Reading...
Play button
Play button
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;
121 Cards in this Set
- Front
- Back
|
NPV
|
Difference btw an investment’s market value and its cost.An investment should be accepted if the NPV >0 and rejected if neg.
|
|
|
Irene and Sue are to receive money from the estate of their rich uncle, when they reach the age of 31. Each of them has asked you to lend her $5,000. Sue is prepared to give you $12,442 in return but Irene will give you $12,969. Which girl would you prefer to lend $5,000?
|
The missing factor in the proposal is the timing of the cashflow so we cannot select.
|
|
|
DCF valuation
|
The process of valuing an investment by discounting its future cash flows.
|
|
|
Important elements in making CF DC
|
The cash flow, the timing and the risk.
|
|
|
Payback period
|
Amount of time required for an investment to generate cash flows that recover its initial cost
|
|
|
How does payback stand in relation to its consideration of the timing of the cash flows?
|
Because payback adds and subtracts cash flows at dollar face value it does not consider the fact that a dollar now is more valuable than a dollar in a year. It ignores the timing of cash flows.
|
|
|
Discounted payback period
|
Length of time required for an investment’s discounted cash flows to equal its initial cost
|
|
|
ARR
|
Investment’s average net income divided by its average book value
|
|
|
IRR
|
Discount rate that makes the NPV of an investment zero. An investment is acceptable when the IRR exceeds the required return.Pbm: multiple rates of return/mutually exclusive investment decisions.
|
|
|
NPV Profile
|
Graphical representation of the relationship between an investment’s NPV’s and various discount rates.
|
|
|
PVI
|
PV of an investment’s future cash flow divided by its initial cost.
|
|
|
Benefit/cost ratio
|
Profitability index of an investment project.
|
|
|
Top Au corporates tend to payback for small investments and discounted cash flow methods for large investments
|
True
|
|
|
Incremental cash flows
|
Difference between the firm’s future cash flows with a project or without the project
|
|
|
Stand-alone principle
|
Evaluation of a project based on the project’s incremental cash flows
|
|
|
Sunk cost
|
Cost that has already been incurred and cannot be removed and therefore should not be considered in an investment dc
|
|
|
Opportunity cost
|
The most valuable alternative that is given up if a particular investment is undertaken
|
|
|
Erosion
|
Cash flows of a new project that come at the expense of a firm’s existing projects
|
|
|
Annual equivalent cost
|
PV of a project’s costs calculated on an annual basis
|
|
|
Nominal rate
|
Real rate + Inflation rate + Cross-product
|
|
|
Forecasting risk
|
Possibility that errors in projected cash flows lead to incorrect decisions
|
|
|
Scenario analysis
|
Determination of what happens to NPV estimates when we ask “what if” questions
|
|
|
Sensitivity analysis
|
Investigation of what happens to NPV when only one variable is engaged.
|
|
|
Simulation analysis
|
Combination of scenario and sensitivity analysis
|
|
|
Variable costs
|
Costs that change when the quantity of output changes
|
|
|
Fixed costs
|
Costs that do not change when the quantity of output changes during a particular time period
|
|
|
Marginal or incremental cost
|
Change in costs that occurs when there is a small change in output
|
|
|
Marginal or incremental revenue
|
Change in revenue that occurs when there is a small change in output
|
|
|
Accounting break-even
|
Sales level that results in zero project net profit
|
|
|
Managerial options
|
Options that managers can exploit if certain things happen in the future
|
|
|
Contingency planning
|
Taking into account the managerial options that are implicit in a project
|
|
|
Strategic options
|
Options for future business moves
|
|
|
Capital rationing
|
Situation that exists if a firm has positive NPV projects but cannot find the necessary financing
|
|
|
Soft rationing
|
When units in a business are allocated a certain amount of financing for capital budgeting
|
|
|
Hard rationing
|
When a business cannot raise financing for a project under any circumstances
|
|
|
Nominal returns
|
Return on an investment not adjusted for inflation
|
|
|
Real returns
|
Returns adjusted for the effects of inflation
|
|
|
Fisher effect
|
Relationship between nominal returns, real returns and inflation.
