WGU C214 Finance (Ch 1-15) – Flashcards
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Par Value
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Face value of a bond (usually 1k)
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Coupon Rate
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Interest rate of the bond, payable in installments. Cannot be changed for the life of the bond.
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Yield to Maturity
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rate of return on a bond
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Affirmative covenants
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things firm promises to do
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negative covenants
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things firm promises to not do
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current yield of a bond
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coupon payment divided by bond amount. NOT the same as YTM.
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Subordinated debenture
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debentures that take last place in a payoff
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Zeros
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bonds that pay no coupon, but sell at a lower price.
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Eurobond
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Pays out in a non-domestic currency (US bond in europe that pays in dollars)
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Foreign Bond
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Bond floated by another country but that is payable in the domestic currency (chinese debt payable in dollars floated in the us)
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Muni-bonds
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floated by local govts to fund infrastructure, exempt from taxes.
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Convertible bonds
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can be converted into equity securities.
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Junk Bonds
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bond that is rated BB or below. higher yield and higher risk.
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Primary Factors influencing bond sensitivity
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Coupon rate, time to maturity (primary factor).
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Primary financial instruments
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stocks and bonds
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Syndicate
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Group that is formed to handle a stock or bond issue. Made up of large investment banks or investors. They may also underwrite.
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Competitive Sale
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underwriters will submit bids, firm will select lowest interest rate, highest price.
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Negotiated sale
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Firm will investigate underwriter bids and will negotiate after more investigation.
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Secondary Markets
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Where stocks are traded after IPO. "the stock market"
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Auction financial Market
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Has a physical location. NYSE. Uses specialists.
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Dealer (stock) market
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does not require a physical location. Uses a network of dealers. NASDAQ.
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Specialist
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provides liquidity in the stock market (NYSE) and sets the spread.
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ASK Price
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Minimum price sellers are willing to sell for
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BID price
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the maximum price buyers are willing to 'bid'/Pay
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Market Order
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executes at the market price
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Limit Order
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executes at the price requested, if available.
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Calculating a simple stock dollar return
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Price (new) - Price (old) + div or coupon
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Calculating a simple stock percentage return
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{Price (new) - Price old +DIV}/ Price old+ X 100
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Agency Costs
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Costs that are incurred when management does not act in the best interest of shareholders.
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Indirect method starts with...
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Net income!
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Formula for CFO
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NI+Depreciation expense + changes in operating accounts
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Increase in an asset account means..
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cash has left the firm. Considered an outflow, decrease in cash on a cash flow statement.
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Increase in a liability account means...
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Cash has come into the firm. Considered inflow, increase cash on cash flow statement.
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Formula for CFI
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Change in gross PP&E OR change in net PPE plus depreciation.
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Formula to calculate dividends
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DIV = (Old RE plus NI) - new RE
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Formula to calculate NI
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NI=Change in RE +divs
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Formula to calculate new RE
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New RE = old RE +NI - DIVS
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Free Cash Flow
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Distributable Cash - can be distributed after funding required reinvestment in PP&E.
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Free Cash Flow Formula (F)
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FCFF= EBIT (1-tax) + depr - change in CAPEX(CFI) - increase in NWC
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Free Cash Flow Formula (Equity holders)
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FCFE = NI + Depreciation - CAPEX - Increases in NWC + Increases in Debt
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Current Ratio (L)
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higher = better likelihood company can meet short term obligations. current assets/current liabilities
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Quick Ratio (L)
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current assets - inventory/current liabilities. greater ability to meet ST obligations since it removes the slower moving inventory.
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AR Turnover/Average collection Period (L)
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how often AR turns over and in how many days.
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Inventory turnover/days on hand (L)
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how often inventory turns over/how many days.
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Total Asset Turnover (E)
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how many sales per dollar of assets
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FAT/Fixed asset turnover (E)
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how many sales per dollar of FIXED assets
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OIROI (Op income ROI) (E)
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tells us how much pre-tax, pre-financing profit per dollar of assets.
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Debt Ratio (F)
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proportion of firms assets financed by debt
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IBDTC (interest bearing debt to total capital) (F)
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omits a/p and accruals from debt ratio calculation.
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Times interest earned (F)
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How many times interest expense can be covered by operating profit.
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FLR Financial Leverage Ratio (F)
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how much is financed with debt or equity.
