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91 Cards in this Set
- Front
- Back
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Target Capital Structure
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The mix of debt, preferred stock and common equity the firm plans to raise to fund its future projects
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Capital Component
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One of the types of capital used by firms to raise funds
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Weighted Average Cost of Capital
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A weighted average of the component costs of debt, preferred stock, and common equity
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Before-Tax Cost of Debt, rd
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The interest rate the firm must pay on new debt
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After-Tax Cost of Debt
rd(1-T) |
The relevant cost of new debt, taking into account the tax deductibility of interest; used to calculate the WACC
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Cost of Preferred Stock, rp
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The rate of return investors require on the firms preferred stock. rp is calculated as the preferred dividend, Dp, divided by the current price
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Cost of Retained Earnings, rs
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The rate of return required by stockholders on a firm's common stock
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Cost of New Common Stock, re
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The cost of external equity; based on the cost of retained earnings, but increased for flotation costs
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Flotation Cost, F
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The percentage cost of issuing new common stock
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Flotation Cost Adjustment
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The amount that must be added to rs to account for flotation costs to find re
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Retained earnings Breakpoint
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The amount of capital raised beyond which new common stock must be issued
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Capital Budgeting
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The process of planning expenditures on assets with cash flows that are expected to extend beyond one year
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Strategic Business Plan
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A long-run plan that outlines in broad terms the firms basic strategy for the next 5 to 10 years
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Net Present Value (NPV)
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A method of ranking investment proposals using the NPV, which is equal to the present value of the project's free cash flows discounted at the cost of capital
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Independent Projects
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Projects with cash flows that are not affected by the acceptance or nonacceptance of other projects
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Mutually exclusive projects
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A set of projects where only one can be accepted
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Internal Rate of Return
IRR |
The discount rate that forces a projects NPV to equal zero
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Multiple IRRs
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The situation where a project has two or more IRRs
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Modified IRR (MIRR)
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The discount rate at which the present value of a projects cost is equal to the present value of its terminal value, where the terminal value is found as the sum of the future values of the cash inflows, compounded at the firm's cost of capital
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Net Present Value Profile
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A graph showing the relationship between a project's NPV and the firm's cost of capital
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Crossover Rate
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The cost of capital at which the NPV profiles of two projects cross and, thus, at which the projects' NPVs are equal
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Payback Period
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The length of time required for an investment's cash flows to cover its cost
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Discounted Payback
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The length of time required for an investment's cash flows, discounted at the investments cost of capital, to cover its costs
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Incremental Cash Flow
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A cash flow that will occur if and only if the firm takes on a project
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Sunk Cost
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A cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected
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Opportunity Cost
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The best return that could be earned on assets the firm already owns if those assets are not used for the new project
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Externality
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An effect on the firm or the environment that is not reflected in the projects cash flows
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Cannibalization
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The situation when a new project reduces cash flows that the firm would otherwise have had
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Stand-Alone Risk
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The risk an asset woud have if it were a firm's onnly asset and if investors owned only one stock. It is measured by the variability of the assets expected returns
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Corporate (within-Firm) risk
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Risk considering the firm's diversification but not stockholder diversification. It is measured by a projects effect on uncertainty about the firm's expected future returns
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Market (beta) Risk
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Considers both firm and stockholder diversification. It is measured by the projects beta coefficient
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Risk-Adjusted Cost of Capital
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The cost of capital appropriate for a given project, given the riskiness of that project. The greater the risk, the higher the cost of capital
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Sensitivity Analysis
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Percentage change in NPV resulting from a given percentage change in an input variable, other things held constant
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Base-Case NPV
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The NPV when sales and other input variables are set equal to their most likely (or base-case) values
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scenario Analysis
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A risk analysis technique in which "bad" and "good" sets of financial circumstances are compared with a most likely, or base case, situation
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Base-Case scenario
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an analysis in which all of the input variables are set at their most likely values
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Worst-Case Scenario
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An analysis in which all of the input variables are set at their worst reasonably forecasted values
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Best-Case Scenario
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An analysis in which all of the input variables are set at their best reasonably forecasted values
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Monte Carlo Simulation
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A risk analysis technique in which probable future events are simulated on a computer, generating estimated rates of return and risk indexes
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Real Option
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The right but not the obligation to take some future action
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Abandonment Option
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The option to shut down a project if operating cash flows turns out to be lower than expected. THis option can both raise expected profitability and lower project risk
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Decision Tree
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A diagram that lays out different branches that are the result of different decisions made or the result of different economic situations
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Option Value
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The difference between the expected NPVs with and without the relevant option. It is the value that is not accounted for in a traditional NPV analysis. A positive option value expands the firm's opportunities
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Optimal Capital Budget
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The annual investment in long-term assets that maximizes the firm's value
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Capital Rationing
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The situation in which a firm can raise only a specified, limited amount of capital regardless of how many good projects it has.
