FIN 338 Final Exam Study Guide

maintain

It is extremely important to _____ dividends but much less important to initiate or increase dividend payments.

70 30

__% of the dividends received by one corporation from another are excluded from taxable income, while the remaining __% are taxed at the ordinary rate.

MIRR

assumes that cash flows from all projects are reinvested at the cost of capital, not at the project's own IRR- better indicator of a projects true profitability than IRR

total investor supplied capital

total amount of short-term debt, long-term debt, preferred stock, and total common equity shown on a balance sheet- the amount of financing that investors have provided to a company

security

refers to a publicly traded financial instrument as opposed to a privately placed instrument

free cash flow

the cash flow available for distribution to all the company's investors after the company has made all investments necessary to sustain ongoing operations

investment timing options

gives companies the option to delay a project rather than implement it immediately- allows a company to reduce the uncertainty of market conditions before it decides to implement the project

interest

_____ charges are NOT included in project cash flows.

restricted voting rights

a provision that automatically deprives a shareholder of voting rights if the shareholder owns more than a specified amount of stock

spontaneous liabilities

liabilities that grow with sales, such as accounts payable and accruals

lead underwriter

managing underwriter; the banking house that sets up the deal

residual

Firms should use the ____ distribution policy to help set their long-run target distribution ratios, but not as a guide to the distribution in any one year.

stockholders creditors inside owner managers outside owners outside stockholders hired managers

Primary agency relationships are between: 1) ______ and _____ 2) _____ _____/_____ (managers who own a controlling interest in the company) and _____ ____ (who have no control) 3) _____ ______ and ____ _____

securitize

Procedures have been developed to ____ various types of debt instruments, thus increasing their liquidity, lowering the cost of capital to borrowers, and generally increasing the efficiency of the financial markets.

economic life

the number of years a project should be operated to maximize its net present value- often less than the maximum potential life

corporate governance

the set of laws, rules, and procedures that influence a company's operations and the decisions its managers make

a d

Which are factors of the WACC that a firm cannot control? a) interest rates in the economy b) the firm's capital budgeting decision rules c) the firm's capital structure d) the general level of stock prices

flotation costs

_____ ___ represent the fees that firms pay to investment bankers to help them issue new common stock.

mutually exclusive

_____ _____ projects are two ways of accomplishing the same result, so if one project is accepted, then the other must be rejected.

capital components

_____ ______ are funds that come from investors.

classified boards

a board of directors with staggered terms

opportunity cost

a cash flow that a firm must forgo in order to accept a project

annual vesting

a certain percentage of the options in a grant vest each year

Hamada equation

shows the effect of debt on the beta coefficient- increases in debt increase beta, and decreases in debt reduce beta

reverse split

situation in which shareholders exchange a particular number of shares of stock for a smaller number of new shares

classified stock

sometimes created by a firm to meet special needs and circumstances- generally when used, one type is designated "Class A", "Class B", and so on- each may be entitled to certain rights

statement of stockholders equity

statement showing the beginning stockholders' equity, any changes due to stock issues/ repurchases, the amount of net income that is retained, and the ending stockholders' equity

window dressing techniques

techniques employed by firms to make their financial statements look better than they really are

horizon value

terminal value or continuing value; the value of operations at the end of the explicit forecast period- equal to the present value of all free cash flows beyond the forecast period, discounted back to the end of the forecast period at the weighted average cost of capital

going public

the act of selling stock to the public at large by a closely held corporation or its principle stockholders

preliminary prospectuses

a prospectus that may be distributed to potential buyers prior to approval of the registration statement by the SEC- after the registration has become effective, the securities, accompanies by the prospectus, may be offered for sale; "red herring" prospectus

liquidity ratios

a ratio that shows the relationship of a firm's cash and other current assets to its current liabilities

annual report

a report issued annually by a corporation to its stockholders- contains basic financial statements as well as management's opinion of the past year's operations and the firm's future prospects

Monte Carlo simulation

a risk analysis technique in which a computer is used to simulate probable future events and thus to estimate the likely profitability and risk of a project

asset management ratios

a set of ratios that measure how effectively a firm is managing its assets

scenario analysis

a shorter version of simulation analysis that uses only a few outcome- often the outcomes are for three scenarios: optimistic, pessimistic, and most likely

asymmetric information

assumes managers have more complete information than investors and leads to a preferred "pecking order" of financing: (1) retained earnings, followed by (2) debt, and then (3) new common stock; singling theory

tax effect theory

assumes that because dividends are in some cases taxed more highly than capital gains, investors might require a higher pre-tax rate of return to induce them to buy dividend-paying stocks

quiet period

begins when the registration statement is made effective and lasts for 40 days after the stock begins trading- purpose is to create a level playing field for all investors by ensuring that they all have access to the same information

market risk

beta risk; the risk of the project as seen by a well-diversified stockholder who owns many different stocks- measured by its effect on the firm's overall beta coefficient