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ROA (P)
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earnings as a percent of capital invested.
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ROE (P)
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How much did I earn as a percentage of each dollar invested? Also calculated as result of Dupont.
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Gross Margin (P)
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percent of revenue remaining after COGS.
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Operating Margin (P)
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percent of sales remaining after covering the cost of the goods sold AND operating expenses. pre-interest, frequently used to compare firms with different capital structures (i.e., different amounts of debt).
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net margin (P)
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how much remains for equity holders after all other costs.
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DUPONT
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efficiency, leverage, financing NISSTAAE. Also = ROE. Also net Margin x TAT X FLR
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Three ways to use ratios
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trend analysis(over time), cross sectional analysis (compare to a peer group) and internal goal monitoring
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pitfalls with ratios
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accounting issues, timing issues
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inflation
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annual decay in the purchasing power of money
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risk premium
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compensation for bearing the risk of an investment.
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TVM - composed of
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amount of cash flows, timing of cash flows, rate of change due to passing of time.
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Annuity (ordinary)
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equally spaced series of cash flows all of the same magnitude. Starts at the END of a period.
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Annuity (due)
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equally spaced series of cash flows all of the same magnitude. Starts at the beginning of a period.
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perpetuity
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annuity that is perpetual. PV = CF/r (payment over interest rate)
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mixed stream cash flows
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series of payments with different magnitudes. Use CF/NPV on calculator!
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TVM in Risk Assessment
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Risk buckets, sensitivity analysis
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Corporate Governance
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control issues in running a company
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Intrinsic value of any asset (stock/bond)
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present value of the stream of expected future cash flows discounted at an appropriate required rate of return.
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Gordon Growth Model
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used for stock valuation V0=(D1 / kcs-g), g = kcs - D1/V0, kcs = D1/V0 + g
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Preferred Stock
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hybrid security, resembles both equity and debt. No fixed maturity, legally equity, can't vote, FIXED Dividends (no matter how well or poorly company does) must be paid before common stockholders and will go into arrears. Paid off first when company liquidated.
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Valuation of Preferred Stock
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V= D/interest rate (perpetuity, as payment is always the same)
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FCF measure of stock valuation
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Used instead of GG model (D0) when no dividend is paid
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Weighted average Return
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Recessionary/Expansionary x returns. Weighted average return to account for economic states.
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Standard deviation of weighted average return
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Probability (return-ER)squared, then sqr root. Gives another measure of risk/volatility wrt economic states
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idiosyncratic risk
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percentage that can be diversified away.
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systematic risk
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cannot be diversified away.
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Return Risk Tradeoff
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Quadrant A is preferred (higher reward, lower risk)
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Markowitz efficient frontier
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consists of a frontier of various portfolios of a given set of stocks that are efficient, or, in other words, have the highest level of expected return for a given level of risk.
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Market portfolio
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all investors will eventually hold the market portfolio.
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CAPM
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Expected Return = risk free rate +beta (market rate - risk free rate). <--risk premium. Suggests that a firm's return is only a function of the level of systematic risk. Most commonly used method to find ER for stocks! Beta =1 at the market.
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Beta in CAPM
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the slope of the market line, ratio of the covariance of returns to the variance of market returns. MEASURES THE FIRMS SYSTEMATIC (NON DIVERSIFIABLE) RISK. market =1
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The covariance between Y and X to the variance of X
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the estimate for beta.
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Independent variable placement
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on the X axis
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Mean
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overall best estimate for expected value
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WACC
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Weighted Average Cost of Capital (Common Equity/Preferred Equity/Debt over market value x cost. Debt also has 1-tax rate multiplier).
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Why use WACC?
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The cost of capital in rate of return (%) terms - can help decide if an investment is a good idea. WACC is the discount rate for the future cash flows that are proposed for the new investment.
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Cost of Common Equity
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usually calculated (in percent) by using the GGM (shareholders), the CAPM , or the mean of past returns. CAPM used most often.
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Cost of Preferred Equity
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calculated using perpetuity model (in percent)
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Before-tax cost of debt
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yield to maturity on bonds OR the interest rate on debt
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after tax cost of debt
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equal to the yield to maturity on a company's bonds multiplied by 1 minus the marginal tax rate
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Method most often used to calculate cost of Common Equity
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CAPM
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Flotation Costs
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costs associated with the issuance of new equity or debt - often due to underwriting fees. Can reduce the price of a new security or add a percentage to the cost of capital.
