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191 Cards in this Set
- Front
- Back
Capital budgeting
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decision making regarding which assets to invest in
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Financing decision
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decision making regarding the way in which to pay for the assets that we want to invest in
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Real assets
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tangible assets that are used in the production of goods and services
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financial assets
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financial claims to the income generated by the firm's real assets.
Any item which can be used to claim money from the company. like stock shares and loans. |
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Corporation
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business that is owned by stockholders
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Limited liability
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by owning stock in a corporation a person is not liable for the obligations that the corporation has. The stockholder is not responsible to pay off any loans the company takes on.
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CFO
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Cheif financial officer. STes overall financial strategy for a corp. Boss over treasurer and controller
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Treasurer
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responsible for financing, cahs management and relationshops with banks and other financial insitutions. Boss is the CFO
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Controller
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responsible for budgeting, accounting and taxes. Boss is the CFO
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Finanical manager
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Intgermidiary between the infevtors and the firm. Takes the financial assets and invests in real assets.
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What can a corp do with net income?
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Reinvest in the compay or pay out dividens to stockholders
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Opportunity cost
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Minimum acceptable rate of return on capital investment.
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What is used to estimate the opportunity cost of a safe investment?
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The rate of return that US government debt securities are offering
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Agency problem
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This is the problem of having conflicts of interest. Example: the manager of a corp is suppose to have the interest of the stockholders as a priority but in reality may have other personal interests
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Stakeholder
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Anyone with a financial interest in the firm
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Financial markets
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Market where securities are issued and traded
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Primary market
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Market where new securities are sold by the actual corporations
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Secondary market
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Market where investors trade securities between themselves
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Securities
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financial assets that can be purchased and traded by investors. Such as stocks and bonds
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Fixed-income market
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Market for dept securities. Called fixed income because these typically pay out a set amount at a set rate.
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Capital market
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Market for long term sources of financing of dept and equity.
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Money market
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Where short term less than 1 year financing is bought and sold.
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Financial intermediary
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An organization that provides funding to corps by getting money from their customers. The financial intermediary is also who the customer would go to if they wanted their money back by creating a claim against themselves
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Mutual fund
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Raise money by selling shares to investors. So, as an investor I give my money to a mutual fund which goes and puts the money with many others and buys a mix of stocks. A financial intermediary
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List fiancial intermedicaries
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Banks, insurance companies, Mutual funds, hedge funds, pension funds. A financial intermediary
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Hedge funds
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A pooling of funds mostly from the very wealthy. Higher risk investments. A financial intermediary
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Pension funds
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Pooling of funds from retirement accounts set up by a corp or company for its employees. A financial intermediary
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Financial institutions
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A financial intermediary that pools funds by selling a service such as accepting deposits or selling insurance
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List finanical insitutions
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Commercial banks, investment banks, insurance companies
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Commercial banks
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Regular bank and credit union
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Investment bank
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Advise and assist companies in raising financing. One way is by purchacing new stock at a set negotiated price from a company and then selling it. Also, manage portfolios for individuals and instututinal investors. Eg. Goldman Sachs
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Liquidity
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Ability to conver and asset on short noticice to cash
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Cost of capital
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Another name for Oppertunity cost. Or the minimum expected rate of return on a capital investment.
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Balance sheet
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Financial statement that shows assets and liabilities. Picture of what is happening at a given moment.
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Common-size balance sheet
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The balance sheet converted to percentages which makes it easier to compare companies of various sizes
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GAAP
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Generaly accepted accounting principles.
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Book Value
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Value of assets or liabilities according to the balnace sheet
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Income statement
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Financial statement that shows the revenues, expenses and net income of a firm. Picture of what happened over a period of time.
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Common-size income statement
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An income statement converted to percentages which allowes for comparisons between corps of different sizes
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Cash flow statement
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Finanical statement that showes the firm's cash receips (what it paid for) and cash payments (what it earned) over a perioud of time.
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EBIT
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Earnings before interest and taxes.
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Marginal tax rate
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The tax rate if the corp earned one more dollar
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Average tax rate
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Total amount of taxes owed divided by total income. Because corporate taxes are a progressive tax, there are many tax rates that are applied. This give you just one number.
