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83 Cards in this Set

  • Front
  • Back

What is Finance?

deals with the valuation of risky cash flows spread throughout time

Corporate Finance

firm-level decisions about investing in projects and financing those investments


individuals deciding which financial assets to invest in

What long-term investment should a firm take on?

Capital Budgeting (Investment decision) deals with NPV

How should the firm raise funds to select investments?

Capital Structure (financing decision); deals with debt to equity (borrow (bonds) vs. Equity)

How should short-term assets be managed and financed?

Working capital management; WC= CA-CL

What are the 5 characteristics of corporation?

1) owned by unlimited number of shareholders

2) Transfer of ownership generally simple

3) Separation of ownership and control

4) Limited Liability

5) Taxed at the corporation level (double taxation)

What are 3 advantages of a corporation?

1) Firm size is large, which allows the firm to raise money

2) expertise, professional management

3) Limited Liability reduces shareholder risk

What are 3 disadvantages of a corporation?

1) Shareholder's Rights

2) Conflict of interest (agency problem with shareholders and managers)

3) Shareholders vs. Bondholders; bondholders are more conservative

Contingency claims that deal with debt

promise by the borrowing firm to repay a fixed dollar amount by a certain date

Senior claim on CF

debt holders get paid first

Shareholder's claim

residual amount that remains after the debt holder are paid

What are advantages of debt?

1) bonds are less ricky than stock

2) Interest expense is tax deductible

Agency Problem

arise when one person is hired to perform a task on behalf of another

Who is the principal and who is the agent in the Stockholder vs. Manager relationship?

Stockholder is the principal and the manager is the agent

What is the main source of conflict in the stockholder vs. manager relationship?

separation of ownership and control

In a stockholder vs. Manager relationship what is interest?

Stockholders want to maximize share price, focus on long-term horizon, and are well diversified

Managers want to maximize compensation and perks, focus on shorter horizon, and minimize personal risk because they are less diversified

Agency Costs

managers do no attempt to maximize stockholder value; stockholders incur costs to monitor and influence.

Who is the agent and the principal in a stockholder vs. bondholder relationship?

Stockholder is the agent the bondholder is the principal

What is the main source of conflict in a stockholder vs. bondholder relationship?

limited liability of corporation

What are the interests of each in a stockholder vs. bondholder relationship?

stockholders want to maximize stock prices; bondholders what to minimize risk and maximize the likelihood of payment

What are the 4 internal governance mechanisms?

1) Annual meeting and proxy vote

2) Board monitoring

3) Incentive Compensation

4) Threat of firing

What are the 3 external governance mechanisms?

1) the market of corporate control

2) debt Discipline

3) Regulations

Proxy vote

a proxy enables shareholders to vote for any matters that come before the board at the annual meeting

What does dual classes of shares do?

creates anti-governance

What are 4 advantages to board of directors?

1) elected by shareholders (in theory)

2) Protect shareholder interest (in theory)

3) Monitor management: hire and fir senior executive, choose compensation structure

4) Independent board members (not employees) and board quality

What are 5 problems with board of directors?

1) Spend limited time on fiduciary duties

2) Directors often nominated by the management

3) CEO often chairs the board

4) directors may lack expertise

5) Many directors are CEOS of other firms (good for expertise; bad for other interest/ busy)

What do incentive compensation do?

align interest between managers and shareholders

What are negatives of incentive compensation?

under-diversification problem; earnings and stock price manipulation

What are advantages of debt discipline?

1) forces manager to work hard to meet debt obligation

2) reduces free cash flow problem

What is a disadvantage of debt discipline?

makes managers too conservative

Sarbanes-Oxley Act

the overall intense of SOX was to improve the accuracy of information given to both board and management of shareholders

When it comes to Time Valuation of money what do you do when you are moving forward in time?


When it comes to Time Valuation of Money what do you do when you are moving backward in time?


What type of cash flow is a preferred stock?


What does NPV assume?

all CF can be reinvested at the discount rate

Internal Rate if Retrun

the discount rate that makes a project's NPV=0


NPV= negative


NPV= Positive

What dies "hurdles" mean?

the IRR is greater than r so you should accept

higher r= ?

lower NPV

What are advantages of IRR?

