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CFA Level 1 > Corporate Finance > Flashcards

Corporate Finance Flashcards

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1
Q

Corporate Governance

A

System of internal controls and procedures (checks and balances) that minimizes and manages conflicts of interest between insiders and external shareholders

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2
Q

Shareholder Theory

A

Primary focus of corporate governance is the interests of the firm’s shareholders, which is the maximization of market value of firm’s common equity

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3
Q

Stakeholder Theory

A

Considers conflicts among several groups that have an interest in the activities and performance of the firm (employees, suppliers, customers, etc.)

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4
Q

Principal-Agent Conflict

A

Agent is hired to act in the interest of the principal, but agent’s interests might not coincide with those of the principal

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5
Q

Information Asymmetry

A

Managers have more and better information about the functioning of the firm and its strategic direction than shareholders do

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6
Q

Related Party Transactions

A

Agreements or specific transactions that benefit entities in which they have a financial interest, to the detriment of minority shareholders

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7
Q

Stakeholder Management

A

Management of company relations with stakeholders based on having good understanding of stakeholder interests and maintaining effective communication with stakeholders

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8
Q

Legal Infrastructure

A

Laws relevant to and the legal recourse of stakeholders when their rights are violated

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9
Q

Contractual Infrastructure

A

Contracts between the company and its stakeholders that spell out the rights and responsibilities of the company and stakeholders

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10
Q

Organizational Infrastracture

A

Company’s corporate governance procedures (internal systems and practices)

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11
Q

Governmental Infrastructure

A

Regulations to which companies are subject

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12
Q

Proxy

A

Shareholder assigns right to vote to another who will attend the meeting (director, management, financial advisor)

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13
Q

Special Resolutions

A

Require supermajority vote for passage (two thirds or three fourths). Mergers, takeovers, amending corporate bylaws

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14
Q

Majority Voting

A

Candidate with the most votes for each single board position is elected

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15
Q

Cumulative Voting

A

Shareholders can cast all their votes for a single candidate or divide them among board candidates (greater minority shareholder representation)

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16
Q

One Tier Board

A

Single board of directors that includes both internal (executive) and external directors

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17
Q

Independent Directors

A

Non-executive directors who have no other relationship with the company

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18
Q

Two Tier Board

A

Supervisory board that excludes executive directors. Management board with executive directors. Both operate independently

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19
Q

Staggered Board

A

Elections for some board positions are held each year. Limits the ability of shareholders to replace board members in any one year

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20
Q

Audit Committee

A

Oversight of financial reporting, implementation of accounting policies, effectiveness of internal controls and internal audit, recommending external auditor, proposing remedies

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21
Q

Governance Commitee

A

Oversight of governance code, implementing code of ethics, managing conflicts of interest, ensuring compliance with laws and regulations

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22
Q

Nominations Committee

A

Proposes qualified candidates for election to the board, aligns board’s composition with company’s corporate governance policies

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23
Q

Compensation Committee

A

Remuneration. Recommends amounts and types of compensation to be paid to directors and senior managers. Oversight of employee benefits

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24
Q

Risk Committee

A

Informs board about appropriate risk policy and risk tolerance of the organization

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25
Q

Investment Committee

A

Reviews and reports proposals for large acquisitions or projects, sale or disposal of company assets or segments, performance of acquired assets

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26
Q

Activist Shareholders

A

Pressure companies in which they hold a significant number of shares for changes, often changes they believe will increase shareholder value

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27
Q

Proxy Fight

A

Seek the proxies of shareholders to vote in favor of their alternative proposals and policies

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28
Q

Tender Offer

A

Offer made for a specific number of shares of a company to gain enough votes to take over the company

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29
Q

Hostile Takeover

A

Senior managers and boards of directors can be replaced by shareholders in a move not supported by company management

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30
Q

Common Law System

A

Judges’ rulings become law (shareholder and creditor interests benefit)

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31
Q

Civil Law System

A

Judges are bound to rule based only on specifically enacted laws

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32
Q

Dual Class Structure

A

One class of shares may be entitled to several votes per share, while another class is entitled to one vote per share

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33
Q

ESG Investing

A

Use of environmental, social, and governance factors in making investment decisions (sustainable/responsible investing)

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34
Q

Negative Screening

A

Exclusionary, Norms-Based. Excluding companies in specific industries from consideration for the portfolio based on their practices regarding human rights, environmental concerns or corruption.

