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Finance Flashcards

1
Q

Calculation for total assets

A

A= l + oe (assets = liabilities + owners equity)

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2
Q

Calculations for common equity

A

common equity= common stock + APIC common+ retained earning - treasury stock OR common equity= total owners equity - (preferred stock + APIC preferred)

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3
Q

Current ratio

A

current ratio= current assets/current liabilities

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4
Q

(net) working capital

A

working capital= current assets - current liabilities

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5
Q

Debt-equity ratio (aka debt-to-total assets ratio)

A

debt-equity ratio= total liabilities/total owners’ equity

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6
Q

debt ratio (aka total debt ratio)

A

debt ratio= total liabilities/total assets

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7
Q

times-interest-earned (aka interest coverage)

A

TIE=EBIT/interest expense

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8
Q

Gross profit margin

A

=gross profit/net sales OR (Sales - COGS)/Sales

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9
Q

operating profit margin

A

=EBIT/net sales

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10
Q

net profit margin=

A

=net income/net sales

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11
Q

dividend payout ratio

A

=dividends/earnings

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12
Q

earnings per share

A

=(net income- preferred stock dividends)/ # of common shares outstanding

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13
Q

ROA

A

=(net income-preferred dividends)/average total assets

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14
Q

ROE

A

=(net income-preferred dividends)/average common equity

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15
Q

Outstanding stock

A

=issued stock - treasury stock

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16
Q

Earnings per (common) share

A

=net income- preferred dividends/weighted average of # of common shares outstanding

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17
Q

Profit (additional terms)

A

earnings; net income

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18
Q

Dividend payout ratio

A

=dividends/net income

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19
Q

ending retained earnings=

A

= beginning retained earning + net income - dividends

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20
Q

Top Line

A

Sales;Revenue

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21
Q

Bottom Line

A

Net Profit; net income

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22
Q

P& L (aka Income Statement)

A

Revenues
(COGS Cost of Goods Sold)
Gross profit
(operating expenses)
EBIT
(interest expense)
EBT
(taxes)
Net Income

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23
Q

Where would you find the retained earnings?

A

Balance sheet (owner’s equity section)

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24
Q

When preparing the pro forma income statement, you start with the __________ because ____________

A

sales forecast; many other items on the incomes statement are a function of sales

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25
Q

What 5 balance sheet items change at the same rate as revenue changes?

A

Cash
A/R
Inventory
A/P
Accrued payables (e.g.,salaries payable)

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26
Q

Risk-return tradeoff

A

the greater the risk, the greater the potential return

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27
Q

Risk (definition)

A

possibility of financial loss; possibility undesired outcome; uncertainty

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28
Q

Rate of return=

A

Profit measured in %; aka return in %; yield

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29
Q

Income (definition)

A

periodic cashflow received from the investment

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30
Q

Income (examples)

A

Interest; rent; dividends;

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31
Q

Interest (formula)

A

=principal x interest rate x fraction of a year

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32
Q

Dividends

A

distribution of the corporation’s net income to the shareholders

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33
Q

Role of the Board of Directors

A

Protect interest of the stockholders; decided if/when to issue dividends

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34
Q

Growth

A

(aka capital gain, appreciation); increase in the investment’s market value

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35
Q

Total return=

A

Income + growth

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36
Q

Calculating return $

A

=amount received from investment - amount invested

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37
Q

Calculating return %

A

= return in $/amount invested

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38
Q

Terms for return in %

A

rate of return; yield

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39
Q

Required return

A

minimum acceptable potential return on an investment, given the risks involved

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40
Q

portfolio

A

collection of investments

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41
Q

Expected Return of portfolio (formula)

A

outcome x probability = product

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42
Q

efficient portfolio

A

Provides either the greatest expected return for a given level of risk OR provides the least risk for a given potential return

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43
Q

Diversifiable risk

A

company-specific; non-systemic

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44
Q

Non-diversifiable

A

Market-risk; systemic

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45
Q

Future value

A

amount to which money will grow by a specified date if invested today at a given rate; expressed in $

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46
Q

CAGR

A

Compound annual growth rate; i in time value of money formula

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47
Q

Present Value

A

The amount which if invested at a given rate would grow to a specified future amount by a specified future date

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48
Q

Discounting

A

Finding the present value (*if discounting problem, probably using present value rather than future value)

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49
Q

Discount rate

A

i in present value formula

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50
Q

How to explain discounting/PV formula

A

If you invest PV today at x% compounded annually [i] for 2 years [n], you will have FV

OR

If you forecast receiving FV from an investment in 2 years [n] and you require a return of x% compounded annually [i], you must invest PV today.

