Financial Management Flashcards
Opportunity Cost
Discounted dollar value of next best benefit lost from an opportunity not taken as a result of choosing another opportunity. The revenue lost from an alternative not selected is an opp cost associated with the alternative that is selected.
Differential Costs
costs that are different between two or more alternatives.
Cost of capital
cost of long term funds -debt/equity used to finance an operation. Major LT sources of capital funding include LT debt, pref stock, comm stock
Cost of debt
rate of return that must be paid to attract and retain lenders’ funds
WACC
Weighted average cost of capital.
Rate of return of each source of capital weighted by its share of the total capital.
Calculation of WACC
- percent of total capital is determined for each source
- percent of each is multiplied by the cost of capital for that source of capital.
- resulting weighted costs of capital are summed to get the WACC.
Effective Interest Rate
The annual interest rate implicit in the relationship between the net proceeds of a borrowing (or other arrangement) and the dollar cost of the borrowing (or other arrangement).
Dollar cost of borrowing / Net proceeds of borrowing
Define “stated rate (of interest)” - also what is it also known as?
Nominal rate or quoted rate
The annual rate of interest specified in a debt instrument or other contract/agreement; it does not take into account the compounding effects of payment frequency.
Define “effective annual percentage rate” (also called the “annual percentage yield”).
Annual percentage rate with compounding on loans that are for a fraction of a year
what is the amount of interest specified in the loan contract called
the stated rate
Effective rate of the loan
net cost of the loan / net proceeds from the loan
Annual Percentage rate
annualized rate for a loan that is less than a full year
what does a yield curve show?
the relationship between time to maturity and bond interest rates
Real interest rate
the stated (nominal) rate minus the rate of inflation for that period
What would be the interest rate on a US treasury bill
the risk free rate plus the inflation premium .
US treasury bills are considered free of default risk, liquidity risk, and maturity risk
Market approach
info generated by market transactions for identical/similar items
income approach
converts future amounts of benefit or sacrifice to determine the current value
cost approach
determines the amount required to acquire or construct a comparable item
Capital Asset Pricing Model
an economic model that determines the relationship between risk and expected return and uses that measure in valuing securities, portfolios, capital projects, and other assets
CAPM formula
Required rate of return = Riskfree rate of return + Beta (Expected rate of return - riskfree rate of return)
Beta > 1
asset being valued moves greater than benchmark. the asset is more volatile than the entire class.
Beta < 1
asset being valued moves less than benchmark. the asset is less volatile than the entire class.
Beta = 1
The individual asset being valued changes in the same proportion as the entire class of the asset being valued; the asset has average systematic risk for the entire class.
Option
a contract that entitles the holder to buy or sell an asset at a stated price within a specified period. financial options are a form of derivative instrument