay. 1For example, if 20% of customers pay in 10 days, 60% pay in 30 days, and 20% pay in 60 days, the average collection period is (20% × 10) + (60% × 30) + (20% × 60) = 2 + 18 + 12 = 32 days.

What is the market risk premium (Rm − Rf)?

The market risk premium is the expected return of the broader stock market such as the S&P 500 or Dow Jones Industrial Average. The "premium" refers to the amount of return expected from the market above and beyond the return that could be earned from a risk-free security.

What is the cost of capital for a firm?

The required rate of return the firm must earn in order to meet investors' and debtholder's expectations.

What is foreign exchange risk or currency risk?

The risk that economic value will be lost due to fluctuations in exchange rates.

What is the risk-free rate of return (Rf)?

The risk-free rate of return typically refers to the current rate of return on a risk-free security such as a U.S. Treasury bill.

How can the use of what-if analysis be beneficial in the evaluation of a merger or acquisition?

The use of what-if analyses can be beneficial by evaluating the likelihood of various scenarios and outcomes. It can identify what circumstances must hold true for the proposed business combination to create value. This allows the management decision maker to evaluate the riskiness of the project.

How is the volatility of a return measured? And, what ratio is calculated from this?

The volatility of a return is measured as the standard deviation (range of potential outcomes for the return). A large (high) standard deviation means that the return outcome could take place over a broad range of outcomes (more risky). A small (low) standard deviation means that the return outcome is likely to take place closer to the expected value (less risky). Standard Deviation: Expected Return Ratio (%Standard Deviation/ Expected Return) : (Expected Rtn/ Expected Rtn)

What is trade credit?

Trade credit, or accounts payable, takes place when a firm makes and receives delivery of a purchase, but does not pay for it upon purchase.