Managerial Finance test 1
Statement of Cash Flows
Financial statement that reports cash receipts and disbursements related to a firm's three major activities: operations, investments, and financing.
Discounting
How much would you be willing to pay to receive $1 in 1 year? Less then $1! If the discount rate is 5% you would pay 1/(1.05)=$.95238. How much would you pay to receive $100 dollars at a 5% discount rate? 100*.95238=$95.238 or 100/(1.05)=$95.238. How much would you pay to receive $100 in 2 years with a 5% discount rate? 100/(1.05)2=$90.703. In 3 years? 100/(1.05)3=$86.384.
Liquidity Ratios
Measures of the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.
NPV
Net Present Value - the difference between the present value of cash inflows and the present value of cash outflows. You would accept projects only with a positive NPV.
primary vs secondary markets
Primary = new-issue market Secondary = existing shares traded among investors
Money vs. Capital Markets
money - markets that trade debt securities with maturities of one year or less (e.g., CDs and U.S. Treasury bills); little or no risk of capital loss, but low return capital - markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year; substantial risk of capital loss, but higher promised return
Secondary Market
one owner selling to another.
cash flow from assets
operating cash flow - net capital spending - change in net working capital
primary market
original sale of securities by government and corporations
OTC
over the counter
Sarbanes-Oxley Act of 2002
provides sweeping new legal protection for employees who report corporate misconduct
effective interest rate
rate established when bonds are issued that maintains a constant value for interest expense as a percentage of bond carrying value in each interest period
Profitability Ratios
ratios that measure the rate of return a firm is earning on various measures of investment
Financial Ratios
relationships determined from a firm's financial information and used for comparison purposes current ratio= current assets divided by current liabilities
coefficient of variation
standard deviation/mean
Perpetuities
streams of equal payments that are expected to continue forever
Periodic Rate
the APR for a charge account divided by the number of billing cycles per year (usually 12)
Future Value
the amount of money in the future that an amount of money today will yield, given prevailing interest rates
par value
the amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity
bond market
the collective buying and selling of bonds; most bond trading is done over the counter, rather than in organized exchanges
Cash Flow
the difference between cash coming in and cash going out of a business
Working Capital
the difference between current assets and current liabilities
Marginal tax rate
the extra taxes paid on an additional dollar of income
Efficient Market Hypothesis
the hypothesis that prices of securities fully reflect available information about securities Weak form Semistrong form Strong form
nominal interest rate
the interest rate actually paid for a loan
Discounted Payback Period
the length of time required for an investment's discounted cash flows to equal its initial cost
Capital Structure
the mix of equity and debt financing a firm uses to meet its permanent financing needs
Supernormal/Non-constant Growth
the part of the firm's life cycle in which it grows much faster than the economy as a whole
Agency Problem
the possibility of conflict of interest between the principal and the agent
Capital Budgeting
the process of planning and managing a firm's long-term investments
expected return
the return on a risky asset expected in the future
stand-alone risk
the risk an investor would face if he or she held only one asset
standard deviation
the square root of the variance
Net Present Value (NPV)
the sum of the present values of expected future cash flows from an investment, minus the cost of that investment must select one method of analysis and provide an answer based solely on that method. most appropriate to use when two investments are mutually exclusive
sinking funds bonds
to reduce the holder's risk require the issuer to create a sinking fund of assets set aside at specified amounts and dates to repay the bonds
Portfolio Risk
total risk associated with owning a portfolio; sum of systematic and unsystematic risk
average tax rate
total taxes paid divided by total income
Quick Ratio
(Current Assets - Inventory) / Current Liabilities
Total Debt Ratio
(Total Assets - Total Equity) / Total Assets
Bond Yields
-Yield to Maturity -Yield to Call
preferred stock
A special type of stock whose owners, though not generally having a say in running the company, have a claim to profits before other stockholders do.
IPO
A stock or bond sold by a corporation for the first time. Proceeds (money from sale) may be used to retire debts, build new plants or buy new equipment or for additional working capital. (Initial Public Offering).
