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Gen Bus 310 > Exam 3 > Flashcards

Exam 3 Flashcards

1
Q

the cost of using debt financing net of the tax savings due to the deductibility of interest expense.

A

after-tax cost of debt

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2
Q

a legal proceeding involving a business that is unable to fulfill its contractually required debt obligations. The process begins with a petition, either filed by the debtor or creditors. After the petition is filed the debtor’s assets are evaluated and a court decides which assets, if any, will be liquidated, which debts will be paid or forgiven, and which parties will control the firm when the proceedings are concluded.

A

bankruptcy

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3
Q

he costs a firm incurs when it files for protection from its creditors. These include lost sales, suppliers changing the terms of their contracts, difficulty in retaining and attracting talented employees, managerial distraction as well as legal and administrative expenditures.

A

bankruptcy costs

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4
Q

the volatility of cash flows generated by a firm’s assets. Since different firms have different assets, the business risk may be unique to a given firm or industry.

A

business risk

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5
Q

the fraction of the financing that is raised from lenders to fund the firm’s assets. It is denoted by the variable wD.

A

capital structure weight of debt

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6
Q

the fraction of the financing that is raised from owners to fund the firm’s assets. It is denoted by the variable wE.

A

capital structure weight of equity

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7
Q

the percentage of money raised from each source of capital, which in this class is stockholders and bondholders. The capital structure weights must some to one in order to account for all the financing.

A

capital structure weights

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8
Q

the minimum required rate of return by a bondholder to provide capital to a firm. This opportunity cost can be estimated by calculating the yield-to-maturity of a firm’s bonds that are currently trading in secondary markets.

A

cost of debt

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9
Q

the minimum required rate of return by a shareholder to provide capital to a firm. This opportunity cost can be estimated by using the Capital Asset Pricing Model (CAPM). Dividends paid to shareholders are not tax deductible, so the cost of equity and the after-tax cost of equity are one and the same.

A

cost of equity

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10
Q

a situation where the firm either is close to bankruptcy or enters bankruptcy

A

financial distress

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11
Q

when the firm gets close to bankruptcy without entering it, it will suffer from lost sales, suppliers changing the terms of their contracts, difficulty in retaining and attracting talented employees, and managerial distraction.

A

financial distress costs

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12
Q

the additional volatility that a manager imposes upon the shareholders by levering up. Increasing the D/E ratio takes the existing business risk and magnifies it from the perspective of the owners. This is because increasing leverage puts payments to the bondholders ahead of those to the residual claimants, the shareholders, in all states of the world, thus making their position riskier.

A

financial risk

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13
Q

The tax savings due to the deductibility on interest expense. The interest tax shield allows the manager to reduce the cash flow from the firm that goes to pay government taxes and use the savings to increase payments to the capital providers, the bondholders and stockholders.

A

interest tax shield

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14
Q

The extent to which debt is used to finance the assets of the firm. The manager tries to pick the leverage that will maximize the value of the firm.

A

leverage

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15
Q

decreasing the use of debt relative to equity to finance a firm’s assets. This is achieved by issuing stock in the primary markets and using the proceeds to repurchase bonds in the secondary market. Though no assets change in the transaction, the firm’s debt-to-equity ratio is reduced. In terms of a balance sheet, the assets on the left-hand side remain fixed while the claims on those asset represented by the right-hand side change.

A

levering down

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16
Q

increasing the use of debt relative to equity to finance a firm’s assets. This is achieved by issuing debt, typically bonds, in the primary markets and using the proceeds to repurchase shares of stock in the secondary market. Though no assets change in the transaction, the firm’s debt-to-equity ratio increases. In terms of a balance sheet, the assets on the left-hand side remain fixed while the claims on those asset represented by the right-hand side change.

A

levering up

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17
Q

the overall return that a set of assets must generate to compensate the capital providers for their opportunity costs, account for taxes, and account for the fraction of the funding coming from each of the capital providers. It is also known as the required return, discount rate, weighted average cost of capital, and WACC.

A

return on assets

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18
Q

the value of the firm is maximized when the marginal benefit from another dollar of debt due to the interest tax shield equals that dollar of debt’s marginal cost due to expected financial distress.

A

Static Theory of Capital Structure

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19
Q

a firm that is financed with 100% equity and thereby no debt

A

unlevered

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20
Q

a measure of volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

A

beta

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21
Q

the equation of the security market line (SML) showing the relationship between expected return and beta.

A

capital asset pricing model (CAPM)

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22
Q

the minimum required rate of return on an investment.

A

cost of capital

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23
Q

a term used interchangeably with asset-specific risk. A risk that is unique to an asset meaning that it can be reduced by holding a portfolio of assets that are uncorrelated.

A

diversifiable risk

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24
Q

the process of spreading investments across more than a single asset. Diversification reduces unsystematic risk by investing in a variety of assets

A

diversification

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25
Q

the average return investors expect to receive if they hold an asset for many periods in which there are uncertain events

A

expected return

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26
Q

a range of investments held by a person or organization.