R

If you have PV at x% compounded annually [i] for [n] years, you will have FV.

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51
Q

PV (formula)

A

PV= FV/ (1+i)^n

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52
Q

Free Cashflow

A

Cashflow generated by the business above and beyond the capital needed to operate it

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53
Q

Free Cashflow Formulas

A

Free Cashflow = [EBIT x (100%- tax rate)] - net change in total operating capital

OR

Free Cashflow= [(EBIT x (100% - tax rate)] - (ending total operating capital - beginning total operating capital)

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54
Q

Total Operating Capital

A

Capital needed to run/operate the business; includes cash , inventory, & net fixed assets

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55
Q

Free Cashflow- 5 uses

A

Pay interest to debtholders; repay debt; pay dividends to shareholders; repurchase stock from shareholders; buy short-term investments/other non-operating assets

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56
Q

EBIT

A

Operating profit; operating income

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57
Q

Goal of financial management

A

Maximize the wealth of the business owners

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58
Q

Net Worth

A

measure of wealth; assets- liabilities= net worth

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59
Q

LLC

A

Limited liability company; owners are “members”

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60
Q

Balance sheet forman

A

Assets Liabilities

current

long term

intangible Equities

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61
Q

Sales discounts

A

Discounts given to A/R customers for paying early

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62
Q

Price markdown

A

Selling at lower sales price

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63
Q

What is 100% on a vertical balance sheet

A

total assets

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64
Q

What is 100% on vertical income statment

A

Total sales (top line; net sales)

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65
Q

Leverage use: risks & benefits

A

interest expense may be greater than operating profit; mace face bankruptcy

Potential to increase ROE; can start enterprise with less capital

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66
Q

Capital budgeting

A

The process of determining which proposed projects (business opportunities) to implement

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67
Q

What financial statement is prepared first and why?

A

Pro forma income statement; net income gets added to retained earnings on the balance sheet

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68
Q

When preparing the pro forma P&L, start with a projection of

A

Revenues, because sales drive over costs/line items

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69
Q

Excess capacity

A

Ability to produce more without expanding facilities (versus @ capacity- maximum productive ouput)

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70
Q

Full capacity sales

A

=actual sales/actual capacity used

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71
Q

annuity

A

Series of equal, regularly-occurring cashflows

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72
Q

Ordinary annuity

A

the regularly-occurring payment comes at the END of each period

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73
Q

Annuity-due

A

the regularly-occurring payment comes at the BEGINNING of each period

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74
Q

Annuity formula n

A

n=number of equal payments being made (*NOT # times interest compounding)

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75
Q

Future value of an annuity

A

The amount that a stream of fixed cashflows will accumulate to in the future, based on the compound growth rate; in $

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76
Q

Present value of an annuity

A

The amount an investor would pay today in order to receive a specified number [n] of fixed period cashflows (PMT), given the required return [i] for the investment; in $

OR

the amount a visit would invest in a project today to receive a specified number [n] of fixed cashflows [PMT], given the required return [i] for the project; in $

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77
Q

Valuation

A

determining the fundamental value of as asset (aka intrinsic or theoretical value; V)

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78
Q

Discounted cashflow analysis

A

finding the present value of an asset’s expected future cashflows best way to find intrinsic value

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79
Q

Absolute valuation

A

fundamental value is based on the asset’s characteristics/qualities

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80
Q

Relative valuation

A

an asset’s fundamental value is based on a comparison to the value of similar assets

