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48 Cards in this Set
- Front
- Back
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ownership |
the right to share in a firm's projects |
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control |
the right to directly manage or elect membership of a firm |
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personal liability |
the responsibility to pay a firm's financial obligations using personal assets when the firm cannot |
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limited liability |
a limit that the owner can only lose the value of their investment when the firm cannot pay its financial obligations |
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sole trader/ proprietorship |
business ceases existence with death or withdraw of sole trader; profits taxed at personal level; one owner; control; personal liability |
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general partner |
ownership, control; personal liability; personal taxation |
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limited partner |
several owners, no control, limited liability, & personal taxation |
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corporation (shareholder) |
many partners, control, limited liability, taxed on corporate and personal (depends on tax system)
-own legal entity, distinct from owners -separation b/w ownership and management |
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Board of Directors |
- each director is elected by firm's owners -hires CEO -monitors firm and sets high level strategy -objective= maximize firm value |
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CEO- Chief Executive Officer
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-everyday manager of the firm -implements rules and policies set by board of directors -advised by high level executives -objective= maximize firm value |
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CFO- Chief Financial Officer |
-evaluates investment decisions -evaluates financing decisions for firm -objective= maximize firm value |
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Advantages of corporation to partnerships and sole traders |
-limited liability for owners -business continuous operation -business continues operation when owner changes |
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Disadvantages of corporation to partnerships and sole traders |
-agency costs b/w owners and management -taxation (in jurisdiction with classical tax system) |
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agency cost |
arises when an employee takes an action that serves their own interests instead of maximizing firm value |
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time value of money |
a $ today is worth more than a $ tomorrow
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compounding |
used to calculate equivalent future value of a cash flow today -multiply cash flow's PV by the interest rate factor associated with intervening time periods Valuet * (1+r)^n= Valuet+n |
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discounting |
used to calculate PV of a cash flow in the future -divide by appropriate discount factor Valuet= (Valuet+n) / ((1+r)^n) |
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annual percentage rate (APR) |
a simplified way to quote interest rates; equal to the total interest that would be earned in a year without compounding
-quoting =r * n |
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effective annual rate (EAR) |
the total amount of interest that will be earned at the end of one year with compounding -financial decision making =(1+r)^n -1 =(1 + APR/n)^n -1 |
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stream |
cash flows describing time and amount |
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value |
reference point in time, usually initial period |
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sequential approach |
move forward one period at a time, computing the total value of cash flows already received
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reference time approach |
compute the value of each individual cash flow at the reference time. add these to the total values |
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time t-value |
a value found by moving all cash flows to time t and taking the sum |
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present value |
the value found at the implied reference point of a specified time period, t=0! |
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annuity |
a stream cash flow arriving at a regular interval over a specified time period |
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constant annuity |
gives total time t-value of all n cash flows from beginning at t+1 |
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perpetuity
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a stream of cash flows that occur at regular intervals and make payments forever |
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constant perpetuity |
constant payments made forever |
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growing perpetuity |
a growing amount paid forever |
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Law of One Price |
if equivalent investment opportunities trade simultaneously in different competitive markets, then they must trade the same price in both markets -prices respond to supply and demand |
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Arbitrage |
represents an opportunity to make a profit w/o taking any risks -Law of One Price hold b/c arbitrage cannot exist in financial markets for long periods of time |
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Key implications of Law of One Price |
1. scaling of cash flows: cash flows in a stream that share a common multiple can be simplified by factoring out that shared common multiple 2. Adding subtracting cash flows: cash flows from different streams that can be added or subtracted if they share the same discount rate and are discounted to the same reference point in time 3. Delayed and Accelerated Cash flows: next card |
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Delayed and Accelerated Cash flows |
a) delayed cash flow: cash flows that are realized further in the future can often be problematic for discounting if we discount individual cash flows back to the present -things are delayed so value is less b) accelerated cash flows: cash flows that are realized early are considered more valuable and to move them to a reference point, we need to accelerate them - things are accelerated so value is more |
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compounding |
Valuet * (1+r)^n= Valuet+n |
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discounting |
Valuet= (Valuet+n)/ ((1+r)^n) |
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APR |
=r *n -r= per period interest rate n= # of interest payments per year |
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EAR |
=(1+r)^n -1 =(1+ APR/n)^n -1 *Differences between APR and EAR represent value of compounding. |
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constant perpetuity |
C/r |
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growing perpetuity |
C/ (r-g) |
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delayed cash flows |
delayed s periods= X/ (1+r)^s |
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accelerated cash flows |
accelerated s periods= X* (1+r)^s |
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PV |
C* annuity factor |
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2 stage model |
annuity + perpetuity |
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3 stage model |
annuity, annuity, & perpetuity |
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for the next 23 years |
t= 24, n=23 |
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until t=24 |
n=24, t=25 for next payment |
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CF24 |
= 760* 1.111^23 |
