Principles of Finance WGU C708
Systematic Risk
"if you can't beat the system" -Beta measures systematic risk -also referred to as market risk- its the risk of particpating in the captial markets -investors receive compensation (higher return) for this risk, as it is not possible to reduce through diversification (systematic risk is also referred to as non-diversifiable risk)
price risk and interest rates are ____ correlated
positively. when interest rates go up, so does price risk.
abscond
to flee, to withdraw from
stock split
to issue a higher number of new shares to replace old shares. This effectively increases the number of shares outstanding without changing the market capitalization of the company.
Finance
to provide or obtain funding for a transaction or undertaking; to back; to support.
Total Equity
total assets - total liabilities
capital intensity equation
total assets / total sales
Total Asset=
total liabilites + owners equity
Obsolescence
when an asset (inventory or fixed asset) is not productive due to spoilage, breakage etc ** example you drop a case of vases during transportation, the company still has to pay for it
spontaneous accounts change when?
when sales change
Can net present value be used to rank capital budgeting projects?
yes
The internal rate of return is the discount rate that gives a net present value of ----.
zero
Sustainable Growth rate Formula broken down
(net income/sales) x (assets/equity) x (1- dividends/net income) or you can net income maring x asset turnover x leverage multiplier x (1-b)
working capital
- a measure of how liquid are a businesses current assets and current liabilites (if a firm had to sell its current liabilites, would it be able to cover those liabilities (debts) -it's how we ensure that a company has enough cash (cash flow) to continue to pay for its operations. -we managed it by managing inventory, accounts recievables, accounts payables and cash
Sinking Fund
- a fund established by a government agency or business for the purpose of reducing debt by repaying or purchasing outstanding loans and securities held against the entity. it helps keep the borrower liquid so it can repay the bondholder
Compond Interest Rates
-you earn money on all funds -yes, interest on interest Example: $100 x 10% for 10 years=$259.37
short term (bills)
1-5 years (less than one year is considered money market)
Retention Ratio (RR)
1-b (payout ratio)
Bond refunding occurs when all three of the following are true:
1. Interest rates in the market are sufficiently less than the coupon rate on the old bond. 2. The price of the old bond is less than par. 3. The sinking fund has accumulated enough money to retire the bond issue.
The ONLY two things a company can do with net income
1. pay to shareholders as dividends 2. retain them in the company as retained earnings
4 methods to reduce DFN?
1. slow sales growth (if the compnay increases prices it gets 2 benefits, increase in net income margin and decreased need for assets and lower DFN 2. examine capacity constraints (do they really need to purchase additional fixed assets to increase capacity, are there other ways to increase without buying machinery or equipment) 3. lower dividend payout ( if the firm retains more of its net income it will have more cash to purchase new assets) 4. Increase net margin (increase price, cut costs)-higher net margin means more cash that the firm can use to purchase assets rather than additional financing
The four financial statements required by GAAP
Balance Sheet, Income Statement Statement of Cash Flow Statement of Owner's Equity
What is the most common method of classifying financial markets based on?
Based on maturity and trading
Bond Rules #1
Bond prices and interest rates move in opposite direction - bonuses prices move in the SAME direction, up or down, together - "this is the liquidity premium theory"
One of the uses of financial statements is as a _____ tool.
budgeting - it also is a collection of reports that describes the compnay's financial activities - it also can tell you the company's profitability, their credit worthiness, and the accurancy of the company's tax returns
Does the IRR represent the annual rate of return on a project?
No, because projects usually have cash inflows that occur over the course of multiple years
cash flow is the actual __________ cash that a company earns
after tax
Selling, General, and Administrative Expenses
aka operating expenses (salaries, rent, office expenses)
Factors that influence market interest rates
alternative investments, inflationary expectations, deferred consumption
Investing activity
an activity that causes changes in non-current assets or involves a return on investment.
Fundamental Analysis
an analysis of a business with the goal of financial projections in terms of income statement, financial statements and health, management and competitive advantages, and competitors and markets.
Suppose a company is planning to increase its dividend payout ratio next year. Given this information, what do you expect to occur in the upcoming year?
an increase in discretionary financing needed
Dow Jones Index
an index that shows how 30 large publicly-owned companies based in the United States have traded during a standard trading session in the stock market.
Liability
an obligation, debt or responsibility owed to someone.
Business Valuation
anaylze the company financial statements to help determine if it would be a good investment
Current Yield Formula
annual coupon/price
Spontaneous Accounts
any account on the income statement or balance sheet that changes by sales changes -salses change on these acocunts: Income statement (revenues, COGS, all operating expenses, depreciation, and taxes) Balance sheet (AR: billings will increase as sales increase, Inventory: if you sell more stuff means you need to buy more stuff, AP: we buy more stuff means we have more invoices to pay for that stuff, Accruals: we sell more stuff means we have to hire more people to make and sell that stuff
inflation linked bonds
are bonds where the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment
Corporate bonds
are issued by businesses
Activity Ratios
are used to gauge the ability of a business to convert various asset, liability, and capital accounts into cash or sales -they are financial anaylsis tools
optimal growth rate
assesses sustainable growth from a total shareholder return creation and profitability perspective, independent of given financial strategy
spontaneous assets
assets of a company that are accumulated automatically as a result of the firm's day-to-day business.
large corporations get most of their financing from _____
bonds and stocks
The cost of money is not related to the concept of ___.
depreciation ** it is related to the time value of money, opportunity cost and time preference
b
dividends / net income
EBIT
earnings before interest and taxes
Sarbanes-Oxley Act of 2002
established requirements for proper financial record keeping for public companies and penalties of as much as 25 years in prison for noncompliance -management must certify the accuracy of finaincial statements (ENRON)
Statement of Owners Equity
explains changes to the company's equity throughout the reporting period, including profit or losses, dividends paid and issues or redemption of sock ** ONE use: to explain the change in the Owner's equity section of the balance sheet. - normall you will see theses on this statement: net income (from the income statement), dividends paid, stock issuance or redemption, other items affecting the firms equity
The three main areas of finance are ____.
financial Institutions, financial markets, and financial management
derivatives
financial instruments whose value depends on the valuation of an underlying asset such as a warrant or option.
return
gain or loss from an investment.
refunding
occurs when an entity that has issued callable bonds calls those debt securities from the debt holders with the express purpose of reissuing new debt at a lower coupon rate.
Net Present Value
the present value of a project or an investment decision determined by summing the discounted incoming and outgoing future cash flows resulting from the decision.
net present value
the present value of a project or an investment decision determined by summing the discounted incoming and outgoing future cash flows resulting from the decision.
clean price
the price of a bond excluding any interest that has accrued since issue or the most recent coupon payment.
Monetary Policy
the process by which the monetary authority of a county controls the supply of money, ofte targeting a rate of interest for the purpose of promoting economic growth
discounting
the process of determining how much money paid/received in the future is worth today. You discount future values of cash back to the present using the discount rate.
capacity planning
the process of determining the production capacity needed by an organization to meet changing demands for its products.
