Definitions Flashcards
Compound interest
The situation in which interest paid on an investment
during the first period is added to the principal.
During the second period, interest is earned on
the original principal plus the interest earned
during the first period.
Future value
The amount to which your investment will grow, or a future dollar amount
Future value factor
The value of (1 + r)^n used as a multiple to calculate an
amount’s future value.
Simple interest
If you only earned interest on your initial investment, it would be referred to as simple interest.
Present value
The value in today’s dollars of a future payment discounted back to present at the required rate of return.
Present value factor
The value of 1 / (1 + r)^n used as a multiplier to calculate an amount’s present value.
Annuity
A series of equal dollar payments made for a specified number of years.
Ordinary annuity
An annuity where the cash flows occur at the end of each period.
Compound annuity
Depositing an equal sum of money at the end of each year for a certain number of years and allowing it to grow.
Annuity future value factor
The value of [(1 + r)^n - 1 / r ] used as a multiplier to
calculate the future value of an annuity.
Annuity present value factor
The value of [1 - (1 + r)^-n / r ] used as a multiplier
to calculate the present value of an annuity
Annuity due
An annuity in which the payments occur at the beginning of each period.
Amortized loan
A loan that is paid off in equal periodic payments.
Effective annual rate (EAR)
The annual compound rate that produces the same
return as the nominal, or quoted, rate when something is compounded on a nonannual basis. In effect, the EAR provides the true rate of return.
Perpetuity
An annuity with an infinite life.
Incremental Cash Flow
The difference
between the cash flows a company will produce both with and without the investment it is thinking about making.
Opportunity cost,
The cost of making
a choice in terms of the next best alternative that must be foregone.
Efficient market
A market in which
the prices of securities at any instant in time fully reflect all publicly available information about the securities and their actual public values.
Agency problem
Problems and conflicts resulting from the separation of the
management and ownership of the firm.
Capital budgeting
The process of
decision making with respect to investments
made in fixed assets; that is, should a proposed project be accepted or rejected?
Capital structure decision
The
decision-making process with funding choices and the mix of long-term sources of funds.
Working capital management
The
management of the firm’s current assets and short-term financing.
Financial markets
Those institutions
and procedures that facilitate transactions
in all types of financial claims.
Sole proprietorship
A business owned by a single individual.
Partnership
An association of two or more individuals joining together as co-owners to operate a business for profit.
General partnership
A partnership in which all partners are fully liable for the indebtedness incurred by the partnership.
Limited partnership
A partnership in which one or more of the partners has limited liability, restricted to the amount of capital he or she invests in the partnership.
Corporation
An entity that legally
functions separate and apart from its owners.
S-corporation
A corporation that,
because of specific qualifications, is taxed as though it were a partnership.
Limited liability company (LLC)
A cross between a partnership and a corporation under which the owners retain
limited liability but the company is run and is
taxed like a partnership.
Weighted average cost of capital
The discount rate that is used to calculate the firm’s value.
Opportunity cost
The cost of making a choice defined in terms of the next best alternative that is foregone.
Financial policy
The mix of sources of funds that the firm uses when raising new money to finance its investments.
Cost of debt
The rate that has to be received from an investment in order to achieve the required rate of return for the creditors. This rate must be adjusted for the fact that an increase in interest payments will result in lower taxes. The cost is based on the debt holders’ opportunity cost of debt in the capital markets.
Flotation costs
The costs incurred by the firm when it issues securities to raise funds.
Cost of preferred equity
The rate of return that must be earned on the
preferred stockholders’ investment in order to satisfy their required rate of return. The cost is based on the preferred stockholders’ opportunity cost of preferred stock in the capital markets.
Cost of common equity
The rate of return that must be earned on the common stockholders’ investment in order to satisfy their required rate of return. The cost is based on the common stockholders’ opportunity cost of common stock in the capital markets.
capital structure
The mix of long-term sources of funds used by the firm. This is also called the firm’s capitalization. The rela tive total (percentage) of each type of fund is emphasized.
Divisional WACC
The cost of capital for a specific business unit or division.
Financial ratios
accounting data restated in relative terms in order to help
people identify some of the financial strengths and weaknesses of a company.
Liquidity
a firm’s ability to pay its bills on time. Liquidity is related to the ease and speed with which a firm can convert its noncash assets into cash, as well as to the size of the firm’s investment in noncash assets relative to its short-term liabilities.
