ACA FM Flashcards
(131 cards)
1
Q
How to calculate accounting rate of return?
A
Avg annual profit from investment / initial investment *100
Or
Avg annual profit from investments / average investment *100
2
Q
What is internal rate of return?
A
A cost of capital at which the NPV of a project is £0
3
Q
What cash flows are relevant?
A
Cash flows (not depreciation)
Future amounts
Directly relevant
Finance related cash flows
Opportunity costs
4
Q
What is the Fisher equation for money rates?
A
(1+m) = (1+ r) x (1 + I)
Where m = money rate
R = real effective rate
I = general inflation rate
5
Q
What are environmental prevention costs?
A
Costs required to eliminate environmental impacts before they occur
6
Q
What are environmental appraisal costs?
A
Costs involved with establishing whether activities are compliant with environmental standards and policies
7
Q
What are environmental internal failure costs?
A
Costs that must be undertaken when contaminats and waste have been created but not released into environment
8
Q
What are environmental external failure costs?
A
Costs that arise when a business releases harmful waste into the environment
9
Q
What is annual equivalent costs calc?
A
EAC = NPV of one cycle of replacement / AF for this cycle
Annuity is the equivalent of money payable each year of the assets life
10
Q
What is hard rationing?
A
External limits on funds available
Eg covenants and caps on borrowing
11
Q
What is soft rationing?
A
Internal constraints
Eg budgets or policies
12
Q
What are the 7 drivers of value for shareholder value analysis?
A
SLOWCAT
Sales growth rate
Life of project cash flows
Operating profit margin
Working capital investment
Cost of Capital
Assets (NC) investment
Tax (Corp Tax)
13
Q
What are the risks associated with overseas investments?
A
Political risks
Product and cultural risks
Different tastes
Different laws
14
Q
What is the sensitivity formula?
A
Sensitivity = NPV of project / PV of cash flows subject to uncertainty *100
15
Q
What are the strengths of sensitivity analysis?
A
Presented in a form which can facilitate subjective judgement
Identifies areas that are key to success
Straight forward to understand
16
Q
What are weaknesses of sensitivity analysis?
A
Only assesses one factor at a time
Assumes changes to variables are made independently
Doesn’t consider probability
Does not directly show decision
17
Q
What is linear regression?
A
Statistical techniques which quantifies the relationship betweeen a dependant variable and independent variable so that forecasts can be made
18
Q
What are advantages of linear regression?
A
Simple to use and easy to explain
Can predict impact of expanding variables beyond current estimates
19
Q
Limitations of linear regression?
A
Not always a linear relationship
Complex models are needed to assess multiple variables
Spurious relationships may be identified
Data collected may be inaccurate or maybe a large error variable
20
Q
Advantages of decision trees?
A
Simple trees are easy to explain and logical to use
Can be used to analyse different outcomes based on a number of variables
21
Q
Limitations of decision trees?
A
Variables have to be simplified and restricted to avoid over complicating the decision tree
Large decision trees can be difficult to interpret
22
Q
What are the advantages of simulation?
A
More information about possible outcomes and their probabilities
Can give information on impact of environmental costs
Useful for problems which can’t be solved analytically
23
Q
Limitations of simulation?
A
Not a technique for decision making
Expensive to design and run
Monte Carlo techniques requires assumptions about probability which may be inaccurate
24
Q
What is prescriptive analysis?
A
Combination of statistical tools and Ai to create the optimum outcome
Eg
Capital rationing decisions
Replacement analysis
Optimal financing balance
25
Benefit to prescriptive analysis?
Identify optimal decisions whilst incorporating multiple variables
26
Limitations of prescriptive analysis?
Creating models is complex and requires specialist data science skills
Reliability depends on reliability of the data
27
What is an expected value?
An average of possible outcomes, weighted by the probability of each outcome occurring
28
Advantages of expected values?
Information reduced to a single number for each choice
Idea or an average is readily understood
29
Limitations of expected values?
Probabilities difficult to estimate
Average may not correspond to any possible outcomes
No indication of the spread of possible results
30
What is unsystematic risk?
Risk that can be eliminated by diversification
Eg labour force strikes or equipment might fail
31
What is systematic risk?
The risk that cannot be eliminated by diversification
32
What is the CAPM used for?
Used to measure systematic risk of investments and the required return
33
What does a beta in the CAPM formula of > 1?