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Post-Audit
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A comparison of actual versus expected results for a given capital project
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Capital
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INvestor-supplied funds such as long and short term loans from individuals and institutions, preferred stock, common stock, and retained earnings.
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Capital Structure
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The mix of debt, preferred stock, and common equity that is used to finance the firm's assets
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Optimal Capital structure
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The capital structure that maximizes a firm;s stock prices
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Business Risk
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The riskiness inherent in the firm's operations if it uses no debt
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Operating Leverage
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The extent to which fixed costs are used in a firm's operations
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Operating Breakeven
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The output quantity at which EBIT=0
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Financial Risk
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An increase in stockholders risk, over and above the firm's basic business risk, resulting from the sue of financial leverage
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Financial Leverage
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The extent to which fixed income securities (debt and preferred stock) are used in a firm's capital structure
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Unlevered Beta, bu
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The firm's beta coefficient if it has no debt
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Trade-off Theory
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The capital structure theory that states that firms trade off the tax benefits of debt financing against problems caused by potential bankruptcy
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Symmetric Information
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The situation where investors and managers have identical information about firms' prospects
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Asymmetric Information
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THe situation where managers have different (better) information about firm's prospects than do investors
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signal
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An action taken by a firm's management that provides clues to investors about how management views the firm's prospects
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Reserve Borrowing Capacity
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The ability to borrow money at a reasonable cost when good investment opportunities arise. Firms often use less debt than specified by the MM optimal capital structure in "normal" times to ensure that they can obtain debt capital later if necessary
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Pecking Order
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The sequence in which firms prefer to raise capital: first spontaneous credit, then retained earnings, then other debt, and finally new common stock
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Windows of opportunity
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The ocasion where a company's managers adjust its firms capital structure to take advantage of certain market situations
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Net Debt
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Equal to total debt less cash and equivalents. Companies ofton look at this measure when setting their target capital structure
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Multinational, or Global, Corporation
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A firm that operates in an integrated fashion in a number of countries
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Vertically integrated Investment
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Occurs when a firm undertakes an investment to secure its input supply at stable prices
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International Monetary System
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The framework within which exchange rates are determined. It is the blueprint for international trade and capital flows
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Exchange Rate
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THe number of units of a given currency that can be purchased for one unit of another currency
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Freely-Floating Regime
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Occurs when the exchange rate is determined by supply and demand for the currency
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Managed-Float Regime
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Occurs when there is significant government intervention to control the exchange rate via manipulation of the currency's supply and demand
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Currency Board Arrangement
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Occurs when a country has its own currency but commits to exchange it for a specified foreign money unit at a fixed exchange rate and legislates domestic currency restrictions, unless it has the foreign currency reserves to cover requested exchanges
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Fixed-Peg Arrangement
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Occurs when a country locks its currency to a specific currency or basket of currencies at a fixed exchange rates
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Cross Rate
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The exchange rate between any two currencies
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American Terms
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The foreign exchange rate quotation that represents the number of American dollars that can be bought with one unit of local currency
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Direct Quotation
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The home currency price of one unit of the foreign currency
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Indirect Quotation
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The foreign currency price of one unit of the home currency
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Spot rate
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The effective exchange rate of a foreign currency for a delivery on (about) that current day
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Forward Exchange Rate
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An agreed-upon price at which two currencies will be exchanged at some future date
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Discount on Forward Rate
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The situation when the spot rate is less than the forward rate
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Premium on Forward rate
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The situation when the spot rate is greater than the forward rate
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Interest Rate parity
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Specifies that investors should expect to earn the same return in all countries after adjusting for risk
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Purchasing Power Parity (PPP)
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The relationship in which the same products cost roughly the same amount in different countries after taking into account the exchange rate
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Eurocredits
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Floating-rate bank loans,available in most major trading currencies, that are tied to LIBOR
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Eurodollar
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A US dollar deposited in a bank outside the US
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Eurobond
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An international bond underwritten by an international syndicate of banks and sold to investors in countries other than the one in whose money unit the bond is denominated
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Foreign Bond
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A type of international bond issued in the domestic capital market of the country in whose currency the bond is denominated, and under written by investment banks from the same country
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AAmerican Depository Receipts (ADRs)
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Certificates representing owndership of foreign stock held in trust
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Country Risk
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The risk that arise from investing or doing business in a particular country
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Exchange Rate Risk
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The risk that exchange rate changes will reduce the number of dollars provided by a given amount of a foreign currency
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Repatriation of Earnings
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The process of sending cash flows from a foreign subsidiary back to the parent company
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Political Risk
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Potential actions by host government that would reduce the value of a company's investment
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Business CLimate
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Refers to a country's social, political, and economic environment
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