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business finance > exam 1 - ch 1, 2, 3, and 5 > Flashcards

exam 1 - ch 1, 2, 3, and 5 Flashcards

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1
Q

what is the goal of the firm?

A

maximize shareholder value

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2
Q

what are the 5 principles of finance?

A
  1. cash flow is what matters
  2. money has a time value
    - meaning that a dollar received today is worth more than a dollar received in the future
  3. risk requires a reward
  4. market prices are generally right
  5. conflicts of interest cause agency problems
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3
Q

what are the 3 basic issues addressed by the study of finance?

A
  • What long-term investments should the firm undertake? - capital budgeting decision
  • How should the firm raise money to funny these investments? - capital structure decision
  • How to manage cash flows arising from day-to-day operations - working capital decision
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4
Q

sole proprietorship

A
  • owned by an individual
  • unlimited liability
  • termination occurs on the owner’s death/choice
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5
Q

general partnership

A

all partners are fully responsible for liabilities incurred by the partnership

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6
Q

limited partnership

A
  • limited liability
  • restricted to the amount of capital invested in the partnership
  • must be one general partner with unlimited liability
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7
Q

corporation

A
  • legally functions separate from its owners
  • owners(shareholders) dictate the direction and policies of the corporation(through board of directors)
  • Shareholder’s liability is restricted to the amount of investment in the company
  • unlimited life
  • double taxation
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8
Q

S-type corporation

A
  • limited liability
  • taxed like a partnership(no double taxation)
  • cannot be used for a joint venture between two corporations
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9
Q

limited liability companies(LLC)

A
  • limited liability
    -taxed like a partnership(no double taxation)
  • cannot appear like a corporation(it will be taxed like one)
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10
Q

public offering

A

both individuals and institutional investors have the opportunity to purchase securities

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11
Q

private/direct placement

A

securities are offered and sold directly to a limited number of investors

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12
Q

primary market

A
  • new issues of securities are sold to initial buyers
  • IPOs and SEOs
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13
Q

initial public offering

A

the first time a company issues its stock to the public

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14
Q

seasoned equity offering

A

sale of additional shares by a company whose shares are already publicly traded

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15
Q

secondary market

A

that market in which previously issued securities are traded

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16
Q

money market

A

for short-term debt instruments(maturity periods of 1 year or less

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17
Q

capital market

A

for long-term financial securities(maturity greater than 1 year)

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18
Q

spot market

A

market in which something sells immediately

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19
Q

futures market

A

the market for buying and selling something at some future date

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20
Q

organized securities exchange

A

tangible entities and financial instruments are traded on its premises and have an address

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21
Q

over the counter market

A
  • all securities markets except organized exchanges
  • no specific geographic location
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22
Q

why might a firm choose an over the counter market over and organized securities exchange?

A
  • they do not meet the listing requirements of the exchange
  • wish to avoid higher reporting requirements and fees
  • may just choose to trade on OTC
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23
Q

underwriters spread

A
  • the difference between the price the corporation gets and the public offering price
  • Money for securities is paid to the issuing firm before the securities are sold
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24
Q

functions of an investment bank in an IPO

A
  • underwriting: assuming the risk
  • distributing: once securities are purchased from the issuing fir, distributed to investors
  • advising: timing of sales, type of security, etc
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25
Q

floatation costs

A

transaction costs incurred when a firms raises funds by issuing securities
(underwriters spread and issuing costs)

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26
Q

negotiated purchase IPO

A
  • mot prevalent method
  • Issuing firms selected an IB to underwrite the issue
  • the firm and IB negotiate the terms of the offer
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27
Q

competitive bid IPO

A

several Its bid for the right to underwrite the firm’s issue

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28
Q

best efforts IPO

A
  • The issue is not underwritten, no money is paid upfront
  • Attempt to sell the shares in return for a commission
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29
Q

privileged subscription

A

Helps market the new issue to a select group of investors such as current stockholders, employees, or customers

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30
Q

direct sale IPO

A
  • Issuing from selling the securities directly to the investing public
  • No IB involved
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31
Q

dutch auction IPO

A
  • Investors place bids indicating how many shares they are willing to buy and at what price
  • The price the stock is sold for becomes the lowest price at which the issuing company can sell all the available shares
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32
Q

opportunity cost

A

ROR on the next best investment alternative

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33
Q

standard deviation

A

dispersion/variability around the mean ROR

34
Q

nominal(quoted) interest rate

A

the interest rate paid on debt securities without an adjustment for any loss in purchasing power

35
Q

real interest rate

A
  • return earned with an adjustment for a loss in purchasing power
  • nominal interest rate less any loss in purchasing power of the dollar during the time of the investment
36
Q

inflation premium

A

a premium to compensate for anticipated inflation that is equal to the price change expected to occur bobber the life of the bond/investment

37
Q

maturity risk premium

A

additional return required in long-term securities to compensate for a greater risk of price fluctuations cause by interest rate changes

38
Q

default risk premium

A

additional return required to compensate for the risk of default

39
Q

liquidity risk premium

A

additional return in securities that cannot be quickly converted into cash at a reasonably predictable price

