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;
46 Cards in this Set
- Front
- Back
|
Three types of capital typically used by a public firm: |
1. Common Stock 2. Debt 3. Preferred Stock |
|
|
Cost of equity - definition |
Return required by equity investors given the risk of the cash flows from the firm |
|
|
Cost of equity - two estimation methods |
1. Dividend Growth Model 2. Security Market Line |
|
|
Cost of debt - definition |
The required return on debt... YTM |
|
|
Cost of debt - tax adjustment |
Interest on debt is tax free... Cost of debt is lowered by the tax rate |
|
|
Cost of preferred stock - definition |
Required return on preferred stock |
|
|
Weighted average cost of capital - list three methods to compute the weights for equity and debt |
? |
|
|
Net present value: decision rule based on NPV |
Do project if NPV is positive |
|
|
Payback and discounted payback: decision rule |
Do project if payback is within predetermined limit |
|
|
Payback and discounted payback: difference between these two |
Regular Payback is based simply on cash flows. Discounted Pb uses time value of money |
|
|
Payback advantages (3) |
1. Easy to understand 2. Adjusts for uncertainty of later cash flows 3. Biased towards liquidity |
|
|
Payback disadvantages (4) |
1. Ignores the time value of money 2. Requires an arbitrary cutoff point 3. Ignores cash flows beyond the cutoff date 4. Biased against long-term projects, such as R&D, and new projects |
|
|
Discounted Payback advantages (4) |
1. Includes time value of money 2. Easy to understand 3. Does not accept negative NPV projects when all future cash flows are positive 4. Biased towards liquidity |
|
|
Discounted Payback disadvantages (4) |
1. May reject positive NPV investments 2. Requires an arbitrary cutoff point 3. Ignores cash flows beyond the cutoff point 4. Biased against long-term projects, such as R&D and new products |
|
|
Internal rate of return: decision rule |
Accept the project if the IRR is greater than the required return (WACC) |
|
|
IRR: identify situations where IRR is not appropriate |
* if cash flows are non-normal * if mutually exclusive project |
|
|
Compare NPV with IRR: list two differences |
*Difference in scale (NPV is in $, IRR is in %) *Differences in reinvestment/discount rate assumption (NPV rate = WACC, IRR rate = IRR) |
|
|
Compare NPV with IRR: identify when these two approaches might conflict and how to resolve |
NPV > IRR *Independent Projects: no conflicts; use either *Mutually exclusive projects: can conflict; use NPV *Non-conventional cash flows: multiple IRRs; use NPV |
|
|
Explain decision scenarios when two projects are mutually exclusive VS independent |
*Mutually exclusive... go with the higher NPV valued project. *Independent... go with project(s) if NPV is positive... (you can do both) |
|
|
Relevant cash flow: two questions |
1. Is this CF a direct result of project? 2. Will this CF disappear if project isn't done?("Yes" = relevant CF) |
|
|
Relevant cash flow ??? *sunk cost *opportunity cost *side effects *changes in net working capital *financing cost *taxes |
*Sunk costs - No *Opportunity Costs - Yes *Side Effects - Yes *Changes in NWC - Yes *Financing Cost - No *Taxes - Yes |
|
|
Depreciation: explain two depreciation methods; tell which one is proper for tax filing vs.income reporting |
*Straight line - financial income reporting *Accelerated - tax filing |
|
|
Current Ratio |
CA/CL >1 is a good thing... you have more assets than debt |
|
|
Quick Ratio |
(CA-Inventory)/CL bigger the better... |
|
|
Debt Ratio |
(TA - TE)/TA = % lower is better... level of indebtedness |
|
|
Debt-Equity Ratio |
TD / TE or TDR / (1 - TDR) Lower is better |
|
|
DuPont Equation |
You can see what's causing ROE to be low or high... RoE = NI / TE .... RoE = RoA * EM RoE = PM * TAT * EM |
|
|
Profit Margin (PM) |
Net Income / Sales (for every $1 in sales, X gets all the way to NI) Measures firm's operating efficiency - how well does it control costs? |
|
|
Return on Assets (ROA) |
Net Income / Total Assets (for every $1 in assets, X income is produced) |
|
|
Return on Equity (ROE) |
Net Income / Total Equity (for every $1 in equity, X income is produced) |
|
|
P/E Ratio |
Price per share / Earnings per share (for $1 of company earnings investors are willing to lend $X) |
|
|
Market-to-book |
Market value per share / book value per share (market value as multiple of original/book value) |
|
|
Simple interest vs. compound interest |
: ) |
|
|
Calculation: estimate present value, future value, interest rate, or time period |
TVM Solver |
|
|
EAR vs. APR: concept and calculation |
Effective Annual Rate *actual rate after accounting for compounding *use this if comparing two alternatives |
|
|
EAR vs. APR: concept and calculation |
Annual Percentage Rate *quoted by law *APR = period rate times # of compounding periods per yr |
|
|
Annuity vs. annuity due: calculation and concept |
: ) |
|
|
How to amortize loans: two approaches (fixed principal vs. fixed total payment) |
??? |
|
|
How to price a bond given maturity, payment frequency, YTM, and coupon rate |
TVM Solver PV |
|
|
Bond yield: YTM is the sum of current yield and capital gain yield |
Current yield = annual coupon / beg. price Capital yield = (end price - beg. price) / beg. price |
|
|
Premium vs. discount bonds: compare YTM with coupon rate for each |
Premium: Coupon > YTM (Bond offers more than your expectations... you'll pay a premium) Discount: YTM > coupon rate |
|
|
Interest rate risk: explain what interest rate risk is for bonds |
Negative change in bond price as a result of increased interest rates. |
|
|
Interest Rate Risk: two factors that determine the interest rate risk |
Time to maturity (long-term bonds = more risk) Coupon rate (low coupon bonds = more risk) |
|
|
Interest Rate Risk: apply the concept and compare bonds of different features based on their interest rate risk |
: ) |
|
|
How to price a stock: based on dividend payment pattern (constant dividend; constant growth and non-normal/supernormal dividend growth) |
???? Constant Dividend: Use formulas... Non-normal Dividend: Use NPV... |
|
|
Differentiate between a dealer and a broker |
Dealer owns... (car dealer) Broker facilitates (land broker) |
