Financial Management I - Week 1 Quiz 1

Front 1

Real assets

Back 1

tangible assets and intangible assets used to carry on business

Front 2

Investment Decision

Back 2

Purchase of real assets

Front 3

Financing Decision

Back 3

sale of financial assets

Front 4

Corporate Capital investment decisions are often referred to as either of these two terms

Back 4

1. capital budgeting or capital expenditure.

Front 5

CAPEX

Back 5

capital expenditure

Front 6

Corporation

Back 6

a legal entity; by law technically a corporation is a person that is owned by the shareholders

ref. pg 5

Front 7

4 characteristics of a corporation

Back 7

1.make contracts

2.carry on business

3. borrow or lend money

4.sue or be sued

ref pg 5

Front 8

What is the main factor that makes a corporation powerful as identified in class

Back 8

Limited liability: shareholders only risk the money they have invested in the corporation. No further legal or financial risk.

Front 9

Each stockholder wants these 3 things:

Back 9

1. to be as rich as possible

2. to transform wealth into the most desirable time pattern of consumption by either investing to spend later or borrowing to spend now

3. To manage the risk characteristics of that of that consumption plan (low risk or high risk)

ref pg 8

Front 10

Definition of "hurdle rate" or "cost of capital"

Back 10

The minimum acceptable rate of return (on an investment)

ref pg 10

Front 11

Agency problem

Back 11

the conflict of interest between management and owners

ref ch 1 slides #10

Front 12

Opportunity Cost of Capital

Back 12

Investing in a project eliminates other opportunities to use invested cash

ref ch 1 slides #11

Front 13

future value definition

Back 13

Amount to which investment will grow after earning interest

Front 14

present value definition

Back 14

Value today of future cash flow. Ex: What do I need to invest to day to get $100 in 2 years at 10% interest. The answer is the present value

Front 15

future value formula

Back 15

The $100 in this formula represents the present Value of $100. Any number could be plugged in.

where FV = Future value, r = interest rate, t = number of years (Periods)

Front 16

DF

Back 16

Discount factor

Front 17

Discount Factor formula

Back 17

where r = interest rate, t = number of years (Periods)

Front 18

Present value formula

Back 18

where C = the amount of cash the investor wants in the future period

Front 19

T or F. Stock market index returns have a clear pattern

Back 19

False

Front 20

Stock market returns are negative approximately what percentage of the time

Back 20

25%

Front 21

What is "variance" in reference to stock markets?

Back 21

Average value of squared deviations from mean; measures volatility/risk. Note: Variance will always be positive

ref ch 7 slides #8

Front 22

What is "standard deviation" in reference to stock markets?

Back 22

Square root of variance; measures volatility/risk

ref ch 7 slides #8

Front 23

How do you calculate the Standard Deviation?

Back 23

take the square root of the variance

Front 24

How do you calculate variance?

Back 24

where the tilda r = the actual return and the r = the expected return. *Pay no attention to the 450 in this answer.

Front 25

Formula for: Portfolio rate of return

Back 25

Front 26

Diversification

Back 26

Strategy designed to reduce risk by spreading the portfolio across many investments

Front 27

Unique Risk

Back 27

Risk factors affecting only that firm; also called “diversifiable risk”

Front 28

Market Risk

Back 28

Economy-wide sources of risk that affect the overall stock market; also called “systematic risk”

Front 29

Market Risk + Unique Risk

Back 29

Total Risk

Front 30

How does a company reduce unique risk?

Back 30

by diversifying their portfolio

Front 31

Market Portfolio

Back 31

Portfolio of all assets in economyUsually uses broad stock market index to represent market

Front 32

Beta

Back 32

Sensitivity of stock’s return to return on market portfolio; it measures a stock’s contribution to portfolio risk

ref ch 7 slides #27

Front 33

Beta formula

Back 33

where :sigma im= covariance with market : sigma squared m= variance of market

Front 34

What are the 3 rules of Net Present Value

Back 34

1. Only cash flow is relevant

2. Estimate cash flows on an incremental basis

3. Treat inflation consistently

Ch. 6 slides #2-#4

Front 35

NPV

Back 35

Net Present Value

Front 36

Say more about the Rule #1 of Net Present Value: 1. Only cash flow is relevant

Back 36

Includes Capital expenditures and working capital.

Rules of thumb for capital expenses:

1.Record capital expenditures when they occur.

2. To determine cash flow from income, add back depreciation and subtract capital expenditure

Front 37

Define: Working capital

Back 37

Difference between company’s short-term assets and liabilities

Front 38

Provide 5 details regarding Net present Value Rule #2: Estimate cash flows on an incremental basis

Back 38

1. Include taxes, salvage value, incidental effects, and opportunity costs

2. Do not confuse average with incremental payoffs

3. Forecast sales today, recognize after-sales cash flow to come later

4. Forget sunk costs

5. Beware of allocated overhead costs

Front 39

Provide 3 details regarding Net present Value Rule #3: Treat inflation consistently

Back 39

1.Use nominal interest rates to discount nominal cash flows

2. Use real interest rates to discount real cash flows

3. Same results from real and nominal figures