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163 Cards in this Set
- Front
- Back
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Time value is necessary because money has
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time value
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A dollar in hand today is worth more or less than a dollar to be received in the future?
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more
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The values of future dollars must be ____ before they can be compared to current dollars.
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adjusted
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In timelines tick marks designate
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ends of periods
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Moving to the right along the timeline is called
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compounding
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Moving to the left along the timeline is called
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discounting
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Where does a discount rate come from?
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Discount rate is the opportunity cost
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Opportunity cost rate is
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the rate that can be earned on alternative investements of similar risk
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Opportunity cost rate does or does not depend on the source of investment funds
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not
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Financial performance of an investment is measured by its
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return
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Returns can be measured either in
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dollar terms or rate of return terms
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Opportunity cost of capital
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an NPV of zero means the project just earns its opportunity cost rate; a positive NPV indicates that the project has positive financial value after opportunity costs are considered
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In capital investment analyses, the rate of return is often called
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internal rate of return (IRR)
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IRR is
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the percentage return expected on the investment
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To interpret the rate of return it must be
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compared to the opportunity cost of capital
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When compounding occurs intra-year the future value of an investment is
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larger than under annual compounding
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When compounding occurs intra-year the present value of an investment is
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smaller than under annual compounding
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Effectivr Annual Rate (EAR) is
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the annual rate that causes PV to grow to the same FV as under intra-year compounding
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Formula for EAR calculation
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[(1+annual EAR/# of times compounded)^# of times compounded]-1.0
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Financial risk is present whenever there is
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some chance of earning a return on an investment that is less than the amount expected
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Risk increases with
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increased probability of a return far below that anticipated
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When expected rate of return is graph which investment is more risky?
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The wider graph; the tighter the curve the less risky
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In their attitude toward investment risk, investors can be
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risk neutral, risk averse, or risk seeking
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In their attitude toward investment risk, most investors are
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risk averse
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Risk averse means
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that higher-risk investments require higher rates of return
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The chance that an event will occur is called
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its probability of occurence or just probability
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A list of all possible event outcomes along with their probabilities
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a probability distribution
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the expected rate of return is estimated before or after an investment is made?
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before
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After an investment is made, the return that is actually achieved is called
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the realized rate of return
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Stand-alone risk is defined and measured assuming an investment will be held in
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isolation
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One commone measure of stand-alone risk is
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standard deviation
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Standard deviation is usually represented by
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lower case sigma
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How do you calculate standard deviation (sigma)?
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sigma = sqrt of variance
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A larger sigma indicates more or less stand-alone risk?
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more
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When graphed which sigma curve indicates more risk?
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the wider curve
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The coefficient of variation (CV) is defined as
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the standard deviation divided by the expected rate of return
sigma/expected rate of return |
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A standardized measure of stand-alone risk is
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CV
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Standard deviation or CV is an applicable measure of investment only when an investment is held
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in isolation
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Mos investments are held as part of a
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portfolio of investments
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When investments are held in portfolios, the relevant risk and return to the investor is that
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of the entire portfolio
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The expected rate of return on a portfolio E(Rp), is
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the weighted average of the components expected returns
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A portfolios risk
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depends on the relationships among the returns, it is not simply a weighted average
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The risk of an individual investment when it is held in isolation
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stand-alone risk
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Part of the stand-alone risk that can be elimnated by diversification
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diversifiable risk
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Part of the stand-alone risk that cannot be eliminated by diversification
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portfolio risk
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Formula for stand-alone risk
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stand-alone risk = portfolio risk + diversifiable risk
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As more investments are randomly added to the portfolio sigma
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decreases
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Incremental risk reduction decreases as
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more assets are added
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The most widely used measure of risk for investment held in portfolios is
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the beta coefficient or just beta
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Beta is
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a relative measure of risk
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Beta depends on
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both the investment and the portfolio
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If beta = 1.0, investment has average risk, where average is defined as
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the riskiness of the portfolio
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If beta > 1.0, investment has
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above avg risk
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If bets < 1.0, investment has
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below avg risk
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Most investments have betas in the range of
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.5 to 1.5
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What do businesses need to acquire the assets needed to provide services?
