Fundamentals of Corporate Finance final

Portfolio

A collection of financial assets, such as stocks and bonds, held by an investor.

Pure play

A company with a single line of business

Sunk Cost

A cost that has already been incurred and that cannot be recouped

Efficient Capital Market

A market reflects all available information in the prices of the securities

Systematic Risk

A risk that influences a large number of assets. Also, market risk.

True

According to DuPont Identity, Return on Equity will decrease if the equity multiplier decreases.

Efficient Market Hypothesis

Asserts that modern US Stock Markets are, as a practical matter, efficient

preferred stock

Equity with preference over common stock in the payment of dividends and in liquidation

U.S. Treasury Bill

Good Proxy for the risk free asset and its rate can be used as the risk free rate. (Stock Rate - TBill Rate = Risk Premium).

Sensitivity Analysis

Holds all projections constant except one; alter that one, and see how sensitive NPV is to change

False

IRR method has advantages because it is easy to understand, close to NPV, and useful when you have limited funds to allocate.

stock dividend

Payment made by a firm to its owners in the form of stock, diluting the value of each share outstanding.

Price per share divided by earnings per share

Price per earnings (PER) ratio is measured as

CAPM

Return depends on the reward for bearing systematic risk and the pure time value of money.

CAPM formula

Risk Free Rate + Beta(Market Rate - Risk Free Rate)

Small Company Stocks

Riskiest investment for past 80 years in US Stock Market

Treasury Bills

Safest investment for past 80 years in US Stock Market

Total Asset Turnover

Sales/Total Assets

An investment is acceptable if its IRR exceeds the required return, else it should be rejected

The Internal Rate of Return (IRR) rule can be best stated as

Divisional Cost of Capital

The cost of capital for a particular division of a company. This may be quite different from the Company WACC, depending on the risk of the division's cash flows.

False

The disadvantages of Payback Rule are no consideration on time value, arbitrary cutoff, ignoring cash flow before cutoff, and strong bias against short-term projects.

True

The internal growth rate is the maximum possible growth rate for a firm that relies only on internal financing.

I and IV only

The internal rate of return can lead to faulty decisions: I. if the cash flows are nonconventional. II. if more than one cash flow is positive. III. if a project's life exceeds 3 years. IV. if two projects are mutually exclusive. a. II only b. IV only c. I and IV only d. II, III, and IV only

Less than zero

The net present value rule states that you should reject a project if the NPV is:

dividend policy

Which of the following is NOT three general questions to the financial manager? a. dividend policy b. capital structure c. financial capital management d. capital auditing

payback

Which one of the following methods can be applied without the use of an interest rate? a. net present value b. internal rate of return c. payback d. profitability index

zero coupon bond

a bond that makes no coupon payments and is thus initially priced at a deep discount

dividend growth model

a model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate

Erosion

a reduction in the sales of a current product whenever a new product is introduced

Unsystematic Risk

a risk that affects at most a small number of assets. Also, unique or asset-specific risk. Diversifiable risk.

floating rate bonds

bonds with interest rates that change with current interest rates otherwise available in the economy

principle of diversification

combining imperfectly correlated assets can produce a portfolio with less variability than the typical individual asset

dividend yield

dividend divided by stock price

Stock dividend

dividend paid in shares of stock rather than in cash

Optimal capital structure

is that debt/equity mix that simultaneously (a) maximizes the value of the firm, (b) minimizes the weighted average cost of capital, and (c) maximizes the market value of the common stock.

Market to Book Ratio

market value of equity / book value of equity

goal of financial management

maximize shareholder wealth

Scenario Analysis

means of answering "What If" questions that affect multiple variables simultaneously.

Ex-dividend date

occurs 2 days prior to the date of record; if you purchase the stock on or after the ex-dividend date, you will not receive the dividend

DuPont Identity

popular expression breaking ROE into three parts: operating efficiency, asset use efficiency, and financial leverage

Asset management ratios

ratios that measure the firm's turnover ratios

Risk Premium

reward for bearing risk, the difference between a risky investment return and the risk-free rate = Rate of return - risk free rate

clientele effect

says that dividend policy is irrelevant because investors that prefer high payouts will invest in firms that have high payouts; and investors that prefer low payouts will invest in firms with low payouts.

Principle of diversification

spreading an investment across a number of assets will eliminate some, but not all, of the risk

common-size statement

standardizes items on the income statement and balance sheet as a percentage of total sales and total assets, respectively

Beta coefficient

the amount of systematic risk present in a particular risky asset relative to that in an average risky asset

stand-alone principle

the assumption that evaluation of a project may be based on the project's incremental cash flows

True

the book value in the financial statements measures a firm's value in the financial statements

agency problem

the conflict of interest between the stockholders and management

Internal rate of return

the discount rate that causes the NPV of a project to equal zero

Declaration date

the dividend is declared by the Board of Directors and becomes a liability of the firm

Risk Premium

the excess return required from an investment in a risky asset over that required from a risk-free investment

systematic risk principle

the expected return on a risky asset depends only on that asset's systematic risk

Debt-equity ratio

the financial ratio measured as total debt divided by equity

Sustainable Growth Rate

the maximum growth rate a firm can achieve without external equity financing while maintaining a constant debt-equity ratio

Opportunity Cost

the most valuable alternative that is given up if a particular investment is undertaken

Forecasting Risk

the possibility that errors in projected cash flows will lead to incorrect decisions

profitability index

the present value of an investment's future cash flows divided by its initial cost

Fisher effect

the relationship between nominal returns, real returns, and inflation

cumulative voting

the voting procedure suitable for getting minority stockholder representation on the board

sales divided by total assets

total asset turnover is measured as

WACC

weighted average cost of capital

average tax rate

which of the following is NOT one of the four factors of the firm growth? a. average tax rate b. total asset turnover c. profit margin d. dividend policy