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Capital structure
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the mix of dept and equity on a balance sheet for long term financing
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OCC
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Oppertunity cost of capital
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Investment decision
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also known as Capital budgeting
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Benefits of a Corporation
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Limited Liability
Infinite lifespan Ease of raising capital |
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Draw backs of a corporation
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Double taxation
Agency problems |
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Direct investment
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the investor buying stock/bonds within the financial markets
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Indirect investment
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Investors giving their money to a financial intermidiart to buy stocks/bonds within the financial markets
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IPO
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Initial public offering. When a company sells new stocks to investors.
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List types of Money market financial items
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Treasury bills, certificates of deposit (CD's), money market bonds
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What information is provided by finanical markets?
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Commodity prices
interest rates company value cost of capital |
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List the function of financial markets
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-Transport cash across time
-Risk transfer and diversification -Liquidity based on the level of marketability of an asset -Provides valuable information |
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Causes of the 2008 financial crisis
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- Fed kept interest rates low to long
- Credit rating agencies did not rate right - US gov't passed laws to allow loans to bad credit borrowers - Banks pushed bad loans - House buyers took on to much risk |
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Market capitalization
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Total market value of equity. Share price times the number of shares outstanding. Shows how much the market feels the corp is worth.
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Market value added
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Market capitalization minus the book value of equity. Shows how much more the market thinks the corp is worth over what is it worth based on its book value.
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Market to book ratio
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market value of equity divided by the book value of equity. This allows for the comparison between corporations. Also, shows how much each dollar invested becomes multiplied by. Eg. Ratio is 3. For every dollar invested the value multiplies to 3 dollars.
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EVA
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Economic value added. Shows how much more or less was earned than what is needed to cover the cost of the capital
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Residual income
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Same as EVA, economic value added
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Calculate EVA
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Equity value added. (Operating income) minus (Cost of capital% x total capitalization)
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Operation income
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Net income + after-tax interest
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ROC
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Return on capital. Shows how much the investment is earning in a percentage which can be compared to how much the capital is costing to see if the investment is at least paying off the cost to having done it
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Calculate ROC
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Return on Capital. (after tax operating income) divided by (average total capitalization)
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ROA
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Return on assets. A percentage that shows how well the assets are making money.
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Calculate ROA
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Return on Assets. (after tax operating income) divided by (average total assets)
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ROE
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Return on Equity. A percentage that shows return to shareholders per dollar that they invested in a percentage. 15% means that for every dollar invested the shareholder gets a 15cent return over their dollar
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Financial intermediaries
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Direct money to corps that need money by creating a claim against themselves.
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Financial market
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Any market where securities are issued and traded
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Primary market
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Market where new securities are issued directly from a corporation
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Secondary market
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any market where securities are traded between investors. Corps are not a part of this market, they only use it to gauge the value of themselves
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IPO
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Initial public offering
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Initial public offering
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The 1st time that a company offers stock in the primary market and the money goes straight to the corp
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Fixed-income market
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Equity and bonds are sold in this market. Called fixed income because the payouts are consistent
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Capital markets
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Are markets where financial instruments that are long term financing like bonds
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Money markets
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Are markets where financial instruments that are short term are sold like commercial paper
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Commercial paper
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money market instruments that mature in one year or less usually by financially strong corps b/c of how soon they have to pay back
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What info do financial markets give?
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Commodity price, interest rate info, company value, cost of capital
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How do financial markets inform us of the cost of capital?
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The market gives us the interest being earned by low risk US backed securities. This is often used as the minimum rate of return.
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Mutual fund
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A financial intermediary that pools people's money and invest it into a diversified portfolio
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Hedge fund
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A finanical intermediary that is very risky and very costly. The FEC does not track this and so is only for the very wealthy that can handle any losses
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Pension fund
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A financial intermediary like the mutual fund but started by a company for it's employees
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What are the functions of finanical markets?