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35
Q

Positive Screening

A

Investors attempt to identify companies that have positive ESG practices

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36
Q

Best In Class

A

Seeks to identify companies within each industry group with the best ESG practices

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37
Q

Impact Investing

A

Investing to promote specific social or environmental goals while still making profitable investments

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38
Q

Green Finance

A

Producing economic growth achieved in a more sustainable way by reducing emissions and better managing natural resource use

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39
Q

Green Bonds

A

Bonds for which the funds raised are used for projects with a positive environmental impact

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40
Q

Thematic Investing

A

Investing in an industry or sector based on a single goal

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41
Q

Capital Budgeting Process

A

Process of identifying and evaluating capital projects (projects where the cash flow to the firm will be received over a period longer than a year)

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42
Q

Replacement Projects to Maintain the Business

A

Made without detailed analysis (can existing operations continue)

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43
Q

Replacement Projects for Cost Reduction

A

Determine whether equipment that is obsolete, but still usable, can be replaced (detailed analysis)

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44
Q

Expansion Projects

A

Taken on to grow the business (require explicit forecast of future demand –> very detailed analysis)

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45
Q

New Product or Market Development

A

Detailed analysis due to large amount of uncertainty involved

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46
Q

Mandatory Projects

A

Required by a governmental agency or insurance company (safety related or environmental concerns). Generate little to no revenue

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47
Q

Other Projects

A

Pet projects of senior management, high-risk endeavors (difficult to analyze)

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48
Q

Incremental Cash Flows

A

Changes in cash flows that will occur if the project is undertaken

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49
Q

Sunk Costs

A

Costs that cannot be avoided, even if the project is not undertaken. Not affected by the accept/reject decision, not included in analysis (consulting fees)

50
Q

Externalities

A

Effects the acceptance of a project may have on other firm cash flows (can be positive or negative)

51
Q

Cannibalization

A

Occurs when a new project takes sales from an existing project

52
Q

Conventional Cash Flow Pattern

A

Sign on the cash flows changes only once (one or more cash outflows followed by one or more cash inflows)

53
Q

Unconventional Cash Flow Pattern

A

More than one sign change (initial investment outflow, a series of inflows, cash outflow at the end)

54
Q

Opportunity Costs

A

Cash flows that a firm will lose by undertaking the project under analysis (cash flows generated by an asset the firm already owns that would be forgone if the project is undertaken)

55
Q

Independent Projects

A

Projects that are unrelated to each other and allow for each project to be evaluated based on its own profitability

56
Q

Mutually Exclusive Projects

A

Only one project in a set of possible projects can be accepted (projects compete with each other)

57
Q

Project Sequencing

A

Investing in a project today creates the opportunity to invest in other projects in the future (project undertaken today is profitable, can invest in a second project down the road)

58
Q

Capital Rationing

A

If a firm’s profitable project opportunities exceed the amount of funds available, firm must ration, or prioritize, its capital expenditures

59
Q

Net Present Value

A

Sum of the present values of all the expected incremental cash flows if a project is undertaken

60
Q

Discount Rate

A

Cost of capital adjusted for the risk level of the project

61
Q

Internal Rate of Return

A

Discount rate makes the present value of the expected incremental after tax cash inflows just equal to the initial cost of the project –> PV(inflows) = PV(outflows) –> Discount rate for which which NPV of a project equals zero
IRR > required rate of return, accept the project
IRR < required rate of return, reject the project