Capitalization
the process of finding the future value of a sum by evaluating the present value.
Forecasting
the process of making statements about events whose actual outcomes (typically) have not yet been observed -the most difficult aspect of preparing a financial forecast is predicting revenue
What does asset turnover measure?
the productivity of the firm's investment in its assets -how effiecienty a company uses its assets to generate sales revenue or sales income for the company -companies with low profit margin tend to have high asset asset turnover
market interest rate
the rate at which interest is paid by a borrower for the use of money that they borrow from a lender in the market.
Yiled (aka yield to maturity)
the rate of return that an investor will earn if they by the bond on the published date and hold the bond until maturity -is considered the value of both the remaining coupon payment and teh face value (maturity value) of the bond -it is the rate "rate of return" that an investor gets from the bond ** bonds are different from bank loans
Weighted Average Cost of Capital (WACC)
the rate that a company is expected to pay on average to all its security holders to finance its assets.
term structure of interest rates (yield curve)
the relationship between the interest on a debt contract and the maturity of the contract.
reinvestment risk
the risk resulting from the fact that interest or dividends earned from an investment may not be able to be reinvested in such a way that they earn the same rate of return as the invested funds that generated them.
Economics
the social science that analyze the production, distribution, and consumption of goods and services
capital intensity
the term for the amount of fixed or real capital present in relation to other factors of production. Rising capital intensity pushes up the productivity of labor.
Term
the time until the bond matures on the maturity date. this varies from a few days up to 30 years
The two main drivers of finance are ____.
the time value of money and risk - since the value of assets change overtime, finance seeks to ensure the change is beneficial for the organization or individual
Market Value
the total value of the company as traded in the market. Calculated by multiplying the number of shares outstanding by the price per share.
Leverage
the use of borrowed funds with a contractually determined return to increase the ability of a business to invest and earn an expected higher return (usually at high risk).
ratio analysis
the use of quantitative techniques on values taken from an enterprise's financial statements. -they give us the ability to review our company's financial performance vs our peers in our industry
Coupon Rate
this is the interest rate paid on the bond. It is the dollar amount of the interest that a bond pays. It is given as a percentage.
straight bond
a bond with no call or put options
debt financing vs equity financing
borrowing vs ownership
financing concerns the ____, _____, or ______ of money.
borrowing, repaying, or raising
Bond markets and stock markets are two types of _____ markets.
capital
Equity
Ownership, especially in terms of net monetary value, of a business
Future Value
PV (1+i)
Types of inflation
Pushed by costs or pulled by demand
capital budgeting
Management must allocate limited resources between competing opportunities (projects)
Income Bond
a debt instrument where coupon payments are only made if the issuer can afford it.
Net present value
the planning process used to determine which of an organization's long-term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing.
capital budgeting
the planning process used to determine which of an organization's long-term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing.
retention ratio formula
% of net income that a firm retains 1- dividend payout ratio
Non-cash expenses
Depreciation, Amortization, obsolescence
Present Vlaue
FV/(1+i)
Is a higher or lower IRR better?
higher
premium
the price above par value at which a security is sold
Example Interest rates UP and bond prices down
$1000 face value 5% coupon (%50 per year) 10 years to matuity $997 purchase price -the bond held to matuity - if they hold the bond for the entire 10 yearsk, there will no be any surprises $50 interest and $1000 face value
Acid Test Ratio
(Current assets - Inventory) / Current liabilities.
Financial Analysis
(also referred to as financial statement analysis) refers to an assessment of the viability, stability, and profitability of an organization or project. -
sales growth rate Formula
(forecasted sales / last years sales) -1
Term Structure of interest rates
(how interest rates change over time, often referred to as the yield curve) - longer maturity (time)= higher yeild (interest rate) -under normal conditions rates rise as time lengthens, due to risk of default, unforseen what if events, -the normal curve= is upward slopping, an inverted curve is downward sloping -three theories - expection hypotheseis, liquidity premium theory and segmented markets
trend anaylsis
- another important part of ratio anaylsis, which means looking at how the ratios have changed over time. This helps to tell an analysist whether or not the company is improving its performance over time
Car Loans and Morgages
- both of theses typs of loans operate on a mnthly payment schedule - amoritizations, each payment includes interest and principal -sum of amortized payments show "real" acquisition costs -ie: you can buy a new care for $275000, the finance manager assures you that 9% is a very fair rate, and she will lend it to you for 6 years so.. monthly payment is n=72, I=.75 PV 27500 FVis 0 Pmt is 495.70 so your total cost is 495.72*72= 35691
Corporation
- business is its own taxable entitiy -must create a board of directors -corporation becomes liable for the debts and financial decisions of the business -corporation seeks external funding (shareholders) -usually goes public to get money -protection from personal assets
DuPont Information
- by splitting ROE into three parts, companies can more easilty understand changes in their returns on equity over time -as profit margins increase, every sale will bring in more monty to the compnay's bottom line, resulitng in higher overall return on equity -as asset turnover increases, a company will generate more sales per asset owned, resulting in a higher overall return on equity. -Increased financial leverage will also lead to an increase in return on equity, since using more debt financing brings on higher interest payments, which are tax deductible. -DuPont analysis helps analysts determine why ROE and ROA vary over time, vary among companies, and vary in industry averages. -DuPont analysis helps companies to determine how to generate profits by analyzing profitability, turnover, and financial leverage.
Debt ratio
- can the compnay pay its long term debts (liabilities) using its total assets Total Debt / Total Assets The higher the ratio, the greater risk will be associated with the firm's operation
Factors influencing Market interest rates
- deferred consumption -iflationary expectations -alternative investments -risk of investments -liquidity preference
Dividend payout ratio
- defined as the % of Net income that the compnay pays to its shareholders as a dividend -Common dividends / net income for the period
GAAP (Generally Accepted Accounting Principles)
- guidelines that govern accountant transactions - matching principle (expenses are recognized when they occur and are "matched" against recognized revenue) Fair Market Value: estimate of the value of an assest based on knowledgeable information on what a buyer might reasonably pay for it Revenue recognition: occurs when revenue is considered realizable and earned (not when cash is paid)
Preferred Stock Dividends
- if any, must be paid before common stock dividends are paid -they are fixed, which means when paid they do not vary in amount -investors buy perferred stock because the fixed dividend is usually paid -dividends are cash payments made to shareholders, normally they are paid quarterly
Unsystematic Risk, Portfolio Diversification
- in general, returns amoung multiple asset classes tend not to move in the same direction at the same time -by creating a diversified portfolio, an investor can reduce risk (volatility) -differes from hedging, which seeks negative iner-asset correlations (and is usually expensive) -portfolios can be either actively or passively managed - type of risk an investor reduce through the process of diversification
NonCash items
- include expenses that are deductible on the income statement that do not cost the compnay any cash -Depreciation" a noncash deductible expense for long-term assets such as buildings, equipment, and vehilces. Assets that can be seen and touched are called tangible assets -Amortization" a non cash deductable expense for long term "intangible", which are valuable but they cannot actually be seen or touched. Examples are copyrights, trademarks, patents and goodwill
IRR (internal rate of return)
- is a discount rate at which the net present value (NPV) of an investment is equal to zero. -If the IRR is higher than the cost of borrowing to fund the investment, the investment should be profitable.
