Fund. Business Finance – Flashcards

------------------------------------------

• Personal finance is concerned with individuals' decisions about how much of their earnings they spend, how much they save, and how to invest. • Business finance involves the same types of decisions: how firms raise money from investors, how firms invest money, and how to decide whether to reinvest profits. • Managerial finance is concerned with the duties of the financial manager working in a business.

• Direct finance: Lenders go through financial markets to give money to borrowers. • Indirect finance: Lenders go through financial intermediaries, which then can give the money to borrowers or to financial markets.

• Accountants devote most of their attention to the collection and presentation of financial data. • Financial managers evaluate the accounting statements, develop additional data, and make decisions on the basis of their assessment of the associated returns and risks.

Corporate governance refers to the rules, processes, and laws by which companies are operated, controlled, and regulated.

Business ethics are the standards of conduct or moral judgment that apply to persons engaged in commerce.

• Agency problems arise when managers place personal goals ahead of the goals of shareholders. • Agency costs arise from agency problems that are borne by shareholders and represent a loss of shareholder wealth.

------------------------------------------

Banks are intermediaries between borrowers and lenders as well as other financial companies. Financial markets are forums in which suppliers of funds and demanders of funds can exchange directly. Primary markets is a financial market in which securities are initially issued; Issuer is directly involved in the process. Secondary market is the one that pre-owned securities are exchanged.

• Dealer markets don't bring seller and buyer together, instead have their orders executed by securities dealers. • Financial markets are forums in which suppliers of funds and demanders of funds can transact business directly. • Transactions in short term marketable securities take place in the money market while transactions in long-term securities take place in the capital market.

• Ordinary income is earned through the sale of a firm's goods or services and is taxed at the different rates. • A firm's marginal tax rate represents the rate at which additional income is taxed. • The average tax rate is the firm's taxes divided by taxable income.

------------------------------------------

The income statement provides a financial summary of a company's operating results during a specified period: Sales-COGS=GP-OP=NET Profit-taxes=NET Profit The balance sheet presents a summary of a firm's financial position at a given point in time. The statement balances the firm's assets (what it owns) against its liabilities, which can be either debt (what it owes) or equity (what was provided by owners) The statement of retained earnings reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year. The statement of cash flows provides a summary of the firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period. This statement not only provides insight into a company's investment, financing and operating activities, but also ties together the income statement and previous and current balance sheets.

• Ratio analysis involves methods of calculating and interpreting financial ratios to analyze and monitor the firm's performance. • Quick ratio=current assets - inventory / current liabilities Example: The quick ratio for Bartlett Company in 2012 is: $1,223,000-$289,000/$620,000=$934,000/$620,000= 1.51 • Debt ratio = Total liabilities ÷ Total assets Example: The debt ratio for Bartlett Company in 2012 is $1,643,000 ÷ $3,597,000 = 0.457 = 45.7% • Price Earnings (P/E) Ratio = Market price per share of common stock ÷ Earnings per share Example: If Bartlett Company's common stock at the end of 2012 was selling at $32.25, using the EPS of $2.90, the P/E ratio at year-end 2012 is: $32.25 ÷ $2.90 = 11.1

------------------------------------------

The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system in the United States. Under this system, the capitalized cost (basis) of tangible property is recovered over a specified life by annual deductions for depreciation. It is important because allows businesses to depreciate the asset faster than equal payments annually.

• Operating flows are cash flows directly related to sale and production of the firm's products and services. • Investment flows are cash flows associated with purchase and sale of both fixed assets and equity investments in other firms. • Financing flows are cash flows that result from debt and equity financing transactions; include incurrence and repayment of debt, cash inflow from the sale of stock, and cash outflows to repurchase stock or pay cash dividends.

• Long-term (strategic) financial plans lay out a company's planned financial actions and the anticipated impact of those actions over periods ranging from 2 to 10 years. Long-term financial plans consider a number of financial activities including: Proposed fixed asset investments Research and development activities Marketing and product development Capital structure Sources of financing • Short-term (operating) financial plans specify short-term financial actions and the anticipated impact of those actions. Key inputs include the sales forecast and other operating and financial data. Key outputs include operating budgets, the cash budget, and pro forma financial statements.

[Problem]

[Problem]

------------------------------------------

Future Value: compounding or growth over time FVn = PV x (1 + r)n • Future value is the value at a given future date of an amount placed on deposit today and earning interest at a specified rate. Found by applying compound interest over a specified period of time. • Compound interest is interest that is earned on a given deposit and has become part of the principal at the end of a specified period. • Principal is the amount of money on which interest is paid. Example: Jane Farber places $800 in a savings account paying 6% interest compounded annually. She wants to know how much money will be in the account at the end of five years. FV5 = $800 x (1 + 0.06)5 = $800 x (1.33823) = $1,070.58 --- Present Value: discounting to today's value PV=FVn / (1+r)n • Present value is the current dollar value of a future amount—the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount. • It is based on the idea that a dollar today is worth more than a dollar tomorrow. Example: Pam Valenti wishes to find the present value of $1,700 that will be received 8 years from now. Pam's opportunity cost is 8%. PV = $1,700/(1 + 0.08)8 = $1,700/1.85093 = $918.46 --- An annuity is a stream of equal periodic cash flows, over a specified time period. These cash flows can be inflows of returns earned on investments or outflows of funds invested to earn future returns. • An ordinary (deferred) annuity is an annuity for which the cash flow occurs at the end of each period • An annuity due is an annuity for which the cash flow occurs at the beginning of each period. • An annuity due will always be greater than an otherwise equivalent ordinary annuity because interest will compound for an additional period.