TIE ratio

determined by dividing earnings before interest and taxes by the interest charges- measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs

low-regular-dividend-plus-extras policy

dividend policy in which a company announces a low regular dividend that is sure can be maintained; if extra funds are available, the company pays a specially designated extra dividend or repurchases shares of stock

reserve borrowing capacity

exists when a firm uses less debt under "normal" conditions than called for by the trade-off theory- allows the firm some flexibility to use debt in the future when additional capital is needed

dividend irrelevance theory

holds that dividend policy has no effect on either the price of a firm's stock or its cost of capital

market multiple analysis

multiplies a market-determined ratio to some value of the target firm to estimate the target's value- multiple can be based on net income, earnings per share, sales, book value, or number of subscribers

ROIC

net operating profit after taxes divided by the operating capital

unsyndicated stock offering

new selling procedure that recently emerged that takes advantage of the trend toward institutional ownership of stock- the managing underwriter, acting alone, sells the issue entirely to a group of institutional investors, thus bypassing both retail stockbrokers and individual investors

interlocking boards of directors

occur when the CEO of Company A sits on the board of Company B while B's CEO sits on A's board

growth option

occurs if an investment creates the opportunity to make another potentially profitable investments that would not otherwise be possible, including options to expand output, to enter a new geographical market, and to introduce complementary products or successive generations of products

stock repurchases

occurs when a firm repurchases its own stock- these shares are then referred to as treasury stock

capital rationing

occurs when management places a constraint on the size of the firm's capital budget during a particular period

going private

occurs when the entire equity of a publicly held firm is purchased by a small group of investors, with the firm's current senior management usually maintaining or increasing their ownership stakes

book building

occurs when the investment banker records the number of shares each investor is willing to buy

cannibalization

occurs when the new business eats into the company's existing business

complementary

project in which case cash flows in the old operation will be increased when the new one is introduced

expansion projects

projects in which the firm makes an investment in

replacement projects

projects in which the firm replaces existing assets, generally to reduce costs

registration statement

required by the SEC before a company's securities can be offered to the public- used to summarize various financial and legal information about the company

value of operations

the present value of all expected future free cash flows then discounted at the weighted average cost of capital

net present value

the present value of the project's expected future cash flows, discounted at the appropriate cost of capital- direct measure of the value of the project to shareholders

going private

the process by which a public company ceases to be a public company- the entire equity of the company is purchased by a smaller group of investors

capital gain

the profit from the sale of a capital asset for more than its purchase price

investment banks

underwriters; a firm that assists in the design of an issuing firm's corporate securities and in the sale of the new securities to investors in the primary market

days sales outstanding

used to appraise accounts receivable and indicates the length of time the firm must wait to receive cash after making a sale- found by dividing receivables by average sales per day

constant growth model

valuation assuming constant growth in free cash flow or dividends

leveraged buyout

way to bond cash flow where a large amount of debt and small amount of cash are used to finance the purchase of a company's shares, after which the firm "goes private"

seasoned equity offering

when a company with publicly traded stock issues additional shares

benchmarking

when a firm compares its ratios to other leading companies in the same industry

oversubscribed

when investors are wishing to purchase more shares than are available

increasing marginal cost of capital

when the cost of capital increases as the capital budget increases

accounting profit

Net income is sometimes called _______ ____.

self supporting growth rate

the maximum growth rate the firm could achieve if it had no access to external capital

NPV

When evaluating mutually exclusive projects, the ___ method is usually the better decision criteria.

operating activities

activities that focus on the amount of cash generated by the firm's operating activities

financing activites

activities that include raising cash by issuing short-term debt, long-term debt, or stock- includes dividend payments, stock repurchases, and principle payments on debt

investing activities

activities that include transactions involving fixed assets or short-term financial investments

cliff vesting

all the options in a grant vest on the same date

abandonment option

allows a company to reduce its output in response to changing market conditions- includes the option to contract production or abandon a project if market conditions deteriorate too much

inventory turnover ratio

cost of goods sold divided by inventories

margin calls

require investors either to put up more money or have their margined stock sold to pay off their loans

carrot

The main ____ in corporate governance is compensation.