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81
Q

Bull market

A

Prices rising

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82
Q

Bear market

A

Prices falling

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83
Q

Public market

A

Open to public investors (e.g., anyone with money)

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84
Q

Securities & Exchange Commission

A

Part of Federal govt; regulates public securities markets (& public financial markets); private markets much less regulated

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85
Q

IPO

A

Initial Public Offering; 1st time a private corporation sells shares to public investors

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86
Q

Functions of securities underwriter

A

Helps issuer comply w/ SEC rules; pricing the issue; locates investors to buy the issuer’s securities

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87
Q

Seasoned ofering

A

subsequent issuance of stock by a public corporation

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88
Q

Primary market

A

transactions involving the issuance of new securities (e.g., IPO); issuers to investors

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89
Q

Secondary market

A

Transactions involving previously-issued securities (e.g., seasoned offerings); investors to investors through brokers; ex: NASDAQ, NYSE

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90
Q

Market Capitalization

A

total market value of company’s outstanding shares

market cap = current market price of stock x number shares outstanding

91
Q

Indexes

A

hypothetical basket of securities intended to measure the investment performance of a specified investment market

92
Q

Spread

A

Difference between 2 interest rates; changes over time

93
Q

positive yield curve (aka & definition)

A

normal; upward sloping; long-term interest rates greater than short term

94
Q

Negative yield curve (aka & definition)

A

inverted; abnormal; short-term interest rates greater than long-term; indicates recession coming

95
Q

Basis points (bp, bps)

A

.01% difference in interest rates

96
Q

Fed fund rate

A

rate that banks charge each other to loan money bank to bank overtnight

97
Q

Prime rate

A

“bank prime”; rate a bank charges its most creditworthy customers

98
Q

yield curve

A

shows the relationship between interest rates and time remaining until maturity at a given point in time; term structure of interest rates

99
Q

positive yield curve

A

normal; upward sloping; long-term interest rates > short term rates

100
Q

Negative yield curve

A

inverted; abnormal; short term interest rates > long term rates; suggests recession ahead

101
Q

Flat yield curve

A

short-term and long-term interest rates are equal

102
Q

maturity

A

when bond holder repays the principal and makes final interest payment

103
Q

real

A

adjusted for effects of inflation

104
Q

NOT real

A

nominal, stated, quoted; does not account for inflation

105
Q

Positive real rate of interest

A

nominal interest rate greater than inflation

106
Q

Negative real rate of interest

A

nominal interest rate less than inflation

107
Q

inflation risk

A

possibility of loss of purchasing power due to rising prices

108
Q

Required interest rate (formula)

A

=expected inflation + profit above inflation

109
Q

inflation premium

A

average projected annual inflation rate over life of the investment

110
Q

real risk-free interest rate

A

r*; interest rate on a risk-free investment, assuming 0% inflation

111
Q

Inflation premium

A

Average annual inflation over the life of a loan

112
Q

Required return (definition & formula)

A

the minimum acceptable potential return on an investment, given the risks

Required return= nominal risk-free rate + default risk premium + LP + MRP
=(r* + inflation premium) + risk premiums

113
Q

Nominal risk-free rate

A

Treasury bills (short term) or treasury notes & bonds (long-term)

r= r* + IP (real risk-free interest rate + Inflation premium)

114
Q

Required return (formula)

A

=(r* + IP) + risk premium(s)

115
Q

Required rate of return on a debt security (formula)

A

=(r* + IP) + default risk premium + liquidity premium + maturity risk premium

116
Q

Money market

A

market for short-term debt securities (mature in 1 year or less); sellers: corporations & governments; buyers: investors

2 types: treasuries or commercial paper

Includes US Treasury Bonds & Bills

117
Q

Bonds

A

Long-term debt securities

118
Q

Bonds whose interest rate (coupon rate) paid on the par value does not change over time

A

fixed-rate bonds

119
Q

Bonds whose coupon rates change over the life of the bond as the market rate of interest changes

A

variable-rate, floating-rate or adjustable rate bonds

120
Q

Par value of bonds issued by corporations

A

$1,000

121
Q

Indenture

A

the contract between the issuer and the bondholders

122
Q

trustee

A

protects the bondholders’ interests

123
Q

Coupon rate

A

interest rate paid on the bond’s par value (principal)

124
Q

A fixed-rate bon’s coupon rate reflects

A

The market rate of interest at the time the bond was issued

125
Q

When market rate of interest increases, market price of bonds___-

A

Decreases; When market rate of interest decreases, price of bonds increases

126
Q

indenture

A

Contract between the issuer & the bondholders

127
Q

Who represents the interests of the bondholders?