Crowding Out
- is a phenomenon occuring when expansionary fiscal policy pradoxically causes interst rates to rise, thereby reducing investment spending (increased governement spending, financed by borrowing "crowds out" investmenr by the private sector
Contractionary Monetary Policy
- is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset value
Expansionary Monetary Policy
- is tradionally used to try to combat unemployment in a recession by lowering interest rates in teh hope that easy credit will entice businesses to expand
Percentage of Sales Forecasting
- is used by many companies to develop forecasted income statements and balance sheets (called pro forma financials) by using the % growth forecasted in Sales and apply that growth rate to any forecast any account that changes as sales changes (called a spontaneous account)
Why should we care about finance in business?
- maximize shareholder value (return on investment) -choose between different investment choices (where should we invest our funds) -make sure money is in the right place at the right time( time value of money, when do we actually issue shares of stocks and collect the money from investors, when do we use it.) * focus on cash flow, not provit: longevity: can show the health of a business
Treasury Securities
-are debt issued by the federal government. the terms range from a few days to 30 years
Return on Equity
- measures how effective the company has been using is equity to generate net income - is what the company's sustainable growth rate (SGR) is based on Net income / avg owners equity the ratio of net income to equity.
Return on Assets Ratio
- measures how effective the compnay has been using its assets to generate net income -found by dividing net income by total assets. The higher the ratio, the better the company is at using their assets to generate income.
Return on Assets Information
- measures the rate of return on the shareholder's equity of common stockholders -only a relative measure of performance -shows how profitable a company's assets are in generating revenue -makes up 2/3 of the dupont equation measuring return on equity
Time Value of Money
- money is worth more today than it is in the future -no waiting= use for immediate consumption -what would convince you to wait? More money, maintain spending power (inflation hedge) therefore no loss of consumption -TVM permits us to do teh analyses to identify the "cost (or value) of waiting
Annuities
- payments of a fixed amount at a set frequency -payments at teh end of a period ordinary annuity -payments at begining of period are annuity due
Parts of Finance
- personal, corporate, government, and behavioral
What Financial Managers May Do
- prepare financial statements, business activity reports and forecasts -supervise employees who do financial reporting and budgeting -monitor financial details to ensure the legal requirements are met -review company financial reports and seeks ways to reduce costs -analyze market trends to find opportunities for expansion or for aquiring other companies -help managment make financial and investment decisions
Why may there be a difference between a company pretax income and taxable income
- pretax income is based on revenue recognition, taxable income is based on the company's cash flow
Pushed by Cost (inflation type)
- production AT FULL capacity (can't make any more) -cost rise, so companies produce less and supply drops -no change in demand -companies that stay in the game charge more
Pulled by Demand (inflation type)
- production NOT at full capacity -demand increases -companies must increase spending to product more (pay over time....) -companies that stay in the game charge more
Depreciation
- records the accouting use of any of the FIXED assets (machinery, equipment) that they company may have purchases -the measurement of the decline in value of assets. Not to be confused with impairment, which is the measurement of the unplanned, extraordinary decline in value of assets.
Amortization
- reords the accounting use of any of teh intangible assest (goodwill, intellectual property) that we have on teh balance sheet -the distribution of the cost of an intangible asset, such as an intellectual property right, over the projected useful life of the asset.
RIsk vs Return
- risk is a variation from expected outcome (could be better or worse) -major consideration in capital budgeting-compare returns with associated risks (dont forget opportunity costs, higher risk requires tie and effort to get information and monitor programs, therefor the risk requires additonal compensation
Sole Proprietorship
- smallest business type -easiest to start -one owner who is soley liable for business decisons -all profits of the business become the owners income -no separation from entreprenuer vs business -business does not pay federal taxes, you do
Multi step income statement construction includes
- subtract income tax from the income before taxes -sub tract operating expenses from income from operations -subtract operating expenses from gross profit to determine income from operations
Understanding Return: Expected Return
- the expected return of a potential investment can be computed by multiplying the probability of a given even by the return in that case and adding together the products of each case ** use a chart
Different Compounding periods
- the units of the period (ie one year) must be the same as teh unit in the interest reate (7% per year) -what if it goes forever---- referred to as a perpetuitiy, easy to solve (value=payment/rrate) -if growing perpetuity (payment1/interest rate minus growth rate)
Simple Interest Rate
- you earn money on the original funds (not the interest) -no interest on interest Example: $100 x 10% for 10 years = $200 ($100 original + 10 interest payment of $10 dollars each
Brand-new companies seldom get bank loans
-"commerical banks" or "retail banks" provide loans, which are a form of debt, as are bonds. - Banks take deposits as well as make loans. -Banks are a type of financial institution -bank loans are more restrictive than issuing bonds or stock
Bond definition details
-Coupons (interest payments) paid by compnay that issues the bond and recieved by investor who bought the bond -face value payment (maturity)- paid by the compnay taht issues the bond-received by the invetor who bought the bond fixed: face value payment, coupon (interest) payment, term variable: price, yield (rate of return)
Elements of Time Value of Money
-PV (present Value)- money now, lump sum stated in dollars -FV (future value(- money in the future, lump sum -N (number of periods- stated in terms of years or parts there of PMT (payment)- multiple sums of money, sated in dollars I (interest rate)- FV is compond, PV is discounted -TVM problems can be though of as "use four to solve five" ie, you will be given four of the inputs and use them to solve for the missing value
Capital budgeting methods
-Payback -Net Present Value (NP) -internal rate of return (IRR)
Key points for Required Rate of Return (RRR)
-The first building block for assessing a required return is the risk-free interest rate. -Determine the difference between simple & compound interest. -Supply and demand impact affect interest rates when the current level of liquid money (supply) coordinates with the total demand for liquid money (demand) to help determine interest rates.