62
Q

Payback Period

A

Number of years it takes to recover the initial cost of an investment (when cumulative net cash flow equals zero)

63
Q

Cumulative Net Cash Flow

A

Running total of the cash flows at the end of each time period

64
Q

Discounted Payback Period

A

Number of years it takes a project to recover its initial investment in present value terms (greater than the payback period without discounting)

65
Q

Profitability Index

A

Present value of a project’s future cash flows divided by the initial cash outlay
PI > 0, accept the project
PI < 0, reject the project

66
Q

NPV Profile

A

Graph that shows a project’s NPV for different discount rates (x axis = discount rates, y axis = NPVs)

67
Q

Crossover Rate

A

Discount rate at which the NPVs of two projects are equal

68
Q

Weighted Average Cost of Capital

A

Marginal Cost of Capital. Rate at which to discount the cash flows associated with a capital budgeting project (k). Cost of financing firm assets (opportunity cost). Average risk of the projects that make up the firm

69
Q

Capital Components

A

Right side of the balance sheet (liabilities). Debt, preferred stock, common equity

70
Q

Component Cost

A

Cost of the capital components. Increase in firm’s total assets is financed through increase in at least one of these capital accounts

71
Q

Kd

A

Rate at which the firm can issue new debt (YTM on existing debt)

72
Q

Kd(1 - t)

A

After tax cost of debt (t is marginal tax rate) used to calculate WACC. Interest rate at which firms can issue new debt net of the tax savings from the tax deductibility of interest

73
Q

Kps

A

Cost of preferred stock

74
Q

Kce

A

Cost of common equity. Required rate of return on common stock

75
Q

Target Capital Structure

A

Proportions based on market values of debt, preferred stock and equity that the firm expects to achieve over time

76
Q

Marginal Cost of Capital Curve

A

Firm’s WACC may increase as larger amounts of capital are raised (cost of raising additional capital) –> upward sloping

77
Q

Investment Opportunity Schedule

A

Given expected returns (IRRs) on potential projects, order expenditures on additional projects from highest to lowest IRR. Ranking of all the projects available to a company

78
Q

Optimal Capital Budget

A

Intersection of investment opportunity schedule and marginal cost of capital curves. Firm should undertake all projects with IRRs greater than cost of funds

79
Q

Matrix Pricing

A

Valuing a bond based on the yields of comparable bonds (same rating yield curve)

80
Q

Dividend Discount Model

A

Dividends are expected to grow at a constant rate (g), gives current value of stock

81
Q

Beta

A

Measure of systematic or market risk (based on business risks of its projects and financial structure)

82
Q

Pure Play Method

A

Estimate a company’s beta based on a publicly traded company engaged in a business similar to, and with risk similar to, project under consideration (engaged purely in similar business)

83
Q

Asset Beta

A

Adjust pure play beta from comparable company for company’s leverage (unlever) and then adjust (re-lever)

84
Q

Country Risk Premium

A

Reflect the increased risk associated with investing in a developed country (beta does not adequately capture country risk). Added to market risk premium when using CAPM

85
Q

Sovereign Yield Spread

A

Difference in yields between the developing country’s government bonds and Treasury bonds of a similar maturity

86
Q

Developing Country Equity Risk Premium

A

Adjust sovereign yield spread by ratio of volatility between country’s equity market and government bond market

87
Q

Marginal Cost of Capital

A

Cost of raising an additional dollar of capital

88
Q

Marginal Cost of Capital Schedule

A

WACC for different amounts of financing (upward slope)

89
Q

Break Points

A

Occur any time the cost of one of the components of a company’s WACC changes

90
Q

Flotation Costs

A

Fees charged by investment bankers when a company raises external equity capital (2%-7%) –> adjust the initial project cost (multiply flotation cost rate by amount of equity capital raised, then subtract that number from initial cash outlay)

91
Q

Market Risk Premium

A

Expected return of the market minus the risk free rate

92
Q

Leverage

A

Amount of fixed costs a firm has. Greater leverage leads to greater variability of firm’s after tax operating earnings and net income