Investments are more affected by changes in macroeconomic variables than the average market investment
34
What is the CAPM equation?
rj = rf + Bj (rm - rf)
rj = required rate of return on investment j
rf = risk free rate of interest
rm = return on market portfolio
Bj = index of systematic risk for security J
35
Advantage of CAPM?
Clearly shows the discount rate that should be related to the projects risk
36
Weaknesses of CAPM?
Companies shareholders may not be diversified
Shareholders are not the only participants
37
What is a forward contract?
A binding agreement to exchange a set amount of goods at a set future date at a price agreed today
38
What is a future?
A standardised contract to buy or sell a specific amount of a commodity at a particular price on a stipulated future date
39
What is an index future?
Can be used to protect against falls in value of a portfolio of shares - important to pension funds
40
What is a put option?
Put up for sale
Investor has the right to sell shares at the exercise price within the specified period
41
What is a call option?
Means an investor is entitled to buy the shares at the exercise price within the specified period
42
What is the intrinsic value?
Computer by assuming the expiry date of the option is todsy
43
What is a forward rate agreement?
Allows borrowers to fix their future rate of interest
44
What are limitations of FRAs?
Usually only available on loans greater than £500k
Difficult to obtain for long periods
No upside potential
45
What are advantages of FRAs?
Protect against downside risk
Tailored
46
What is a maturity mismatch?
If actual period of lending does not agree to futures period (3m)
47
How to calculate maturity mismatch?
Number of future contracts = amount of actual loan or deposit / futures contract size
x
Length of loan / 3 months
48
What are the advantages of swaps?
Enable the switch from a floating rate to a fixed interest rate
Arrangement costs are significantly less than termination
Can be used to make interest rate savings
Available for longer periods
Flexible
49
Disadvantages of swaps?
Swap agreement may collapse (not favourable for either party)
Unfavourable market movement d
Financial statements may be misleading
50
What is transaction risk?
Role of adverse exchange rates occurring in the course of normal international trading transactions
51
What is translation risk?
Risk that organisation will make exchange losses
52
What is economic risk?
Refers to the exchange rate movements on international competitiveness of company
53
How to reduce transaction risk?
Invoice in companies home currency
Match receipts and payments
Matching assets and liabilities
Leading and lagging
54
When does a discount arise in forwards?
When the overseas currency is weaker than the spot rate
55
When does a premium arise in forwards?
Overseas currency is stronger than the spot, quoted at a premium
56
Do you add or deduct discounts from forwards?
Discount is added to the spot rate
Premium is subracted from the spot rate
-ADDIS
57
What is the formula for interest rate parity on spot and forward rates?
Forward rate = spot rate x l + if / l +iuk
uk always on bottom
58
Advantages of currency futures?
Transaction date flexibility
Exchange regulated market- less counterparty risk
Easy to buy and sell in a liquid market
59
Disadvantages of currency futures?
Not tailored
Limited currencies
Broker fees charged
Need to deposit and maintain a margin account
60
Advantages of currency options?
Removes downside risk
Leaves upside potential
61
Drawbacks of currency options?
High costs - 5% fx covered
Options paid for as soon as they are bought
Tailor made options lack negotiability - hard to sell on
Not available in every currency
62
Problems with cryptocurrencies?
Only likely to exchange for a narrow range of major currencies
Exchange rates very volatile
63
How to calculate the dividend payout ratio?
Dividend / earnings after tax and preference dividends
64
How to calculate theoretical ex rights price?
(Market value of shares pre rights issue + rights proceeds + project npv) / number of shares ex rights
=PV of new total dividends / number of ex rights shares
65
What is the dividend yield calc?
Dividend per share / market price per share *100
66
How to calculate earnings per share?
Profit distributable to ordinary shareholders / number of ordinary shares issued
67
How to calculate price earnings ratio?
Market price per share / EPS
68
Characteristics of venture capital?
Exerts some control over the running of the business but do not run the business
Usually medium term investment
Return is from capital gains after 3-5years
Exit route is via trade sale or flotation
Failure to hit targets can lead to equity ratchet
69
Advantages of crowdfunding?
Available to start up companies
Builds awareness of new business and attracts customers
Can be a quick process
70
What are the costs associated with crowdfunding?
Fee to crowdfunding website
Legal and advisory costs
Administrative costs
71
What is an initial coin offering?
ICO raises finance from investors:
Investor receives token for a share or utility
Payment made in cryptocurrency
White paper is issued
72
What are advantages to convertible loans?