|
|
|
Risk premium
|
Excess return required from an investment is a risk asset over a risk-free investment
|
|
|
Variance
|
Average squared deviation between the actual return and the average return
|
|
|
Standard deviation
|
Positive square root of variance.
|
|
|
Normal distribution
|
Symmetric bell-shaped frequency distribution that can be defined by its mean and standard deviation
|
|
|
Efficient capital market
|
Market in which security prices reflect available information
|
|
|
Efficient market hypothesis
|
Hypothesis that actual capital markets are efficient. All investments in an efficient market are zero NPV investments.
|
|
|
Expected returns
|
Return on a risk asset expected in the future
|
|
|
Portfolio
|
Group of assets, such as shares and debentures held by an investor
|
|
|
Portfolio weight
|
% of a portfolio’s total value in particular asset
|
|
|
Systematic risk
|
Risk that influences a large number of assets. Also market risk
|
|
|
Non-systematic risk
|
Risk that affects at most a small number of assets. Also unique or asset-specific risk
|
|
|
Principle of diversification
|
Principle stating that spreading an investment across a number of assets will eliminate some but not all risk
|
|
|
Systematic risk principle
|
Principle stating that the expected return on a risky asset depends only on that asset’s systematic risk
|
|
|
Beta coefficient
|
Amount of systematic risk present in a particular risky asset relative to an average risky asset
|
|
|
Security market line
|
Positively sloped straight line displaying the relationship between expected return and beta
|
|
|
Market risk premium
|
Slope of the SML, difference between expected return on market portfolio and the risk-free rate
|
|
|
Capital asset pricing model
|
Equation of the SML showing the relationship between expected return and beta
|
|
|
Systematic risk
|
Covariance risk
|
|
|
Beta
|
Systematic risk divided by the standard deviation of return on the market
|
|
|
Efficient portfolios
|
Fully diversified portfolios only have a systematic risk
|
|
|
SML equation
|
SML equation explains the expected return for all assets
|
|
|
CML equation
|
CML equation explains the expected return for efficient portfolios
|
|
|
Cost of capital
|
Minimum required return on new investment
|
|
|
Risk premium
|
Expected return – Risk-free rate
|
|
|
Total return
|
Expected return + Unexpected return
|
|
|
Announcement
|
Expected part + Surprise
|
|
|
Total risk
|
Systematic risk + Non-systematic risk
|
|
|
Financial system
|
Consists of individuals, companies, markets and governments that are involved in the process of exchanging financial assets
|
|
|
Financial intermediary
|
Institution that acts as a principal in accepting funds from depositors and lending them to borrowers
|
|
|
Market
|
Arrangement whereby participants buy and sell
|
|
|
Primary market
|
Market where securities are traded for the first time
|
|
|
Secondary market
|
Market where subsequent trading of securities occurs.
|
|
|
Ordinary shares
|
Risk capital of a company; as such shares have residual and ownership rights
|
|
|
Bonds
|
Loans made to government body
|
|
|
Debentures or unsecured notes
|
Loans made to companies for a fixed period at a fixed rate of interest
|
|
|
Unlisted market trading
|
This trading is confined to bargaining by individual buyers and sellers and around $3bn is invested in the unlisted equity market
|
|
|
Trading banks
|
Account for 56% of total asset of the finance sector in Australia
|
|
|
Wholesale banking
|
Involves transactions with companies or businesses
|
|
|
Merchant banks
|
Have little direct involvement in the retail banking sector as they are primarily concerned with wholesale banking. They have been responsible for the dev of cash mgmt. trusts, rebatable preference shares, commercial bills market, the currency hedge market, the promissory note market and the unofficial deposit market
|
|
|
Finance companies
|
Control about 2% of total assets of the finance sector in Australia
|
|
|
ASX
|
Australia’s central marketplace for companies raising funds
|
|
|
Short-term financial decisions
|
Typically involve cash inflows and outflows that occur within a year or less
|
|
|
Overdraft
|
Where the bank permits the customer to draw more money from the bank account that has been put in it
|
|
|
Term loan
|
Advance of funds made by a bank for a fixed period and a specific purpose
|
|
|
Bill of exchange
|
A negotiable instrument that involves a drawer, acceptor and payee
|
|
|
Debenture trust deed
|
Written agreement between the corporation and the lender detailing the terms of the debt issue
|
|
|
Registered form
|
Registrar of company records ownership of each note; payment is made directly to the owner of the record.