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To transport cash over time, risk transfer because you chose how much risk to take on, diversification by allowing you to own a little bit of a lot of items, creates liquidity due to the speed of trade, provides information and prices the value of companies
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Balance sheet
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created by the accountant showing assets and liabilities at a certain point in time
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Total assets
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is equal to Total liabilities + Total shareholder equity
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Shareholder equity
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is equal to Total Assets - Total liablities
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What does the total assets side of the balance sheet tell the financial manager?
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It tells them what resources the corp needs
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What does the total liabilities side of the balance sheet tel the financial manager?
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It gives them inforamiton that helps them decide how to pay for the resources that the assets side tells them are needed
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Current assets
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assets that are very liquid like marketable securities, accounts receivable and inventories
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Fixed assets
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Assets that cannot by converted into cash very easily like property, patents, trademarks, copyrights and machinery
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What are the two types of fixed assets?
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Tangible and intangible assets
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Tangible assets
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are fixed assets that can be touched like property and machinery
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intangible assets
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are fixed asstes that canot be touched like goodwill, trademarks, copyrights and patents
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What is the value of goodwill?
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the difference between the book value of a company and the market value of the company
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What two kinds of liability are there?
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Current and long term liabilities
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Net working capital
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Equals current assets minus current liabilities
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What does net working capital tell you
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how well a corp can pay for their bills today with the money they earn now
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Book value
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Value of shareholder's equity at one point in time based on the balance sheet
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Market value
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how much the market would pay for the company.
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common size balance sheet
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Taking all the values on the balance sheet and making them percentages. this allowes you to compare companies of different sizes
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income statement
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Financial statement that shows the revenues and expenses and net income over a time frame
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common size income statement
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taking all the values on the income statement and converting them to percentages. This allowes you to compare companies of different sizes
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Why is cash flow not the same as profit
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Cash flow shows the true movement of money while profit calculates depreciation (which does not truly move money) and accoiunts receivable (which is money that has not year been received and therefore is not part of the cash flow)
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Calculate cash flow
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Net income (plus) depreciation (minus) accounts receivable (plus) accounts payable (minus) inventories = cash flow from operations
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What kind of tax structure does the US have?
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progressive, where levels of income are taxed at different levels
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Primary offering
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Same as IPO or initial public offering
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Bid price
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The prices at which investors are willing to buy shares. If you own shares, you can sell at this price
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Ask price
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The prices at which current share-owners are willing to sell their shares. You can buy shares at this price.
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Bid-ask spread
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The difference between the bid price and the ask price.
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Market order
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An order to buy or sell shares at the best currently available market price.
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Limit order
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An order to buy or sell shares at a predetermined price, to be executed when the market price reaches the requested price.
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Market Cap
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Same as Market capitalization. Market price multiplied by shares outstanding
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P/E ratio
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Price of one share (divided by) earnings of one share. (WHAT DOES THIS TELL YOU?)
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Dividend Yield
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Dividends paid (divided by) share price. Tells the investor how much dividend income they can expect for every $1 invested in the stock.
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Liquidation value
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Net proceeds that can be earned if all the firm’s assets were sold and the creditors were paid.
Market value (minus) total liabilities |
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Market value balance sheet
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Balance sheet showing market rather than book values of assets, liabilities, and shareholders’ equity.
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Going concern
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The difference between a company’s actual (is actual value the same as market value?) value and its book or liquidation value is called its going-concern value.
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Extra earning power
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A company may have the ability to earn a higher rate of return on assets; the value of these assets will be higher than their book value. (DON'T UNDERSTAND WHAT THIS MEANS)
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Value of future investments
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If investors believe a company will potentially make very profitable investments in the future, they will pay more for the company’s stock today.
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Intrinsic value
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The value today of the future cash payoffs from a stock or other security. Assists in the comparison of different financial items
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What factors determine "Going concern"?
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Extra earning power
Worth of intangible assets Value of future investments |
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What would be the rate of return if a bond or security is bought at the intrinsic value price?
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The rate of return will be the same as the discount rate
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Discount rate
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WHAT IS THIS??
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Calculate Expected return
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Ending value (minus) starting value (plus) the dividend payment (divided by) starting value
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What does expected return tell you?