Obtaining finance at a lower rate of interest
Encouraging possible investors
Avoiding redemption problems
Ability to issue equity fairly cheaply
73
What are loan stocks with warrants?
Loan stocks which cannot be converted into equity but give the owner the right to subscribe at future fixed dates for ordinary shares at a predetermined price
74
Advantages of peer to peer lending?
Interest rates are lower
Quicker to arrange than bank loans
More accessible to those with low credit ratings
Use has grown rapidly
75
What is the gearing ratio?
Debt / Equity
76
Interest cover calc?
Earnings before interest and taxes / interest
77
What are the flaws of the dividend growth model?
Growth is assumed to be less than the investors rate of return
Assumes linear growth which is of realistic
78
How to calculate g for dividend growth model?
N\^ newest dividend / oldest dividend -1
79
How to calculate growth under the earnings retention model or Gordon growth model?
G = rb
G= growth in future dividends
R = return on equity
B = proportion of profits retained
80
What are problems with the earnings retention model?
Reliance on accounting profits
Assumption that r and b will be constant
Inflation can distort accounting rate of return
Model assumes all new finance comes from equity - ignores the use of debt
81
What are the shortcomings of the dividend valuation model?
Underlying assumptions:
Shares have value bc of dividends, not always true
Dividends either do not grow, or grow at constant rate, not true
Estimates future dividends based on historic data
Data Used:
Share price used in DVM is subject to volatility
Growth in future dividends ads more likely to mirror future growth
82
What is the perpetuity valuation formula for preference shares?
Kp = D / Po
D = constant annual dividend
Po = ex dividend market value
83
How to calculate the tax cost of debt
Pre tax cost of debt x (1 - T)
84
How to calculate irredeemable debt?
Kd = interest (1-t)/Po
Po = price of bond ex interest
Interest = interest paid on the bond
Kd = required return of debt holder
85
How to calculate WACC?
k = (MVe x ke) + (MVd x Kd) / MVe + MVd
where mve = total market value of issued shares
MVd = total market value of debt
86
When to use the weighted average cost of capital?
Can only be used for project appraisal if:
- historical proportions of debt and equity are not to be changed
- the business operating risk of the firm is not to be changed
- the finance is not project specific
87
What are problems with weighted average cost of capital?
Which sources of finance to include
Loans without market values
Cost of capital for small companies
88
What is business risk?
Variability in earnings before interest and tax associated with the industrial sector
89
What is financial risk?
Additional variability in returns as a result of having fixed interest debt in the capital structure
90
What does M&M model 1958 stated about capital structures and WACC?
No corporation tax advantage for firms to issue debt.
WACC is constant regardless of the level of gearing.
No optimal level of gearing
Benefits of cheap debt finance are directly offset against increased returns required for shareholders for extra financial risk
Cost of equity rises in direct proportion to increased gearing
91
What is the M&M model for 1963?
In presence of corporation tax, it is advantageous for the firm to issue debts (gear up)
Effect of interest being allowable against tax means that geared companies pay less tax
WACC falls as gearing levels rise
Geared companies will have more cash to payout to investors
Optimal level of gearing is 100% debt
92
Limitations of the M&M model?
Assumes perfect capital markets
Ignores bankruptcy risks
Tax exhaustion - assumes tax paying position
Loan covenants - ignored
93
How to calculate adjusted present value?
Calculate a base case value of a project using Keu (cost of equity to unagreed co), this gives value of project as if it was ungeared
Establish present value old the tax shield arising as a result of the debt capacity generated by the project
94
What is a good APV?
Positive value for APV suggests an increase in shareholder wealth so project should go ahead
95
What is the pecking order for lines of equity finance?
Retained earnings
Rights issues and placing
New issues
96
What are the different theories to consider in terms of dividends?
Tratiiinal theory - using retained earnings sacrifices current income
Signalling
Clientele
Cash availability
Agency issues
97
What are share repurchases?
Alternative to dividend payouts - company can use cash to repurchase issued shares
Invite current shareholders to tender their shares or buying shares from stock market.
Reduces equity and increases gearing
Co can use cash without disruption to normal dividend
98
What are scrip dividends?
A new issue of shares to existing shareholders in lieu of cash dividends
Company avoids liquidity problems
Shareholder swaps income for capital gains and may be better ofd
99
What is organic growth?
Involves retention of profits and or the raising of new finance to fund internally generated projects
100
What is an acquisition?
Bidder acquires target company inentireky or buys sufficient shares to exercise control.
