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Flashcards in Economics II Deck (107)
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1
Q

Debt

A

Lending from banks or bond buyers

2
Q

Equity

A

Selling shares/stake

Publicly / Privately

3
Q

Retained Profit

A

Previous years profit not distributed to share holders as dividends

4
Q

Trade Credit

A

Pay suppliers later than they get paid

5
Q

Invoice Discounting

A

Selling trade debt for a fee

6
Q

Free Cash Flow

A

Operating Cash Flow - Capital Expenditure

Cash gener from revenues - acquir/maintain fixed assets

7
Q

Operating Expenditure

A

Ongoing cost to running a business

8
Q

Simulation

A

Estimation of probabilities of different possible outcomes

9
Q

Break-Even Analysis

A

Analysis of level of sales at which the project breaks even

10
Q

Exogenous

Endogenous

A

Internal Cause

External Cause

11
Q

Option Pricing

A

A contract giving purchaser right to buy asset in future at specified strike price.
Protect material price changes
Option seller must have asset to hand

12
Q

Intrinsic Value

A

Difference between strike price and underlying asset

13
Q

Iron Triangle of PM

A

Time, Cost, Scope and Quality

14
Q

Sensitivity Analysis

A

Analysis of effect of changes in one variable

15
Q

Scenario Analysis

A

Project Analysis given particular combination of assumptions

16
Q

CAPM Model

A
Cost of Equity
Ke = Rf + B(Rm - Rf)
Rf - Risk Free
B - Risk Estimate
Rm - Risk Market
CAPM > 1 - Firms move more than marker more risk
17
Q

ROSF

A

(Net Profit after interest payment) / (Shareholder Funds)
Single Year rate of return on each unit of share capital
Narrow assessment of profitability

18
Q

Capital Employed

A

Total Assets - Current Liabilities (Debt + Equity)

19
Q

ROTA

A

2 Part Du Pont
PBIT / TA = (PBIT / T) x (T / TA)
Relationship of OP margin + its asset turnover ratio

20
Q

ROCE

A

3 Part Du Pont
PBIT / TA = (PBIT / T) x (T / TA) x (TA / K)
Efficiency of which its capital is employed
Higher % the better

21
Q

ROE

A

5 Part Du Pont
PAIT / E =
(PBIT / T) x (T / TA) x (TA / K) x (PAIT / PBIT) x (K / E)

22
Q

Capital Worth

A

Total Assets - Total Liabilties

23
Q

Developers into 2 types

A

Speculative - Develop and Sell/Rent

Owner-user - Develop and use as part of the business

24
Q

Net Present Value

A

Comparing cost of project with future value of revenue discount rate applied so it can be compared with alternative investments

25
Q

Developer J-Curve

A

Initial High Risk -ve cost costs (trough high risk period)
Trade Credit / off plan sales reduce risk and cash inflow
Cash revenues increase as costs get smaller

26
Q

End of a project

A

Divestment in Fixed Costs - Plant/equipment moved/sold

Divestment in Working Capital - inventory sold accounts receivable collected

27
Q

3 Components of Cash Flow

A

-ve cashflow from investment in fixed assets
-ve cashflow from investment in working capital
+ve cashflow from operations (revenue)

28
Q

Payback Definition

A

Time taken to recover initial investment

Packback period < specified cut off period

29
Q

Delay Causes in PFI Projects

A

42% - PM issue / subcontractor under finance/resourcing
15% Jarvis PLc (railway) financial difficulties
6% - Planning permission issue / dispute between parties

30
Q

Uncertainty vs Risk

A

Uncertainty cannot be quantified, unknown risk
Risk is measurable and can be quantified
Actuaries collect data

31
Q

Exchange Rate Risk Mitigation

A

Forward Contracts - Lock agreed exchange rate Option
Price Variance Clauses - Client agrees to take some exposure, as full hedge is expensive
Hedging - Buy asset that will do opposite if euro crashes

