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