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The rate of return that you got during the time that you owned, "held" the investment
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Calculate Intrinsic value
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Expected dividend per share in one year (plus) predicted stock price in 1 year (divided by) 1 (plus) the rate of return
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Expected return AKA
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Holding period return
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Dividend discount model
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This is a way to calculate what the price of a stock today should be based in the dividends and future value of a stock
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What three kinds of dividend discount models exist?
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Model for no growth
Model for constant growth Model for variable growth, aka non-contant growth |
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Calculate the dividend discount using the no growth model
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Starting price = Dividend (divided by) rate of return
P = DIV / r |
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Calculate the dividend discount using the constant growth model
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Starting price = Dividend (divided by) rate of return (minus) growth
P = DIV / (r - g) |
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Calculate the dividend discount using the non-constant growth model
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P = [DIV / (1+r)^1] + [DIV / (1+r)^2] +[DIV / (1+r)^h] + [P / (1+r)^h]
First P is the present day value. The other P is the final dividend payout when the investment is over. |
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Calculate expected rate of return
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r = (div / p) + g
Expected rate = (dividend divided by price paid today) + growth rate |
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Sustainable growth rate
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g = return on equity (x) plow-back rate
g = ROE x [(earnings - dividends) / earnings)] |
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Present value of growth opportunities
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The value the market gives to the future growth of a firm over what the firm actually pays out in dividends
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PVOG
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present value of growth
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Calculate PVOG
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present price = (earnings per share / r) + PVGO
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What two methods of stock analysis are there
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Technical analysis and fundamental analysis
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Technical analysis
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Investors who attempt to identify undervalued stocks by searching for patterns in past stock prices.
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Fundamental analysis
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Investors who attempt to find mispriced securities by analyzing fundamental information, such as accounting performance and earnings prospects.
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What is the problem with relying on technical analysis
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"Random walk" which is the fact that the market does not follow set and predictable paths
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What happens when there are many good market analysts?
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Any bargains quickly disappear and the prices stay fair.
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What are the three levels of market efficiency
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Weak-form efficient
Semi-strong-form efficient Strong-firm efficient |
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Weak-form efficient
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prices only reflect what happened in the past
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Semi-strong-form efficient
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prices reflect what happened in the past and publicly available information about the future of a firm
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Strong-firm efficient
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price reflects all available information and is not over or undervalued
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What are the 3 market anomalies
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Earnings announcement puzzle
New-issue puzzle Bubbles |
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Earnings announcement puzzle
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In an efficient stock market, a company’s stock price should react instantly at the announcement of unexpectedly good or bad earnings but sometimes it just won't react this way
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New-issue puzzle
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When firms issue stock to the public, investors typically rush to buy and these investors usually realize immediate capital gains when in reality early gains often turn into losses for the investor. So why do people still rush in? Anomaly
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Bubbles
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There are sometimes cases where market prices as a whole become difficult or impossible to justify. Yet people keep investing with no real proof that they will get pay outs.
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Behavioral finance
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Another way to analyze the market but using psychology to understand what the buyers are doing.
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Asset turn over ratio
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How fast are assets becoming sales
= Sales (divided by) total assets or average total assets |
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Receivable turnover rate
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How fast the firm is collecting of the accounts receivable
= Sales (divided by) receivables at the beginning of the period |
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Inventory turnover rate
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how fast the firm is rotating through their goods
= Cost of goods sold / inventory at beginning of the period of time |
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Average collection period
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how long does it take to collect on the accounts receivables
= Receivables at beginning of period of time (divided by) [sales/365] |
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Profit margin
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shows how good the firm is at managing the cost of running the firm. The higher the better
= net income / sales |
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Operating profit margin
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Measurement of the proportion of a company's revenue is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt.
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Calculate operating profit margin
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(Net income + after-tax interest) / sales
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After-tax interest
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NEED TO UNDERSTAND THIS
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Long term dept ratio
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Tell you how much of the long term capital is in the form of long term dept.