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capital
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Capital comes in two basic forms:
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equity and debt
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Capital is allocated in a free market economy by
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price
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What on a debt security is the cost of that capital?
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interest rate
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What four primary factors influence the general level of interest rates?
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investment opportunities, time preferences for consumption, risk, and inflation expectations
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Long-term debt includes:
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bonds and corporate/municipal bonds
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Types of bonds:
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treasury, corporate, and municipal
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Corporate/municipal bonds may be:
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mortgage bonds, debentures, and subordinated debentures
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Term loans
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borrower makes a series of payments (principle and interest) to lender, private placement, short-term (maturities of 2-7 yrs), fixed or variable interest rate
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What are the advantages of term loans over public offerings(bonds)?
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speed, flexibility, issuance costs
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What are the disadvantages of term loans?
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size limits, maturity limts
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What is different about bonds from term loans?
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Bonds are registered with SEC and they are a public offering
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Government or Treasury Bonds are issued by
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US Treasury
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Corporate bonds are issued by
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investor-owned firms
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Municipal bonds are issued by
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governments other than federal
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Most bonds have maturities of
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20-30 years, but shorter and longer as well
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Most bonds have what type of interest rate?
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fixed, but floating and variable as well
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Floating rate bonds are
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riskier to issuer but saver to buyer
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Mortgage bonds
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real assets are pledged as security
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Debentures
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unsecured real assets, backed by revenue-producing power of firm
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Subordinated debentures
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if bankruptcy, claim on assets only after senior debt, higher risk, higher interest rate
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Municipal bonds
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issued by states, counties, cities, and backed by taxing power, interest is tax exempt so investors accept lower rates, no SEC registration but official statement and annual statements
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Advantages of short-term debt over long-term debt
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faster, lower issuance costs, fewer restrictive covenants, generally lower interest rate
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Disadvantages of short term over long-term debt
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rollover risk, renewal risk
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Common types of short-term debt
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commercial paper, bank loans (notes payable)
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Important sources of short-term credit to healthcare providers
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commercial banks
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Bank loans appear on the balance sheet as
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notes payable
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Blank loan concepts
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promissory note, compensating balance, line of credit
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In a secured loan, the borrower pledges assets as what for the loan?
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Collateral
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For short-term loans the most commonly pledged assets are
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receivables and inventories
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The lender has recourse to the borrowing provider if receivables are
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pledged
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The buyer (lender) has no recourse to the selling(borrowing) business, receivables are effectively sold when they are
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factored
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Healthcare providers are more likely to use receivables financing than
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inventory financing
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if inventory financing is used, the inventory may be secured by a
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blanket lien, trust receipt, warehouse receipt
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The form of inventory financing used depends on
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the type of inventory and situation at hand
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Advantages to debt financing
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profits accrue to owners not creditors, tax deductibility of interest and tax-exempt debt lead to lower cost of capital, no sharing of control with creditors
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Disadvantages of debt financing
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principal and interest is a fixed charge and can lead to bankruptcy, increases the risk of the business and hence the cost of capital, covenants may restric management
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There are two parties to lease transactions
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the lessee and the lessor
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Uses the asset and makes the lease (rental) payments
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lessee
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Owns the asset and receives the lease (rental) payments
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lessor
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The lease decision is what type of decision for the lessee?
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financing
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The lease decision is what type of decision for the lessor?
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investment
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Primary lease types
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operating and financial
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Operating leases are
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short term, normally cancelable, maintenance usually included
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Financial leases are
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long term, normally noncancelable, maintenance usually not included,
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What is a special type of financial lease?
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sale and leaseback
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Leases are classified by the IRS as
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either guideline or nonguideline
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For what type of lease is the entire lease payment tax deductible to the lesee?
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guidline (operating)
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For what type of lease is only the imputed interest payment deductible?