A

Trustee

128
Q

How often is bond interest paid?

A

Semi-annually

129
Q

Terms of bond issue

A

interest rate, how frequently interest paid, maturity date, collateral

130
Q

Covenants

A

restrictions imposed on the bond issuer under the indenture

131
Q

Sinking funds

A

Requires the issuer to retire a portion of the bond issued each year

132
Q

Terms for principal of the bond

A

maturity value; par value; face value

133
Q

Institutional investors that need investment income, so invest heavily in bonds

A

Pension funds; insurance companies

134
Q

Reasons why a bond’s market value may change over time

A
  1. Change in bond’s rating (rare) or change in market interest rates
135
Q

What kind of capital are bonds?

A

Debt

136
Q

Interest on corporate vs municipal bonds

A

Corporate bonds are taxable, so investors require higher interest rate than municipal bonds

137
Q

Private placements

A

bonds sales in private market to institutional investors; avoids costly SEC registration

138
Q

Mortage

A

A bond secured by real estate; secured bonds= backed by collateral

139
Q

Debentures

A

Bonds that are unsecured (e.g., no collateral)

140
Q

Zero-coupon bonds

A

Bonds that pay no periodic interest; higher risk to investors, but helps issuer b/c decreases cashflow needs

141
Q

When do issuers call bonds?

A

Once the interest rates have declined; e.g., when the bonds are at a premium

142
Q

Refunding operation

A

When corporations issues new bonds at lower rates and use that money to pay off older bonds; favors the issuer

143
Q

Coupon rate on callable vs non-callable bonds

A

Higher rate on callable because greater risk to the bond holder

144
Q

Convertible bonds

A

May be exchanged for common stock; benefits bondholder, but current stockholders face risk of dilution; lower coupon rate than non-convertible

145
Q

Current yield

A

= annual coupon interest in $ (PMT) / current market price of the bond; given as percent; only indicates income portion of total growth

146
Q

Relationship between bond’s market price/market value and its current yield

A

inverse

147
Q

yield-to-maturity

A

The compound annual total return earned if bond is held to maturity; indicates current/market rate of interest and investors required rate of return for the bond; i variable in Vbond calculations; total return

148
Q

Yield-to-call

A

Current market rate of interest for the callable bond; required return for callable bond; i for callable bond valuation if interest rates have fallen; total return

149
Q

Advantages of purchasing preferred stock

A

with fewer investors in a market, the market is less efficient and easier to outperform

150
Q

Stated dividends

A

Dividends to preferred stock owners; fixed rate ($ or % of par); paid before common stockholders, but not guaranteed **No growth potential over time

151
Q

Benefits to issuing preferred stock instead of bonds

A

not required to pay dividends (legally)

152
Q

Liquidation asset claims priority

A

Secured creditors, unsecured creditors, preferred shareholders, common shareholders

153
Q

Timeline & impact on books when issuing dividends

A

Date of declaration: A + L increases- dividend payable + equity- (decreases retained earnings); payment date A (cash decreases) = L (decreases dividend payable) + cash

154
Q

Flotation costs

A

Paid by issuers to securities underwriters

155
Q

Who is more likely to invest in commercial than treasuries?

A

Institutional investors (compared to individual investors)

156
Q

2 services of investment banks

A

Mergers & Acquisitions; Securities underwriting

157
Q

Functions of a securities u nderwriter

A

Helps issuer comply with SEC rules; pricing the issue; locates investors to buy the securities

158
Q

When do companies want to do IPOs and season offerings?