NOPAT

the amount of profit a company would generate if it had no debt and no financial assets

interest debtholders repay debtholders dividends shareholders repurchase stock stockholders short investments

5 good uses of cash flow: 1) pay ____ to _____- the net cost to the company is the after-tax interest expense 2) ___ _____ 3) pay _____ to ______ 4) ______ ____ from ______ 5) buy ___-term _______ in other non-operating assets

B

A company is considering investing in a project in which the risk is greater than the firm's current risk based on any method of risk. Which of the following should management do when evaluating this project? a) they should always reject the project, because it will increase the firm's risk level b) to take the higher risk level into account, they will need to use a discount rate that is greater than the cost of capital to evaluate the project c) to take the higher risk level into account, they will need to increase the IRR of the project d) to take the higher risk level into account, they will need to increase the NPV of the project

making a market

A dealer who holds a certain inventory of the shares of a particular company and then offers to buy or sell that company's stock is said to be ____ __ ____.

capital structure dividend investment

A firm can affect its cost of capital through: 1) its _____ ____ policy 2) its ______ policy 3) its ______ (capital budgeting) policy

a

A negatively assigned AFN value represents: a) a surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends b) a shortage of internally generated funds that must be raised outside the company to finance the company's forecasted future growth c) a point at which the funds generated within the firm equal the demands for funds to finance the firm's future expected sales requirements

decrease

Accounts payable and accrued liabilities represent obligations that the firm must pay off. Assuming everything else holds constant, if they increase, the firm's AFN will ______.

SEC

After the stock market crash in 1929, the ___ was established to protect investors from fraudulent investment and to regulate the securities industry.

historical premiums current premium experts current market

Approaches to estimate the market risk premium: 1) calculate ______ ____ and use them to estimate the ____ ____ 2) survey _____ 3) use the _____ value of the ____ to estimate forward-looking premiums

venture capital fund

As the company grows, its financing requirements may exceed the resources of individual investors, in which case it is likely to turn to a ____ ____ ___.

more

Capital budgeting is the process of planning and controlling investments in assets that are expected to produce cash flows for ___ than one year.

net worth

Common equity is sometimes called ___ ___.

A B

Evaluate the effect of each following factor and place a check next to each factor that is likely to increase a firm's need for external capital- that is, AFN a) the firm switches its supplier for the majority of its raw materials. The new supplier offers less favorable credit terms and this reduces the trade credit available to the firm, resulting in a reduction in accounts payable b) the firm's forecasted sales unexpectedly increased c) the firm previously thought its fixed assets were being operated at full capacity, but now it learns that is actually has excess capacity

interest rates credit crises market risk premium tax rates

Factors beyond managerial control: 1) _____ ___ 2) ____ _____ 3) _____ ___ _____ 4) ____ ____

subtracted

Flotation costs will be _____ from the amount the firm will receive from issuing its new bonds.

angel investors

For most start ups, the first round of external financing comes through a private placement of equity to one or more individual investors called ____ _____ who in return may receive a seat on the board of directors.

differentials incremental

For replacement projects, find the cash flow ______ between the new and old projects, and these are the _____ cash flows to be analyzed.

a c

For which of the following reasons are capital budgeting decisions important to a business organization? a) capital investments have multiyear life spans, so mistakes linger for a long time b) capital investments are relatively inexpensive c) capital investments are difficult to reverse without incurring large additional expenses

statement of corporate objectives

Green Moose Industries has told its operating managers that it wants to attain a 40% market share, a 15% ROE, and a 8% earnings growth rate. This would be an example of a ______ __ _______.

mission statement

Green Moose Industries's board of directors has stated that "The firm's goal is to maximize shareholder wealth over time." This statement most likely represents the firm's ____ _____.

greater equal

If a firm cannot invest retained earnings to earn a rate of return ____ than or ____ to the rehired rate of return on retained earnings, it should return those funds to its stockholders.

leveraged buyout

If a public company is bought using borrowed funds, it is referred to as a _____ ____- the outside equity in a buyout often comes from a private equity fund

selling group

If the IPO involves a large amount, investment banks form a _____ ____ to distribute and sell the securities.

always

If the crossover rate on the NPV profile is below the horizontal axis, the methods will ____ agree.

best efforts

If the investment bank does not guarantee the sale of the securities, the investment bank is working on a ___ ____ deal.

best efforts

In a ____ ____ sale, the bank does not guarantee that the securities will be sold or that the company will get the cash it needs, only that it will put forth its "best efforts".

lower

In general, the ____ the risk of a firm as perceived by its existing and potential investors, the lower the firm's cost of capital.

nonaccredited investors

In most public offerings, investors are classified based on their profiles. Individual investors with relatively less net worth than senior executives, directors, and high-wealth investors are referred to as _____ _____.

municipals

Interest received from most state and local government bonds, called _____, is not subject to federal taxation.

taxes brokerage costs

MM's initial dividend theory made a number of important assumptions- the absence of ____ and ____ ___.

