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95 Cards in this Set
- Front
- Back
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What are when bondholders are lending the corporation money for some stated period of time?
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Debt Instrument
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What are corporate bonds can be traded in the secondary market and price at which a given bond trades is determined by market conditions and terms of the bond?
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Liquid Asset
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What is usually $1000 also called face value?
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Par Value
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What is when borrowers (firms) typically make periodic interest payments to the bondholders?
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Coupon Interest Rate
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What is the time at which the original principal (Par Value) is repaid to the bondholder?
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Maturity
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What is the document which details the legal obligation of the corporation to the bondholders?
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Indenture
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What are somewhat more susceptible to adverse effects of changes in circumstances and economic conditions than debt in higher rate categories?
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Lower debt ratings
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What determines the investor's periodic cash flow?
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Interest Payment= Coupon Rate X Par
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How do you find current yield on bond quotes?
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Coupon Rate/ Market Price
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What is its intrinsic value or the present value of its expected future cash flows, where these cash flows are discounted back to the present using the investor's required rate of return?
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Value of an asset
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What is value impacted by?
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Asset characteristics, Investor attributes, these two areas determine the investor's required rate of return
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What are asset characteristics that are basic factors determining value?
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Expected level of cash flow, timing of cash flow, Riskiness of cash flow
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What are investor attributes that are basic factors determining value?
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Investor's assessment of the riskiness of the asset's cash flows, Investor's willingness to bear risk
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What does present value of expected cash flows discounted using investor's required rate?
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Asset Value
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What are 3 Cash Flows?
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Amount that is paid to purchase the bond (PV), Periodic Interest Payments made to the bondholders (PMT), Repayment of Par Value at end of Bond's Life (FV)
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What equals time frame for cash flows (N)?
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Bond's Maturity
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What is the rate at which future cash flows are being discounted to present (1/Yr)?
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Interest Rate for Time Value
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When do bond prices fall?
rise? |
during periods of rising interest and during periods of falling interest rates
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What are the 5 ways interest rates are determined by?
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Real Rate of Interest, Expected Inflation, Default Risk, Interest Rate Risk, Liquidity Risk
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What compensates for the lender's lost opportunity to consume?
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Real Rate of Interest
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What is there is some risk that the borrower will not repay the interest and/or principal on time, or at all?
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Default Risk
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What happens to interest and payments if there is a greater chance of default?
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The greater the interest rate the investor demands and the issuer must pay
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What is when savers are hurt by inflation since the money that is saved will purchase fewer goods and services?
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Expected Inflation
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How do you find expected inflation rate?
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1 + inflation rate
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What are investments that are easy to sell without losing value and are more liquid?
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Liquidity
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What type of securities have a higher interest rate to compensate the lender for the inconvenience of being stuck?
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Liquid Securities
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What is equation for determination of Interest Rates?
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k = k* + IP + DRP + IRP + LP
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What does k stand for?
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the nominal, or observed rate of security
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What does k* stand for?
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real, risk free rate of interest
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What does IP stand for?
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Inflation Premium
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What does DRP stand for?
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Default Risk Premium
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What does LP stand for?
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Liquidity Premium- reflects the ability to sell security easily
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What does IRP stand for?
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Interest Rate Risk Premium - Reflects interest rate risk long term securites are more sensitive to changes in interest rates
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Common Stock?
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owners of the firm, claim on Assets and Earnings not claimed by other creditors (residual claim),
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Preferred Stock?
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A hybrid security with both debt and equity characteristics, has priority over common stock in receipt of dividends and in liquidation, Dividends are fixed as a percentage of par value, and only participating preferred stock (which is rare) shares in the residual income with the common stockholders
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What does Dividend Yield equal?
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Dividend/Closing Price
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What is investor's return from dividend (assumes constant stock price)?
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Dividend Yield
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What indicates market premium for given common stock?
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Price to Earnings Ratio (PE)
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What does PE =?
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Closing price/ Earnings per Share
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What stock has no PE because these stock investors are not entitled to Residual Earnings?
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Preferred Stock
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What does Po stand for?
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Intrinsic Value of Preferred Stock
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What equals PV of all dividends discounted at investor's Required Rate of Return?
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Po
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Po= perpetuity= ?
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D/R
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What type of stock dividends may vary over time?
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Common Stock Dividends
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When valuing common stock, what is the equation?
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Po= D1/R-g
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What is constant with stockholders expected Rate of Return common stockholders?
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Dividend
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Which stock has the dividend yield from the quote that does not equal the expected rate of return?
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common stock
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What is the decision making process for investment in fixed assets; specifically, it involves measuring the incremental cash flows associated with investment proposals and evaluating the attractiveness of these cash flows relative to the project's cost?
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Capital Budgeting
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What is the process to analyze investment (any investment)?
