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84 Cards in this Set
- Front
- Back
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Define Finance
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The process of obtaining money and using it to give maximum advantage to the organisation.
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Define financial plan
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The planning and provision of adequate financial resources to meet existing obligations as they fall due and to finance future business development.
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3 factors that influence financial plan
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Environmental (government, monetary policy, trade patterns)
Market structure and quality Products and skills |
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+/- of Payback
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Simple Length of time capital is at risk is known - Actual timing of cash flows is ignored Built in discrimination towards short term projects Cash flows after payback are ignored |
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Define ARR
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average annual profits / average capital investment
where average annual profits = cash flows less depreciation average capital investment = (investment + residual)/2 |
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+/- of ARR
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Simple and easy to understand - Subjective since target is set by management Hard to compare to cost of capital Ignores project life Ignores timing of cash flows Does not measure gain in shareholder wealth |
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+/- of NPV
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Measures change in shareholder wealth Easy to calculate - Only applicable if risk matches overall company risk Difficulty predicting future cash flows Difficult to understand |
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IRR formula
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= A + ((B-A) x Na/(Na-Nb))
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+/- of IRR
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More easily understood Comparable Considers time value of money - Interpolation technique is difficult Changes in cash flows may make more than one IRR possible Does not take into account project size |
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3 states of project certainty?
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Certainty - only one possible outcome
Risk - all possible outcomes are known, including their probabilities Uncertainty - not all possible outcomes are known |
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Project standard deviation formula?
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sqrt (sum of: p (return - average return)^2 )
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2 basic principles of financing?
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Matching
Relationship between risk and return |
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4 methods of issuing shares
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Offer for sale (company invites public and institutions to buy shares)
Offer for subscription (allows company to abort if not enough) Placing (placed with broker who then sells) Rights issue (existing shareholders offered pro-rata) |
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+/- of share capital
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Does not need to be repaid Does not require dividend - Loss of control High costs Non tax-deductible |
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4 conditions usually attached to preference shares
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Cumulation (unpaid dividend carries over)
Redemption Convertibility (shareholder can choose to convert to ordinary) Participation (take part in profits above certain minimum) |
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+/- of preference shares
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No dilution (no voting rights) No loss of control over profits Dividend does not have to be paid Alternative to debt (e.g. when too many covenants) - High costs Non tax-deductible |
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+/- of bonds
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Lower required rate of return Tax deductible - Claim on assets |
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3 forms of medium term finance?
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Term loans (3-10 years, negotiated repayment)
Hire purchase (finance company purchases asset, allows company to hire, at end of agreement asset passes to hiree) Leasing |
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3 forms of short term finance?
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Overdraft (repayable on demand)
Bills of exchange (a promise to pay a sum at a given date, e.g. post dated cheque, can be traded e.g. with banks sort of like factoring) Factoring (provides finance 80% immediately and 20% less 1-2% when paid, sales ledger administration, credit insurance) |
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5 advantages of joining an exchange
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Raising finance
Exit route Finding buyers Enhanced status Employee benefits |
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4 disadvantages of joining an exchange
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Cost (5-10%)
Public scrutiny Dilution Ongoing responsibilities |
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FSA was replaced by what three bodies
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Financial Policy Committee (FPC) (financial stability)
Prudential Regulation Authority (PRA) (regulates financial services) Financial Conduct Authority (FCA) (regulates conduct of firms) |
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4 advisers for listing
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Sponsor (merchant bank, help with prospectus, reports to UKLA on suitability for listing, reports to Exchange on suitability for trading, can underwrite, co-ordinates other advisors)
Broker (helps with market conditions and pricing, marketing) Lawyers (legal documents and verification of prospectus) Accountants (financial information required in prospectus, accountant's report) |
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3 requirements to list on AIM
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Legally established public company or freely traded shares
Publish annual and interim accounts Have a nominated adviser and broker |
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3 reasons to be excluded from FTSE100
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Overseas resident for tax purposes
Subsidiary of company in index Large static shareholding |
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Define earnings yield?
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EPS / price
(aka opposite of P/E) maximum possible dividend yield |
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Define redemption yield?
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The IRR of the bond
The discount rate that would make coupon + principal equal the current market price |
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Dividend growth model formula
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D(1+g) / (r-g)
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4 purposes of ratio analysis?