|
|
|
Bearer security
|
Security whose ownership is not registered by the issuer and possession of the physical document is primary evidence of ownership
|
|
|
Sinking funds
|
Account managed by the debenture trustee for early debenture redemption
|
|
|
Call premium
|
Amount by which the call price exceeds the paid-up value of the debenture
|
|
|
Deferred call
|
Call provision prohibiting the company from redeeming the debt prior to a certain date
|
|
|
Protective covenant
|
Part of the trust deed limiting certain transactions that can be taken during the term of the loan, usually to protect the lender’s interest.
|
|
|
Preference shares
|
Shares with dividend priority over ordinary shares, normally with a fixed dividend rate, sometimes without voting rights
|
|
|
Ordinary shares
|
Equity without priority for dividends or in bankruptcy
|
|
|
Shareholders
|
Owners of equity in a corporation
|
|
|
Retained earnings
|
Corporate earnings not paid out as dividends
|
|
|
Book value
|
Accounting per share value of firm’s equity. Also called net worth.
|
|
|
Dividend
|
Payment by a corporation to shareholders made in either cash or shares.
|
|
|
Bankruptcy
|
Condition where all or part of the organisation’s assets are transferred to creditors.
|
|
|
Prospectus
|
Document required by law to be issued with share offers to the public
|
|
|
Private placement
|
Sale of securities to large institutional investors or selected clients of a sharebroker
|
|
|
Tombstone
|
Advertisement announcing completion of public offering
|
|
|
Underwriters
|
Investment firms that act as intermediaries between a company selling securities and investing public
|
|
|
Sub-underwriters
|
Ground of underwriters formed to reduce the risk and help to sell an issue
|
|
|
Ex-rights
|
Period when shares are selling without a recently declared right, normally beginning four business days before the holder-of-record date
|
|
|
Holder-of-record date
|
Date on which existing shareholders on company records are designated as the recipient of share rights. Also called: date on record
|
|
|
Dividend reinvestment schemes
|
Offer shareholders the opportunity to apply all or part of their cash dividends to the purchase of newly issued shares, allowing the shareholder to reinvest the dividend without incurring any transaction costs.
|
|
|
Dilution
|
Loss in existing shareholders’ value, in terms of either ownership, market value, book value or EPS
|
|
|
Term loan
|
Direct business loans of typically one to five years
|
|
|
Private placement
|
Loans, usually long-term in nature, provided directly by a limited number of investors.
|
|
|
Number of new shares
|
Funds to be raised / subscription price
|
|
|
Cost of equity
|
Return that equity investors require on their investment
|
|
|
Cost of debt
|
Return that lenders require on the firm’s debt
|
|
|
WACC
|
= weighted average cost of capital; weighted average of the costs of debt and equity
|
|
|
Pure play approach
|
Use of a WACC that is unique to a particular project
|
|
|
Home-made leverage
|
Use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed.
|
|
|
M&M proposition I
|
Value of the firm is independent of its capital structure
|
|
|
M&M proposition II
|
Firm’s cost of equity capital is a positive linear function of its capital structure
|
|
|
Business risk
|
Equity risk that comes from the nature of the firm’s operating activities
|
|
|
Financial risk
|
Equity risk that comes from the financial policy (i.e. capital structure) of the firm
|
|
|
Pecking order theory
|
Process of the firm choosing profits, debt and equity in this order to finance investments
|
|
|
Information asymmetry cost
|
Arises because investors do not have the same information as mgmt. in relation to the prospects of the firm
|
|
|
Agency costs of debt
|
Arise because equity holders may act in their own right interest rather than the interest of the firm as a whole
|
