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112 Cards in this Set
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capital budgeting
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the process of planning and managing a firm's long-term investments
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capital structure
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the mixture of debt and equity maintained by a firm
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working capital
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a firm's short-term assets and liabilities
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sole proprietorship
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business owned by one person
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adv: easiest to start, least regulated, owner keeps all profit, taxed once as personal income
disadv: ltd to life of owner, equity capital ltd to owner's personal wealth, unltd liab, difficult to sell ownership interest |
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partnership
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a business formed by 2 or more individuals or entities
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adv: 2 or more owners, more capital available, relatively easy to start, income taxed once as personal income
disadv: unltd liab, partnership dissolves when one partner dies or wishes to sell, difficult to transfer ownership |
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corporation
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a business created as a distinct legal entity composed of one or more individuals or entities
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adv: ltd liab, unltd life, separation of ownership and mgmt, easy to transfer ownership, easier to raise capital (not ltd to owners' wealth
disadv: sep. of ownership and mgmt, double tax |
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agency problems
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the possibility of conflict of interest between the stockholders and the management of a firm
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stakeholders
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someone other than a stockholder or creditor who has a claim on the cash flows of the firm
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future value (FV)
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the amount an investment is worth after one or more periods
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compounding
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the process of accumulating interest on an investment over time to earn more interest
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interest on interest
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interest earned on the reinvestment of previous interest payments
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compound interest
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interest earned on both the initial principal and the interest reinvested from other periods
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simple interest
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interest earned only on the original principal amount invested
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future value equation
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FV=PV(1+r)^t
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future value interest factor (FVIF)
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(1+r)^t
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present value (PV)
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the current value of future cash flows discounted at the appropriate discount rate
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discount
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calculate the PV of some future amount
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discount factor/discount rate/present value interest factor (PVIF)
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1/((1+R)^t)
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discount rate
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the rate used to calculate the PV of future cash flows
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discounted cash flow (DCF) valuation
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calculating the present value of a future cash flow to determine its value today
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PV equation
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PV=FV[1/((1+r)^t)]
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important relationship 1
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r is constant
FV is constant increase t |
increase in FVIF
decrease in PVIF decrese in PV |
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important relationship 2
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t is constant
FV is constant increase r |
increase in FVIF
decrease in PVIF decrease in PV |
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annuity
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a level stream of cash flows for a fixed period of time
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ordinary annuity
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annuities that occur at the end of a period
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annuity due
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an annuity for which the cash flows occur at the beginning of the period
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perpetuity
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an annuity in which the cash flows continue forever
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consol
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a type of perpetuity
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stated interest rate (quoted interest rate)
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the interest rate expressed in terms of the interest payment made each period
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effective annual rate (EAR)
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the interest rate expressed as if it were compounded once per year
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annual percentage rate (APR)
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the interest rate charged per period multiplied by the number of periods per year
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coupon
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the stated interest payment made on a bond
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face value (par value)
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the principal amount of a bond that is repaid at the end of the term
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coupon rate
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the annual coupon divided by the face value of a bond
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maturity
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the specified date on which the principal amount of a bond is paid
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yield to maturity (YTM)
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the rate required in the market on a bond
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What increases interest rate risk?