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Review performance of organisation over time
Compare with specific competitors Compare with industry Forecast future performance using past performance |
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Gross margin?
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Gross profit / Turnover
Fall may indicate falling sales or rising costs |
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Mark-up?
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Gross profit / Cost of sales
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Net profit margin?
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PBIT / Turnover
Includes distribution and admin |
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ROCE?
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PBIT / Capital employed
aka primary ratio allows comparisons across industries shareholder funds + long term creditors, or total assets - current liabilities |
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Asset turnover?
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Turnover / Capital employed
Provides info about company's efficiency at generating sales from available assets |
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Current ratio?
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Current assets / Current liabilities
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Quick ratio?
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Current assets - stock / Current liabilities
aka acid test stock isn't really liquid |
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Debtor days?
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Trade debtors / credit sales x 365
Approximates number of days debtors take to pay |
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Creditor days?
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Trade creditors / purchases x 365
Approximates number of days to pay suppliers Purchases can be extracted from cost of sales equation: CoS = opening stock + purchases - closing stock |
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Stock turnover?
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Cost of Sales / Stock
Approximates number of times stock was sold during the year |
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Stock days?
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Stock / CoS x 365
Number of days stock is held for |
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Working capital cycle?
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= debtor days + stock days - creditor days
The amount of time taken to convert stock to cash |
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Gearing?
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= loan capital / shareholders' funds
higher is riskier can also be loan capital / total capital employed |
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Interest cover?
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PBIT / Interest charges
how many times company can afford to pay interest |
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5 limitations of ratio analysis?
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Calculated using historic numbers which include inflation effects
Organisations can manipulate year end statements Differing accounting policies Difficult to assess sufficient information to calculate meaningful ratios Difficult to compare unless companies are similar |
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4 types of ratios?
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Profitability
Liquidity Management Risk |
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4 main objectives of cash flow management?
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Liquidity
Safety Return Flexibility |
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2 reasons why cash flow budget does not equal P&L at year end?
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Timing differences (e.g. of sales)
Non-cash movements (e.g. depreciation) |
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Define price elasticity of demand?
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= % change in demand / % change in price
always negative |
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5 factors influencing price elasticity of demand?
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Substitute products
Advertising/taste Luxury/necessity Proportion of income spent on good Time |
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Define cross price elasticity of demand?
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% change in demand A / % change in price B
positive for substitute products, negative for complementary products |
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Define income elasticity of demand?
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% change in demand / % change in income
positive for normal goods, higher for luxury, negative for inferior |
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4 factors of production?
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Land - rent
Labour - wages Capital (plant, factories, components, tools) - interest Enterprise (organising other three factors, risk) - profit |
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4 types of market structures?
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Perfect competition (many sellers, homogenous product, no barriers)
Monopolistic competition (many sellers, differentiated product, no barriers) Oligopoly (few sellers, homogenous or differentiated product, barriers) Monopoly (single seller, no close substitues, barriers) |
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4 aspects of perfect competition?
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Homogenous product
Each buyer and seller is small relative to market Free entry and exit in long run Perfect information |
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3 types of barriers to entry?
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Natural (e.g. economies of scale)
Legal (e.g. patents) Artificial (e.g. brand loyalty) |
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4 typical government macroeconomic objectives?
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Economic growth
Low unemployment Low inflation Avoidance of balance of payments deficits and exchange rate problems |
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Aggregate demand formula?
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C + I + G + X - M
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Define the consumption function?
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C = a + bY
a = autonomous consumption b= marginal propensity to consume |
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Define the multiplier effect?
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1 / (1-MPC) or 1 / MPS
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3 types of equilibrium unemployment?
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Frictional (people switching jobs)
Seasonal Structural (industry to industry, retraining) |
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3 reasons inflation is a problem?
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Uncertainty (in planning, budgeting, investing)
Redistribution of income (hits the poor) Balance of payments (exports become expensive, imports cheap) |
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3 reasons for increasing inflation?
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Cost-push (increasing costs of production) (Keynes)
Demand-pull (increase in demand) (Keynes) Increase in circulating money (Monetarist) |
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4 issues with fiscal policy?