A

portfolio

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27
Q

wanting to avoid risk unless adequately compensated for it.

A

risk averse

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28
Q

the excess return from an investment in a risky asset over that required from a risk-free investment.

A

risk premium

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29
Q

a positively sloped straight line displaying the relationship between expected return and beta.

A

security market line (SML)

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30
Q

a risk that influences a large number of assets.

A

systematic risk or market risk

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31
Q

the expected return on a risky asset depends only on that asset’s systematic risk.

A

systematic risk principle

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32
Q

a risk that affects at most a small number of assets.

A

unsystematic risk or asset-specific risk

33
Q

an agent who arranges security transactions among investors

A

broker

34
Q

equity without priority for dividends or in bankruptcy

A

common stock

35
Q

the stated interest payment made on a bond

A

coupon

36
Q

the annual coupon divided by the face value of a bond

A

coupon rate

37
Q

an agent who buys and sells securities from inventory

A

dealer

38
Q

an unsecured debt, usually with a maturity of ten years or more

A

debenture

39
Q

a bond whose stated interest rate is less than the market rate of interest

A

discount bond

40
Q

payments by a corporation to shareholders, made in either cash or stock

A

dividends

41
Q

a model that determines the current price of a stock as its dividends next period divided by the discount rate less the dividend growth rate

A

dividend growth model

42
Q

the principal amount of a bond that is repaid at the end of the term. Also called par value.

A

face value

43
Q

the written agreement between the corporation and the lender detailing the terms of the debt issue

A

indenture

44
Q

the specified date on which the principal amount of a bond is paid.

A

maturity date

45
Q

an unsecured debt, usually with a maturity under ten years

A

note

46
Q

a bond whose stated interest rate is exactly the same as the market interest rate

A

par value bond

47
Q

stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights

A

preferred stock

48
Q

a bond whose stated interest rate is greater than the market rate of interest

A

premium bond

49
Q

the market in which new securities are originally sold to investors

A

primary market

50
Q

a part of the indenture limiting certain actions that might be taken during the term of the loan, usually to protect the lender’s interest

A

protective covenant

51
Q

a grant of authority by a shareholder allowing another individual to vote his or her shares

A

proxy

52
Q

the market in which previously issued securities are traded among investors

A

secondary market

53
Q

the number of years until the face value of the bond is paid

A

time to maturity

54
Q

the interest rate required in the market on a bond

A

yield to maturity (YTM)

55
Q

an estimate of the after-tax value of an asset at the end of its depreciation

A

after-tax salvage value (ATSV)

56
Q

the stream of cash inflows and outflows generated by the firm’s assets

A

cash flows from assets (CFFA)

57
Q

in calculating operating cash flows (OCF) start with net income and add back any noncash items such as depreciation

A

bottom up approach

58
Q

a method of allocating the cost of a tangible asset over its useful life

A

depreciation

59
Q

the cash flows of a new project that come at the expense of a firm’s existing projects

A

erosion

60
Q

any and all changes in the firm’s future cash flows that are a direct consequence of taking the project

A

incremental cash flows

61
Q

if the internal rate of return for a projected is greater than the rate of return on the next best investment of similar risk, the project should be accepted

A

IRR Rule

62
Q

a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications

A

modified accelerated cost recovery system (MACRS)

63
Q

if the present value of all the cash inflows is greater than the present value of all the cash outflows, the project should be accepted

A

NPV Rule

64
Q

the amount of time required for an investment to generate cash flows sufficient to recover its initial cost

A

payback period

65
Q

if a project’s calculated payback period is less than the pre-specified period of time then the project should be accepted

A

Payback Rule

66
Q

financial statements prepared to show the forecast or projected operating results and balance sheet for a project under consideration

A

pro forma financial statements

67
Q

the estimated resale value, or market value, of an asset at the end of its useful life

A

salvage value

68
Q

the impact, both good and bad, a new project has on the cash flows of other existing lines of the business

A

side effects

69
Q

the assumption that evaluation of a project is based on the project’s incremental cash flows

A

stand-alone principle

70
Q

a cost that has already been incurred and cannot be recovered and therefore should not be considered in an investment decision

A

sunk cost

71
Q

ATSV

A

Salvage Value – tax rate × (Salvage Value – Book Value)

72
Q

operating cash flow (OCF)

A

net income + depreciation

73
Q

cash flow from assets m(CFFA)

A

= operating cash flow (OCF)
─ changes in networking capital (DNWC)
─ net capital spending (NCS)

74
Q

Bond Coupon Rate

A

Annual Coupon ÷ Face Value

75
Q

Bond Value

A

Present Value of the Coupons + Present Value of the Face Amount

76
Q

Municipal bond

A

pay interest that is federally tax-free

77
Q

default risk

A

is the chance that companies or individuals will be unable to make the required payments on their debt obligations

78
Q

cost of capital

A

opportunity cost

Gen Bus 310 (2 decks)

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