= long term dept / (long term dept + equity) |
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Long term dept equity ratio
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Shows how much of what a company is worth is based on the dept that it has taken on
= long term dept / equity |
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Total dept ratio
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For every $ in assets how much of it was bought by loans
= total liabilities / total assets |
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Times interest earned
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How capable is the company of paying the interest of the dept they have
= EBIT / interest payments |
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Cash coverage ratio
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How much cash on hand the firm has to pay their interest expenses
= (EBIT + Depreciation) / interest payments |
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Net working capital to total assets ratio
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Shows how liquid a company is. if the company paid off all their short term dept how much of the assets are still available
= net working capital / total assets |
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Net working capital
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Shows how much a company has of assets once it has paid off all the dept items that are currently due
= current assets - current liabilities |
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Quick ratio
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This is a way to measure liquidity. AKA the acid test
= (cash + marketable securities + receivables) / current liabilities |
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Cash ratio
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Show how much cash on hand the firm has over the dept they owe
= (cash + marketable securities) / current liabilities |
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DuPont ROA method
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Breaks the ROA equation to help figure out if it is turn over ratio or the profitability ratio that is an issue
= (sales / asstes) x [(net income + interest / sales)] |
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DuPont ROE method
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Breaks up the ROE equation to help figure out if it is the leverage ratio, asset turn over ratio, operating profit margin or dept burden that is the issue
= (Assets / equity) x (sales / assets) x [(net income + interest / sales)] x [(net income / net income + interest)] |
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Payout ratio
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how much of earnings/equity is paid out to shareholders
=dividens / earnings |
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Plowback ratio
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How much of earning/equity is kept int he corp for reinvestment
= (earnings - dividends) / earnings or = 1 - payout ratio |
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Sustainable growth rate
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If long term dept says the same how much can the firm grow from the plowback rate that is being kept
= plowback ratio x ROE = [(earnings - dividends) / earnings] x (earnings/equity) = (earnings - dividends) / equity |
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Net present value
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Present value of cash flows minus initial investments.
= Cash flow at time 0 + [cash flow at time 1/(1-r)^1] + [cash flow at time 2/(1-r)^2] + [cash flow at time T /(1-r)^T] |
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Present value
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Value of discounted cash flows at time t = 0
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Net present value rule
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Managers increase shareholders’ wealth by accepting all projects that are worth more than they cost. Therefore, they should accept all projects with a positive net present value.
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Equivalent annual annuity
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When you are comparing two investments that have different length of investments. Like comparing two trucks one that has to be replace in 3 years and one that that has to be replaced in 5 years. First you bring both their costs to their net present value and then you have calculate in the different time lines the only way to be able to compare these different investments
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On calculator how do you find NPV
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Enter each cash flow separately into the CFj. Then the interest of your opportunity cost into 1/yr key. Then the red function key, then NPV.
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Payback period
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Time until cash flows recover the initial investment of the project.
how long it takes for the item invested in to make back the money that it took to buy it |
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Payback rule
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Specifies that a project be accepted if its payback period is less than the specified cutoff period. The cutoff period is whatever you want it to be.
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Discounted payback rule
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This is the number of periods before the present value of cash flows that will be coming in equals or passes the initial investment.
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Internal rate of return
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What the discount rate of a project is when NPV = 0. This lets you see how much of a return investments could give you
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IRR rule
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Internal rate of return rule. Managers increase shareholders’ wealth by accepting all projects which offer a rate of return that is higher than the opportunity cost of capital.
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Problem with using IRR instead of NPV
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you cannot use IRR when there are multiple rates of return
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How is the problem of multiple rates of return solved when using IRR?
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Use MIRR, modified investment rate of return
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Profitability index
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Ratio of net present value to initial investment. Tell you
= NPV / initial investment |
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When would you use the profitability index
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When you are comparing projects that have similar NPV but have different investment costs to start with
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Capital rationing
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Setting a limit on how much money you have to spend on future investments
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Soft rationing
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Capital rationing limits on available funds imposed by management.
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Hard rationing
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Capital rationing limits on available funds imposed by the unavailability of funds in the capital market. When you can't get money from selling bonds or stock to fund your projects
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On calculator how do you find EAA
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Fine the NPV of the projects you are looking at then find the "PMT" of each. Enter NPV as the PV, the discount rate in 1/yr, the # of periods in N, then find PMT. This PMT amount is what you can use to compare the different projects.
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