A

Bear markets

159
Q

Efficient market hypothesis (4 implications)

A

1 If all investors have same info, its factored into security’s price as soon as available; 2 markets react to new info only if it differs than what was expected; 3 it’s impossible to consistently beat an efficient market; 4 the larger the number of participants, the greater the market efficiency

160
Q

S&P 500

A

Measures performance of 500 large US companies’ stocks

161
Q

Russell 20000

A

Measures performance of 2000 small US companies’ stocks

162
Q

EAFE

A

Measures performance of developed-country stocks in Europe, Australasia & far east

163
Q

Dow Jones Industrial Average

A

30 large- cap US companies

164
Q

3 examples of debt capital

A

Bank loans; short-term debt securities; long-term debt securities (aka bonds)

165
Q

Monetary policy

A

Policy regarding the growth of the money supply, set by the federal reserve bank; Either loosening/stimulative with higher monetary supply and decreasing interest rates

or

tightening, restrictive with decreased money supply and increasing interest rates

166
Q

Junk Bonds

A

aka Speculative or high-yield bonds; anything BELOW BBB-

167
Q

Bond rating agencies

A

Moody’s & S&P Standard & Poor’s; for-profit agencies (NOT the govt)

168
Q

TIPS

A

Treasury Inflation-Protected Security; REAL interest rate; principal adjusts annually for inflation; backed by “the full fait & credit of the US Govt” and most secure investment in the world- taxes to pay; extremely liquid; “government securities”

169
Q

Timeline of treasury securities

A

Bills (up to 1 year); notes (2-10 years); bonds (10+ years)

170
Q

How would you know on statements if corporation has issued bonds?

A

Balance sheet; liabilities

171
Q

DRIP

A

Dividend reinvestment plan; automatically uses cash dividends to buy more shares of stock

172
Q

3 ways corporations pay dividends

A

$; stock- % par; property

173
Q

CAGR formula

A

FV= PV * (1+i)^n

174
Q

Dividend

A

Payment of corporation’s net income/profit to the shareholders; BoD decides whether and when corporation will pay a dividend; typically paid quarterly

175
Q

Dividend types

A

cash (most common); Stock (DRIP Dividend Reinvestment Plan); or Property

176
Q

Transfer agent

A

maintains shareholder roster

177
Q

How dividends affect books- timeline

A

On declaration date, liabilities increase and OE retained earnings decreases; on record date, book aren’t affected; on payment date, assets cash decreased and liabilities dividend payable decreases

178
Q

Dividend Yield

A

annual dividend in $/current market price of stock (answer is a %); only measures income not the total return

179
Q

Beta

A

the slope o a regression line (x=market performance, y=stock’s performance; market=1..0; 1+ higher risk, >1 lower risk

180
Q

equities market

A

market for common stock; stock=equities

181
Q

Required return on a stock (formula)

A

=nominal risk-free rate + [beta x market risk premium]

182
Q

Marketrisk premium (formula)

A

expected return on the makret- nominal risk-free rate

183
Q

At equilibrium, required return =

A

expected return

184
Q

WACC=

A

Weighted average cost of capital; the corporation’s required return on proposed projects

185
Q

Impact of WACC on Vfirm

A

As WACC decreases, Vfirm increases; as WACC increases, Vfirm decreases

186
Q

Capital Structure

A

the % of the corporation’s capital from bonds rbonds, preferred stock rpreferred and common stock rstock

187
Q

Optimal capital structure

A

the capital structure that produces the lowest WACC; the capital structure that maximizes Vfirm (value of common stock)

188
Q

The security that will increase in value the most if the company is successful is _______

A

common stock; riskiest and highest required return for investors

189
Q

Flotation costs for debt securities

A

are lower than for preferred and common stock; these go to securities underwriters

190
Q

How does new debt affect WACC?

A

Increases debt weight and decreases stock weight in WACC (WACC decreases) BUT higher cost of new debt increases WACC; increases shareholders’ risk, so required return on stock increases (WACC increases)

191
Q

How does more debt affect interest rate and risk to common stockholders?