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Which type of bond will have a higher YTM?
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Long term bonds. A longer length to maturity implies greater risk so yields on bonds will actually increase as time to maturity increases
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Difference between cost of internal and external equity?
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Flotation costs
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If income tax rates increase, cost of debt will....
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Decrease (due to tax shelter)
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DFN
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Discretionary Financing Needed. If positive, funding needed for discretionary accounts (long term debt, notes payable, stock). If negative, company has enough funding.
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Percent of Sales Method
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Most common method of forecasting
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Spontaneous Accounts
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Accounts that will vary automatically with sales - a/p, a/r, cash, inventory - most current asset and liabilities accounts.
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Discretionary accounts
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left to the discretion of management. Long term debt, notes payable, common stock accounts.
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Calculating the change in a spontaneous account
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divide last year's spontaneous account by last year's sales to determine the percentage it holds. That percentage would be multiplied against this year's projected sales to predict the spont account this year.
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Formula for projected RE
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Old RE + projected sales x net margin x (1-div/ni) OR old RE + NI - dividends. OR old RE + change in RE
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Dividend payout ratio
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DIV/NI
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Plowback ratio
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1-(DIV/NI) (amount of funds firm retains)
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DFN formula
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Projected Total Assets - Projected Total Liabilities - Projected Owners' Equity
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Sustainable Growth Rate (SGR)
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level of growth where four key financial ratios—profitability, asset utilization, leverage and payout (plowback)—are constant and where the firm does not need to issue any new equity to fund the growth.
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SGR Formula
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ROE (1 - div/ni), OR Dupont x (1-div/ni)
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Capital Budgeting Decisions
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Estimation of the allocation of money, timing of cash flows to perform a cost benefit analysis of a proposed project.
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Differential cash flow
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cash flows associated with using the asset each year.
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Terminal Cash Flow
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Cash flow associated with unwinding the project at the end. Generally the money from disposing of the asset (inc taxes) and recapture of NWC.
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Soft Skills
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Project evaluation is based on incremental cash flows, as well as incidental cash, opportunity costs, sunk costs
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Hard skills
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Tax code and TVM issues (depreciation/taxes)
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MACRS (Modified Accelerated Cost Recovery System)
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Used to depreciate assets instead of straight line (33/45/15/7)
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WCinv (working capital investment)
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Current assets - current liabilities. (change in inventory, a/r) Cash outflow at the beginning, cash inflow at the end when recaptured.
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Differential Cash Flows
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incremental revenue - incr expenses - diff depreciation = (EBT), then minus tax, add back depreciation. No recognition of interest expense, as tax is considered in WACC.
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Payback period
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number of years required to recoup the initial outlay
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hurdle period
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used during payback analysis to see if project will be paid back by that time. Flawed because cash flows after hurdle are not considered, no risk adjustment.
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NPV (Net Present Value)
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net of all the present cash flow values. If positive, accept the project. Reject if negative. Zero would mean indifference. better used with multiple projects or sign changes in cash flows.
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IRR (internal rate of return)
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solves for the rate of return that makes present value of inflows = initial outlay. If > required return (WACC), accept project. Difficult to use with multiple sign changes.
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capital structure
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the mixture between a firm's level of debt and a firm's level of equity. Remember, debt is cheaper than equity!
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business or operating risk
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risk that firms face because of variability in operating income.
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Degree of Operating leverage (DOL)
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measures business risk. (sales - variable costs)/EBIT. tells how much EBIT will change for a given percent in sales. Higher values mean the company has higher fixed costs and faces higher business risk.
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Degree of Financial Leverage (DFL)
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EBIT/(ebit - interest). Percentage change in pre-tax profit r/t change in EBIT. Financial leverage can increase profitability of a firm (can also be dangerous).
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Degree of Combined Leverage (DCL)
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Percentage change in operating income for every percentage change in sales. (sales -variable costs)/(EBIT - interest expense). Remember that fixed costs are generally financed with debt and higher fixed costs result in higher business risk (DOL). Also, remember that more debt leads to more interest expense, which affects financial risk (DFL). DOL x DFL.