40
Q

nominal interest rate =

A

= inflation premium + real risk-free rate + default-risk premium + maturity-risk premium + liquidity-risk premium

41
Q

(nominal) risk free interest rate =

A

= real risk-free rate + inflation premium

42
Q

the fisher effect

A

Nominal interest rate = real interest rate + rate of inflation + (real interest rate) * (rate of inflation)

43
Q

approximation approach for nominal interest rate

A

Nominal interest rate = real rate if interest + inflation risk premium

44
Q

term structure of interest rate(yield curve)

A

the relationship between a debt security’s rate of return and the length of time until the debt matures

45
Q

Unbiased expectations theory

A

term structure is determined by an investor’s expectations about future interest rates

46
Q

Liquidity preference theory

A

investors require maturity-risk premiums to compensate them for buying securities that expose them to the risk of fluctuating interest rates

47
Q

market segmentation theory

A

the rate of interest for a particular maturity is determined solely by demand and supply for a given maturity, and it is independent of the demand and supply for securities having different maturities

48
Q

future value

A

the amount a sum will grow to in a certain number of years when compounded at a specific rate

49
Q

present value

A

the value in today’s dollars of a future payment discounted back to the present at the required rate of return

50
Q

annuities

A
  • A series of equal dollar payments for a specified number of years
  • Ordinary annuity payments occur at the end of each period
51
Q

annuities due

A
  • Ordinary annuities in which all payments have been shifted forward by one time period
  • With annuity due, each annuity payment occurs at the beginning of the period rather than at the end of the period
52
Q

(APR) annual percentage rate

A

The interest rate indicates the amount of interest paid or earned in one year without compounding(annually)

53
Q

APR =

A

interest rate per period x compounding periods in a year(m)

54
Q

(EAR) effective annual rate

A
  • the annual compound rate that produces the same return as the nominal/quoted rate when money is compounded on a non-annual basis
  • provides the true rate of return
55
Q

EAR =

A

[1 + (APR / (m)compounding periods per year)]^m - 1

56
Q

what adjustments do you have to make when finding FV or PV with non-annual periods?

A
  • N = n x m
    (number of payments per year
  • I/Y = r / m
    (rate per period)
57
Q

perpetuity

A

an annuity that continues forever

58
Q

what are common operating expenses?

A
  • selling/marketing expenses
  • general administrative expenses
  • depreciation expense
59
Q

overview of income statement

A
  • sales(revenue) - cost of goods sold = gross profit
  • Gross profit - operating expenses = operating income(EBIT)
  • Operating income(EBIT) - interest expense= EBT
  • EBT - income tax = net income
60
Q

common sized income statement

A

Restates the income statement items as a percentage of sales

61
Q

fundamental accounting equation

A

A = L + E

62
Q

book value

A
  • the value of an asset as shown on a firm’s balance sheet
  • Represents the historical cost of the asset rather than its current MV or replacement cost
63
Q

current assets

A
  • assets that are relatively liquid or expected to be converted into cash within 12 months
  • Cash, accounts receivable, inventory, prepaid expenses
64
Q

fixed assets

A
  • property, plant, and equipment
  • used for more than 1 year
65
Q

net fixed assets =

A

Gross fixed assets(balance sheet) - Accumulated depreciation(balance sheet)

66
Q

other fixed assets

A

neither current nor fixed, may include long-term investments and intangible assets such as patents, copyrights, and goodwill

67
Q

what are common current debt items?

A
  • accounts payable
  • accrued expenses
  • short term notes
68
Q

preferred stock

A

preference(over common stock) with regard to payment of dividend and seniority at a settlement of bankruptcy claims

69
Q

retained earnings

A

a cumulative total of all the net income over the life of the firm, less common stock dividends that have been paid out over the years

70
Q

debt ratio

A

total liabilities / total assets
- percentage of assets that are financed by debt

71
Q

new working capital

A

current assets - current liabilities
- measure of a firms ability to repay its debt

72
Q

accrual basis

A

the principle of recording revenues when earned and expenses when incurred, rather than when cash in received or paid

73
Q

what are sources of cash?

A
  • decrease in an asset
  • increase in a liability or equity
74
Q

what are uses of cash

A
  • increase in an asset
  • decrease in a liability or equity
75
Q

how to determine cash flows from operations?

A
  1. Start with net income
  2. Add back depreciation expenses
  3. Consider other items(AR, inventory, other current assets, AP, other accrued expenses/liabilities)
76
Q

how to determine cash flows from investing?

A
  • changes in fixed assets
  • increase in assets = outflow of cash
77
Q

how to determine cash flows from financing?

A

Inflow: the firm borrows more money, an increase in stockholders’ equity
Outflow: firm repays debt, pays dividends, repurchases stock

78
Q

ending cash =

A

beginning cash + change in cash

79
Q

what are the items taken from the income statement for the cash flows statement?

A

net income and depreciation expenses

80
Q

consider everything on the balance sheet for the cash flows statement except:

A
  • accumulated depreciation
  • net fixed assets
  • changes in retained earnings

business finance (2 decks)

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