Lectures 1,2,3 Flashcards
(46 cards)
Present value definition
The discounted value of future cash flows
What is the discount factor
It is the present value of $1 at a stated future date, given by 1/(1+r)^t
What is net present value
A project’s contribution to net wealth. Calculated by present value - investment.
Opportunity cost of capital (hurdle rate)
A shareholder’s return that is given up when investing in a project instead of similarly risky financial securities.
2 ways to decide whether a project is worth investing in
Positive net present value or if rate of return is above opportunity cost of capital
Discounted cash flow (DCF)
The sum of future cash flows multiplied by their discount factors to get present value.
PV of a perpetuity
Cash flow/interest rate, (C/r). This assumes that the stream of payments starts 1 period from now.
What is an annuity
It is an asset that pays a fixed sum each year for a specified number of years.
What is a perpetuity due
A perpetuity that starts immediately, the payments occur at the start of each period. PV is C + C/r or C/r(1+r)
What is the profitability index and when should it be used
It should be used to choose between projects to invest in when resources are limited. It is calculated by ( NPV/investment )
What are real assets
Tangible assets and intangible assets used to carry on business
What are financial assets
They are claims on real assets, for example a bank loan or a corporate bond
What are securities
Tradable financial assets
What are investment decisions of buying or building tangible assets sometimes called
Capital expenditure (Capex), or capital budgeting
Examples of intangible assets
Advertising, R&D and developing computer software
What is the capital structure decision
The decision between debt and equity financing
What is meant by equity financing
Means issuing more shares or reinvesting cash
What is a corporation
It is a legal person, owned by shareholders. As a legal person the corporation can make contracts, carry on a business, borrow or lend money, and sue or be sued. Shareholders have limited liability
What is the main goal of a financial manager
To maximise shareholder wealth.
Why is profit maximization not a well defined financial objective?
See page 9 in book
Difference between hard and soft capital rationing
Soft rationing is provisional limits set by management to control investment expenditure while hard rationing is where the company finds it difficult to raise financing and projects with significant NPV are passed up.
Soft rationing should never cost the company anything where hard does
What are current assets
A current asset is any asset which can reasonably be expected to be sold, consumed, or exhausted through the normal operations of a business within the current fiscal year or operating cycle or financial year.
Market value added definiton
The difference between market value and book value of a firm’s equity.
What is economic value added (EVA)
Net income after deducting the dollar return required by investors.
EVA = income earned - (cost of capital x investment)
