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163 Cards in this Set

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