A

increases risk to common stock holders; increases interest rate

192
Q

Recapitalization

A

significant change in the capital structure

193
Q

Why is debt cheaper than equity capital?

A
  1. bonds are less risky than socks, so investor’s required rate of return is lower; flotation costs for deb securities are lower than for stock; interest paid on debt is tax deductible (unlike dividends)
194
Q

Net issue price

A

the amout the issuer receives after paying flotation costs to the securities underwriter; =offering price-flotation costs

195
Q

Preferred vs common stock dividends

A

preferred stock dividends are fixed; common can change over time

196
Q

offering price

A

price investors pay for the security

197
Q

Most expensive capital?

A

common equity; issuing new common shares 2/2 flotation costs

198
Q

a DRIP allows the corporation to issue shares without using

A

securities underwriter; so cheaper

199
Q

Common equity types

A

Retained earnings (reinvested profits); issuance of new common shares

200
Q

Factors influencing WACC

A

corporation cannot control: 1. market prices/interest rates 2… market risk premium/investors’ risk aversion 3. tax rates; Can control 1. capital structure policy, 2 dividend policy, 3. investment (capital budgeting) policy

201
Q

How to maximize the value of the firm?

A

maximize the value of the common stock (aka maximizing the wealth of the owners, maximizing the shareholder value)

202
Q

Vfirm (formula)

A

=future free cash flows/ (1+i)^n ; i=WACC and it’s a %

203
Q

Future cashflows (formula)

A

=[EBIT x (100%-tax rate)] - increase in total operational capital

204
Q

Price earnings ratio

A

indicates how much investors must pay for $1 of free cashflow; = market price per share/free cash flow per share; aka earning multiple

205
Q

PE ratio and stock valuation

A

if high P/E ratio, investors perceive greater growth potential and stock could be overvalued; if low PE ration, investors perceive less growth potential and stock could be undervalued

206
Q

Price/cashflow useful when

A

company has reported a loss but has positive cashflow (e.g., when significant depreciation or amortization expense)

207
Q

3 drawbacks of payback period method of capital budgeting

A

does not account for time value of money; does not account for cashflows received after the payback period; no relationships between payback period and investor wealth, so impossible to say what payback period is acceptable

208
Q

Capital budgeting

A

budget for fixed assets & long-term expenditures; based on pro-forma cashflow estimates

209
Q

Fixed assets aka

A

plant assets; Property, plant & equipment PPE; hard assets; capital assets

210
Q

Expenditure

A

Cash outflow (*Not same as expense)

211
Q

Optimal capital budget

A

capital budget that maximizes the value of the firm

212
Q

Capital rationing

A

not funding/pursing all projects that would increase the value of the firm

213
Q

Payback period

A

How long it takes the firm to recover its initial cash investment in the project; sometimes used to eliminate opportunities

214
Q

Disadvantages of the payback method:

A

does not account for time-value of money; does not account for cashflows received after the payback period; doesn’t tell rate of return or impact on firm’s wealth

215
Q

Net Present Value

A

PVinflows - PVoutflows; in $; use WACC for i

216
Q

IRR

A

Internal Rate of Return; expected return; invest if greater than WACC; i variable; discount rate at which NPV = 0

217
Q

MIRR

A

Modified internal rate of return; %; assumes cashflows re-invested @ WACC; invest if greater than WACC

218
Q

Drawbacks of IRR

A

can give multiple/different answers; assumes cashflows are reinvested @ project’s IRR

219
Q

Effective Annual Rate

A

Annual Percentage Yield; EFF; annualized rate when interest in compounded more frequently than annually; the actual annual rate earned

220
Q

Vfim

A

present value of its expected future free cashflows; capital budgeting based on pro forma (projected) cashflows

221
Q

Capital budgeting should only take into account_______

A

Incremental cashflows

222
Q

Sunk cost

A

cost that has already been incurred & cannot be altered by future courses of action ; NOT incremental/relevant

223
Q

Opportunity cost

A

the cost of not pursuing another alternative; foregone costs; ARE incremental/relevant

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