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1. Determine the future expected dollar earnings from investment. 2. Determine an appropriate required rate of return, (R), for this investment. 3. Calculate Value- using one of many criteria 4. Make Decision
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What is amount of capital spent to get project going?
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Cost of Project
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What are 3 Capital Budgeting Methods?
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Net Present Value (NPV), Payback period (PB), Internal Rate of Return (IRR)
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What is the present value of all costs and benefits of a project, the concept is similar to Intrinsic Value of a security but subtracts of cost of project, measures the increase in value to the firm if the project is undertaken?
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Net Present Value
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NPV = ?
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PV of Inflows - Cost of Project
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What type project accept one project out of entire population of projects?
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Mutually Exclusive
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What type of project accept all profitable projects out of the entire population?
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Independent
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If projects are this then accept all projects with NPV>0?
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Independent
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If projects are this accept higher with NPV>0?
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Mutually Exclusive
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What are advantages of NPV?
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NPV is consistent with the goal of shareholder wealth maximization, it considers the magnitude and the timing of cash flows over a projects expected life, a firm can be thought of as a series of projects and the firm's total value is the sum of the NPV's of all the independent projects that make it up, NPV approach indicates whether a proposed project will yield the rate of return required by the firms investors
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What are disadvantages of NPV?
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People can find NPV, expressed in absolute dollars, more difficult to explain rather than a concept which expresses result as a rate of return
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What is the number of years needed to recover the initial cost of the project?
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Payback Period
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What are advantages of PB?
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Easy and inexpensive to use, Provides a crude measure of project risk, provides a measure of project liquidity
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What are disadvantages of PB?
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No objective decision criterion, fails to consider timing of cash flows, fails to consider cash flows beyond the PB period
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What graphs the Net Present Value of the project at different discount rates?
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Net Present Value Profile
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What is the IRR is the Required Return in which NPV = 0?
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Internal Rate of Return on Project
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What type of project is the not the best method of evaluation for internal rate of return?
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Mutually Exclusive
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What are the advantages of IRR?
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Widely used in industry, nearly 54% use it as their primary capital budgeting technique, considers both the magnitude and timing of cash flows over the project's life
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What are the disadvantages of IRR?
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When there occur both positive and negative CF's during the project's life, there may exist more than one IRR. In fact, there can be as many IRRs as there are sign changes in the cash flows, the best solution to this problem is to use NPV, IRR and NPV can give conflicting signals for mutually exclusive decisions. The two models are based on different assumptions regarding the reinvestment rate.
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What does not adjust for timing differences? (method)
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Payback method
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What methods take into account the time value of money?
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NPV and IRR
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What methods use all cash flows?
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NPV and IRR
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Which method ignores cash flows that occurs after the payback period?
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Payback method
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What should be measured on an incremental basis?
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Cash Flows
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What are cash flows that will occur if a capital budgeting project is accepted, but that will not occur if the investment is rejected?
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Incremental Cash Flows
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What should be measured after-tax?
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cash flows
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What should not be considered in measuring incremental cash flows?
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Sunk costs
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How should the value of resources used in the projects be measured in terms of?
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Opportunity costs
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What type of payments do you ignore in measuring incremental cash flows?
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interest payments
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What is when an asset's value is expensed over its useful life for federal tax purposes?
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Depreciation
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What is a noncash expense?
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Depreciation
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What type of depreciation do US companies use for tax purposes?
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MACRS
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What is the total amount to be depreciated over the accounting life of the asset?
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Depreciable basis
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What is equal to cost of the asset plus any setup and delivery costs incurred?
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Depreciable basis
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What is the depreciable basis (cost) of the asset time the MACRS% for the current year of service?
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Depreciation expense
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What = Basis - Accumulated Depreciation
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Book Value
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What is capital spent and recovered for the purchase/sale of fixed assets?
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Capital Spending
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What is working capital investments required to support the project?
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Net Working Capital
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What is the annual cash flows realized from the operation of the project?
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Operating Cash Flow
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What is the sum of the cash flows by year?
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Total Project Cash Flow
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What is an important part of capital budgeting?
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setting the required rate for the individual project
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How do you find firm's capital structure (% of debt)?
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Amount of Long Term Debt (D)/Total Capital Sources(V)
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How do you find % of P. Stock?
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Amount of Preferred Stock(PS)/Total Capital Sources(V)
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How do you find % of C Stock?
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Amount of Common Stock (E)/Total Capital Sources(V)
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What are the two methods to determine cost?
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Dividend Growth Model Approach and Security Market Line Approach
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What is the overall required rate that is used to determine the NPV for individual projects?
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Weighted Average Cost of Capital (WACC)
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What does the WACC take into account (3)?
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taxes, component costs of capital and the firm's capital structure
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