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leveraged recapitalization
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used to increase debt to equity. Issue new debt, pay back outstanding shares or issue dividends.
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leveraged buyout
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take on new debt to acquire another company
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nationalization
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government purchases controlling shares in a company
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cash cycle
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the length of time between when the inventory is paid for and the time when the company is paid for the finished product
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operating cycle
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the length of time between when the raw materials are received to the time when the company is paid for the finished product
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operating balance
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amount of cash the firm needs to pay its immediate bills
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reserve balance
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amount of cash the firm must hold as a safety net. could be determined by lenders or management.
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Comparable Multiples method of firm valuation
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multiply p/e ratio of comparable for your firm, multiply by your firm's earnings. = estimated price of your firm. most often method used in entrepreneurial firms
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earnings yield
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earnings/price = sometimes preferred over p/e because number will be very small when earnings fall close to zero (P/E would be very large).
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EBITDA
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earnings before interest, taxes, depreciation and amortization. popular to compare entrepreneurial firms (EBITDA/Price ratio - multiply by your firm's price).
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DCF Method of firm valuation
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value (a) = cash flow measure / (1 + discount rate measure) to the t power. Common to use FCFF as the CF, WACC as the discount rate, then put into GGM)
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Value of firm equation
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Vfirm=Vequity+Vdebt
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Five steps of DCF firm valuation
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Forecast as far into the future as you reasonably can (usually 3-5 years is the maximum you can forecast) and construct pro forma statements; Compute the free cash flow for each of these forecasted years; In the last year of the forecast, estimate a terminal value and add it to the last year's free cash flow from step 2; Compute an appropriate discount rate; and Use time value of money to discount back the cash flows to the present value (net present value/tvm)
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National banking act
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Act that began financial regulation in the uS
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Dodd Frank act
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Established risk-based insurance premiums for banks known as CAMELS,Creation of Financial Stability Oversight Council, Volcker Rule, "too big to fail" , monitoring of insurance industry
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CAMELS
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Capital Adequacy, Asset Quality, Management quality, Earnings, Liquidity, Sensitivity to market risj
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Volcker Rule
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limits bank investments in hedge funds and proprietary trading.
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Financial Stability Oversight Council
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Dodd-Frank Act, monitors how systematic risk impacts the industry
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Form S-1 "red herring"
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initial offering prospectus for IPO
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Form 10-Q
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quarterly report with the SEC
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Form 10-K
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yearly report with the SEC
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Rule 144a
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from the securities act of 1933. Allows accredited investors to buy capital without registration
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Regulation S
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from securities act of 1933. Allows raising capital in other countries without registration. Cannot be sold to us citizens or corporations.
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Securities Act of 1933
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Requires firms to register with SEC before a public offering, except wrt rule 144a/regulation s.
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Prospectus
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includes audited financial statement information, the name of the lead underwriter(s), a discussion about the firm and its prospects by management, the price of the offer, the number of shares being offered, and even a section of risk factors, among many other requirements
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Firm commitment offering
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underwriter purchases shares then sells them to the primary market at the offer price. they then can throw them into the secondary market (NYSE/NASDAQ)
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SOX 2002
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designed to ensure that public company boards of directors actually represented the shareholders in good faith. Second, it was designed to monitor company executives and ensure they were truthful in their SEC reporting. also to ensure that public accounting firms were being honest in their audits of public companies
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Section 302 of SOX
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requires a set of internal control policies that can add significant expense to operating firms
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FINRA (Financial Industry Regulatory Authority)
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the largest independent regulating service for all securities firms operating within the United States.Companies that trade in equities, corporate bonds, financial futures, and options that are not regulated by another SRO, must be members to be compliant with the SEC.
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Functions of FINRA
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to license individuals, admit firms to the industry, write rules to govern their behavior, examine firms for regulatory compliance, and to discipline members that do not comply with federal securities laws . Along with these oversight roles, it offers education opportunities for industry professionals, qualification exams, and outsourced regulatory products to various markets and exchanges
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Terminal Value
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final year CF/ WACC
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Statistical Moment
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measure of the shape of the distribution at a particular point (such as the mean)
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Best estimate for expected value
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mean
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standard deviation of expected returns
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estimate of volatility
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Collection float
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the time it takes for a firm to be able to use the payments from customers
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disbursement float
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the time it takes for a company's payment to become an actual outflow
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