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Year 2 Semester 1 > Finance Topic 1, 2, 3 > Flashcards

Finance Topic 1, 2, 3 Flashcards

1
Q

Time value of money

A

grows over time

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1
Q

future value

A
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2
Q

annuity

A

same amount money received
every year for T years
start 1 year from now (first payment in 1 year from today)

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2
Q

present value

A
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3
Q

perpetuity

A

same amount money received
every year FOREVER
starting 1 year from now

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4
Q

capital investment

A

expenditure today = generate cash inflow tomorrow
cost < benefit

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5
Q

Investment appraisal techniques

A
  1. NPV
  2. IRR
  3. payback
  4. ARR
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6
Q

Payback

A

yrs to recover initial
target - less than and shortest
screening method

+ - imminent cf, simple, cf based
- time value, size/time of cf, outside period cf

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7
Q

NPV

A

discounted cf - cost of capita/ target rate of return - discount rate
-cost + sum of future cash inflows

+ primary obj, DCF model, time value, account all cf
- understand, estimate discount rate (not constant) , capital is scarce

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8
Q

primary objective

A

maximise SHs wealth

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9
Q

IRR

A

cost of capital/discount rate when applied = NPV of 0
IRR > target rate (higher is better), mkt rate < discount = +ve IRR
return rate < cost of borrowing = won’t do it
dont know the correct IRR

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10
Q

multiple IRR

A

non normal cash flows = more than 1 change in cf direction
project calls for large cash outflow during end of life

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11
Q

goal of a finance manager

A

maximise SH wealth
-select project that maximises firm value
-detailed analysis of project and aspects
-international = more factors to analyse

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12
Q

9 issues of international

A
  1. financing arragements
  2. risk adjustment
  3. foreign exchange
  4. remittance
  5. taxation
  6. project vs parent cash flow
  7. uncertain salvage value
  8. blocked funds
  9. inflation
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13
Q

multinational capital budgeting

A
  • evaluate international projects
  • NPV
  • c.f in more than 1 currency
  • subsidiary = manage daily
  • parent = finances project
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14
Q

capital investment decision stages

A
  1. estimate expected cash flow
  2. cost of capital
  3. NPV
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15
Q

estimating cash flows

A
  1. estimate future
  2. incremental
  3. cash
    (working capital)
    inflow = +
    outflow = -

parent view = max MNC value, cf remitted to parent = shows perf, determine financial viability

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16
Q

incremental cash flow

A

relevant, because// all incremental, non cash items not considered
1. sunk costs (exclude) - cant be recovered e.g cost of financial analysis
2. opportunity costs (include) - cash flow without the project, benefits forgone because of the project
3. externalities (include) - 2 product linked e.g. cannibalisation, new product add or take away from existing

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17
Q

whether to include

A

incremental cash flow
would the cash flow be influenced by the investment decision
YES - include in analysis
NO - dont include it

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18
Q

working capital

A

CHANGES to cash flow
CA - CL
decrease = inflow = money loosen from asset
increase = outflow = money tied up in asset

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19
Q

project cash flow

A
  1. initial inv
  2. operating rev & expense
  3. profit from subsidiary
  4. post tax profit
  5. remittance to parent
  6. parent may rely on dividend received to cover central expenses
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20
Q

sources of finance

A
  1. kd - before tax cost of debt
  2. ke - cost of equity

firms use both E & D to finance - weighted average cost of capital

cost of capital = discount rate = reflect risk and type of cf = increase cost of borrowing = increase risk = political and foreign exchange uncertainty

21
Q

kd

A

interest firm pays to borrow from bank or bond market to fund project
before tax cost of debt
after tax = kd(1-t)

22
Q

ke

A

cost of equity
return (expected) return on equity firm pays investors

23
Q

CAPM

A

ke = kf + beta(km - kf)