93
Q

Business Risk

A

Risk associated with a firm’s operating income. Result of uncertainty about a firm’s revenues and expenditures necessary to produce those revenues. Combination of sales and operating risk

94
Q

Sales Risk

A

Uncertainty about the firm’s sales

95
Q

Operating Risk

A

Additional uncertainty about operating earnings caused by fixed operating costs (greater proportion of fixed to variable costs)

96
Q

Financial Risk

A

Additional risk firm’s common stockholders must bear when the firm uses fixed cost (debt) financing

97
Q

Degree of Operating Leverage

A

Percentage change in operating income (EBIT) that results from a given percentage change in sales –> highest at low levels of sales

98
Q

Degree of Financial Leverage

A

Ratio of the percentage change in net income (or EPS) to the percentage change in EBIT

99
Q

Degree of Total Leverage

A

Combines degree of operating leverage and degree of financial leverage. Measures sensitivity in EPS to changes in sales

100
Q

Breakeven Quantity of Sales

A

Quantity of sales for which revenues equal total costs, so net income is zero. Sales a firm must generate to cover all fixed and variable costs

101
Q

Contribution Margin

A

Difference between price and variable cost per unit

102
Q

Operating Breakeven Quantity of Sales

A

Consider only fixed operating costs and ignore fixed financing costs

103
Q

Primary Sources of Liquidity

A

Sources of cash it uses in its normal day to day operations

104
Q

Cash Balances

A

Result from selling goods and services, collecting receivables, generating cash from other sources (short term investments)

105
Q

Short Term Funding

A

Trade credit from vendors and lines of credit from banks

106
Q

Secondary Sources of Liquidity

A

Liquidating short term or long lived assets, negotiating debt agreements, filing for bankruptcy and reorganizing the company

107
Q

Drags on Liquidity

A

Delay or reduce cash inflows or increase borrowing costs (uncollected receivables, bad debts, obsolete inventory, tight short term credit)

108
Q

Pulls on Liquidity

A

Accelerate cash outflows (paying vendors sooner than is optimal and changes in credit terms that require paying outstanding balances)

109
Q

Operating Cycle

A

Average number of days it takes to turn raw materials into cash proceeds from sales

110
Q

Cash Conversion Cycle

A

Length of time it takes to turn the firm’s cash investment in inventory back into cash, in the form of collections from the sales of inventory

111
Q

Daily Cash Position

A

Uninvested cash balances a firm has available to make routine purchases and pay expenses as they come due

112
Q

Adjustable Rate Preferred Stock

A

Dividend rate reset quarterly to current market yields (percent of dividends received exempt from federal tax)

113
Q

Aging Schedule

A

Calculate average days of receivables over time. Can make percentage of total outstanding receivables

114
Q

Weighted Average Collection Period

A

Indicates average days outstanding per dollar of receivables (weights % of total receivables in each category, multiplied by average days to collect)

115
Q

Uncommitted Line of Credit

A

Bank extends offer of credit for a certain amount but may refuse to lend if circumstances change

116
Q

Committed Line of Credit

A

Bank extends offer of credit that it commits to for certain period of time

117
Q

Revolving Line of Credit

A

For longer terms than committed lines of credit. Can be verified and listed on firm’s financial statements in footnotes as source of liquidity

118
Q

Blanket Lien

A

Gives bank a claim to all current and future firm assets as collateral in case primary collateral is insufficient

119
Q

Banker’s Acceptances

A

Used by firms that export goods. Guarantee from the bank of the firm that has ordered the goods stating that a payment will be made upon receipt of the goods

120
Q

Factoring

A

Actual sale of receivables at a discount from their face values. Factor (buyer) takes on responsibility of collecting receivables and credit risks

121
Q

Commercial Paper

A

Short-term debt securities that can be issued by large, creditworthy companies. Interest costs slightly less than rate they could get from bank

CFA Level 1 (7 decks)

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