General Partnership
-Two owners at a minimum -owners persoanally share the liability for teh business debts and other financial decisions -partners share the business profits -business profits are considered income for the individual partners -business doesn't pay taxes, each partner does
Operating Margin
-a profitability ratio -how much a of company's sales on a % basis are generating operating * how much profit a comany makes for each dollar in revenue -the higher the ratio the more profitable the company is from its operations (operating income divided by revenue)
Variance
-a statistical concept describing the range around expected return within which an investment return can be reasonably expected to fall -used to measure the degree of risk in an investment -applied to three maint asset classes (money market, bonds, and stocks, will enable the building of a portfolio for (almost) all investors -time horizon and variance acceptance (risk acceptance) are positively correlated ** if you have a lot of time you can have a greater risk
DuPont Equation
-an expression which breaks return on equity down into three parts: profit margin, asset turnover, and leverage. -developed to help managers make effective decisions to increase ROE. ROE= Net Income Margin x Total Asset Turnover x leverage multiplier
Net Present Value (NPV)
-anaylzes capital investment proposal by compairing the initial cash investment with the present value of the net cash flows -it uses the compnay's own discount rate with the time value of money math (discount rate is like interest rate in reverse, it is the company's requried rate of return, used to bring future cash flows back to the present) -is the preferred method to rank capital budgeting projects
Banks
-are federally funded -make only loans to businesses that are already established, that have strong credit scores, that can make monthly payments every month and that have assets to serve as collateral for the loan. -many new businesses do not meet these requirements and must seek EQUITY from investors instead -ie bank loans are for businesses that can show a high likelihood of repaying them
Municipal Bonds
-are issued by state and local governments and their many local jurisdictions, such as school districts, sewer and water districts, highway and transportation authorities
Bonds
-are less risky for investors than common and preferred stock -face value and coupon value on bonds are fixed -the yield curve, the term structure of interest rates and the liquidiy premium theory are all portrayals of the same concept- the longer the bond term, the higher the yield, the shorter the bond term the lower the yield -the phenomenon of risking market interst rates causing bond prices to go dow is called "price risk"
Callable Bonds
-are not common -they allow the issuer to reduce the term of the bonds. -the issuer may use this feature to refinance the debt at a lower rate by "calling it in" (paying off) the bonds before they are schedule to mature. the debt balance owed can the be refinanced at a lower interest rate
Puttable Bonds
-are rare -they allow the bond owner to require the compnay who issued the bonds to pay the face value early, before the bond maturity date
Understanding the Time Value of Money
-assumes people are rational -time preferences (pay now or pay you later, your choice, hold money in hand, invest, what if) -opportunity cost (choices are usually mutual exclusive, may account for loss of benefits from foregone alternatives, unavoidable in all cirmunstances)
What are cashflows in finance?
-cash flow means cash on which taxes have already been paid. In capital budgeting, we are dealing with furture anticipated Cash flows -in finance cash flow is used in capital budgeting rather than either past or anticpated "net income" -Net income, is an important accounting element, but is not the same thing as cash flows because non-cash items are considered in arriving at Net income
Common Stock Facts
-common and preferred stock are forms of equity -common and preferred shareholders are owners of the compnay -dividends are cash payments to shareholders
All publicly traded corporations issue
-common stock -only a relatively small percentage of publicly traded corporations issue -for a corporation to have preferred stock, it must also have common stock
Voting Rights
-common stock and shareholders do have voting rights -preferred stock shareholders usually DO NOT have voting rights -among the items that common stock share holders vote on is selection of the board of directors, who hire the chief executive of the corporation
Financing Facts
-companies should consider the debt and equity currently in use when determining how to finance a project -preferred stock pays a fixed dividend and doe not have voting rights -bonds are less restrictive than bank loans
Shareholders
-company stock ownership -has voting rights, may lose if company underperforms
Net Present Value Facts
-considers the time value of money -positive numbers are acceptable projects -the word net in NPV means that we are summing positive and negative cashflows, all such cash flows are shown at their present values
Equity Facts
-creditors are paid before shareholders in event of bankruptcy -angel investors and venture capitalists are equity investors, they specialize in working with new companies -common and preferred stock are forms of equity, compnaies that issue them are already established
Main purpose of capital budgeting
-determine if proposed capital projects should be accepted and to rank such proposals
Purpose of Capital budgeting
-determine which projects to accept or reject -rank proposed projects according to their desirability -evaluate the cash inflows and cash outflows of proposed projects to make sound business decisions
Payback
-determines the time needed to recover the original investment -measured in months/years -does not use TVM -simple and easy to use
Zero Coupon Bonds
-do not pay interest at regular intervals, such as annually. They do not have a "coupon Rate", which is the same as an interest rate. Instead they are priced to sell at a substantial discount. -the difference between face value and the deeply discounted purchase price is the rate of return that investors make on zero coupon bonds
Drivers of Interest Rates
-economists generally agree that the interest rates yielded by any investment take into account the risk free cost of capital, inflationary expectations, the level of risk in the investment, and the cost of the transaction
Common Stock Fact
-have voting rights -dvidends vary in amount -it is riskier than debt because it is a form of equity -shareholders are not guaranteed dividends so their returns can be uncertain
Interest Rate Levels
-in the US the federal reserve (often referred to as the FED) implement monetary policies by largely targeting the federal funds, this is the revenue that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the FED -expansionary monteary policy -contractionary policy -crowding out
Types of Risk
-interest rate risk (rates change) -credit risk ( borrower cant repay) -liquidity risk (can't convert to cash fast enough) -market risk (decine in market-decline in investment) -operational Risk (bad management) -foreign investment risk (risk of investing in foreign markets) -model risk (past doesn't predict the future)
Bonds are Loans
-investors who buy bonds are making a loan to the company or government entity taht has issued Bonds the bond investor is a creditor -corporations and governement entities who issue Bonds are borrowing money from the investors the bond issuer is a debtor -as loans, bonds are a form of debt, a synonym for debt is liability
SEC:Securities and Exchange Commission
-is a federal agency which holds primary responsibility for enforcing teh federal securities laws and regulating the securities industry, the nations stock and opitions exchange, and other electronic securities market in the US
Statements of Cashflows
-is a financial statement required by the GAAP accounting rules that is used in evaluating a company's PAST cash flows -three sections: operating, investing, and financing
Systematic risk
-is priced in the market since it is undiversifiable -it what provides a stock's "risk premium" -a risk that remains after an investor has extesively diversified his portfolio -ex: risk resulting from a general decline in the US stock markets
Cashflow facts
-is the actual after tax cash that a compnay earns -different than net income -capital budgeting deals with estimated future cash flows
Why is the internal rate of return (IRR) used?
-is the discount rate that results in a net present value of zero - it requires one cash outflow and may have multiple cash inflows -it measures invesment efficiency, the higher the IRR the better -it does not represent the annual rate of return of a project -represents the rate of return on a project over the projects lifetime, so if a project is 20 years the IRR will give us the percentage that covers that 20 years
IRR Facts
-is the discounted rate that results in a NPV of zero -the higher the number the better -can be calculated when there is one negative cash outflow and multiple cash inflows
Why is net present vaue used?
-it uses the company's own discount rate with TMV math -used by proposed projects with a postive net present value are acceptable, the higher the NPV the more desireable the proposed project -brings future cashflows back to the present value using the discount rate
Why is capital budgeting important?
-large sums of money are involved and it is difficult and expensive to reverse capital budgeting decisions -the results of capital budgeting decisions are : yes they will pursue a project or no they will not
Bankruptcy
-laws have strict priorities regarding who gets paid in what order -creditors (whose who own bonds and wo are owed money on loans) are paid before equity (common and preferred shareholders) -thus equity is riskier than debt
Bond holders
-lenders to the company -no voting rights -gets paid no matter what
Current Ratio
-liquidity ratio -can the company pay is short term debts (liabilities) using short term assets current assets / current liabilities.