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Government spending may replace private spending
Government financing may push up interest rates so private sector can't borrow to consume and invest Multiplier is difficult to predict Time lag |
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6 examples of Monetarist policies for improving market?
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Reduce power of trade unions
Reduce income taxes and welfare Reduce business tax Reduce government expenditure Reduce red tape Encourage competition by privatisation and deregulation |
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4 examples of Keynesian interventionist policies?
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Investment in retraining unemployed workers
Directly sponsoring research and development Subsidies and tax breaks Infrastructure improvements |
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3 types of market efficiency?
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Pricing efficiency (investor can only make risk-adjusted return from investment since prices move in a rational and instantaneous way to news, this is what efficent market hypothesis refers to)
Operational efficiency (low stock market costs) Allocational efficiency (markets channel funds to firms with most promising real investment opportunities) |
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3 reasons share markets must be efficient?
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To encourage share buying (investors know shares are priced correctly)
To allow financial management (decisions of financial manager are reflected accurately in share price) To help allocate resources |
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3 reasons why cost of debt is less than cost of equity?
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Cost of raising debt is less
Annual return required is less (less risky due to security and payment before dividend, and in liquidation debtholders are paid before shareholders) Cost of interest is tax deductible |
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Irredeemable debt cost equation?
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Kd = i x (1-t)
---------- MVexint i = interest t = tax rate MVexint = market value of debt excluding interest due |
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Traditional view of capital structure?
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There is optimal debt/equity ratio
Over moderate debt ranges, cost of capital falls since debt costs less, and it is assumed that moderate amounts of debt do not add significantly to the risks attached to equity As debt increases, however Equity shareholders realise their investment is becoming riskier and demand higher return Lenders recognise increasing risk and expect higher return |
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5 MM assumptions?
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Capital markets are perfect
No taxation No transaction costs Individuals can borrow at same rate as firms Home made gearing has same risk as corporate gearing |
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Non-tax MM theory?
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Debt is cheaper than equity
Saving in capital cost because of rise in debt is matched exactly by rise in cost of equity Therefore capital structure is irrelevant to firm value |
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MM theory with tax?
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WACC is at its lowest when company capital is made up almost entirely of debt
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3 reasons level of dividend is important?
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Communicates message about management's view of current and future profitability (cash speaks stronger than words)
Dividend is cash in hand so more certain than promise of future income Investors place emphasis on past dividend performance when making decisions, so management should avoid erratic dividend changes |
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4 dates involved in dividend payments?
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Announcement date
Record date (payment will be made to shareholders who own the share at this date) Ex-dividend date (date at which buyers are not entitled to dividend) Payment date |
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Traditional theory of dividend policy v MM theory of dividend policy?
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There is an optimal dividend
Too low undermines shareholder confidence, too high bleeds company of cash Investor wealth is unaffected by dividend payments, therefore dividend policy does not affect cost of equity Unwanted dividends can be used to buy shares, wanted dividends can be created by selling shares Assumes no tax |
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2 implications of stock market valuing securities as part of diversified portfolio?
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Undiversified investors pay too much and will be subject to additional risk for which they are not compensated
Market is less concerned with volatility of individual stock than with its tendency to move in sympathy with the market |
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2 types of risk associated with an investment?
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Systematic risk (e.g. political, economic - common to all companies)
Specific risk (market demand for company's products, nature and location of assets, capital structure, management quality) |
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Reasons some investors are unable to invest in diversified portfolio?
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Transaction costs prohibitive since portfolio is so small
Lack of expertise |
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Open- vs closed-ended?
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Open-ended:
shares/units created as a result of investment or redeemed in case of sale unit trusts, OEICs Closed-ended: finite number of shares investment trusts |
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+/- of investment schemes?
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Investors have access to diversified portfolio Investors benefit from lower dealing and taxation costs Funds invested by professional fund manager - Value of collective investment scheme may be affected by factors other than value of underlying assets (eg departure of fund manager) Fees and charges No discounts or voting rights |
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CAPM formula?
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k = Rf + B(Rm - Rf)
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Issue with CAPM?
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Diversified shareholder will encourage risk whereas financial manager will lose job
This conflict may be solved with profit related bonuses and options |
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Portfolio theory standard deviation formula?
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SQRT ( sum of probability x (return - expected return)^2 )
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