[Problem]

The effective (true) annual rate (EAR) is the annual rate of interest actually paid or earned. In general, the effective rate > nominal rate whenever compounding occurs more than once per year. EAR=(1+r/m)mxn-1 Example: Fred Moreno wishes to find the effective annual rate associated with an 8% nominal annual rate (r = 0.08) when interest is compounded (1) annually (m = 1); (2) semiannually (m = 2); and (3) quarterly (m = 4). EAR=(1+0.08/1)1-1=(1+0.08)1-1=1+0.08-1=0.08=8%

A perpetuity is an annuity with an infinite life, providing continual annual cash flow. If a perpetuity pays an annual cash flow of CF, starting one year from now, the present value of the cash flow stream is PV = CF ÷ r

------------------------------------------

• A bond is a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms. • The bond's coupon interest rate is the percentage of a bond's par value that will be paid annually, typically in two equal semiannual payments, as interest. • The bond's par value, or face value, is the amount borrowed by the company and the amount owed to the bond holder on the maturity date. • The bond's maturity date is the time at which a bond becomes due and the principal must be repaid

• The term structure of interest rates is the relationship between the maturity and rate of return for bonds with similar levels of risk. A graphic depiction of the term structure of interest rates is called the yield curve. The yield to maturity is the compound annual rate of return earned on a debt security purchased on a given day and held to maturity. • A normal yield curve is an upward-sloping yield curve indicates that long-term interest rates are generally higher than short-term interest rates. • An inverted yield curve is a downward-sloping yield curve indicates that short-term interest rates are generally higher than long-term interest rates. • A flat yield curve is a yield curve that indicates that interest rates do not vary much at different maturities. [Look graphic for yield curves]

• Expectations theory is the theory that the yield curve reflects investor expectations about future interest rates; an expectation of rising interest rates results in an upward-sloping yield curve, and an expectation of declining rates results in a downward-sloping yield curve. • Liquidity preference theory suggests that long-term rates are generally higher than short-term rates (hence, the yield curve is upward sloping) because investors perceive short-term investments to be more liquid and less risky than long-term investments. Borrowers must offer higher rates on long-term bonds to entice investors away from their preferred short-term securities.

A call feature, which is included in nearly all corporate bond issues, gives the issuer the opportunity to repurchase bonds at a stated call price prior to maturity. • The call price is the stated price at which a bond may be repurchased, by use of a call feature, prior to maturity. • The call premium is the amount by which a bond's call price exceeds its par value.

...

[Problem]

------------------------------------------

• Debt includes all borrowing incurred by a firm, including bonds, and is repaid according to a fixed schedule of payments. • Equity consists of funds provided by the firm's owners (investors or stockholders) that are repaid subject to the firm's performance. • Debt financing is obtained from creditors and equity financing is obtained from investors who then become part owners of the firm. • Creditors (lenders or debtholders) have a legal right to be repaid, whereas investors only have an expectation of being repaid.

• The common stock of a firm can be privately owned by an private investors, closely owned by an individual investor or a small group of investors, or publicly owned by a broad group of investors. • A preemptive right allows common stockholders to maintain their proportionate ownership in the corporation when new shares are issued, thus protecting them from dilution of their ownership. • Dilution of ownership is a reduction in each previous shareholder's fractional ownership resulting from the issuance of additional shares of common stock. • Dilution of earnings is a reduction in each previous shareholder's fractional claim on the firm's earnings resulting from the issuance of additional shares of common stock. • Preferred stock gives its holders certain privileges that make them senior to common stockholders. • Preferred stockholders are promised a fixed periodic dividend, which is stated either as a percentage or as a dollar amount. • Par-value preferred stock is preferred stock with a stated face value that is used with the specified dividend percentage to determine the annual dollar dividend. • No-par preferred stock is preferred stock with no stated face value but with a stated annual dollar dividend. • Preferred stock is often considered quasi-debt because, much like interest on debt, it specifies a fixed periodic payment (dividend). • Preferred stock is unlike debt in that it has no maturity date. • Because they have a fixed claim on the firm's income that takes precedence over the claim of common stockholders, preferred stockholders are exposed to less risk. • Preferred stockholders are not normally given a voting right, although preferred stockholders are sometimes allowed to elect one member of the board of directors.

• IPOs are typically made by small, fast-growing companies that either: - require additional capital to continue expanding, or - have met a milestone for going public that was established in a contract to obtain VC funding. • The firm must obtain approval of current shareholders, and hire an investment bank to underwrite the offering. • The investment banker is responsible for promoting the stock and facilitating the sale of the company's IPO shares. • An investment banker is a financial intermediary that specializes in selling new security issues and advising firms with regard to major financial transactions. • Underwriting is the role of the investment banker in bearing the risk of reselling, at a profit, the securities purchased from an issuing corporation at an agreed-on price. • This process involves purchasing the security issue from the issuing corporation at an agreed-on price and bearing the risk of reselling it to the public at a profit. • The investment banker also provides the issuer with advice about pricing and other important aspects of the issue.

The efficient-market hypothesis (EMH) is a theory describing the behavior of an assumed "perfect" market in which: - securities are in equilibrium, - security prices fully reflect all available information and react swiftly to new information, and - because stocks are fully and fairly priced, investors need not waste time looking for mispriced securities.

[Problem]