Quick Ratio
-liquidity ratio -can the company pay its short term debts (liabilities) using short term assets including inventory aka: acid test ratio (Current Assets - Inventory) / Current Liabilities
Financial Managers
-managers who examine financial data prepared by accountants and recommend strategies for improving the financial performance of the firm -perform data analysis and advise senior managerson profit maximizing ideas -types: controllers, treasures, credit managers, cash managers, risk managers, and insurance managers
Price-To-Book-Ratio
-market ratio -how much value is management creating from its assets- higher is better - used to compare a company's current market price to its book value.
Price/Earnings (P/E) Ratios
-market ratio -used to determine the relative value of a company- higher P/E means the investor is paying more per dollar of net income so it should have a higher price than a similiar firm with a lower P/E. OFten quoted as a TTM (trailing 12 months) -market price per share/earnings per share
TVM facts
-money should grow in value as time moves forward, when interst is earned on interest, as well as on principal, this is called compounding -money should shrink in value as we move backwards in time, this is called discouting or using a discount rate -money today is worth more the the same amount in the future
Equity other than common and preferred stock
-new companies that are not yet producing much income and that do not have many assets often need to seek EQUITY from private parties, such as friends, relatives, and acquiantances. Professionals who provide equity to new companies that have strong potential are called angel investors and venture capitalists
Yield Curves
-normal yield curve suggest that interest rates will be raised in the future -a flat yield curve suggest that interest rates will be cut -an inverted yield curve suggests that interest rates will be dramatically cut
Buying and sellng stocks and bonds after the first sale
-owners of common stock, preferred stock, and most bonds sell them to others in the secondary market through what the text calles retail securities firm which is a stockbroker -most of such sales and purchases (called trades) are done online in the real world
Secured Creditor
-paid before unsecured creditors. their debt is secured by specific assets of the company - a specific asset could be a warehouse, inventory or vehicles
Preferred Stock vs common stock
-preferred stock: has no voting rights, dividends fixed, paid first Common stock: yes voting rights, no dividends fixed, paid first -both are part of Equity. - the common and preferred shareholders are the owners of the compnay -investors who own preferred and common stock are called shareholders or stockholders -equity is riskier than debt
Return on Equity (ROE)
-profitability ratio -how effect is the company in using is equity (investment funds) to generate profits -15%-20% are acceptable = net income (after tax)/ total equity * total equity is total shareholders equity
Return on Total Assets (ROA)
-profitability ratio -how effective is the company in using its assets to generate profits net income divided by total assets
Net Profit Margin
-profitability ratio -how much of a company's sales on a basis are generating net income net profit dividded by sales times 100
Gross Profit Margin
-profitability ratio -how much of the compnay's sales on a % basis are generating gross profits sales (Sales-COGS) gross profit divided by sales times 100
Balance Sheet
-reports a point-in-time snapshot of the assets, liabilities and equity of the entity. -lists all the company's assets (stuff it owns, uses to generate sales and profits) and all of the ways it uses to pay for thoses assets (liabilities(debt) and owners equity (stock + the company's accumulated net profits) equation: total assets = total liabilities + owners equity
Cash Flow From Operations (CFO)
-represents the actual cash that is generate from the operations of the company. The income statement is where much of the operations of the company is listed, but there are balance sheet accounts that are also part of the operations. These include accounts recieveables, inventory, accounts payable and accurals
Categorization of Risk Tolerance
-risk adverse or risk avoiding (they cannot tolerate uncertainty) -risk neutral -risk-loving or risk seeking (FOMO) -the general progression in the risk return spectrum is short term devt, long term devt, property, high yield debt, and equity
The yield curve
-shows the effects of teh liquidigy premium theory -the chart on which the yield curve is shown displays the "term structure of interest rates -shows that bonds with longer terms have higher yeild (rates) and bonds with shorter terms have lower yields (rates)
Payback info
-simple and convient to use -determines the time needed to recover the initial investment -the answer is given in units, such as years and portions of years
The amount of perferred dividend is
-stated as a percentage of the perferred stock, accourding to corporate charter, which is the legal document setting up the corporation
Systematic vs Non-systematic risk
-systematic risk affects common stock (like a roller coaster when it goes up you go up, when someone invest in common stock it goes up therefore the stock maret goes up) -systematic risk affects the entire stock market, not just a particular stock or industry. It is a risk that is unpredictable and impossible to avoid -unsystematic risk affects an individual stock. it can be reduced by "diversifying" or owning multiple stocks and other investments
Liquidity Premium Theory
-term structure of interest rate - long term rates refelct investor's future interest rate assumptions + a premium for holding long term bonds -Investors prefer short-term liquid securities but will be willing to invest in long-term securities if compensated with a premium for lower liquidity
Expectation Hypothesis
-term structure of interest rate -long term rate determned by the market's expectation for the short term rate plus a constant risk premiu the theory that yields to maturity are determined solely by expectations of future short-term interest rates
Segmented Markets Theory
-term strucuter of interest rates - S/T and L/T not substiutiable, rates are determined by Supply and demand -rates are determined by supply and demand; long and short-term debts are not substitutable
The Bond Market is Huge
-the amount of indebtedness via bonds is greater than the amount of indebtediness via bank loans -the bond market value is growing faster than the stock market during 24 of the past 25 years -the bond market is growing faster than the stock market -no calculations are required for bonds
Capital Budgeting
-the decision making process that businesses use to decide whether to invest money in new assets, such as a computer systems, equipment, buildings or any other assets that a compnay needs to expand and grow -is used to determine whether entirely new lines of products or servies (new projects) are worth pursing -businesses have various opportuniteis to make money, capital budgeting ranks those opportunities according to their potential profitability
Trading Stocks and Bonds Facts
-the first time issued, the issuing company receives most of the money -investment bankers are specialists who arrange for common stock, preferred stock, and bonds to be sold the first time (primary market) -stockbrokers or retail securities firms are used in the second market, which is where stock and bonds are traded (except not the first time)
What is an ideal method to evaluate captial investment projects?
-the method must consider TVM -net present value (NPV) does consider the TVM -(money today is worth more than the same amount of money in the future)
Shareholder preemptive rights
-the right to retain their proportional ownershiop in a company should it issue another stock offering ** the right to purchase additonal shares before they are made available to the public
Risk vs Return : BETA
-used to determine an investment's return sensitivity in relation to overal market risk -beta describes the correlated volatility of an asset in relation to the votalitiy of a benchmark generally estimated via the use of representative indicies, such as teh S&P 500 - Beta is also referred to as financial risk or market risk - higher beta investments tend to be more volatile and therefor risker, but provide the potential for higher returns. -lower beta investments poose less risk but generally have lower returns
Sales growth Rate
-used to forecast the income statement and balance sheet using the percentage of sales method of forecasting. All of the spontaneious accounts are changed by Sales Growth Rate. the change in spontaneous accounts also drives the forecast of the discretionary accounts -(forecasted sales / last years sales) -1
Common Stock Dividends
-vary widely among companies -they can also very from quater to quarter for the same company -to many investors in common stock, the dividend is only of secondary importance. The main reason that most investors buy common stock is the expectation that it will increase in value, and that they will be able to sell it for more than what they paid for it, which is called "gain"
Preferred stock Facts
-when dividends are paid, they are fixed -investors who buy mainly interested in fix dividends -stock dividends are paid beore common stock dividends
Rules of Bonds
-when market interest rates go up bond prices go down -when market interst rates go down bond prices go up
medium term (notes)
6-12 years
DFN (Discretionary Financing Needed) Formula
= assets-liabilities-equity
callable bonds
A callable bond (also called "redeemable bond") is a type of bond (debt security) that allows the ISSUER of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity.