32
Q

Asymmetric Information

A

Where one party has more info than another

33
Q

Securitisation / NINJA

A

Allowed mortgage obligations to be pooled together to create financial products that could be resold via capital markets
No Income No Jobs or Assets

34
Q

Dutch Books

A

A set of odds and bets which guarantees a profit regardless of the outcome of the gamble

35
Q

Moral Hazard

A

One party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the costs

36
Q

PFI

A

Type of Public Private Partnership
Private firms paid more to complete gov contracts FIXED
Integrated Public Procurement
700 projects signed 2013 Mar 9.6bn ann gov liabiliti 13/14

37
Q

PF2

A

Increased equity 15% from 10%
No soft facilities management
Only really used for schools and road project investments

38
Q

Profit Margin

A

PBIT / Turnover

39
Q

Interest Tax Burden

A

PAIT / PBIT

40
Q

ROCE

A

PBIT / Capital Employed

41
Q

Gearing

A

Total Assets / Capital Employed

Ratio of companies debt to value of ordinary shares

42
Q

Asset Turnover

A

Turnover / Total Assets

43
Q

Ponzi Scheme

A

Operator generates funds for old investors w/ new ones
High risk FCF < INterest + principle payment
Constant Short run refinancing, increasing pot insolvency

44
Q

ADCSR

A

Ratio determining how many times your turnover is over your debt repayment

45
Q

Hedge

A

A risk management technique to reduce losses/gain/risk
Least risky FCF > principle + interest payment
FCF < Annual Debt Cover Service Ratio
Liquid asset kicker - margin of safety superfluous to ops

46
Q

Speculative

A

Medium Risk
FCF > Interest payments
Trading in an asset, risk losing everything or substantial gain
Risk insolvency if variable interest rates incre above limit
Pay interest on loan/refinance in future to pay principal

47
Q

Flows of Funds into a company

A
Sales Revenue
Gross Trading Profit - Current CoProdu/Interest Payment
Taxable Profit - Taxation
Net Profit - Dividends
Retained Earnings
48
Q

Internal Cash Flow

A

New Equity, New Creditors, New LT debt Finance

New Investment expenditure, Repayment of loans, increase financial assets

49
Q

Capital Intensity

A

Requiring of large amounts of resources in order operate

50
Q

Residual Claimant

A

After all costs of production have been paid the money left is to the residual claimants

51
Q

Securitisation Advantages

A
Can be low risk ideal for pension funds
Regular and consistent cash flow
AAA credit ratings
Assets removed from the business onto SPV
Pass on the risk
52
Q

Special Purpose Vehicle

A

A subsidiary company with asset/liability structure and legal status to fulfil narrow.specific/temporary objectives. Isolate from firm to reduce risk..

53
Q

CDO

A

Collaterised Debt Obligation

Debt, range of returns some more/less risky

54
Q

Banking Crisis

A

More people invest in CDO’s and demand increases
Banks try to increase supply by offering more mortgages
People who can afford them already have them
Banks offer to people that cannot afford them NINJA
Defaulting turns CDO’s into houses and they put them on the market
High supply reduces price and housing price collapses

55
Q

Securitisation Disadvantages

A

More complicated way of funding than bank loans
People default and have asset rather than income
Can cause global financial crisis

56
Q

Market Risk

A

Risk affecting whole market
Cannot be diversified
Systematic Risk

57
Q

Idiosyncratic Risk

A

Risk specific to a firm or industry

Can be diversified

58
Q

Advantages of Equity

A

Less risk, no monthly loan repayments
Dont take funds out of business
Credit problems only option

59
Q

Disadvantages of Equity

A

Investors return could be higher than interest payments
Loss of control
Potential conflict

60
Q

Advantages of Debt

A

Control, once debt is repaid tie is severed
Loan interest is tax deductible, dividends not
Predictability of cash flow, agreed in advance