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nonguidline (capital/financial)
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A type of lease in which the implied interest payment is nontaxable to the lessor
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tax-exempt lease
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For financial accounting purposes leases are classified as
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either capital or operating
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Leases that must be shown directly on the lessee's balance sheet
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capital
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Leases that are sometimes referred to as off-blance sheet financing, must be disclosed in the footnotes
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operating
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Leasing is a substitute for
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debt financing
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Leasing
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obligates the lessee to fixed payments, lessors have rights similar to lenders
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Leasing uses up a business's
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debt capacity
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Formula for NAL
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NAL = PV leasing - PV owning
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Measures the dollar advantage of leasing versus borrowing and buying
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NAL
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A positive NAL indicates
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leasing is the better option
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The equivalent after-tax cost rate implied in the lease contract
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IRR
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If th IRR is less than the after-tax cost of debt
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leasing is the better option
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Leasing is driven by asymmetries
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tax differentials, including AMT, ability to bear risk (residual value risk, utilization risk, project life risk), maintenance services, lower information costs, lower risk in bankruptcy
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The analysis of potential additions to a business's fixed assets
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capital budgeting
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Decisions about capital budgeting are
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typically long term in nature, often involve large expenditures, usually define strategic direction
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For analysis purposes, projects are classified according to purpose and size
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mandatory replacement, expansion of existing services, expansion to new services
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Overview of capital budgeting financial analysis
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estimate the capital outlay, forecast the cash inflow (operating and terminal), assess the project's riskiness, estimate the cost of capital, measure the financial impact
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Time breakeven is measured by
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payback or payback period
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Strengths of payback
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provides an indication of a project's risk and liquidity, easy to calculate and understand
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Weaknesses of payback
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ignores time value, ignores all cash flows that occur after the payback period
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Return on Investment (ROI) focuses on a project's
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expected profitability
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Measures a project's time value adjusted dollar return
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Net present value (NPV)
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measures a project's rate of (percentage) return
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Internal rate of return (IRR)
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The sum of the present values of the project's net cash flows
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NPV
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What is the discount rate used in ROI analysis?
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project cost of capital
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If we assume that the project being considered has average risk, its project cost of capital is equal to
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the corporate cost of capital
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A positive NPV signifies that the project
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is a good idea
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one of the most important characterisitcs of a business is its
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financial performance
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Financial performance analysis
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assesses a business' financial condition
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Focuses on the information in a business' financial statements with the goal of assessing financial condition
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financial statement analysis
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Focuses on operating data with the goal of explaining financial performance
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operating analysis
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focuses on assessing managerial performance
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MVA and EVA
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a technique used in financial statement analysis
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ratio analysis
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Ratio analysis category that tells if a business is generating sufficient funds
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profitability
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Ratio analysis category that tells if the business can meet its cash obligations
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liquidity
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Ratio analysis category that tells if the business is using the right mix of debt and equity
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Debt management
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Ratio analysis category that tells if the business has the right amount of assets for its volume
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asset management
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Profitability ratios
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total margin, ROA, ROE
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Total margin
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net income/total revenue
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ROA
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net income/total assets
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ROE
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net income/total equity
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Liquidity ratios
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current ratio, days cash on hand (DCOH)
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current ratio
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CA/CL
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DCOH
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(cash+marketable securities)/cash expenses/365
60 is a good number don't want to get below 45 |
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debt management ratios
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debt ratio, times interest earned (TIE)
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debt ratio
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total debt/total assets
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TIE ratio
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EBIT/interest expense
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asset management ratios
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FA turnover, TA turnover, average collection period (ACP)
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FA turnover
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total revenue/net fixed assets
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TA turnover
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total revenue/total assets
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ACP
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net patients accounts rec./net patient service rev./365
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Two performance measures that are being used frequently that focus on managerial performance
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MVA & EVA
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Focuses on mangement's aggregate contribution to sharehold wealth
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Market value added (MVA)
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focuses on current managerial performance on an annual basis
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economic value added (EVA)
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MVA equation
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MV of equity - BV of equity
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EVA equation
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dollar earning to investors - dollar cost of capital employed
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NOPAT
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net operating profit after taxes
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EVA
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NOPAT - dollar capital costs
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CCC
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corporate cost of capital
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