101
Characteristics of organic growth?
Costs are spread over time
Rate of change within firm is likely to be slower and avoids disruption and behavioural problems associated with acquisition
May be more risky than acquiring an established business
102
Characteristics of acquisition?
Faster approach to growth
Overcomes barriers to entry in new markets
Bidding company shareholders often lose out as a result of paying too much, high costs or overestimated synergies
103
Advantages of asset based approaches to valuations?
Simple to calculate
Assets more certain than income
Useful for asset strippers if there are valuable tangible assets
104
What are disadvantages of asset based approach to valuation?
Book values likely to be out of date
Ignores future earnings
Service businesses would be undervalued due to value of intangibles
Ignores value of digital assets so undervalued companies with valuable content that is stored electronically
105
What is the income based valuation approached based on?
Present value of the future cash flows
Requires estimate of future and discount rate
Max price paid should be: market value of combined businesses less market value of bidder before bid is made
106
Advantages to income based approach for valuation?
Technically the best method especially for service businesses
Incorporates all available relevant cash flows and the time value of money
107
What are the disadvantages of income approach to valuation?
Estimated cash flows may be too optimistic
Calculating suitable discount rate can be problematic
108
What is the price earnings model?
Share price divided by the earnings per share for a company
109
How to calculate output for the PE model?
Value = P/E x earnings
Higher pe = more confident the market is that future earnings will increase
110
How to find value for unquoted companies?
Find a pe for similar quoted company (same industry, size, gearing, risk etc)
Adjust downwards for non marketability of unquoted shares
111
What are the advantages for pe model for valuation?
Reflects stock markets view of the potential of a company
Considers earnings creating potential of the company
112
What are the disadvantages of P/E ratio model for valuation?
Using industry average may not reflect the company being valued
Earnings can be manipulated by accounting policies
Using past earnings may not reflect future potential
113
How to calculate the enterprise value?
Enterprise value multiple x EBITDA
114
How to calculate the equity value of a business?
Enterprise value - market value of debt + cash and cash equivalents
115
How to calculate value of unquoted companies using ebitda method?
Find or calculate an EBITDA/ EV multiple for similar company (quoted)
Multiple the most recent EBITDA by the EV / EBITDA value
Deduct the MV of debt and add cash to calculate equity value
Adjust downwards for non marketability of unquoted shares
116
Advantages of Enterprise value / EBITDA value?
Unaffected by capital structure or depreciation policies of company
Takes net debt into account
Enables direct comparison between companies which might have different policies
Technique most commonly used by investors
117
Disadvantages of enterprise value?
Simplistic
Ignores capex and tax
Using past earnings may not reflect future potential
Using an industry average or proxy multiple may not properly reflect the company being valued
118
How to calculate the dividend yield method?
Dividend per share / market price of share x 100
119
How to value unquoted company using dividend yield model?
Find a dividend yield for similar quoted company
Dividend the most recent dividend per share for the company that is valued by the dividend yield
Adjust downwards for non marketability of unquoted
shares
120
What is the dividend valuation method calculated?
Value = d0(1+g)/(ke-g)
d0 is dividend at time 0
g is the growth rate
ke is the cost of equity
121
Advantages of dividend methods?
Most effective when the investor is looking for dividend income rather than control
122
Disadvantages of dividend valuation model?
Dividend payments of growth may not be stable
Using dividend yield or ke of a proxy company or industry average may not reflect the company being valued
123
Why is valuation of technology companies difficult?
No track record of profits
Unpredictable market acceptance
Unknown competition
Inexperienced management
Stock market sentiment
124
What’s good about cash buying business?
Attractive to seller
Known consideration received
125
What’s bad about cash sale or business?
Liquidity issues
Possible immediate tax issues
126
Advantages of share for share exchange?
Preserves liquidity
No immediate tax issues
Sellers can undertake not to sell the shares to ensure continued cooperation with buyer
127
Disadvantages of share for share issue?
Increased dilution
Uncertain amount received
Dealing costs to sell shares
128
Advantaged of loan stock for share exchange?
Avoids dilution
More assured return than on shares
129
Disadvantages of loan stock for share exchange?
Gearing problems s
May prefer equity
130
Why may a company divest?
Lack of fit
Subsidiary too small
Conglomerate discounts - parts of business worth more when sold separately
Trading poorly
Parent co may need to improve liquidity
131
Positives of management buy out?
Viewed positively by employees
