Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
83 Cards in this Set
- Front
- Back
What is Finance? |
deals with the valuation of risky cash flows spread throughout time |
|
Corporate Finance |
firm-level decisions about investing in projects and financing those investments |
|
Investments |
individuals deciding which financial assets to invest in |
|
What long-term investment should a firm take on? |
Capital Budgeting (Investment decision) deals with NPV |
|
How should the firm raise funds to select investments? |
Capital Structure (financing decision); deals with debt to equity (borrow (bonds) vs. Equity) |
|
How should short-term assets be managed and financed? |
Working capital management; WC= CA-CL |
|
What are the 5 characteristics of corporation? |
1) owned by unlimited number of shareholders 2) Transfer of ownership generally simple 3) Separation of ownership and control 4) Limited Liability 5) Taxed at the corporation level (double taxation) |
|
What are 3 advantages of a corporation? |
1) Firm size is large, which allows the firm to raise money 2) expertise, professional management 3) Limited Liability reduces shareholder risk |
|
What are 3 disadvantages of a corporation? |
1) Shareholder's Rights 2) Conflict of interest (agency problem with shareholders and managers) 3) Shareholders vs. Bondholders; bondholders are more conservative |
|
Contingency claims that deal with debt |
promise by the borrowing firm to repay a fixed dollar amount by a certain date |
|
Senior claim on CF |
debt holders get paid first |
|
Shareholder's claim |
residual amount that remains after the debt holder are paid |
|
What are advantages of debt? |
1) bonds are less ricky than stock 2) Interest expense is tax deductible |
|
Agency Problem |
arise when one person is hired to perform a task on behalf of another |
|
Who is the principal and who is the agent in the Stockholder vs. Manager relationship? |
Stockholder is the principal and the manager is the agent |
|
What is the main source of conflict in the stockholder vs. manager relationship? |
separation of ownership and control |
|
In a stockholder vs. Manager relationship what is interest? |
Stockholders want to maximize share price, focus on long-term horizon, and are well diversified
Managers want to maximize compensation and perks, focus on shorter horizon, and minimize personal risk because they are less diversified |
|
Agency Costs |
managers do no attempt to maximize stockholder value; stockholders incur costs to monitor and influence. |
|
Who is the agent and the principal in a stockholder vs. bondholder relationship? |
Stockholder is the agent the bondholder is the principal |
|
What is the main source of conflict in a stockholder vs. bondholder relationship? |
limited liability of corporation |
|
What are the interests of each in a stockholder vs. bondholder relationship? |
stockholders want to maximize stock prices; bondholders what to minimize risk and maximize the likelihood of payment |
|
What are the 4 internal governance mechanisms? |
1) Annual meeting and proxy vote 2) Board monitoring 3) Incentive Compensation 4) Threat of firing |
|
What are the 3 external governance mechanisms? |
1) the market of corporate control 2) debt Discipline 3) Regulations |
|
Proxy vote |
a proxy enables shareholders to vote for any matters that come before the board at the annual meeting |
|
What does dual classes of shares do? |
creates anti-governance |
|
What are 4 advantages to board of directors? |
1) elected by shareholders (in theory) 2) Protect shareholder interest (in theory) 3) Monitor management: hire and fir senior executive, choose compensation structure 4) Independent board members (not employees) and board quality |
|
What are 5 problems with board of directors? |
1) Spend limited time on fiduciary duties 2) Directors often nominated by the management 3) CEO often chairs the board 4) directors may lack expertise 5) Many directors are CEOS of other firms (good for expertise; bad for other interest/ busy) |
|
What do incentive compensation do? |
align interest between managers and shareholders |
|
What are negatives of incentive compensation? |
under-diversification problem; earnings and stock price manipulation |
|
What are advantages of debt discipline? |
1) forces manager to work hard to meet debt obligation 2) reduces free cash flow problem |
|
What is a disadvantage of debt discipline? |
makes managers too conservative |
|
Sarbanes-Oxley Act |
the overall intense of SOX was to improve the accuracy of information given to both board and management of shareholders |
|
When it comes to Time Valuation of money what do you do when you are moving forward in time? |
divide |
|
When it comes to Time Valuation of Money what do you do when you are moving backward in time? |
multiple |
|
What type of cash flow is a preferred stock? |
perpetutity |
|
What does NPV assume? |
all CF can be reinvested at the discount rate |
|
Internal Rate if Retrun |
the discount rate that makes a project's NPV=0 |
|
r>IRR |
NPV= negative |
|
r<IRR |
NPV= Positive |
|
What dies "hurdles" mean? |
the IRR is greater than r so you should accept |
|
higher r= ? |
lower NPV |