61
Q

Disadvantages of Debt

A

Qualification, need to have high credit rating
Fixed payments bad for unpredictable cash flow
Collateral risk

62
Q

Land Banking

A

Large areas of land waiting to be developed on

63
Q

Government Bonds

A

Debt security issued by government to fund spending
Backed by the credit of government so risk free
Predictable income, greater guarantee and risk free

64
Q

NPV

A

Overall value of inward cash flows in excess of outward cash flows in present value terms
Accept investment if NPV is positive

65
Q

Adv/Disadv of NPV

A

Recognises time Value of money
Takes into account entire inflows and returns
Projects may have unequal lives, returns or costs

66
Q

Finance

A

Pays at the beginning

67
Q

Funding

A

Pays at the end
Gov funding: tax payer funds eventually (education/health)
User funding/private revenues: individual user via charging (toll, road, utilities)

68
Q

Private Finance

A

Banks and equity investors wanting a return

Financed by the gov borrowing money from private investors to pay for specific projects.

69
Q

Public Government Finance

A

Lend against future tax revenues.
Public infrastructure, can be financed by the government earning future revenue from tax, which then is used to pay for specific projects.

70
Q

Why is debt desirable

A
  • Interest on debt is cheap thus reduces liability so shareholders get more for their return.
  • Replaces the need to issue new shares & dilute ownership (debt still enables ownership of company)
71
Q

Prioritisation on liquidation of assets

A
  1. Administrator’s fees
  2. Fixed charge holders (senior debt)
  3. Preferential creditors (e.g. employees)
  4. Floating charge holders.
  5. Unsecured creditors (e.g. trade creditors and unsecured debt)
  6. Subordinated debt holders
  7. Preference shareholders
  8. Ordinary shareholders
72
Q

Time Value for Money

A

100 now, Greater purchasing power, future cash is less certain borrower may default
Borrowers need more profit cos of delay receipt

73
Q

Myers 1984

A

Pecking order - used retained earnings first

74
Q

Shareholder Returns

A

Share price appreciation - increase in market value

Dividends - share in net profit

75
Q

Forward / Backward Looking

A

Based on previous historical transactions

Expected future profitability

76
Q

What do Projects Face

A

Inflation: impact real future values
Demand: impact on revenues
Design: can specification be achieved.
Construction risk: on time & budget.
Availability: contractual levels of output.
Legislative: legal changes affect operations.
Policy: will general policy change(refinancing gain share)
Maintenance risk: can we predict OPEX.
Planning risk: can projects meet planning.
Technology: can we rely on innovation (reducing costs)

77
Q

Developer

Contractor

A

May not receive payment until project is finished & sold.
Receive staged/interim progress payments from client.

78
Q

IRR

A

Discount rate that makes NPV = 0

At what discount rate will you break even

79
Q

Liquid Asset Kicker

A

Uncommitted capital used to cover deficits between debt service & net FCF

80
Q

Cash flow margin

Capital value margin

A

Assumed certainty of net cash flows.

Assumed appreciation of asset

81
Q

What is more risky

A

Bigger is more risky, greater variance in the mean

Smaller but higher less risky as less variance

82
Q

CAPEX

A

Money spent acquiring/maintaining fixed assets
More expensive than future OPEX
Not subject to discountin expensive present value terms

83
Q

Whole Life Cost

A

Total cost of ownership over a lifetime
Cost of build + operations
CAPEX + OPEX
Higher CAPEX today for lower OPEX tomorrow

84
Q

Performance Bond

A

Provide surity/insurance against construction risk

Assess contractor risk failure and price on: Job complexity, schedule, contractor expertise, past performance etc

85
Q

Relevance of Du Pont

A

Separate influences of profitability
Companies overall financial health/stability
Clues on business strategy

