Week 1 Flashcards
What is the Required Rate of Return (RRR) using the CAPM formula?
CAPM = rRF + (rM - rRF) x Beta (B)
rM: Market rate (expected return on the market as a whole)
(rM - rRF): Market Risk Premium (Equity Risk Premium (the excess or premium amount over and above the risk-free rate)).
B: Beta Coefficient (used to “customize” the formula for an individual firm).
What are the 3 forms of business?
1.) Sole Proprietorship
2.) Partnership
3.) Corporation
What are the advantages and disadvantages of a Sole Proprietorship?
Advantages:
- Easy to Form
- Subject to fewer government regulations
- Avoids corporate income tax
Disadvantages:
- Limited financial capital
- Limited human capital
- Unlimited Liability
- Limited Life
- Difficult to value and sell
What are the advantages and disadvantages of a partnership?
Advantages:
- Easy to form
- Subject to fewer government regulations
- Avoids corporate income tax
Disadvantages:
- Limited financial capital
- Limited human capital
- Unlimited Liability
- Limited Life
- Difficult to value and sell
What are the advantages and disadvantages of a corporation?
Advantages:
- Unlimited Life
- Easily transferred ownership
- Limited liability
- Greater access to financial capital
Disadvantages:
- More difficult and expensive to create
- Double taxation
- More expensive reporting requirements
What are the 4 types of hybrid forms of business?
1.) Sub-Chapter S Corporations
2.) Limited Liability Corporations
3.) Limited Liability Partnerships
4.) Professional Corporations
What is opportunity cost?
Ans: The next best option that could have been chosen.
Ex.: Opportunity cost of studying.
Ans: Going out with friends
What are externalities?
Ans: “A consequence of and economic activity that is experienced by unrelated third parties.”
English definition: Something that affects us, but over which we have no control.
What is scarcity?
Ans: Things that are NOT available in unlimited quantities.
Ex’s.: Time, money
Why do/should you buy shares in a corporation?
Ans: If you think it is a good investment, you should buy shares so its value will increase over time.
How do you measure the increase in value of an investment portfolio?
Ans: The value of your investment is equal to the number of shares you own times the share price.
What is risk?
Definition: Risk is the element of uncertainty about the future; the degree of likelihood that something will happen.
Ex.: Sporting game; you play and take your chances, you don’t know what the outcome will be
What is the Risk - Reward Trade-Off?
Seeking out risk because the perceived potential for injury or loss is outweighed by the benefits/fun.
Risk aversion or Risk tolerance is?
The amount of risk a person is willing to bear.
What is the equation for total return?
Total Return = rRF + IP + DP + LP + MP
rRF: Risk-Free rate
IP: Inflation Premium
DP: Default Premium
LP: Liquidity Premium
MP: Maturity Premium
What is an Inflation Premium
Ans: amount of risk to account for inflation over time.
What is a Default Premium?
Ans: Amount of risk due to the firm possibly being unable to meet its financial obligations, or in extreme cases, go out of business.
What is a Liquidity Premium?
Ans: Amount of risk based on how marketable the investment is. Low liquidity increases risk because of the inability to divest it should it be warranted.
What is a Maturity Premium?
Ans: Amount of risk involved based on the certainty of the maturity value of the investment.
Systemic risk is?
Ans: System-wide risk factors such as fluctuating prices, fluctuating interest rates, inflation, and exchange rates.
Non-Systemic risk is?
Ans: Firm specific risk factors such as default risk, business risk, financial risk, and externalities.
Categorize the following as systematic risk or non-systematic risk:
- The general state of the economy
- Reinvestment rate risk
- Financial risk
- Inflation
- Union labor strikes
- Actions of competitors
- Fluctuating interest rates
- Changing currency values
- Core business operations
- Debt financing
- Interest rate risk
- Business risk
- (General state of Econ.) Systematic
- (Reinvestment rate risk) Systematic
- (Financial risk) Non-Systematic
- (Inflation) Systematic
- (Labor strikes) Non-Systematic
- (Competitors actions) Non-Systematic
- (Fluctuating interest rates) Systematic
- (Changing currency values) Systematic
- (Core business ops.) Non-Systematic
- (Debt financing) Non-Systematic
- (Interest rate risk) Systematic
- (Business risk) Non-Systematic
What are potential harms to a company’s intrinsic values?
1.) Does not spend the time necessary to maximize a firms value ( i.e. little focus, directed to corporate strategy, objectives, etc.)
2.) Employs corporate resources for personal benefit
3.) Avoids difficult, but value-adding, decisions based on non-corporate factors
4.) Takes too much or not enough risk to maximize returns
5.) Invests (or stockpiles) corporate resources in investments with less-than-optimal returns, rather than returning the funds to stockholders
6.) Does not release all information desired by investors
What is the current ratio formula?
Current assets/current liabilities
What is the “quick” ratio?
Current assets - inventory/current liabilities
What is the “net working capital” ratio?
Current assets - current liabilities
What is the “Days Sales Outstanding (DSO)” ratio?
Accounts Receivable (A/R) / (Credit sales / 365)
What is the “Days Sales in Inventory (DSI)” ratio?
Inventory / (COGS / 365)
What is the “Fixed Asset Turnover (FATO)” ratio?
Sales / Net fixed assets
What is the “Asset Turnover (ATO)” ratio?
Sales / total assets
What is the “debt to assets” ratio?
Total debt / total assets
What is the “liabilities to assets” ratio?
Total liabilities / total assets
What is the “debt to equity” ratio?
Total debt / total equity
What is the “financial leverage (equity multiplier)” ratio?
Total assets / total equity
What is the “Times interest earned (TIE)” ratio?
EBIT / interest expense
What is the “gross margin” ratio?
Gross profit / sales
What is the “operating margin” ratio?
EBIT / sales
What is the “profit margin” ratio?
Net income / sales
What is the “ROA” ratio?
Net income / total assets
What is the “ROE” ratio?
Net income / common equity
What is the “Earnings Per Share (EPS)” ratio?
Net income / common shares outstanding
What is the “P/E” ratio?
Market price / EPS
What is the “earnings yield” ratio?
EPS / market price
What is the “book value per share” ratio?
Common equity / common shares outstanding
What is the “market to book” ratio?
Market price / book value per share
What is the equation for Net operating profit after taxes (NOPAT)?
NOPAT = EBIT + (1 - tax rate)
What is EBIT?
Earnings Before Interest and Tax
How do you calculate free cash flow?
NOPAT +/- Non-Cash reserves +/- Changes in NOWC +/- Capital expenditures = Free cash flow
What is NOWC?
NWC - non-operating assets - non-operating liabilities