brokerage costs taxes bankruptcy costs same the same debt

MM's study was based on these assumptions: - there are no _____ ____ - there are no ___ - there are no _____ ____ - investors can borrow at the ___ rate as corporations - all investors have __ ___ information as management about the firm's future investment opportunities - EBIT is not affected by the use of ___

increased higher increase less

Maturity structure: - Suppose a company took a 2-year debt that could be rolled for a 10-year asset maturity- it would have to pay a higher rate if interest rates _____ - a firm is likely to use short-term debt when managers expect ____ earnings that will ____ the value of the firm's stock - secured debt is ___ costly than unsecured debt

underwritten

On an ______ issue, the company gets a guarantee: the bank agrees to buy the entire issue and then resell the stock to customers.

increases

On average, if a company splits its stock or declares a stock dividend, this will _____ the market value of its stock- probably due to signaling because managers engage in these practices if they think future earnings will increase.

10

Once the investment bank sells the securities, investors must pay the bank within ___ days.

2 20

Ordinary corporate operating losses can be carried backward for __ years or forward for __ years to offset taxable income in a given year.

hybrid par value dividends omit

Preferred stock is a ____ because like bonds, it has a ___ ___ and a fixed amount of _____ must be paid on it before they can be paid on the common stock, however, if the preferred dividends are not earned, directors can ___ it without throwing the company into bankruptcy like common stock.

d a c b

Put the following activities of the capital budgeting process in order: a) estimating the relevant cash flows b) reviewing a project's post-implementation and post-termination performance c) evaluating alternatives and selecting the projects to be implemented d) generating capital investment project proposals

gather data statement of cash flows ROIC FCF ratio analysis

Steps of financial analysis: 1) ____ ____ 2) examine the _____ ____ ____ ____ 3) calculate and examine the ____ and ____ 4) begin ___ ____

broker open market tender offer block negotiated

Stock repurchases are made in 1 of 3 ways: 1) a publicly owned firm can buy back its own stock through a ____ on the ___ ____ 2) a firm can make a ____ ____, under which it permits stockholders to send in shares in exchange for a specified price per share 3) the firm can purchase a ____ of shares from one large holder on a _____ basis

True

Sunk costs should not be included in the calculation of a project's cash flow stream. This represents a recommended practice for the estimation of a project's cash flow stream.

True

TRUE/ FALSE: A firm's WACC reflects the composite cost of debt preferred stock, and comma equity capital.

False

TRUE/ FALSE: A project's cash flows should be measured on a pretax basis. This represents a recommended practice for the estimation of a project's cash flows.

False

TRUE/ FALSE: Because most firms tens to raise funds in large, lumpy amounts, their WACCs should reflect the individual, after-tax cost of the particular source of funds used to finance an investment project.

true

TRUE/FALSE: Going private helps save administrative costs related to securities registration, reports, and investor relations.

true

TRUE/FALSE: Listing a stock in an exchange can lead to a decrease in the cost of equity for the firm and an increase in the value of the firm's stock.

true

TRUE/FALSE: The underwriter is likely to promote the shares by distributing analyst reports on the stock to its associate brokerage house.

after

The calculation of the weighted average cost of capital should be on the ___-tax cost of the net dollar of financing capital to be raised.

independent

The cash flows for ______ projects are not affected by other projects.

inflation

The EAA approach to evaluating projects with unequal lives does not do a good job of taking ____ into account.

IRR cost of capital

The IRR method assumes that cash flows are reinvested at a rate of return equal to the ___. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the ___ __ _____.

required rate of return IRR

The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the ____ ___ __ ____, and the IRR calculation assumes that the rate at which cash flows can be reinvested is the ___.

dividend policy capital structure

The financial plan incorporates the company's _____ policy, which determines the targeted size and method of cash distributions to shareholders and the ____ ____, which determines the targeted mix of debt and equity used to finance the firm- in turn determines the relative mix of distributions to shareholders and payments to debt holders.

stick

The main ____ in corporate governance is the threat of removal.

corporate scope

The market has a tendency to value focused firms more highly than diversified ones, particularly when firms have diversified their operations into areas about which management knows little in the pursuit of sales growth. Having a clearly defined and reasonable _____ ____ can help a firm avoid expanding into areas that could get the firm into trouble in the long run.

volatile

The ready availability of information causes stock prices to be _____.

less

The stock of a privately owned firm is ___ liquid than that of a publicly held firm.

free cash flows

The value of operations depends on all the future expected ___ ___ ___, defined as after-tax operating profit minus the amount of new investment in working capital and fixed assets necessary to sustain the business.

increases reduces

Theories say that underpricing _____ the likelihood of oversubscription, which ____ the risk to the underwriter.

annually semiannually

Unless operating in a rapidly changing environment, firms will generally calculate their current WACC _____ or ______.

equal

When a project has an NPV of $0, the project is earning a rate of return ____ to the project's WACC. It's OK to accept a project with an NPV of $0, because the project is earning the required minimum rate of return.

