Important Ch 3-4 L2 Flashcards
Cost-benefit analysis
Rome of the financial manager
To make decisions on behalf of the firm’s investors
Competitive market
a market in which goods can be bought AND sold at the same price
The valuation principle
Basically: The best financial decision makes the firm and its investors wealthier, because the value of its benefits exceed the value of its costs
Textbook: The value of a commodity or an asset to the firm or its investors is determined by its competitive market price. The benefits and costs of a decision should be evaluated using those market prices. When the value of the benefits exceeds the value of the costs, the decision will increase the market value of the firm.
Arbitrage
the practice of buying and selling equivalent goods in different markets to take advantage of a price difference
Law of one price
the same good or securities must have the same price, if they dont at one point it will be one same price the more people trade it
interest rate factor
(1+r), usel to calculste the value of dollars plus interest in the future (if multiplied)
Discount factor / disount rate
Rules of determining cash flow value at different times
Rule 1: Only cash flows in the same unit can be compared - usually in cash today (PV)
Rule 2: In order to calculate cash future value, you must compound it
Rule 3: To calculator PV of a future CF we need to discount it
Compounding (compounding interest)
The process of moving forward along the timeline to determine CF value in the future
(
important when Calculating PV AND FV
You have to calculate PV/FV for each cash flow and THEN add them together
Perpetuities - meaning and shortcut
m: a stream of CF that occur at regular intervals and lasts forever
s: calculating infinite cash flow is impossible and therefore we use the cost of installing the perpetuity (Principal - P) to calculate the perpetuity
Annuity- meaning and shortcut
m: stream of CF consisting of a fixed number of equal cash flows paid at regular intervals (ends after fixed # of payments)
s: figuring out the value of the annuity is done by taking the initial investment and subtracting the PV of the initial investment (P)
growing perpetuity
a stream of CF that occur at regular intervals and grow at a constant rate forever
differs from a regular perpetuity because the entire interest isn’t withdrawn and the reinvestment isn’t only the P, it’s usually P + x%
growing annuity
a stream of N growing cash flows, paid at regular intervals
