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44 Cards in this Set
- Front
- Back
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What is the difference between book value and market value? Which should we use for decision making purposes?
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market value is the price at which assets, liabilities and equity could actually be bought or sold; the book value is what is put on the balance sheet...Market value is usally more important as it is more up to date
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What is the difference between accounting income and cash flow? Which do we need to use when making decisions?
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Accounting income is purely revenue - expenses = income; Cash flow is when cash is actually changing hands, either coming in or leaving. We need to use cash flow since it is more current.
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What is the difference between average and marginal tax rates? Which should we use when making financial decisions?
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Average tax rates are the tax bill/taxable income, while marginal tax rates are the percentage paid on the next dollar earned. Marginal tax rates are used for financial decisions.
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How do we determine a firm’s cash flows? What are the equations, and where do we find the information?
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Figure out the cash flow from operating, investing and financing activities; the sum of these three flows will determine the statement of cash flows
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How do you standardize balance sheets and income statements?
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balance sheets: compute all accounts as a percent of total assets...income statements: compute all line itmes as a percent of sales
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Why is standardization useful?
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Standardized statements make it easier to compare financial information, particularly as the company grows; it also is useful for comparing companies of different sizes
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What are the major categories of financial ratios
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•Short-term solvency or liquidity ratios
•Long-term solvency or financial leverage ratios •Asset management or turnover ratios •Profitability ratios •Market value ratios |
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What are some of the problems associated with financial statement analysis?
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•There is no underlying theory, so there is no way to know which ratios are most relevant
•Benchmarking is difficult for diversified firms •Globalization and international competition makes comparison more difficult because of differences in accounting regulations •Firms have different fiscal years •Extraordinary, or one-time, events |
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What is the purpose of financial planning?
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Trying to develop a plan for investments in new assets, the degree of financial leverage, how much cash to be paid to shareholders, and liquidity requirements
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What are the major decision areas involved in developing a plan?
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sales forecast, pro forma statements, asset requirements, financial requirements, plug variables
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What is the percentage of sales approach?
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Some items vary directly with sales, others do not
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What is the internal growth rate?
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tells us how much the firm can grow assets using retained earnings as the only source of financing
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What is the sustainable growth rate?
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tells us how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio
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What are the major determinants of growth?
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Profit margin, total asset turnover, financial leverage, and dividend policy
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What is the difference between simple interest and compound interest?
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Simple interest is purely the number of periods times the amount invested times the rate...compound interest includes the interest on top of interest in successive periods
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What is the relation between present value and future value?
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They can be used to find each other, if the number of periods and rate are given. The present value gives you the value of your money now, and the future value gives you the value of your money in x amount of time in the future
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Why do we discount future values?
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Time value of money and risk
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When might you want to compute the number of periods?
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If you want to know how much time a certain investment will take place given the amount you have now at a given rate and how much your investment will be at a later time to get you the desired product/service/whatever it is you are investing for
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You know the payment amount for a loan, and you want to know how much was borrowed. Do you compute a present value or a future value?
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present value
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What is the definition of an APR?
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this is the annual rate that is quoted by law; the equation is APR = period rate times the number of periods per year
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What is the effective annual rate?
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This is the actual rate paid (or received) after accounting for compounding that occurs during the year
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Which rate should you use to compare alternative investments or loans?
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APR
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Which rate do you need to use in the time value of money calculations?
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EAR
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What is a pure discount loan? What is a good example of a pure discount loan?
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principal is repaid at some future date; no periodic interest payments. Treasury bills are a good example
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What is an interest-only loan? What is a good example of an interest-only loan?
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only interest payments are made (so principal is not paid down); loan from a bank
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What is an amortized loan? What is a good example of an amortized loan?
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loan payments are the same amount of every period; loan for a mortgage
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How do you find the value of a bond, and why do bond prices change?
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You need to know the number of periods until maturity, face value, coupon and market interest rate for bonds with similar characteristics to find the value of a bond. Bond prices change because
fluctuations in interest rates will determine bond prices (for example when interest rates increase, bond prices decrease and vice versa) |
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What is a bond indenture, and what are some of the important features?
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Is the contract between the company and the bondholders that includes: the basic terms of hte bonds, total amount issued, description of property used as security, sinking fund provisions, call provisions, and details of protective covenants.
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What are bond ratings, and why are they important?
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These ratings rate the strength of certain bonds and these are taken seriously by people trying to invest in these. Anything higher than the low B's is considered strong and anything under is considered a junk bond
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How does inflation affect interest rates?
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inflation rates affect real and nominal interest rates because the rate of inflation will change the real value of the money at a future date
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What is the term structure of interest rates?
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the term structure is the relation between time to maturity and yields, all else equal
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What factors determine the required return on bonds?
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whether the bond has an upward or downward sloping term structure
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How do stocks trade?
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stocks are traded by many means; but mostly through the NYSE and NASDAQ
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Understand model types: equity valuation vs. firm valuation
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We use EQUITY valuation if the firm has stable leverage (stable capitual structure) and if we are trying to value the equity portion of the firm...We use FIRM valuation if the firm does not have the correct capital structure (leverage is currently too high or too low) and we are just trying to value the firm
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When should you use dividend models?
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–the firm consistently pays dividends
–these dividends are close to the value of Free Cash Flow to Equity –Free Cash Flow to Equity is difficult to calculate •i.e., Banks, Financial Services Companies, Insurance Companies, etc. |
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When should you use FCFE models?
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–Dividends are not a good measure of FCFE
•If dividends are less than 80% of FCFEover the last 5 years •If dividends are greater than 110% OF FCFEover the last 5 years –Dividends are not available or not consistently provided •i.e., internet firms, Bio-Tech firms, start-ups, etc. |
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What is the appropriate discount rate? (stock valuation)
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for FCFF, the appropriate rate is WACC...for FCFE the appropriate rate is the cost of equity
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How do you discount the terminal value? (stock valuation)
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depends if the terminal value is real or nominal in which case you would use real discount for real and nominal for nominal
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How do you estimate the growth rate? (stock valuation)
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estimate stable growth rates using the firm's growth over the last few periods; non-stable growth rates are more complicated
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Which of the investments discussed have had the highest average return and risk premium?
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small-company stocks
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Which of the investments discussed have had the highest standard deviation?
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small-company stocks
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What is capital market efficiency?
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Capital market efficiency states that stock prices are in equilibrium or are "fairly" priced. This is plausible because there are many investors doing research and this is reflected in stock prices
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What are the three forms of market efficiency?
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STRONG FORM: prices reflects all information (private and public) and abnormal returns cannot be earned; markets do not show this...SEMI-STRONG FORM: prices reflect all publicly available information, investors can't gain abnormal returns trading on said information...WEAK FORM: prices reflect all past market information, markets are generally this type
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When should you use arithmetic means?...geometric means?
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15-20 years or less use arithmetic...20-40 years: split the difference between them...40 + years: use the geometric
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