86
Q

Gilts

A

Lending against future tax revenues

87
Q

RRR

A

Required Reserve Ratio

Amount of money they need to to prevent insolvency

88
Q

Expansionary Monetary Policy

A

Increase aggregate demand / increase growth
Cutting interest rates or increasing money supply
More borrowing - more spending - AD1 incr AD2 LRAS
Lower unemployment

89
Q

Why EMP Doesn’t Works

A

Consumer confidence low, dont want to spend
Credit crunch banks may not have funds to loan
Global - fall in expo negates effects of incr comsumption

90
Q

Low Interest Rates

A

Reduce cost of spending so more likely to
Reduce incentive to save so spend money instead
Lower repayments more disposable income
Reduce value of pound - SPICED

91
Q

Interest Rate and Pound

A

Lower incentive for foreign investments
Less hot money flows
Lower demand so pound falls

92
Q

Contractors Gearing

A

Lower Gearing 0-20%
Higher equity vs debt
Pay more tax, less interest, equity is not tax deductible
Return attributed to shareholders is high
ROSF is low and Earnings per share is low

93
Q

Developers Gearing

A
Higher Gearing 60-80%
Higher debt vs equity
Pay more interest, less tax 
Return to shareholders is lower
Less equity so return per share/ROSF is higher
94
Q

Why are Government Bonds risk free

A

Can easily increase taxes and generate revenue to pay off their debt, more easily than a firm

95
Q

How to determine the correct discount rate

A

Need to use WACC, weighted debt and equity

Compares proportion is funded by debt / equity

96
Q

ROCE vs ROSF

A

ROCE measures profitabili/effici of capital employed
(Higher ROCE means greater returns)
ROSF is a profitability measurement of the firm
(Higher greater return in dividends for shareholders)

97
Q

Debt investor more risk adverse?

A

They’re guaranteed to get something in return
Interest payment or asset
Equity, ordinary shareholder lowest repayment
Debt Seniority
Equity won’t make you bankrupt

98
Q

Accounting Cost vs Opportunity Cost

A

Rev - Explicit costs (raw mat/utilities/cost of production)

Value of next best alternative forgone when decision is made includes implicit costs

99
Q

High vs Low Capital Intensity

A

Costs come from investment in machines, equipment
Contractors with lots of plant
Software developers with few machines

100
Q

Similar ROCE to ROSF

A

When gearing is 0

There is no tax

101
Q

Assumptions about future project cash flows can be relied upon?

A

No certainty for cash flow, needs to be adjusted for risk
Discount rate an estimation
Actually uses a discount rate to get present value
Easy to compare/contrast projects

102
Q

Two types of firms

  • Risk profiles in terms of attracting equity investors,
  • Key indicators equity investors use to assess investment potential
A

Talk about systematic risk
If all plots on capm line then all unique risk
Spotify has high systematic risk
Thames water low systematic risk

103
Q

Firms more debt than ROCE

A

-K=TA-CL=D+E
-Incr debt incr liabilities not have enough assets to pay debt, insolvency
-Increase risk of administration and finally bankruptcy
-Debt can finance growths likely to increase total assets
-Incr TA incre K which also has the effect of incre ROCE

104
Q

Benefits of Investing in each firm

A

Stock Y riskier, great area around 0% high risk 0/- return
Stock Y great area over X higher chance of high return
Stock Y greater variance more risky
Stock X return less but mean is higher

105
Q

CAPM Diagram

A

Y - Expected return X - Standard deviation (risk)
CAPM > 1 - Firms move more than marker more risk
Rf intersects diversification curve B
Increasing expected returns without increasing stnd dev

106
Q

Scatter Graphs Firm A / B

A
Positive Beta above 1 like 1.6
Lower Beta between 0-1 like 0.5
Beta 1 - S&amp;P 500
Beta > 1 - NASDAQ
Beta < 1 - Utilities
107
Q

Benefits Today Costs Tomorrow

A

Discount rate used to give accurate measurement

If discount rate is wrong makes it useless