Business Finance

Internal rate of return

The discount rate that forces a pojects NPV to equal zero

Dividend

A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors. Dividends are payments made by publicly listed companies as a reward to investors for putting their money into the venture. Announcements of dividend payouts are generally accompanied by a proportional increase or decrease in a company's stock price

Dividend policy

A dividend policy is the policy company uses to structure its dividend payout to shareholders. Dividends are often part of a company's strategy. However, they are under no obligation to repay shareholders using dividends. Stable, constant, and residual are the three types of dividend policies. Even though investors know companies are not required to pay dividends, many consider it a bellwether of that specific company's financial health. Some researches suggest the dividend policy is irrelevant, in theory, because investors can sell a portion of their shares or portfolio if they need funds. This is the dividend irrelevance theory, which infers that dividend payouts minimally affect a stock's price

High-growth companies

A high-growth company whose business generates significant positive cash flows or earnings, which increases at significantly faster rates than the overall economy. A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Thus, it typically pays little to no dividends to stockholders opting instead to put most or all of its profits back into its expanding business

Mature companies

A mature company is a company that is well-established in its industry, with a well-known product and loyal customer following. Mature companies are categorized by their busines stage, in which they typically exhibit slow and steady growth. Because of their ability to generate steady revenue and prfit growth for many years, mature companies tend to pay dividends consistently

Net present value

A method of ranking investment proposals using the NPV, which value of the project's free cash flows discounted at the cost of capital

Mutually exclusive

A set of projects where only one can be accepted

Cost of Capital

Cost of capital represents the return a company needs in order to take on a capital project, such as purchasing new equipment or constructing a new buidling. Cost of capital typically encompasses the cots of both equity amd debt, weighted acccording to the company's preferred or existing capital structure, known as the weighted average cost of capital (WACC). A company's investment decisions for new projects should always generate a return that exceeds the firm's cots of capital used to finance the project-otherwise, the project will not generate a return for investors.

Undestand capital budgeting policy

Capital budegting is used by companies to evaluate major projects and investments, such as new olants or equipment. The process involves to determine whether the expected return meets a set benchmark. The major methods of capital budgeting included discounted cash flows, payback, and throughput analyses

"Capital"

Capital is the term for financial assets, such as funds held in deposit accounts and/or funds obtained from special financing sources. Capital can also be associated with capital of a company that requires significant amounts of capital to finance or expand

Capital Structure

Capital structure refers toa company's mix of capital, which consists of a combination of debt and equity. Equity consists of a caompany's common and preferred stock plus retained earnings. What constitutes debt varies, but typically includes short-term borroeing, long-term debt, and a portion of the principal amount of operating leases and redeemable preferred stock

Growth rates effect on expected return

Growth rates are used to express the annual change in a variable as a percentage, such as revenues or investents. Growth rates can be beneficial in assessing a company's performance and to predict future performance.

Stock's intrinsic value

Intrinsic value refers to somce fundamental, objective value contained in an asset or financial contract. If the market price is below that value it may be a good buy, and if above a good sale. When evaluatinng stocks, there are several methods for arriving at a fair assessment of a share's intrinsic value

Why some investors prefer dividends

Investors who prefer dividends could simply create their own dividend policy by selling a percentage of their stock each year. Most investors face transactions costs when they sell stock, so investors who are looking for a steady stream of income would logically prefer that companies pay regular dividends. Also, retirees who have accumulated wealth over time and now want annual income from their investments probably prefer dividend-paying stocks

Investments vs. Distribution

Once a company becomes profitable, itmust decide what to do with the cash it generates. It may choose to retain the cash and use it to purchase aditional operating assets, repay debt, or acquire other companies. Or it may choose to return the cash to shareholders. If shareholders prefer firms that return most of their earnings, then they should invest in a company with a low payout ratio. The optimal distribution policy is based on each specific share holder, but most companies seek to strike a balnce between investment and distribution

Independent

Projects with cash flows that are not affected by the acceptance or non-acceptance of other projects

Why some investors prefer retained earnings

The U.S. tax code encourages many individual investors to prefer capital gains over dividends. One key advantage is that taxes must be paid on dividends the year they are received, but taxes on capital gains are not paid until the stock is sold and the profit/loss is realized. Due to time value effects, a dollar of taxes paid in the future has a lower effective cost than a dollar of taxes paid today.

After-tax cost of debt

The after-tax cost of debt is the interest paid on debt less any income tax savings due to deductible interest expenses. To calculate the after-tax cost of debt, subtract a company's effective tax rate from 1, ad multiply the different by its cost of debt. The company's marginal tax rate is not used, rather, the company's state and the federal tax rate are added tigether to ascertain its effective tax rate.

Modified internal rate of return

The discount rate at which the present value of a project's cost is equal to the present value of its terminal value is found as the sum of the future values of the cash inflows, compounded at the firm's cost of capital

Discount dividend model (DDM)

The dividend discount model is a quantitative method used for predicting the price of a company's stock based on the theory that its present-day price is worth the sum of all its future dividend payments when discounted back to their present value. It attempts to calculate the fair value of stock irrespective of the prevailing market conditions and takes into consideration the dividend payout factors and the market expected returns. if the value obtained from the DDM is higher then the current trading price of shares, then the stock is undervalued and qualifies for a buy, and vise versa

Corporate Valuation model

a valuation model used as an alternative to the discounted dividend model to determine a firm's value, especially one with no history of dividends, or the value of a division of a larger firm. The corporate model first calculates the firm's free cash flows, then finds their present values to determine the firm's value

Payback

The length of time required for an investments cash flos to cover its cost

Discounted payback

The length of time required for an investments cash flows. discounted at the investment's cost of capital, to cover its cost

Differences between common stcok and preferred stock

The main difference between preferred and common stock is that preferred stock gives no voting rights to the shareholders while common stock does. Preferred stock shareholders have a priority over a company's income, meaning they are paid dividends before common stock shareholders. Common stock shareholders are last in line when it comes to company assets, which means they will be paid out after creditors, shareholders, and preferred stock shareholders.

Capital Components

There are three main sources: debt, preferred stock, and common equity. These are all called the components of capital. Debt either long-term or short-term, preferred stock, is similiar to debt because it has predictable fixed dividends and common equity- which is raised by selling common stock to investors.

Treasury stock

Treasury stocks are stocks that have been repurchased and is being held by the issuing company. A treasury stock reduces total shareholders equity on a company's balance sheet, and it is therfore a contra equity account. There are two methods to record treasury stock; the cost method and the par value method

Corporate decision and firm value

corporate decsions should be analyzed in terms of how alternative courses of actions are likely affected before attempting to measure how a given decision will affect the value of a company's stock

Required rate of return

the minimum rate of return on a common stock that a stockholder considers acceptable. Different investors typically have different opinions, but the key is again the marginal investor. The determinates of the required rate of return, exoected inflation, and risk

Expected rate of return

the rate of return on a common stock that a stockholder expects to receive in the future. The expected return can be above or below the required return, but a rational investor will buy the stock if the expected rate of return, exceeds the required rate of return. Sell the stock if the expected rate of return is less than the required rate of return. Hold the stick if these returns are equal. The main key is the investor, whose views determine the actual stock price.

Weighted Average Cost of Capital

the weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionally weighted. All sources of capital, including common stock, preferred stock, bonds, and any other ling-term debt, are included in the WACC, you must multiply the cost of each capital component by its proportional weight. The sum of these results, in turn, is multiplied by 1 minus the corporate tax rate.