Lectures 1,2,3 Flashcards
Present value definition
The discounted value of future cash flows
What is the discount factor
It is the present value of $1 at a stated future date, given by 1/(1+r)^t
What is net present value
A project’s contribution to net wealth. Calculated by present value - investment.
Opportunity cost of capital (hurdle rate)
A shareholder’s return that is given up when investing in a project instead of similarly risky financial securities.
2 ways to decide whether a project is worth investing in
Positive net present value or if rate of return is above opportunity cost of capital
Discounted cash flow (DCF)
The sum of future cash flows multiplied by their discount factors to get present value.
PV of a perpetuity
Cash flow/interest rate, (C/r). This assumes that the stream of payments starts 1 period from now.
What is an annuity
It is an asset that pays a fixed sum each year for a specified number of years.
What is a perpetuity due
A perpetuity that starts immediately, the payments occur at the start of each period. PV is C + C/r or C/r(1+r)
What is the profitability index and when should it be used
It should be used to choose between projects to invest in when resources are limited. It is calculated by ( NPV/investment )
What are real assets
Tangible assets and intangible assets used to carry on business
What are financial assets
They are claims on real assets, for example a bank loan or a corporate bond
What are securities
Tradable financial assets
What are investment decisions of buying or building tangible assets sometimes called
Capital expenditure (Capex), or capital budgeting
Examples of intangible assets
Advertising, R&D and developing computer software
What is the capital structure decision
The decision between debt and equity financing
What is meant by equity financing
Means issuing more shares or reinvesting cash
What is a corporation
It is a legal person, owned by shareholders. As a legal person the corporation can make contracts, carry on a business, borrow or lend money, and sue or be sued. Shareholders have limited liability
What is the main goal of a financial manager
To maximise shareholder wealth.
Why is profit maximization not a well defined financial objective?
See page 9 in book
Difference between hard and soft capital rationing
Soft rationing is provisional limits set by management to control investment expenditure while hard rationing is where the company finds it difficult to raise financing and projects with significant NPV are passed up.
Soft rationing should never cost the company anything where hard does
What are current assets
A current asset is any asset which can reasonably be expected to be sold, consumed, or exhausted through the normal operations of a business within the current fiscal year or operating cycle or financial year.
Market value added definiton
The difference between market value and book value of a firm’s equity.
What is economic value added (EVA)
Net income after deducting the dollar return required by investors.
EVA = income earned - (cost of capital x investment)
What are financial statements
Financial statements are accounting reports issued periodically that present past performance information and a snapshot of the firm’s assets and the financing of those assets.
What is a balance sheet
Balance sheet records a snapshot of the firm’s financial position at the end of fiscal year.
What is an income statement
Accounts payable
This is what you owe suppliers
What is net working capital
current assets - current liabilities
What are recievables
Sales for which the company has not yet been paid
Net book value
Acquisition cost – Accumulated Depreciation
What is market capitalisation and formula
The total market value of equity given by:
no of shares x market price per share
What is Market Value Added (MVA)
Market cap - equity book value (total shareholder equity)
What does treasury stock represent on liabilities of balance sheet
They represent share repurchases by the company, it is another form of payout other than dividends.
Why does a share repurchase shrink shareholder equity?
A share repurchase would reduce the company’s cash holdings and therefore its assets by the amount of cash expended in the buyback.
What is enterprise value
It measures the value of the underlying business assets.
EV = Market value of equity + debt - cash
Think of this as the cost to acquire a business or the total value of the firm to debt and equity investors combined.
Leverage ratio
assets/equity
Dupont formula for ROA
asset turnover x operating profit margin (sales/assets * after tax interest + net income /sales)
What are financial statements
Accounting reports issued periodically that present past performance information and a snapshot of the firm’s assets and the financing of those assets
What is a balance sheet
It records a snapshot of the firm’s financial position at the end of the fiscal year
What does the income statement show
Income statement lists the firm’s revenues and expenses over a fiscal year.
Formula for an annuity lasting t-years
C( 1/r - 1/r(1+r)^t )
How to calculate long term capital
long term debt + shareholder equity
Long-term debt ratio
Long term debt / long term debt + equity
Total debt ratio
Total liabilities/ total assets
Formula for WACC
(cost of equity * %equity) + (cost of debt * %debt * (1-Tc))