A B C

Which of the following are assumptions of the sustainable growth model? a) the firm pays out a constant proportion of its earnings as dividends b) the firm will not issue any new stock next year c) the firm's total asset turnover ratio remains constant d) the firm uses all equity and no debt financing

a c

Which of the following are examples of a capital budgeting process? a) Company A's investment in a research and development program b) Company B's $25,000 investment in short-term marketable securities c) Company C's investment in employee education and training programs

A

Which of the following is correct? a) a firm's WACC should decrease if its tax rate increases, but the yield to maturity of its noncallable bonds remains the same and all other factors are held constant b) the market value of a firm's debt and equity tends to stay more stable over time. consequently, the firm should use the book value weight to define its optimal capital structure c) a firm's after-tax cost of preferred stock may be significantly less than its before-tax cost, because issuing preferred stock dividends creates a tax shelter

A B

Which of the following statements about the financial planning process are true? a) the firm will need to calculate the amount of funds it will be able to generate internally. If that is not enough capital to support the financial plan, the firm will need to raise external funds to support the financial plan or the plan will have to be revised to focus on the highest value opportunities b) new computer software has made it easier for top-level managers to monitor the workings of the financial plan, and that has reduced the need for analysts and "middle managers" who previously developed, maintained, and explained the financial plan c) firms should use a performance-base management compensation system that is abde on a manager's ability to achieve short-run success

a c d

Which of the following statements are true about the activities involved in the IPO process? a) the underwriter selects institutional clients and takes the IPO team on a roadshow to make presentations to these clients across different cities b) during the roadshow, the IPO team can make forecasts and express their opinions about the projected value of the company after the IPO to lure institutional investors c) issuing firms mostly allow underpricing of their IPO because the company wants to create excitement and have a successful IPO, which would help the company in future offerings d) the investment banker estimates the potential demand for the securities by recording the number of shares that each investor is willing to buy (called book-building)

A B

Which of the following statements are true? a) the SEC does not allow companies to specify or limit which groups or types of investors to whom a company can issue securities b) as soon as a company decides to sell stock to prospective investors, it starts to advertise in order to increase the marketability of its new shares c) the SEC evaluates the information give in the prospectus and has the right to delay or stop a public offering if the information is misrepresented or if material facts are not included in the prospectus d) the SEC requires that all marketing and promotional material be distributed, along with the prospectus, to all prospective investors

b

Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? a) the DPB period is calculating using net income instead of cash flows b) the DPB period does not take the project's entire life into account c) the DPB period does not take the time value of money into account

sunk cost

a cost that already occurred and is not affected by the capital project decision- not relevant to capital budgeting decision

proxy

a document giving one person the authority to act for another, typically the power to vote shares of common stock

competitive bid

a firm decides to raise capital and has made a preliminary decision to sell a block of securities to the entity that makes the highest offer

DuPont equation

a formula showing that the rate of return on equity can be found as the profit margin multiplied by the product of total assets turnover and the equity multiplier

SEC

a government agency that regulates the sales of new securities and the operations of securities exchanges- helps ensure stable markets, sound brokerage firms, and the absence of stock manipulation

private equity fund

a limited liability partnership created to own and manage investments in nontraded equity

forecasted financial statements method

a method of forecasting financial statements to determine the additional funds needed

DCF approach

a method of valuing a business that involves the application of capital budgeting procedures to an entire firm rather than to a single project

EVA

a method used to measure a firm's true profitability found by taking the firm's after-tax operating profit and subtracting the annual cost of all the capital a firm uses

depreciation

a non-cash charge against tangible assets, such as buildings or machines- is taken for the purpose of showing an asset's estimated dollar cost of the capital equipment used up in the production process

cost of new common equity

a project financed with external equity must earn a higher rate of return because it must cover the flotation costs, thus this is higher than that of common equity raised internally by reinvesting earnings

S corporations

a small corporation that, under Subchapter S of the Internal Revenue code, elects to be taxed as a proprietorship or a partnership yet retains limited liability and other benefits of the corporate form of organization

balance sheets

a statement of the firm's financial position at a specific point in time- the firm's assets are listed on the left-hand side; the right-hand side shows its liabilities and equity, or the claims against these assets

capital budget

a summary of planned investments of assets that will last more than a year

progressive tax

a tax system in which the higher one's income, the larger the percentage paid in taxes

underinvestment problem

a type of agency problem in which high debt can cause managers to forgo positive NPV projects unless they are extremely safe

entity multiple

a type of market multiple that calculates the entity values of a company by multiplying EBITDA by and EBITDA market multiple- used to value the entire company, not just the stock