Net Operating Profit After Taxes (NOPAT)
The profit a company would generate if it had no debt and held only operating assets. EBIT(1-tax rate)
Perpetuity Formula
=(Cash Flow)/(discount rate - growth rate)
Operating Cash Flow
=NOPAT + Depreciation
Partnership
A business in which two or more persons combine their assets and skills disadvantages-unlimited liability, limited life, difficulty transferring ownership
Sole Proprietorship
A business owned by one person Keeps all profits, unlimited liability for business debts, all income is taxed as personal income, limited to owner's life span, amount of equity that cab be raised is limited to the proprietor's personal wealth.
Corporation
A business owned by stockholders who share in its profits but are not personally responsible for its debts double taxed also called- joint stock companies, public limited companies, or limited liability companies
Bond Ratings
A grade given to bonds that indicates their credit quality
Liquidity Premium (LP)
A premium added to the equilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to its "fair market value"
Maturity Risk Premium (MRP)
A premium that reflects interest rate risk; bonds with longer maturities have greater interest rate risk.
Stakeholders
All the people who stand to gain or lose by the policies and activities of a business and whose concerns the business needs to address.
APR
Annual Percentage Rate
Balance Sheet Equation
Assets = Liabilities + Owner's Equity
Payback Period
investment required/annual net cash inflow
Cash Ratio
Cash / Current Liabilities
Bond Valuation
Changes in bond prices due to changes in interest rates
Annuties
Designed to provide income for the policyholder during their lifetime.
Market Value Ratios
Ratios that relate the firm's stock price to its earnings and book value per share.
Market Interest Rates
Real Risk Free Rate of Interest (k*) ,The nominal, quoted, risk-free rate (krf), Inflation Premium (IP), Maturity Risk Premium (MRP), Liquidity Premium (LP), Default Risk Premium (DRP), Yields (Yield Curve)
Statement of Retained Earnings
Reports the way that net income and the distribution of dividends affected the financial position of the company during the accounting period.
Income Statement
Revenues - Expenses = Net Income period of time
Management Compensation
Stocks- share value- better leadership
correlation coefficient
Tendency to move together (correlation) and degree of relationship (r)
Default Risk Premium (DRP)
The difference between the interest rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability.
taxes on dividends
The maximum tax rate for cash dividends received from corporate stock investments is reduced to 15% for individuals with income under $400,000 ($450,000 for couples). If income exceeds these levels, the rate is increased to 20%. By taxing these cash distributions at lower rates, long term investment in stocks (as opposed to bonds) is promoted. This favorable tax treatment applies to both common and preferred stocks.
Net cash flow
The receipts of a business minus its payments Net income + Depreciation(non-cash expense)
Compounding
What is the future value (what amount will it have grown to) of $1 in 1 year at a market rate of 5%? 1*(1.05)=$1.05. What is the future value of $100 in 2 years at a market rate of 5%? 100*(1.05)2=$110.25. In three years? 100*(1.05)3=$115.7352. the process of accumulating interest on an investment over time to earn more interest
Maximize the market value of the equity
What is the goal of financial management for a sole proprietorship?
Capital Asset Pricing Model (CAPM)
a model that relates the required rate of return on a security to its systematic risk as measured by beta the relationship between risk and rates of return
Balance sheet
a statement of the assets, liabilities, and capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period. Assets=Liabilities +Shareholder's equity
annuity due
an annuity for which the cash flows occur at the beginning of the period
Zero Growth Stocks
assumes the dividend stream remains constant over time
Inflation Premium (IP)
average expected inflation rate over the life of a risk-free loan
callable bonds
bonds that may be repurchased by the issuer at a specified call price during the call period
Zero Coupon Bonds
bonds that pay no annual interest but are sold at a discount below par, thus compensating investors in the form of capital appreciation
Ratios
comparison,/evaluation purposes. Used by creditors, suppliers, customers, stockholders
Four Basic Areas of Finance
corporate finance, investments, financial institutions, international finance
Net Working Capital (NWC)
current assets - current liabilities 3 things to keep in mind when examining a balance sheet: liquidity,debt vs.equity, market value vs. book value
Dealer vs. Auction Markets
dealers- buy for themselves auction--physical location
Debt Management Ratios
degree to which a firm can meet it's long-term financial obligations
EAR
effective annual rate pg.45
Present Value
enter as a negative, A dollar today is worth more than a dollar tomorrow.
Asset Management Ratios
financial ratios that measure how effectively a firm is using its assets to generate revenues or cash
Beta
how a security moves with the market