Study Guide Flashcards
Excess cash flows can result in
paying dividends
reinvest in projects
Net Present Value
measures the present value of all of the changes in a firm’s current and future free cash flow resulting from an investment
Capital Budgeting decisions are
independent of finance decisions
What does NPV miss?
misses the value of options that managers have to expand, scale back, or abandon investment projects once they are undertaken
IRR
tells you the return you expect to earn each year
Qualities of IRR (3 things)
- NPV is equal to 0
- depends only on the characteristics of cash flows
- discount rate is not part of the equation
IRR and NPV criteria lead to the same investment decision when
initial cash flow being -
followed by the rest being positive
vice versa
investment decision does not change
Problems with IRR
Multiple discount rates exist
inappropriate to use IRR to choose among projects
Payback Period
is the time until the sum of future cash flows equals the initial investment
“time it takes to get our money back”
Issues Concerning Payback
- Doesn’t correspond to a measure of an invt. effect on value of firm
- Doesn’t discount cash flows
- Benchmark payback period is arbitary
- ignores distant cash flows
Machinery is
not part of NWC since it is not long term
What is a measure of total risk?
Standard Deviation
List out the order of risk from least to highest
T Bills
Bonds
Large Firm Common Stocks
Small Firm Common Stocks
Higher risk means that there is going to be a
higher return
When correlation is close to 1 it is
getting close and similar to one another in having a linear relationship
Systematic Risk and…
market
non-diversifiable
Unsystematic Risk and…
firm specific
diversifiable
When correlation goes towards -1 you get
lower risk and more diversification
A stock’s Beta measures
its non-diversifiable, systematic, or market risk
Example of non-diversifiable risk
interest rates
war
market rates
Examples of diversifiable risk
death of a ceo
markets and acquisitions
- both only effect a single company
Higher Beta indicates
higher market risk
the company is more affected by changes in the overall economy and therefore has higher required returns
What type of companies sell high betas?
Luxury companies
T-Bills =
R f
S&P 500 =
R m
Any asset that plots below the SML is
overpriced and has a negative NPV
Beta vs standard deviation
beta measures a stock’s volatility relative to the market as a whole, while standard deviation measures the risk of individual stocks.
Required Returns represent
a cost of raising capital
firms with high risk will have
high WACC’s
Tax deductibility of interest payments on debt results in
lowers the cost of debt for firms
Order of Operations
Debt - lowest
preferred stock
common stock
Venture Capital
money invested to finance a new firm
Interest tax shield
increases the value of the firm
M&M Proposition assumes
no taxes
no fees
fixed investment policy
capital strucutre doesn’t impact firm value
Beta is associated with
(2 things)
compensated risk
which is affiliated with required rate of return
St.Dev and risk
StandardDeviation involves total risk so therefore it is both systematic risk and unsystematic risk
What decides to accept or reject IRR?
if irr is above market then take it
Beta vs StDev
beta is compensated risk while stdev is total risk of everything