ESOPs

a type of retirement plan in which employees own stock in the company

dividend reinvestment plans

allows stockholders to automatically purchase shares of common stock of the paying corporation in lieu of receiving cash dividends- one plan involves stock that is already outstanding in which the dividends of all participants are pooled and the stock is purchased on the open market- participants benefit from lower transaction costs; the other involves newly issued stock where the company issues new shares to participants- issues stock in lieu of the cash dividend

trend analysis

an analysis of a firm's financial ratios over time- used to estimate the likelihood of improvement or deterioration in its financial situation

proxy fight

an attempt to take over a company in which an outside group solicits existing shareholders' proxies in an effort to overthrow management and take control of the business

agency costs

an expense, either direct or indirect, that is borne by a principal as a result of having delegated authority to an agent

NASD

an industry group primarily concerned with the operation of the over-the-counter market

NPV break-even analysis

analysis that finds the level of an input that produces an NPV of exactly zero

common size analysis

analysis where all income statement items are divided by sales and all balance sheet items are divided by total assets

percentage change analysis

analysis where growth rates are calculated for all income statement items and balance sheet accounts relative to a base year

agency relationship

arises when someone called a principal hires someone called an agent to perform some service, and the principle delegates decision-making authority to the agent

roadshow

before an IPO, the senior management team and the investment banker make presentations to potential investors- they make three to five presentations daily over a 2-week period in 10 to 20 cities

BEP ratio

calculated by dividing earnings before interest and taxes by total assets- shows the raw earning power of the firm's assets before the influence of taxes and leverage

profit margin

calculated by dividing net income by sales- gives the profit per dollar of sales

P/E ratio

calculated by dividing price per share by earrings per share- shows how much investors are willing to pay per dollar of reported profits

average tax rate

calculated by taking the total amount of tax paid divided by taxable income

financing feedback

circularity created when additional debt causes additional interest expense, which reduces the addition to retained earnings, which in turn requires a higher level of debt, which causes still more interest expense, cause the cycle to be repeated

ordinary income

consists primarily of wages or profits from a proprietorship or partnership, plus investment income

stock split

current shareholders are given some number (or fraction) of shares for each stock share owned

FCF valuation

defines the total value of a company as the present value of its expected free cash flows discounted at the weighted average cost of capital plus the value of non-operating assets such as T-bills

bird in the hand

dividend preference theory; assumes that investors value a dollar of dividends more highly than a dollar of expected capital gains, because a certain dividend is less risky than a possibly capital gain- implies that a high-dividend stock has a higher price and lower required return, all else held equal

EBITDA

earnings before interest, taxes, depreciation, and amortization

coefficient of variation

equal to the standard deviation divided by the expected return- a standardized risk measure that allows comparisons between investments having different expected returns and standard deviations

strike price

exercise price; the price stated in the option contract a which the security can be bought (or sold)

equity risk premium

expected market return munis the risk-free rate

project financing

financing method in which the project's creditors do not have full recourse against the borrowers; the lenders and lessors must be paid from the project's cash flows and equity

horizon date

forecast horizon or terminal date; the last year in the forecast

ROE

found by dividing net income by common equity

profitability index

found by dividing the project's present value of future cash flows by its initial cost- when greater than 1, the project will have a positive NPV

quick ratio

found by taking current assets less inventories and then dividing by current liabilities

shelf registration

frequently, companies will file a master registration statement and then update it with a short form statement just before an offering- termed this because companies put new securities "on the shelf" and then later sell them when the market is right

preemptive right

gives the current shareholders the right to purchase any new shares issued in proportion to their current holdings-enables current owners to maintain their proportionate share of ownership and control of the business

targeted share repurchases

greenmail; occurs when a company buys back stock from a potential acquirer at a price that is higher than the market price- in return, the potential acquirer agrees not to attempt to take over the company

holder-of-record date

if a company lists the stockholder as an owner on this date, then the stockholder receives the dividend

residual distribution model

in this model, firms should pay dividends only when more earnings are available than needed to support the optimal cash budget

nonoperating assets

include investments in marketable securities and non-controlling interests in the stock of other companies

accredited investors

include the officers and directors of the company, high-wealth individuals, and institutional investors

stock dividends

increases in the number of shares outstanding but at a slower rate than splits- current shareholders receive additional shares on some promotional bases- thus, a holder of 100 shares would receive 5 additional shares at no cost if a 5% dividend were declared

