Intro to Business Finance and Cost of Capital Flashcards
What is a corporation?
A corporation is a business organised as a legal entity distinct
from its owners
- has limited liability
- can be public or private and in both cases can be closely held (limited number of shareholders)
What is Business Finance?
‘Every decision made in a business has financial
implications, and any decision that involves the
use of money is a corporate finance decision.’ - Aswath Damodaran, Stern School of Business, NYU
What are some examples of Business Finance?
-Marketing
Launching a new advertising campaign
- Operations
Introducing a new production line in a factory
- Strategy
Merging with another firm
What is corporate governance?
“The laws, regulations, institutions, and corporate practices that
protect shareholders and other investors.”
What is the principal agent problem?
The prinicpal agent problem is when there is a difference in interests between a manager and the shareholders of a company.
What is (net) working capital?
Short-term, or current, assets and liabilities are collectively
known as (net) working capital
– It is the capital required in the short term to run the
business
Net working capital = Current Assets - Current Liabilities
What are the items of current assets
and current liabilities
Current assets are:
Accounts receivable
– sales to firms/individuals that have not yet been paid for
* Inventory
– raw materials, work in process, and finished goods
* Cash balances
– most of the cash is in the form of bank deposits
* Marketable securities
– firms invest excess cash in a variety of short-term securities
such as Treasury bills
Current Liabilities are:
* Accounts payable
– outstanding payments that are due to other firms
* Short-term borrowing
– a major source is bank loans / large well-known firms may
also issue commercial paper to investors
What is opportunity cost of capital?
The (opportunity) cost of capital is the minimum
acceptable rate of return for capital investment
It is the cost of an alternative (investment
opportunities available to investors in financial
markets) that must be forgone in order to pursue
a certain investment.
Cost of capital and risk
For a given level of risk in a project, its cost of capital
is the expected return that investors can achieve in
financial markets at the same level of risk.
Safe project’s r ⇒ current
interest rates on safe debt
securities.
Risky project‘s r ⇒ expected
return at the same level of risk
(it has to be estimated).