What does a higher P/B ratio imply?
A higher P/B ratio implies that investors expect management to create more value from a given set of assets.
puttable bond
A puttable bond (put bond, putable, or retractable bond) is a bond with an embedded put option. The holder of the puttable bond has the right, but not the obligation, to demand early repayment of the principal.
sinking bond
A reserve account in which the issuer of a bond periodically retires some part of the bond principal prior to maturity so that enough capital will be accumulated by the maturity date to pay off the bond.
Regulation S
A safe harbor by the SEC to sell securities outside of the US without publicly registering.
Three parties key to the corporation's functioning are ____.
Managers, shareholders, and bondholders
The deviation from the principal's interest by the agent
Agency costs
Liabilities
Amounts owed to creditors Current Liabilites (debts we other other people in less than a year) Accounts Payable (debts we owe for operations...rent, utilities, office stuff) Accruals (payroll related debts we owe to employees and tax authorities) Notes payable (short term debt) Long term Debt (debt we owe that we pay for more than one year)
historical cost principle
An accounting principle that states that companies should record assets at their cost.
Securities Exchange Act of 1934
An act that regulates the trading of securities such as stocks and bonds in the secondary market -a law governing the secondary trading of securities in the United States of America. -also known as teh consumer protection laws for retail investors
The balance sheet is the only financial statement which __.
Applies to a single point in the calendar year
Accounting equation
Assets=Liabilities+Equity
Equity Multiplier
Average Total Assets / Average Stockholders' Equity
debenture bonds
Bonds that are unsecured (i.e., not backed by any collateral such as equipment). -an external source of financing
The three types of ________ are cash from operations, investing, and financing.
Cash Flow
Buying and Selling stocks and bonds
Common Stock, preferred stock, and most bonds are first sold in the primary market. the specialist who arrange for these sales are called investment bankers. the compnay that issues the stock or teh bonds recieves the money from the buyers, excepts for the amounts that the investment bankers and affiliated stockbrokers are paid
____ stockholders often have voting rights, exercising some measure of control over company board elections and corporate policy, while ____ stockholders usually lack these rights.
Common; preferred
Bond
a documentary obligation to pay a sum or to perform a contract; a debenture.
In order to be an annuity (and use the formulas explained in the annuity module), the cash flows need to have three traits:
Constant payment size Payments occur at fixed intervals A constant interest rate
Divdend Pay Out Ratio (b)
Dividends/net income
______ managers perform data analysis and advise senior managers on profit-maximizing ideas.
Financial
What type of activity is paying out a dividend?
Financing. Receiving a dividend from another company's stock is an investing activity.
A bond pays a coupon rate equal to the LIBOR rate plus 0.30%. The coupon rate is recalculated every three months. What type of bond is this?
Floating rate note
Finance is fundamentally a ____-looking field, while accounting is fundamentally a ___-looking field.
Forward; backward -accounting: organize and compile past information -Fiance: prepares one to decide what to do with that information "future", fund manangement and assset allocation
Additional Funds Needed (AFN)
Funds that a firm must raise externally through new borrowing or by selling new stock. -also known as DFN: descretionary financing needed or EFN: external financing needed
Gross profit margin
Gross Profit / Sales
Financial markets can address which problem faced by a company's management?
Information asymmetry
In using the percentage of sales forecasting method, the assumption is that ____.
Inventories will increase proportionately with sales
Reinvestment risk and interest rates are ____ correlated
Inversely. As interest rates rise, reinvestment risk goes down
In the bond market, firms raise debt financing directly from ____.
Investors
Why is IRR used?
It measures investment efficiency. the Higher the IRR, the better
Why is net present value used?
It uses the company's own discount rate with the time value of money
he primary goal of both investment and financing decisions is to ___________.
Maximize shareholder value
NASDAQ
National Association of Securities Dealers Automated Quotations
DuPont Equation (ROE)
Net Income / Sales X Sales / Total Assets X Assets / Equity or Net Margin X TAT X FLR
ROE (Return on Equity)
Net Income/Total Equity
DuPont Analysis Formula
Net Profit Margin×Asset Turnover×Equity Multiplier
Off-balance-sheet
Off-balance sheet (OBS), or Incognito Leverage, usually means an asset or debt or financing activity not on the company's balance sheet.
shareholder
One who owns shares of stock
When markety interest rates go up bond price go down if you sell the bond before it matures and
Price Risk is the name for the risk that market interest rates will go up causing your bond price to go down if you sell your bond before it matures - when market interest rates go down bond prices go up if you sell bond before it matures
Price of a callable bond
Price of callable bond = Price of straight bond - Price of call option.
Price of a puttable bond
Price of straight bond + Price of put option
private placement
Private placement (or non-public offering) is a funding round of securities which are sold not through a public offering, but rather through a private offering, mostly to a small number of chosen investors.
Earnings Per Share
Profit/weighted average common shares
AFN equation
Projected increase in assets - spontaneous increase in liabilities - any increase in retained earnings. If this value is negative, this means the action or project which is being undertaken will generate extra income for the company, which can be invested elsewhere.
Sustainable growth rate formula
ROE x (1-b) b=dividend payout ratio which is dividends/net income
Income Statement Breakdown
Revenue: sales of the companys products or services - COGS: all direct expenses =Gross Profit (aka Gross Margin): -operating expenses, (AKA S,Gs&A expenses)alaires, rent, office expenses -Depreciation/amortization Expense: Non-cash expenses, things we do not right a check for =Earnings before interest and Taxes (EBIT): aka operating profit and operating income - Interest expense: (notes payable and long term debt - earnings before taxes (EBT) - Taxes =net income
Who prefers riskier projects? (shareholder or bond holders)
Share holders do, because of the chance or probabiity of a higher expected return
Beta is also referred to as ___.
Systematic risk
Government Finance
The Study of public policy and government cash flows
Effective APR
The amount you pay after fees and compound interest have been added to the charges.
Capacity Utilization
a concept in economics and managerial accounting which refers to the extend to which an enterprise or a nation actually uses its installed productive capacity
What is financial leverage?
