Flashcards in Term 1 Deck (80):
What is the main objective in CF?
Shareholder value maximisation
What is an activist investor?
Somebody who buys shares to influence board decisions
What are the three key issues of CF?
Key issues of Investment Decisions?
Use NPV to value investments, take highest
Key issues of Financing Decisions
Can use retained earnings or external sources (equity v debt)
What are the key issues of dividend devisions?
Dividends are not a legal obligation, therefore should have a higher ROR than debt
What is BETA?
Measure of company risk, likelihood of dividend failure
Based on assumption markets are efficient
What is the current macroeconomic environment?
Slowing Economic Growth
What are the three costs of the principal agent problem?
Monitoring expenditures by the principal- So principal can ensure that agent is working well
The bonding expenditures by the agent- A long term contract to show the agent is dedicated
How can you limit detrimental managerial behaviour?
Internal Control Mechanisms
External Control Mechanisms
What determins a firms share price?
Value of the company
How to you calculate the future value of a sum?
How do you calculate the Present value of a future value?
Future Value / (1+i)^n
What are the financial returns to a shareholder?
Growth of share price
How do you calculate a share price?
Ke is discount rate
What are the sources of uncertainty when calculating financial returns?
Difficult in estimating dividends
Difficult to calculate cost of capital
How do you calculate dividend yeild?
How do you calculate Capital gains yeild?
How do you calculate Total Return?
Div Yeild + Capital Gains Yeild
How do you calculate a share price if held for multiple years?
P0=D1/1+Ke + D2+P2/(1+Ke)^2...
How do you calculate the price for constant dividends?
G is dividend growth
Can be manipulated to determine cost of capital
How do you calculate the share price for non constant dividends?
P=D1/1+Ke + D2/(1+Ke)^2 + D3/(1+Ke)^3 +(D4/Ke-G)/(1+ke)^4
What are home made dividends?
Selling a portion of your shares to provide the dividends if they are withheld
How do you calculate the yield on a bond?
How do you calculate the YTM/Price of a bond?
PB= C[(1-(1/(1+i)^n))/i) +FaceValue/(1+i)^n
C=Annual interest Payment
What is the fisher sepeartion theorem?
Seperation of investment and consumption decisions raises consumer utility
What are the assumptions of FST?
Outcomes of investment are certainty
No transactions costs or taxes
Decision relates to one period only
Y0 income is received at the beginning of the period and Y1 income at end
MU of consumption is positive
MU of consumption is decreasing as consumption increases
What is C0 and C1
C0 is consumption at begining
C1 is at end
Discuss the IR method for FST?
The IR declines as more is invested, for that extra amount:
First 100 = 10%
Second 100 = 9%
How do you calculate wealth in P0 and P1
What is the slope of the Financial Market Line?
What is the optimum point of consumption with the Financial market line
Where it is tangential to an IC
What is the optimum point with all 3 Lines drawn?
Where the Production opportunity set is tangential to financial market line
Name some forms of capital expenditure?
Expansion of business
Development of new business
Replacement of machinery
What is the process of capital budgeting?
What is the difference between in-dependant and mutually exclusive projects?
Independent - Cash flows to not impact on other project
Mutually Exclusive - Accepting one may prevents others
What is payback period:
Time required to recoup initial investment
Benefits: Simple and easy to use
Does not consider profitability
What is the Accounting ROR?
Average rate of profit:
What is NPV?
Cash flow from each period, discounted
What is IRR?
Set NPV =0
Can be multiple IRR, Unconventional cash flows can cause issues, therefore must use incremental cash flow
How do you use incremental cash flows
Take project B away from project A
This gives the NPV is switching from A to B
If positive, B is the better project
What else can cause issues with IRR?
If you have unconventional cash flows, rely on NPV
How do you ration capital
Calculate B/C by dividing NPV by Initial Invesment
Rank them in order
Assume all projects are divisible
How do yo calculate Real Interest Rate?
What are the two types of capital rationing?
Hard - Has problems raising funds
Soft - Internal constraints to prevent investment
What is a sensitivity analyisis?
Calculate NPV in a positive, negative and middle ground mindset
Then change key variables and see how they are altered
What are modern approaches to risk ananalysis?
Bayes - Laplace
What is a maxi-min approach
Consider worst possible outcomes and choose the best
What is Maximax
Consider best possible outcomes and choose the best
What is Bayes - Laplace?
Average payoffs across all states, take best, assume all probabilities equal
What is Hurwicz criterion?
A weighted average of Maximax and Minimax
Weights are a and 1-a
If A =1, maximin outcome
What is Minimax Regret?
This approach penalises for wrong decisions
If P1 is chosen, but N2 occurs, the opportunity cost is the forgone payoff of N2
How do you calculate returns to an asset?
How do you calculate returns to an assset adjusting for Dividends?
R=(Pt-Pt-1)/Pt-1 + DT/Pt-1
R=Capital Yeild + Dividend Yield
How do you calcualte average return on a stock?
Sum the values and divide by the number
How do you calculate the variance of risk?
How do you choose between investments, the easy way?
If same risk, choose higher returns
If same returns, choose lower risk
What is unsystematic risk?
Unique Risk, associated with particular assets
Can be diversified
What is systematic Risk
Unique Risk, effects all assets
Cannot be diversified away
What is the market portfolio?
The portfolio that maximises diversification thus minimising risk
How do you calculate Expected Return on a portfolio?
Weight multiplied by return
How do you calculate the covarience of a portfolio?
How do you calculate correlation coefficent?
1=No Risk Reduction
-1=Max Risk Reduction
How do you calculate the portfolio Variance?
X^2VarX1 +X^2VarX2+ 2XXCov
What is the efficiency boundary?
A line which will be chosen by an efficient investor, as it maximises returns
If you have a risk free asset, what happens to the portfolio?
Constant Return, no risk
Variance(P) becomes Variance of X1 times weight
What is the slope of a Risky-Risk free Portfolio Line?
What is the optimum combination of a risky-risk free portfolio, the marker portfolio?
A point of tangent between the risk free line and the efficient portfolio
Can an investor borrow to invest?
Any point on the line after the tangent point will need to be borrowed to achieve
What are the characteristics of the market portfolio?
Represents maximum diversification
Exists on capital market line
What is the expected return on the market portfolio?
ER = Rf+[E(Rm-Rf)/SDRm]SDRi
Lamda = E(Rm-Rf)/SDRm
Market price of risk
What does diversification look like when plotted on a graph?
1/x, assymptope at bottom is systematic risk
What determined the level of systematic risk faced by a firm?
Sensitivity of revenues to economic activity
Degree of cost senstivity
Gearing - More Debt = more Risk
An investor will only be rewarded for taking which type of risk?
What are the assumptions of CAPM?
Investors are risk averse and utility maximises
Single rate of interest
All assets perfectly divisible
What is the CAPM expression?
(E(Rm)-Rf) = Market risk premium
Cov/Variance referes to how the asset is related to the market
What is BETA?
Measure of risk = Cov(i,m)/VarM
How can you calculate correlation coefficient?
P=Correlation coefficient between market and i
Why do all assets return to SML line?
If ROR is above equilibrium, investors invest and price rises, causing ROR to fall