Principles of Finance

Question 1

What are shareholders?

Answer 1

the stakeholders that managers focus on with the goal of maximizing the market value of their shareholdings

Question 2

What 4 concepts are needed to examine shareholders.

Answer 2

1. The time value of money and interest rates
2. Uncertainly, risk and expected returns
3. Riskless arbitrage and the law of one price. (The idea that the same asset, for example, gold, trading in two different markets must trade at the same price)
4. The role of information and capital market efficiency. (The idea that the market prices we observe reflect all relevant information available
   at that point in time)

Question 3

What does the basic valuation principle state?

Answer 3

it states that if the value of benefits exceed the value of costs, then the decision will increase the value of the firm

Question 4

What is the difference between the value of money today and money in the future called?

Answer 4

the time value of money

Question 5

What does the risk free interest rate measure?

Answer 5

It measures the rate of exchange over time

Question 6

How do you convert money in today into money in the future, and vice versa?

Answer 6

By depositing (money in today into money in the future) or borrowing (money in the future into money in today) from a bank.

Question 7

What is compounded interest?

Answer 7

• Interest accrued (that is, earned) is added back to the principal and is reinvested
• The (future) value of a cash flow is calculated based on the principal and interest accrued
• This compounding of interest over time is referred to as interest on interest

Question 8

What is simple interest?

Answer 8

The value of a cash flow calculated without including any accrued (that is, earned) interest to the amount you invest.

Question 9

Present value of a single cash flow.

Answer 9

• The present value (Pv0) at r% p.a. of an amount (FVn) at the end of time n is the
  amount which invested today would grow to FVn in time n

Question 10

Formula sheet:
1 - Future value of a single cash flow using simple interest
2 - Present value of a single cash flow using simple interest
3 - Future value of a single cash flow
4 - Present value of a single cash flow

Answer 10

1 - FVn = PV0(1 + n  r)
2 - PV0 = FVn/(1 + n  r)
3 - FVn = PV0(1 + r)n
4 - PV0 = FVn/(1 + r)n

Question 11

What is a perpetuity?

Answer 11

Its an equal periodic cash flow that goes on for ever and ever.