|
What are advantages of IRR? |
1) people like to look at returns 2) Comparable across projects of different sized (because it tells you the return of each dollar) 3) useful in preparing analysis for outside investors |
|
What are problems with IRR? |
1) Some cash flow streams can have multiple IRRs 2) reinvestment rate assumption: IRR assumes all CF are reinvested at IRR, however, reinvestment at the opportunity cost of capital is a better assumption |
|
What is IRR bias toward? |
smaller sized projects |
|
What does MIRR fix? |
1) eliminates multiple IRRs when there are negative future CF (unconventional CF) 2) Fixes the reinvestment rate problem; assuming all CF are reinvested at the opportunity cost of capital |
|
How do you find MIRR? |
1) Discount all negative CF to PV using the opportunity cost of capital rate 2) Compound all positive CF to FV using the opportunity cost of capital rate 3) Plug in PV (-) and FV(+) to find I/Y which will be MIRR |
|
What is the rule with MIRR? |
MIRR> opportunity cost of capital Accept |
|
What problem does IIRR fix? |
size problem; one project is larger than another |
|
How do you find IIRR? |
1) Take the CF form the larger project and subtract the smaller project 2) Find IRR on calculator, that will be IIRR |
|
What is the Rule with IIRR |
IIRR> WACC choose Large project
IIRR<WACC choose Small project |
|
What are advantages of the Profitability Index? |
1) May be useful when available investment funds are limited 2) Easy to understand and communicate 3) Correct decision when evaluating independent projects |
|
What is a problem of the profitability index? |
it does not consider the scale of investment |
|
Profitability Index |
means per dollar investment how much NPV is generated |
|
What is profitability index bias toward? |
small projects |
|
Payback period |
number of years to recover initial costs |
|
Rule for Payback period |
Payback period > t years reject |
|
what does discounted Payback Period do? |
discounts all the CF to PV; factors in TVM |
|
Soft Rationing |
Capital budgets for divisions and subdivisions of a firm for planning and control purposes. (Internal) |
|
Hard Rationing |
difficult or costly to raise more capital. (External, by market) |
|
When dealing with capital constraints what does it mean to maximize total NPV? |
do within budget and the Sum of NPV of all projects |
|
When do you use Least Common Multiple (LCM)? |
when projects have uneven lives and if projects can be repeated to have "common" lives |
|
How do you find LCM? |
1) Repeat the CF of the shorter life project to "common life" and calculate CF 2) find NPV of repeated project and compare to NPV of longer life project |
|
What is the rule for LCM? |
If shorter life NPV repeated is greater than longer life project's NPV, do shorter project |
|
How do you find EAA? |
1) Find NPV of both projects in Calculator 2) for each project, use the NPV you found as the PV in calculator and find PMT, this will be your EAA for the project |
|
What is the rule with EAA? |
choose the project with a larger EAA |
|
(Rev.- Costs- Dep)= |
EBIT (Earnings before Interest and tax) |
|
(Rev.- Costs- Dep.) (1-t)= |
EBIT(1-T); NOPLAT-> Net Operating Income Less Adjusted Taxes |
|
What are depreciation tax effects? |
it is a non-cash expense; It lowers taxable income so it generates "extra" CF |
|
If Working capital increases what does that mean? |
cash out flow |
|
Capital gain/Loss |
SV(t)-BV(t) |
|
Project CF= ? |
FCFF- Initial Investment + After-Tax Salvage Value |
|
When dealing with change in working capital, and the change is positive, what do you do when trying to find FCFF? |
subtract it |
|
When deal with change in working capital and the change is negative, what do you do when trying to find FCFF? |
add it |
|
Once you find the FCFF, how do you find the Final CF? |
1) Factor in the Initial outlay (-) at year 0 and the After-tax Salvage value in the final year (+) 2) If there are opportunity costs or externalities, factor those in as well 3) once you have the Final CF for each year, find NPV |
|
What is Product Cannibalization? |
when consumers of a company's product switch to another product of the company |
|
sensitivity Analysis |
change one variable at a time to analyze which factors affect NPV the most; isolate effe of one variable |
|
Scenario Analysis |
project analysis given a particular combination or assumptions; allow several variables to change, create best/worst scenario |
|
Break Even Analysis |
analysis of the level of sales (or other variable) at which the company breaks even |
|
Simulation Analysis |
estimation of the probabilities of different possible outcomes; generate NPV estimates for a wide range of scenarios |
|
% change in Rev./NPV |
New-old/old |
|
How to you find the Break Even Quantity using the accounting method |
set NI =0 and solve |
|
What does the accounting break even method not consider? |
initial investment |
|
How do you fin the Break Even quantity using Financial method? |
1) for CF add back depreciation to NI equation 2) On calculator set PV to initial investment and find PMT, this will be what you set you CF equation to 3) Solve for Q in equation |