= risk free rate + systematic risk (expected return on mkt portfolio

24
Q

Cost of capital

A
25
Q

Methods of determining cost of capital

A
  1. Convert foreign project cash flows into home currency
    - predict future ER
    - discount home currency discount rate
  2. NPV calc in foreign currency
    - discount to NPV foreign discount rate
    - translate foreign NPV into home NPV @spot
26
Q

Home vs foreign cost of capital

A
27
Q

computing NPV

A

currency exchange
1. interest rate parity
2. purchasing power parity

28
Q

interest rate parity

A

F/S = (1+Rhome) divided by (1 +Roverseas)

difference in interest rates in any 2 countries = same as difference between forward and spot rate (of respective currencies)

29
Q

arbitrage

A

buy in 1 market and sell in another at higher price

30
Q

purchasing power parity

A

arbitrage
based on law of 1 price
home per foreign -
F0/S0 = 1 +Rh divided by 1 + Rf
forward ER/Spot ER = 1 + home interest rate / 1 + foreign interest rate

S1/S0 = 1 + ih divided by 1 + if (inflation)
expected spot rate divided by current spot rate

31
Q

exposure to international risk

A
  • international = decrease MNC risk to home eco conditions
  1. ER movements
  2. Foreign exchange conditions
  3. political risk
32
Q

foreign exchange risk

A
  • variability of firm value due to uncertain exchange rate (volatile/fluctuate) = risk
  • MNC = inflow and outflow exchange currency daily
  1. Transaction
  2. Translation
33
Q

Transaction risk

A

risk of change = expected value of contract between signing and execution = result of unexpected changes in foreign E.R

34
Q

translation risk

A

gain and losses from ER
occur due to converting financial statements from 1 currency to another = consolidate

35
Q

foreign economies risk

A

demand of product in foreign country = dependent on economic conditions in market

36
Q

goal of MNC

A
  • max SH wealth
  • max firm value
    profit max - SHs, employee rights, creditors, ST & LT
37
Q

political risk

A

uncertain activities in host gov
action/instability = difficult for efficient operations = not operating at full capacity = max profit in unstable turbulence = negative influence on c.f.
e.g terrorism and war

38
Q

agency theory

A

conflict of interest between principals (SHs) & agents (manager/employees)
- regarding profit, dividends and retaining
-self interested behaviour

39
Q

self interested behaviour

A

imperfect labour & capital markets
managers max own utility = expense of corporate SH
managers = consume corp resource, risk averse = outside inv see decisions are made contrasting best interest

40
Q

agency costs

A

costs borne by SHs = encourage managers to max SH wealth rather than own self interest

  • monitor managers
  • structuring organisation
  • opportunity costs from SHs, restrictions = limit manager ability to max wealth
41
Q

management style of MNC

A
  1. centralised = direct control of foreign subsidiaries = reduce agency costs - everything back to parent
  2. decentralised = max wealth of MNC SHs = max overall MNC wealth, agency more significant
42
Q

depreciation

A

straight line method
cost - scrap value divided by useful life
tax deductible not cash flow

43
Q

2 methods

A
  1. convert foreign - home, predict future ER, discount @ home currency discount rate (cost of capital)
  2. NPV call in foreign currency, discount NPV at foreign discount rate, translate foreign NPV to home at spot rate
44
Q

taxable profit

A

operating cash flow (inflows) - depreciation

45
Q

NPV

A

sum of present values

46
Q

discount factor

A

1 divided (1 + r) to power of t

47
Q

Double taxation

A

levying of tax by 2 or more jurisdictions on same declared income (income taxes) , asset (capital taxes) or financial transaction (sales taxes)
double liability often mitigated by tax treaties between countries

48
Q

methods of double taxation

A
  1. deduction
  2. exemption
  3. credit
49
Q

deduction

A

allow tax as expense
tax on net tax after profits not original - pay tax on the amount after other country has taxed

50
Q

exemption

A

making foreign income exempt
country of residence doesnt tax foreign income of residents

51
Q

credit

A

country of residence gives credit for foreign tax paid
refund what paid in foreign

Year 2 Semester 1 (19 decks)

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