Financial Management Flashcards
Free cash flow calculation
Free cash flow is measured as net operating profit after taxes, plus depreciation and amortization, minus capital expenditures plus/minus changes in working capital.
Note that the increase in working capital reduces free cash flow because an increase implies more cash is invested in working capital; thus, cash flows are reduced.
A company will seek to minimize its weighted-average cost of capital (WACC). Why?
The WACC is not only the cost to the firm for its long-term financing, but also the minimum the firm must earn on its investments. The lower the WACC, the lower the required revenue needed to earn a profit and the easier it is to increase shareholder value.
The composition of Nominal (quoted) rate
Generally, the nominal (quoted) rate composes of real risk-free (inflation-free) rate of interests + inflation premium + default premium + maturity premium + liquidity premium
What is the market rate of interest on a one-year U.S. Treasury bill?
real risk free rate + expected inflation rate
How does a high tax rate affect debt financing and equity financing?
Other things being equal, the higher the tax rate of a firm, the greater the benefit from debt financing because the cost of debt (interest expense) is tax deductible and therefore generates a tax savings. That tax savings offsets the nominal cost of the debt. Since interest is not paid on dividends to equity holders and since dividends are not tax deductible, there is no comparable savings related to equity financing.
Definition of Accounting rate of return
The accounting rate of return = (Change in) Annual accounting income/Initial Investment
What is capital asset pricing model?
The capital asset pricing model does consider the time value of money through the use of the risk-free rate of return. Therefore, failure to consider the time value of money is not a limitation of the model.