The equity multiplier. An indirect analysis of a company's use of debt to finance its assets. - the amount of debt that a compnay utilizes to finance its operations, as compared with the amount of equity that the company utilizes -increased leverage will lead to an increase in return on equity
Securities Act of 1933
The first major federal law regulating the securities industry. It requires firms issuing new stock in a public offering to file a registration statement with the SEC. -investors must be accuratley informed, often views as as for the primary investor -primary purpose is to ensure that buyers of securities receive complete and accurate information before they invest
compounding period
The length of time between the points at which interest is paid.
Bond Rule #2
The longer the bond's term, the higher the bond's yield. and The shorter the bond's term, the lower teh bond;s yield -the price of a bond with a longer term will be MORE affected by a change in interst rates (up or dow) than a Bond with a shorter term
face value (par value)
The payment to the bondholder at the maturity of the bond.
valuation
The process of estimating the market value of a financial asset or liability
Moral Hazard
The prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.
Which yield curve theory is based on the premises that financial instruments of different terms are not substitutable and therefore the supply and demand in the markets for short-term and long-term instruments is determined largely independently?
The segmented market hypothesis
Corporate Finance
The study of fund management by businesses (management) overtime -primary goal is to maximize shareholder value
Personal Finance
The study of household wealth management over time
Behavioral Finance
The study of stock market behavior
When crowding out occurs, investment spending decreases. What causes this phenomenon?
The total money supply is increased, increasing interest rates. * expansionary fiscal policy causes interest rates to rise, thereby reducing investment spending
The underlying driver behind all of finance is ____.
Time
premium bond
a debt instrument bought at a price above par value.
unsecured debt
Unsecured debt comprises financial obligations, where creditors do not have recourse to the assets of the borrower to satisfy their claims.
which type of risk can be diversified away - systematic or unsystematic?
Unsystematic
required return
What would a rational investor expect for the use of her money?
cost-push inflation
When prices rise due to an increase in the cost of production.
Drawbacks of DuPont Analysis
While expansive, it still relies on accounting equations and data that can be manipulated. Lacks context as to why the individual ratios are high or low, or even whether they should be considered high or low at all.
Debenture
a bond that is not secured by any company assets -an investor who owns a debenture is an unsecured creditor
Earnings Management
a euphemism, such as creative accounting, to refer to fraudulent accounting practices that manipulate reporting of income, assets, or liabilities with the intent to influence interpretations of the income statements.
Money Market
a market in which money is lent for periods of one year or less -a market for trading short-term debt instruments, such as treasury bills, commericial paper, banker's acceptances, and CD's
beta
a measure firms can use in order to determine an investment's return sensitivity in relation to overall market risk. Beta describes the correlated volatility of an asset in relation to the volatility of the benchmark that said asset is being compared to.
Profit Margin
a measure of profitability -indicator of a company's pricing strategies and how well the compnay controls costs
Effective Annual Rate (EAR)
a measurement of how much interest actually accrues per year if it compounds more than once per year
ratio
a number representing a comparison between two things.
Debtor
a person or firm that owes money, one in debt, or one who owes a debt.
Investment
a placement of capital in expectation of deriving income or profit from its use.
Rule of 72
a quick formula for computing how long it will take to double money invested at a given interest rate - Divide 72 by interest rate. if ten percent, divide by 10.
Recapitalization
a restructuring of a company's mixture of equity and debt.
Time series
a sequence of data points, measured typically at successive time instants spaced at uniform time intervals. Cross-sectional data refers to data collected by observing many subjects at the same point of time, or without regard to differences in time.
dividends
a small payment to each person who owns a stock of a company -payments made to shareholders -(it is a portion of the firms net income) -normally paid on a per share basis
annuity
a specified income payable at stated intervals for a fixed or a contingent period, often for the recipient's life, in consideration of a stipulated premium paid either in prior installment payments or in a single payment. For example, a retirement annuity paid to a public officer following his or her retirement.
variance
a statistical concept describing the range around expected return within which an investment return can be reasonably expected to fall.
nonprobability sample
a subset of the population in which the probability of getting any particular sample may be calculated, and therefore cannot be used to represent the whole population.
probability sample
a technique of studying a population subset in which the likelihood of getting any particular subset may be calculated.
liquidity premium
a term used to explain a difference between two types of financial securities (e.g., stocks), that have all the same qualities except liquidity.
mutual funds
a type of professionally-managed collective investment vehicle that pools money from many investors to purchase securities. The term is most commonly applied only to those collective investment vehicles that are regulated, available to the general public and open-ended in nature.
fungible
able to replace or be replaced by another identical item; mutually interchangeable
9 major types of financial institutions
central banks, retail and commercial banks, internet banks, credit unions, savings and loan associations, investment banks and companies, brokerage firms, insurance companies, mortgage companies
Values
collection of guiding principles, what one deems correct, important, desirable in life, especially regarding personal conduct
Owners Equity
common stock (ownership) retained earnings
In the event of bankruptcy, _____ stock investors receive any remaining funds after bondholders, creditors (including employees), and ____ stockholders are paid.
common; preferred
Yield
commonly refers to the dividend, interest or return the investor receives from a security like a stock or bond, and is usually reported as an annual figure.
principal-agent problem
concerns the difficulties in motivating one party (the "agent"), to act on behalf of another (the "principal"). -when the principles (shareholders) preferences are NOT aligned with the agents (managers) preferences
Expected Return
considering the magnitude and likelihood of exogenous events, the average yield that an investor predicts will be earned.
Ratio Anaylsis
consists of calculating financial performance using 5 basic types of ratios: profitability, liquidity, activity (efficiency), debt, and market -information comes from financial statements and is the foundation to fiancial anaylsis
Working Capital =
current assets - current liabilities
current ratio
current assets divided by current liabilities
Assets
current assets(can be converted to cash in less than a year) accounts payable( sales that we billedd to customers for purchases made on credit) Inventory: stuff we use to make products Fixed assets (equipment we've just purchased that we use to make what we sell) Goss Fixed Assets: Less Accumulated Deprecitation Net fixed assets
Net Income
gross profit minus operating expenses and taxes. Net earnings and net profit are also known as "net income." -only two things a firm can do with this: 1. pay them to share holders 2. retain them in the compnay's (retained earnings)
Four basic principles of GAAP
historical cost principle, revenue recognition principle, matching principle, and full disclosure principle.
Insider Trading Act of 1988
imposed stiff penalities for practicing insider traiding - SEC can impose upto 3 times the profit for punishment (acting before public knowledge)
demand-pull inflation
increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand
Interest rates and bond prices carry an ____ relationship.
inverse
Longitudinal Data
involves repeated observations of the same variables over long periods of time, often many decades
Internal growth rate
is a formula for calculating the maximum growth rate a firm can achieve without resorting to external financing
unlike bonds that are classified as a debt ____, preferred stock is considered an equity ____.
liability; asset
Liquidity ratio
liquid assets/short term liabilities
Price/Earnings (P/E) Ratio
market price per share/earnings per share
Efficiency Ratios
measure how effective is the company in using its assets to generate assets/income
Liquidity Ratios
measure how much cash is available for the compnay to pays its debt -current ratio and quick ratio (acid ratio test)
Profitability Ratios
measure the company use of assets and expenses to generate a return that's acceptable to its shareholders -5 types (operating margin, gross profit margin, net profit margin, return on total assets (ROA) and return on equity (ROE))
Debt Ratios
measure the firm's ability to pay its long term debt total debt/total assets or total liability /total assets * the higher the ratio the greater the risk associated with the firms operation
Market Ratios
measure the return and the value of teh company's stock and teh cost of issuing that stock -price/earning ratie (P/E) and price to book ratio
Free Cash Flow
net income plus depreciation and amortization, less changes in working capital, less capital expenditure.
