Fin Final Exam Flashcards
The primary goal of the firm is to
maximize
The dollar value of a stockholder’s wealth
Your shareholder value is directly correlated with how many shares of a company you own
Leverage
reflects the ability of fixed costs to magnify the rate of return
The portfolio effect
states that as more assets are added to a portfolio, the risk of the portfolio decreases
- The balance sheet
financial statement reflecting the firm’s financial position at a point in time
A current asset
-industries
-Cash and cash equivalents.
-Marketable securities.
-Accounts receivable.
-Inventory.
-Supplies.
-Prepaid expenses.
-Other liquid assets.
-not CA: notes payable
- Liquidity ratios measure what?
a company’s ability to pay its short-term obligations
How to calculate the acid test ratio?
one needs to deduct inventories from the current assets before dividing it by current liabilities.
The profit margin
sales is net income after taxes divided by sales
Return on assets
-a profitability ratio that provides how much profit a company is able to generate from its assets.
-a profitability ratio that provides how much profit a company is able to generate from its assets.
- Current assets are listed on the balance sheet how?
in order of their liquidity
- What is net working capital?
is the excess of current assets over current liabilities
- What is float?
the status of funds in the process of collection
- The market segmentation theory on the term structure of interest rates believes?
- the interest rate for bonds of one maturity is determined by the supply and demand for bonds of
that maturity.
-bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on
bonds of different maturities do not move together over time.
- investors’ strong preference for short-term relative to long-term bonds explains why yield curves
typically slope upward.
All of the above
- What does 1/10, net 30 mean?
if the bill is paid within 10 days, there is a 1% discount. Otherwise, the total amount is due within 30 days.
- The term structure of interest rates is properly portrayed by:
-The term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. The term structure of interest rates is also known as a yield curve, and it plays a central role in an economy.
- An inverted yield curve would suggest that:
short-term interest rates are expected to fall sharply in the future.
- Relationship between risk and return
-The higher an investment’s risk, the HIGHER the return required to induce investors to purchase the asset
-AVERSE; investors dislike risk and require HIGHER rates of return as an inducement to buy riskier securities.
- The valuation principle
-Value of asset/commodity to the firm or its investors is determined by its competitive market price
-The benefits & costs of a decision should be evaluated using those market prices
-When benefits exceed cost, the decision will increase the market value of the firm
- Yield to maturity on bonds
-the discount rate that sets the present value of the promised bond payments equal to the current market price of the bond
-the interest rate that will make the present value of the cash flows equal to the price (or initial investment)
-interest plus price appreciation (or loss)
achieved by holding the bond to maturity
- The relationship between a bond’s price and yield to maturity or the market interest rate:
inverse
- A premium bond
A bond that sells above its par value. When going rate of interest is below the coupon rate
- A bond’s annual coupon interest
-calculated by dividing the sum of the annual coupon payments by the par value.??
- Relationship between stock prices and the interest rate
inverse relationship
- The after-tax cost of bond debt is equal to:
the before tax cost of the bond times (1 - tax rate)
- Defensive stocks and aggressive stocks relationship with beta
-Aggressive stocks, with betas greater than 1: exaggerate the response of the portfolio to broad market movements
-Defensive stocks, with betas below 1:dampen the response.
- Capital budgeting methods and the time value of money
-payback not take into account time value of money
-ignores the time value of money = ARR
-considers time value of money = NPV
- The payback method
- The payback method does not consider the time value of money
-The length of time that a cumulated stream of future cash flows equals the initial cash outlay
- The net present value method
- The internal rate of return method
-the discount rate that sets the net present value of the project to zero
- IRR, NPV, PI, project acceptance rules
-IRR: if the IRR on a project or investment is greater than the minimum RRR—typically the cost of capital, then the project or investment can be pursued.
-NPV: accept the project if the NPV is positive and reject the project if the NPV is NPV is negative
-PI:accept projects with a PI greater than one, and to reject projects with a PI less than one.
- Diversification and correlation coefficients
Diversification and correlation coefficients
- A premium, par, and discount bond
-premium bond: When a bond’s value exceeds its face value, sell at premium
-par bond: the bond sells at a discount when the market value is less than the par value
-discount bond: a bond that sells for its par value
- The capital asset pricing model:
Theory used to price risky assets
- Focuses on the tradeoff between the risk of an asset and the expected return associated with that asset
ERi = RFR + (Beta)(ERM-RFR) + FSR
-relevant risk: Beta, Systematic Risk, Market risk,
rate of return: market risk, beta risk, systematic risk
- The Security Market Line (SML)
-The line that reflects the relationship between systematic risk and return available for all risky assets in the capital market at a given time.
-A change in the risk characteristics for a specific investment.
-A change in investors attitudes towards risk.
-It reflects a change in expected real growth, inflation or the ease/tightness of money.
- Beta and risk
-Beta measures market risk.
-A company with a higher beta has greater risk and also greater expected returns.
- The reinvestment rate assumption for the internal rate of return method
-cash flows are reinvested at a rate of return equal to the IRR
-the issue that the IRR calculation implicitly assumes that the cash flows generated by the project are reinvested at the same rate as the IRR
- The reinvestment rate assumption and the net present value method
-The reinvestment rate assumption and the net present value method
- The reinvestment rate assumption is more reasonable than in the IRR process.
- Two projects are mutually exclusive if:
the accepting of one project has no bearing on the accepting or rejecting of the other project.
- Systematic risk or non-diversifiable risk
-portion of a stock’s risk or variability that cannot be eliminated through diversification.
- It results from factors that affect all stocks. In fact, the term “systematic” comes from the fact that this type of risk systematically affects all stocks, i.e. it is of the system.
- An example of unsystematic or diversifiable risk is:
strikes, outcomes of legal proceedings, or natural disasters.
- As an investor adds addition, different stocks to a portfolio:
Diversifying your portfolio is one of the best things you can do to lower the overall risk of your holdings. Diversification removes non-systemic risk, leaving only the overall risk of investing in the stock market
- Beta measures:
a stock’s sensitivity to market risks
- Beta of stock X is calculated how?
(beta = (sold stocks/total stocks)(beta) + (remaining stocks/total stocks)X) - solve for X.
- The discounted cash flow model of valuation is:
-the sum of the cash flow in each period divided by one plus the discount rate (WACC) raised to the power of the period number
- Po = D1/(Ke – g).
- Aggressive stocks and beta
-A company stock with beta greater than one is called an aggressive stock.
- Defensive stocks and beta
Defensive stocks typically have betas of less than one
- The net cash flows from an investment project are?
the difference between revenues from selling its product and current costs. Given a projection of the net cash flows, the remaining value of the project at any time after the investment is made, up to the closing date, is the firm’s discounted net cash flow from that time on.
- Which of the capital budgeting methods are considered unsophisticated?
-ARR (AVG RATE OF RETURN)
-Payback method
- The profitability index is calculated by?
dividing the present value of future cash flows that will be generated by the project by the initial cost of the project
- When a project’s cash flows are discounted by its internal rate of return, it has a
NPV will be zero
- Relationship between IRR and NPV
the IRR is the rate at which the NPV of an investment equals zero
- The firm’s weighted average cost of capital and project acceptance
-The weighted average cost of capital for a firm is the: discount rate which the firm should apply to all of the projects it undertakes.
- The correlation coefficient
-a measure of the linear correlation between two variables X and Y
-a measure of the linear correlation between two variables X and Y
- Relationship between PI and NPV
If a firm has a basket of positive NPV projects and is subject to capital rationing, PI may provide a good ranking measure of the projects, indicating the “bang for the buck” of each particular project.
