Ch 8 & 9 FIN 3403

What is an NPV Profile? What is the crossover point on an NPV profile? Be able to calculate. Be able to choose, from a group of projects, which ones to invest in given various statistics about the projects and a limited amount of cash to invest.

An abbreviation for net present value profile. An NPV profile charts the net present value of a business activity as a function of the cost of capital. This comparison allows decision-makers to determine the profitability of a project or initiative in different potential financing scenarios, enabling more effective cost-benefit planning.

What is the return from capital gains on a share of common stock?

An increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price 2.Profit that results when the price of a security held by a mutual fund rises above its purchase price and the security is sold (realized gain)

Average Accounting Return (no calculation)

An investments average net income divided by its average book value.

What is the purpose of capital budgeting analysis?

The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark.

What is the problem with using IRR with non-conventional cash flows? With mutually exclusive projects?

IRR is unreliable with non-conventional cash flows or mutually exclusive ... Cannot be used to rank mutually exclusive projects

What is equity capital?

Invested money that, in contrast to debt capital, is not repaid to the investors in the normal course of business. It represents the risk capital staked by the owners through purchase of a company's common stock (ordinary shares).

Discuss the structure of a corporation (shareholders, board of directors, management)

Shareholders, board of directors elected by shareholders, CEO (chief executive and other corporate officers appointed), Middle Management, Supervisory management, and employees. Voting upon Board of directors by those who own common stock. The board of directors is responsible for governing the corporation and for establishing and overseeing corporate policy on a wide range of financial and procedural matters.

Payback Period

The amount of time required for an investment to generate cash flows suffiecient to recover its initial cost. Weakness is coming off witht he right cutoff period

Net Present Value

The difference between an investments market value and its cost. Should be accepted if it is positive and rejected if negative

Internal Rate of Return

The discount rate that makes the npv of an investment zero

Discounted Payback Period

The length of time required for an investments discounted cash flows to equal its initial cost.

Profitability Index

The present value of an investment's future cash flows divided by its initial cost. Also, benefit-cost ratio.

Explain characteristics of dividends

1.Unless a dividend is declared by the board of directors of a corporation, it is not a liability for the corporation, a corporation cannot defualt on an undeclared dividend. 2. Payments of dividends by the corporation is not a business expense. Dividends paid out of the corporations aftertax porfits. 3. Dividends recieved by individual shareholders are taxable.

What is preferred stock?

A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights.

What is a proxy?

A grant of authority by a shareholder to someone else to vote his or her shares -much of voting in large public corporations are don this way

What is the dividend yield?

A stock's expected cash dividend divided by its current price.

What are characteristics of equity?

Equities are assets of a company spread among shareholders of stock. An equity investment means buying of shares of a corporation. The investor buys shares in order to receive income from dividends and capital gains, as the value of the stock rises.

Know how to calculate the value of a share of stock given assumptions about future dividends What is the theory behind why expected dividends can be used to value a share of stock? In the long run, why is this a valid assumption? What are the issues with this method of valuing equity? How are earnings or sales multiples used to value stock as an alternative to future dividend models?

The value of a share f stock can be estimated by using the PV of future dividends. An alternative valuation procedure, called the "corporate valuation model," calls for finding the expected future free cash flows, discounting those cash flows at the weighted average cost of capital, summing the PVs of the free cash flows, subtracting the market values of debt and preferred to calculate the value of the common equity, and then dividing by the number of shares outstanding to find the value of a share of common stock. In theory, the two methods should produce the same stock value.

Explain why minority shareholders might prefer cumulative voting over straight voting

With straight voting, you have a number of votes equal to the number of shares you have, and you vote on each director's seat separately. But with cumulative voting, the number of votes you have is the number of shares you have times the number of directors' seats there are. Cumulative voting allows minority participation.