Net Income Margin
net income/sales
ROE ratio
net profit/sales x sales assets /assets x assets/equity
Return an Assets Ratio
net profit/sales x sales/ total assets= netincome/total assets
Total Asset Turnover
net sales/average total assets
nominal rate
nominal rate refers to the rate before adjustment for inflation
Reinvestment Risk
occurs when bonds we have recently been paid our maturity value payment, we want to invest in another bond and market interest reates have gone down. (ie we had been earning 5% interest on bonds and bonds have now matured, rates have gone down, and new bonds only pay 4%. This means that we were recieving %50 interest per year, but now we can only receive $40 in interest per year because market interest rates have gone DOWN
Operating Margin Formula
operating income divided by revenue.
What are the 3 sections on the statement of cash flows?
operating, investing, and financing (OIF- oh if only we could remember)
types of Cash flow statements
operations (CFO) Investing (CFI) Financing (CFF)
long term (bonds)
over 12 years
The _____ is the simplest structure open to collaborative ownership.
partnership
payback
payback determines the time needed to recover the original investment
Which investment proposal ranking method is widely used due to its simplicity, despite having several limitations?
payback period
The word "net" in Net Present Value means that we are summing ____ and ____ cashflows. All such cash flows are shown at their ____ values.
positive; negative; present.
The following bond component is mainly determined by market interest rates and varies frequently
price
Price risk vs investment risk
price risk positively correlated to interest rates, reinvestment risk is inversely correlated -
Ratios
profitability liquidity debt market efficeincy
How is net present value used?
proposed projects with positive net present values are acceptable. The higher the NPV, the more desirable the proposed project
the main purposes of capital budgeting are to determine if proposed capital projects should be accepted and to ____ such proposals.
rank
Nominal Rate
refers to the rate before adjustment for inflation, the real rate is the nominal rate minus infation
Income Statement
reports on a company's expenses and profits to show whether the company made or lost money. -** a historical record of the sales, income and cost of the business over time - contains all of the revenue, expenses, interest and taxes that a company pays and reflects of that as Net Income (aka the bottom line). this reflects most of the firms operations.
Cash flow statement
reports the flow of cash in and out of the business, dividing cash into operating, investing and financing activities. - one purpose to explain the change in cashe form one period to the next
Cash Flow from Financing (CFF)
represents the amount of short term debt (notes payable), long term debt, preferred stock and common stock a company has either sold to the public, borrowed from a bank, or repaid over the current period. Is also subtracts any dividends that have been paid to equity holders.
Cash Flow from Investing (CFI)
represents the equipment, machinery, etc. that the company has purchased in the current period. It also includeds any investment of cash in things like bonds, stock etc. that the company has made in the current period.
Revenue Recognition Principle
requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received.
retention ratio
retained earnings divided by net income. = 1-b (b is the payout ratio, which is dividends divided by net income)
The most difficult aspect of preparing a financial forecast is predicting _____.
revenue
Which are components of an income statement?
revenues and expenses
Operating income
revenue—operating expenses. (Does not include other expenses such as taxes and depreciation).
Sales Growth Rate Formula using Calculator
shift 2nd #5 key (percent change), enter this years sales hit enter key hit down arrow key enter last years sales hit enter key hit down arrow key hit CPT key
Asset
something or someone of any value; any portion of one's property or effects so considered.
Which type of financial statement is used to determine the short-term viability of a company?
statement of cash flows
Preferred Stock
stock with a dividend, usually fixed, that is paid out of profits before any dividend can be paid on common stock. It also has priority to common stock in liquidation.
two common capital markets
stocks and bonds
call premium
the additional cost paid by the issuer for the right to buy back the bond at a predetermined price at a certain time in the futue
incremental cash flows
the additional money flowing in or out of a business due to a project.
External Financing Needed
the amount of financing a firm must raise from outside sources to acquire the assets necessary to support its forecasted level of sales
par value
the amount of money a holder will get back once a bond matures; a bond can be sold at par, at premium, or discount.
Price
the amount of money that is paid for the bod
Face Value (Maturity value)
the amount the bond will pay at the end when it matures
annual percentage rate
the annual rate charged for borrowing or earned through an investment, expressed as a percentage that represents the actual yearly cost of funds over the term of a loan.
A firm is trying to choose the most profitable project to invest in. Which feature should be used as the company's discount rate?
the company's reinvestement rate
interest rates
the cost of borrowing money; generally refers to the interest charged by a lender such as a bank on a loan. -based on the required return (or what financial investor would expect for the use of the money) : risk free rate= US treasures (zero fault risk) -since most investments carry risk we add a risk premium, an additional payment to motivate investor to provide funds
maturity
the date when a bond is due to be repaid
Gross profit
the difference between net sales and the cost of goods sold.
discretionary financing need
the difference between total assets and total liabilities and owner's equity. this is the amount the firm THINKS it will need to raise - tells how much additional financing (debt and or equity) the compnay nees for next year based on the forecast of the balance sheet and income statement DFN= Assets-liabilities- equity
Cost of Goods Sold (COGS)
the direct cost atrributes to goods produced and sold by a business. (material costs, direct labor)
liquidity
the ease with which an asset can be converted into cash
Net profit
the gross revenue minus all expenses.
discount rate
the interest rate used to discount future cash flows of a financial instrument; the annual interest rate used to decrease the amounts of future cash flow to yield their present value.
Benchmarking
the key to ratio anaylsis is the concept of benchmarking, which means comparing the company's ratio to something that is meaningful. The usual way to do this is to compare its ratios to those of their industry. industry ratios are available in a variety of publications. The most notable one is published by Dun and Bradstreet
Sustainable growth rate
the maximum rate of growth that a company or social enterprise can sustain without having to finance growth with additional equity or debt. * as the annual percentage of increase in sales that is consistent with a defined financial policy
Required rate of return
the minimum annual percentage earned by an investment that will induce individuals or companies to put money into a particular security or project. -fundamental building blocks are: risk free return (should get the more than if deposited in a saving account, and risk premium
actual interest rates
the nominal (stated) interest rate minus the inflation premium.
spontaneous liabilities
the obligations of a company that are accumulated as a result of the company's day-to-day business. An increase in spontaneous liabilities is normally tied to an increase in a company's cost of goods sold (or cost of sales).
capital market
the part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments. -used when wanting to purchase new equipment -for long term financial nees -has primary market and secondary market