sensitivity analysis

indicates exactly how much net present value will change in response to a given change in an input variable, other things held constant- sometimes called "what if" analysis because it answers this type of question

current ratio

indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future- found by dividing current assets by current liabilities

symmetric information

information assuming that investors have the same information about a firm's prospects as its managers

signaling content

information content; a theory that holds that investors regard dividend changes as "signals" of management forecasts- thus, when dividends are raised, this is viewed by investors as recognition by management of future earnings increases- if a firm's stock price increases with a dividend increase, the reason may not be investor preference for dividends but rather expectations of higher future earnings; conversely, a dividend reduction may signal that management is forecasting poor earnings in the future

managing underwriter

investment bank that organizes and leads the syndicate

trading operations

investment banks buy and sell securities on behalf of clients and for themselves to make profits- in this process, they sometimes accumulate large positions that become difficult to sell

matchmaking

investment banks find potential targets for acquirers and earn a fee if the deal goes through

securitization

investment banks often purchase institutional loans, bundle them to create new securities, and sell these new securities to investors- this helps distribute risk

recapitalize

means the firm should issue enough additional debt to optimize its capital structure and then use the debt proceeds to repurchase stock; recap

total asset turnover ratio

measures the turnover of all the firm's asset- calculated by dividing sales by total assets

accounting beta method

method in which a regression is run of the division's accounting return on assets against the average return on assets for a large sample of companies

pure play method

method where the company tries to find the betas of several publicly held specialized companies in the same line of business as the division being evaluated, and then averages those betas to determine the cost of capital for its own division

selling group

on larger offerings more investment banks are included in this group which includes all members of the underwriting syndicate plus additional dealers who take relatively small percentages of the total issue from the members of the underwriting syndicate

net operating working capital

operating assets minus operating current liabilities

managerial options

options that give opportunities to managers to respond to changing market conditions; real options, strategic options embedded options

target distribution ratio

percentage of net income distributed to shareholders through cash dividends or stock repurchases

target payout ratio

percentage of net income paid as a cash dividend

vesting period

period during which employee stock options cannot be exercised

nonpecuniary benefits

perks that are not actual cash payments, such as lavish offices, memberships at country clubs, corporate jets, and excessively large staffs

flexibility options

permit the firm to alter operations depending on how conditions change during the life of the project

shareholder rights provision

poison pill; allows existing shareholders to purchase additional shares of stock at a price that is lower than the market value if a potential acquire purchases a controlling stake in the company

operating profit margin

ratio of earnings before interest and taxes divided by sales

gross profit margin

ratio of gross profit (sales minus cost of goods sold) divided by sales

profitability ratios

ratios that show the combined effects of liquidity, asset management, and debt on operations

market value ratios

relate the firm's stock price to its earrings and book value per share

statement of cash flows

reports the impact of a firm's operating, investing, and financing activities on cash flows over an accounting period

founders shares

stock owned by the firm's founders that have sole voting rights but restricted dividends for a specified number of years

prospectus

summarizes information about a new security issue and the issuing company

tracking stock

target stock; stock whose dividends are tied to a particular part of a company

clientele effect

the attraction of companies with specific dividend policies to those investors whose needs are best served by those policies- thus, companies with high dividends will have a clientele of investors with low marginal tax rates and strong desires for current income; conversely, companies with low dividends will have a clientele of investors with high marginal tax rates and little need for current income

unlevered beta

the beta the firm would have if it had no debt

flotation cost

the cost incurred during the security issuing process

crossover rate

the cost of capital at which the NPV profiles for two projects intersect

operating current assets

the current assets used to support operations, such as cash, accounts receivable, and inventory- does not include short-term investments

operating current liabilities

the current liabilities that are a natural consequence of the firm's operations, such as accounts payable and accruals- does not include notes payable or any other short-term debt that charges interest

payment date

the date on which a firm actually mails dividend checks

declaration date

the date on which a firm's directors issue a statement declaring a dividend

ex-dividend date

the date when the right to the dividend leaves the stock- established by stockbrokers to avoid confusion, and it is 2 days prior to the holder-of-record date- if stock sale is made prior, then the dividend is paid to the buyer; if the stock is bought on or after, the dividend is paid to the seller

MVA

the difference between the market value of the firm (sum of the market value of common equity, the market value of debt, and the market value of preferred stock) and the book value of the firm's common equity, debt and preferred stock

spread

the difference between the price at which an underwriter sells the stock in an initial public offering and the proceeds that the underwriter passes on to the issuing firm; the fee collected by the underwriter- often about 7% of the offering price