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Longer time to maturity and low coupon rate
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current yield
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a bond's annual coupon divided by it's price
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indenture
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the written agreement between the corporation and the lender detailing the terms of the debt issue
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registered form
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the form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record
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bearer form
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the form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond
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debenture
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an unsecured debt, usually with a maturity of 10 years or more
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note
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an unsecured debt, usually with a maturity under 10 years
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call provision
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an agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity
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deferred call provision
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a call provision prohibiting the company from redeeming a bond prior to a certain date
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call-protected bond
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a bond that, during a certain period, cannot be redeemed by the issuer
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protective covenant
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a part of the indenture limiting certain actions that might be taken during the term of a loan, usually to protect the lender's interest
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zero coupon bond
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a bond that makes no coupon payments and is thus initially priced at a deep discount
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bid price
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the price a dealer is willing to pay for a security
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ask price
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the price a dealer is willing to take for a security
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bid-ask spread
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the difference between the bid price and the ask price, represents dealer's profit
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clean price
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the price of a bond net of accrued interest; this is the price that is typically quoted
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dirty price
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the price of a bond including accrued interest, aka the full or invoice price; this is the price the buyer actually pays
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real rates
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interest rates or rates of return that have been adjusted for inflation
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nominal rates
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interest rates or rates of return that have not been adjusted for inflation
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Fisher effect
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the relationship between nominal returns, real returns, and inflation
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term structure of interest rates
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the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money
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inflation premium
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the portion of a nominal interest rate that represents compensation for expected future inflation
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interest rate risk premium
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the compensation investors demand for bearing interest rate risk
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Treasury yield curve
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a plot of the yields on Treasury notes and bonds relative to maturity
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default risk premium
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the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default
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taxability premium
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the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status
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liquidity premium
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the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity
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dividend growth model
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a model that determines the current price of a stock as it's dividend next period divided by the discount rate less the dividend growth rate
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dividend yield
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a stock's expected cash dividend divided by it's current price
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capital gains yield
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the dividend growth rate, or the rate at which the value of an investment grows
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common stock
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equity without priority for dividends or in bankruptcy
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straight voting
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a procedure in which a shareholder may cast all votes for each member of the board of directors
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proxy
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a grant of authority by a shareholder allowing another individual to vote his or her shares
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dividends
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payments by a corporation to shareholders, made in either cash or stock
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preferred stock
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stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights
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primary market
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the market in which new securities are originally sold to investors
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secondary market
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the market in which previously issued securities are traded among investors
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dealer
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an agent who buys and sells securities from inventory
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broker
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an agent who arranges security transactions among investors
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member
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as of 2006, a member is the owner of a trading license on the NYSE
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commission brokers
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NYSE members who execute customer orders to buy and sell stock transmitted to the exchange floor
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specialist
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a NYSE member acting as a dealer in a small number of securities on the exchange floor; often called a market maker
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floor brokers
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NYSE members who execute orders for commission brokers on a fee basis; sometimes called $2 brokers
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SuperDOT system
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an electronic NYSE system allowing orders to be transmitted directly to the specialist
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floor traders
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NYSE members who trade for their own accounts, trying to anticipate temporary price fluctuations
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order flow
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the flow of customer orders to buy and sell securities
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specialist's post
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a fixed place on the exchange floor where the specialist operates
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over-the-counter (OTC) market
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securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories
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electronic communications network (ECN)
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a web site that allows investors to trade directly with each other
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net present value (NPV)
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the difference between an investment's market value and it's cost
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discounted cash flow (DCF) valuation
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the process of valuing an investment by discounting it's future cash flows
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NPV rule
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an investment should be accepted if the NPV is positive and rejected if it is negative
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payback period
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the amount of time required for an investment to generate cash flows sufficient to recover it's initial cost
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payback period rule
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an investment is acceptable if it's calculated payback period is less than some prespecified number of years
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discounted payback period
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the length of time required for an investment's discounted cash flows to equal it's initial cost
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discounted payback rule
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an investment is acceptable if it's discounted payback is less than some prespecified number of years
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average accounting return (AAR)
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an investment's average net income divided by it's average book value
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AAR rule
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a project is acceptable if it's AAR exceeds a target AAR
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internal rate of return (IRR)
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the discount rate that makes the NPV of an investment zero
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IRR rule
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an investment is acceptable if the IRR exceeds the required return; should be rejected otherwise
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net present value profile
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a graphical representation of the relationship between an investment's NPV and various discount rates
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multiple rates of return
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the possibility that more than one discount rate will make the NPV of an investment zero
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mutually exclusive investment decisions
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a situation in which taking one investment prevents the taking of another
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profitability index (PI)
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the PV of an investment's future cash flows divided by it's initial cost; aka benefit-cost ratio
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incremental cash flows
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the difference between a firm's future cash flows with a project and those without the project; The ICF for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project
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stand-alone principle
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the assumption that evaluation of a project may be based on the project's ICF
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sunk cost
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a cost that has already been incurred and cannot be removed an therefore should not be considered in an investment decision
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opportunity costs
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the most valuable alternative that is given up if a particular investment is undertaken
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erosion
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the cash flows of a new project that come at the expense of a firm's existing projects
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pro forma financial statements
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financial statements projecting future years' operation
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accelerated cost recovery system (ACRS)
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a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications
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bottom-up approach
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OCF = net income + depreciation
no interest expense |
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top-down approach
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OCF = sales - costs - taxes
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tax shield approach
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OCF = (sales - costs) * (1 - T) + depreciation * T
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depreciation tax shield
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the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate
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equivalent annual cost (EAC)
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the PV of a project's cost calculated on an annual basis
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