Midterm Flashcards
What does the cash flow cycle indicate about cash flow and profits?
Cash flow and profits are not the same.
What principle does the income statement embody?
The accrual principle.
What is the cash flow statement an elaboration of?
Sources and uses statement.
What is the Value Problem in accounting?
Accounting statements have limitations in valuing financial health.
How do accounting values differ from market values?
Accounting values are transaction-based and backward-looking, while market values are forward-looking.
What false dichotomy does accounting often create?
Between realized and unrealized income.
What is the implication of accountants not assigning a cost to equity capital?
It suggests that positive accounting profit means financial health.
How does fair value accounting address the Value Problem?
It values widely traded assets and liabilities at market price rather than historical cost.
What are the potential downsides of fair value accounting?
Distortions, volatility, complexity, and subjectivity.
What are the levers of performance for companies?
Profit margin, asset turnover, and financial leverage.
What does ROE stand for?
Return on Equity.
What does ROE equal?
The product of profit margin, asset turnover, and financial leverage.
What are the three problems associated with ROE?
- Timing
- Risk
- Value
What does profit margin measure?
The fraction of each sales dollar that becomes profits.
What does asset turnover summarize?
Asset management performance.
What does financial leverage summarize?
Debt relative to equity financing.
What is ratio analysis?
The use of multiple ratios to analyze financial performance.
What are pro forma statements used for?
To estimate the need for external funding.
What do cash flow forecasts project?
External funding required as the difference between anticipated sources and uses of cash.
What do cash budgets project?
The change in cash balance over the forecast period.
What is sensitivity analysis?
Change one uncertain input at a time.
What is scenario analysis?
Coordinated changes in several inputs to mirror particular scenarios.
What is simulation in financial analysis?
Assigning probability distributions to uncertain inputs and generating possible outcomes.
What are the steps for evaluating an investment opportunity?
- Estimate relevant cash flows
- Calculate a figure of merit
- Compare the figure of merit to an acceptable criterion
Why does money have a time value?
- Cash deferred = opportunity cost
- Inflation reduces purchasing power
- Risk increases with futurity of a cash flow
What does NPV stand for?
Net Present Value.
What is the IRR?
Discount rate when NPV = 0.
What is the cash flow principle?
If money moves, count it.
What is the with-without principle?
All cash flows that differ with or without the investments are relevant.
What does an investment’s total risk refer to?
The range of possible returns.
What is systematic risk?
Part of total risk that cannot be avoided through diversification.
How is the cost of capital defined?
Risk-adjusted discount rate.
What is the cost of equity capital?
Opportunity cost incurred by owners.
What does beta measure?
An asset’s relative systematic risk.
What are the four pitfalls in discounted cash flow analysis?
- Confounding enterprise perspective with equity perspective
- Using nominal discount rate to value real cash flows
- Ignoring possibly valuable real options in firm investments
- Forgetting that a constant discount rate implies risk grows with the futurity of the cash flow