1) people like to look at returns

2) Comparable across projects of different sized (because it tells you the return of each dollar)

3) useful in preparing analysis for outside investors

What are problems with IRR?

1) Some cash flow streams can have multiple IRRs

2) reinvestment rate assumption: IRR assumes all CF are reinvested at IRR, however, reinvestment at the opportunity cost of capital is a better assumption

What is IRR bias toward?

smaller sized projects

What does MIRR fix?

1) eliminates multiple IRRs when there are negative future CF (unconventional CF)

2) Fixes the reinvestment rate problem; assuming all CF are reinvested at the opportunity cost of capital

How do you find MIRR?

1) Discount all negative CF to PV using the opportunity cost of capital rate

2) Compound all positive CF to FV using the opportunity cost of capital rate

3) Plug in PV (-) and FV(+) to find I/Y which will be MIRR

What is the rule with MIRR?

MIRR> opportunity cost of capital Accept

What problem does IIRR fix?

size problem; one project is larger than another

How do you find IIRR?

1) Take the CF form the larger project and subtract the smaller project

2) Find IRR on calculator, that will be IIRR

What is the Rule with IIRR

IIRR> WACC choose Large project

IIRR<WACC choose Small project

What are advantages of the Profitability Index?

1) May be useful when available investment funds are limited

2) Easy to understand and communicate

3) Correct decision when evaluating independent projects

What is a problem of the profitability index?

it does not consider the scale of investment

Profitability Index

means per dollar investment how much NPV is generated

What is profitability index bias toward?

small projects

Payback period

number of years to recover initial costs

Rule for Payback period

Payback period > t years reject

what does discounted Payback Period do?

discounts all the CF to PV; factors in TVM

Soft Rationing

Capital budgets for divisions and subdivisions of a firm for planning and control purposes. (Internal)

Hard Rationing

difficult or costly to raise more capital. (External, by market)

When dealing with capital constraints what does it mean to maximize total NPV?

do within budget and the Sum of NPV of all projects

When do you use Least Common Multiple (LCM)?

when projects have uneven lives and if projects can be repeated to have "common" lives

How do you find LCM?

1) Repeat the CF of the shorter life project to "common life" and calculate CF

2) find NPV of repeated project and compare to NPV of longer life project

What is the rule for LCM?

If shorter life NPV repeated is greater than longer life project's NPV, do shorter project

How do you find EAA?

1) Find NPV of both projects in Calculator

2) for each project, use the NPV you found as the PV in calculator and find PMT, this will be your EAA for the project

What is the rule with EAA?

choose the project with a larger EAA

(Rev.- Costs- Dep)=

EBIT (Earnings before Interest and tax)

(Rev.- Costs- Dep.) (1-t)=

EBIT(1-T); NOPLAT-> Net Operating Income Less Adjusted Taxes

What are depreciation tax effects?

it is a non-cash expense; It lowers taxable income so it generates "extra" CF

If Working capital increases what does that mean?

cash out flow

Capital gain/Loss


Project CF= ?

FCFF- Initial Investment + After-Tax Salvage Value

When dealing with change in working capital, and the change is positive, what do you do when trying to find FCFF?

subtract it

When deal with change in working capital and the change is negative, what do you do when trying to find FCFF?

add it

Once you find the FCFF, how do you find the Final CF?

1) Factor in the Initial outlay (-) at year 0 and the After-tax Salvage value in the final year (+)

2) If there are opportunity costs or externalities, factor those in as well

3) once you have the Final CF for each year, find NPV

What is Product Cannibalization?

when consumers of a company's product switch to another product of the company

sensitivity Analysis

change one variable at a time to analyze which factors affect NPV the most; isolate effe of one variable

Scenario Analysis

project analysis given a particular combination or assumptions; allow several variables to change, create best/worst scenario

Break Even Analysis

analysis of the level of sales (or other variable) at which the company breaks even

Simulation Analysis

estimation of the probabilities of different possible outcomes; generate NPV estimates for a wide range of scenarios

% change in Rev./NPV


How to you find the Break Even Quantity using the accounting method

set NI =0 and solve

What does the accounting break even method not consider?

initial investment

How do you fin the Break Even quantity using Financial method?

1) for CF add back depreciation to NI equation

2) On calculator set PV to initial investment and find PMT, this will be what you set you CF equation to

3) Solve for Q in equation