IRR

the discount rate that equates the present value of the expected future cash inflows and outflows- measures the rate of return on a project, assuming all cash flows can be reinvested at this rate

optimal distribution policy

the distribution policy that maximizes the value of the firm by choosing the optimal level and form of distributions (dividends and stock repurchases)

capital intensity ratio

the dollar amount of assets required to produce a dollar of sales

externalities

the effects of a project on other parts of the firm or on the environment

intrinsic value of equity

the estimated value of operations plus non- operating assets minus the value of debt and the value of preferred stock

operating leverage

the extent to which fixed costs are used in a firm's operations- if a high percentage of a firm's total costs are fixed costs, then the firm is said to have a high degree of leverage; is a measure of one element of business risk but does not include the second major element, sales variability

financial leverage

the extent to which fixed-income securities (debt and preferred stock) are used in a firm's capital structure

entity valuation model

the free cash flow valuation model because it values the entire company, not just its common stock

project cash flows

the incremental cash flows of a proposed project

intrinsic stock price

the intrinsic value of equity divided by the number of shares

capital loss

the loss from the sale of a capital asset for less than its purchase price

venture capitalists

the manager of a venture capital fund- the fund raises most of its capital from institutional investors and invests in start-up companies in exchange for equity

capital structure

the manner in which a firm's assets are financed- that is, the right side of the balance sheet; normally expressed as the percentage of each type of capital used by the firm such as debt, preferred stock, and common equity

margin requirements

the margin is the percent of a stock's price that an investor has borrowed in order to purchase the stock- the SEC sets these, which is the maximum percentage of debt that can be used to purchase a stock

discounted payback

the number of years it takes a firm to recover its project investment based on discounted cash flows

payback period

the number of years it takes a firm to recover its project investment- does not capture a project's entire cash flow stream and is thus not the preferred evaluation method- does measure a project's liquidity, so many firms use it as a risk measure

payout ratio

the percent of net income that the firm pays out in dividends

retention ratio

the percent of net income that the firm retains

percentage flotation cost

the percentage of proceeds paid to the investment bankers

distribution policy

the policy that sets the level of distributions and the form of the distributions (dividends and stock repurchases)

equity multiplier

the ratio of assets to common equity

ROA

the ratio of net income to total assets

fixed assets turnover ratio

the ratio of sales to net fixed assets- measures how effectively the firm uses its plant and equipment

debt ratio

the ratio of total debt to total assets- measures the percentage of funds provided by investors other than preferred or common shareholders

liabilities to assets ratio

the ratio of total liabilities to total assets- measures the percentage of funds provided by creditors

improper accumulation

the retention of earnings by a business for the purpose of enabling stockholders to avoid personal income taxes on dividends

financial risk

the risk added by the used of debt financing, which increases the variability of earnings before taxes (but after interest)- thus, along with business risk, it contributes to the uncertainty of net income and earnings per share

business risk

the risk inherent in the operations of the firm, prior to the financing decision- inherent in future operating income or earnings before interest and taxes; caused by many factors- most important are sales variability and operating leverage

private placement of public equity

the sale of stock to only one or a few investors, usually institutional investors- advantages are lower flotation costs and greater speed, since the shares issued are not subject to SEC registration

private placements

the sale of stock to only one or a few investors, usually institutional investors- the advantages are lower flotation costs and greater speed, since the shares issued are not subject to SEC registration

optimal capital budget

the set of projects that maximizes the value of the firm

total net operating capital

the sum of NOWC and operating long-term assets

net cash flow

the sum of net income plus non-cash adjustments

marginal tax rate

the tax rate on the last unit of income

total investor supplied operating capital

the total amount of short-term debt, long-term debt, preferred stock, and total common equity shown on a balance sheet, less the amount of short-term investments shown on the balance sheet- the amount of financing used in operations that investors have provided a company

total intrinsic value

the value of operations plus the value of short-term investments (assuming the company owns no other non operating assets- true for most companies)

stand alone risk

the variability of the project's returns- ignore diversification by both the firm and its stockholders

capital budgeting

the whole process of analyzing projects and deciding whether they should be included in the capital budget

lumpy assets

those assets that cannot be acquired smoothly and instead require large, discrete additions

incremental cash flows

those cash flows that arise solely from the asset that is being evaluated

flotation costs

those costs occurring when a company issues a new security, including fees to an investment banker and legal fees

AFN equation

those funds required from external sources to increase the firm's assets to support a sales increase- those funds that are required but not generated internally must be obtained from external sources

corporate risk

with-in firm risk; the variability the project contributes to the corporation's returns, giving consideration to the fact that the project represents only one asset of the firm's portfolio of assets and so some of its risk will be diversified away