Term
[image]Dynamic process to determine how to meet goals.
wMake, implement, and then revise plans
wForecast financial statements and estimate financing needs
[image]Identify the feasibility of strategy
[image]Identify interactions and options
[image]Avoid surprises |
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Term
Net work capital measures __________
Return on equity measures_________ |
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Term
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| If two portfolios give you the same payout, they should have had the same initial price |
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| ***Options are always riskier than stocks |
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Hedge Ratio
Under Binomial Option Pricing |
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Definition
| range of option values/ range of stock values |
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| NPV with option - NPV without option |
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The opportunity to make changes to planned activities
By varying output or production methods |
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The cost of using a security
You must lower the price by the flotation cost |
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| Preferred stock is riskier than debt so a firm should pay more for it because of the risk |
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| If a company has no debt, the ______and _____should be the same |
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| Retained earnings are an opportunity cost because it means you dont' pay dividends |
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Planning and Managing Expenditures of long lived assets
- Tend to be long term decisions, expensive, and not easily reversed |
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| Difficulties of Capital Budgeting |
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Definition
- Benefits occur in the future
- THe cost and benefits occur at different times
- Setting a value on quality
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| How do you evaluate a project |
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Definition
- Payback- how long it takes to get investment back
- Net present value($)
- Internal Rate of Return (%)
- Profitability index (benefits-cost ratio)
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| For Equal Cash flows, Payback equals |
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| For unequal cash flows, pay back equals..... |
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Definition
| when the sum of the cash flows is greater than or equal to the investment |
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| Cons of Payback method (3) |
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Definition
- Ignores time value of money
- Ignores any cash flow after the payback
- Arbitrary decison rule
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*** Accept if Net Present Value of a project is greater than zero
NPV is the present value of cash flows - inital investment |
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Definition
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| When is NPV used for valuation |
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Definition
| large decisions and when cash flows are easily measured |
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| Cons of NPV method of valuation |
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Definition
- results are sensitive to the interest rates
- solution is a dollar amount rather than a %age
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Definition
| Accept if IRR>Cost of Capital |
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| When do you use IRR for valuation |
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Definition
| when you need to capture a complex project in a single number that is easy to communicate |
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Definition
| You cannot have 2 IRRs. Irr is where it crosses the x axis. if it changes signs more than once. |
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Term
| Non conventional cash flow |
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Definition
When cash flow sign changes more than once
i.e. CF0= -100, C01= 100, CO2= -100
You have as many IRRs as you have changes in sign.
Therefore you can't use IRR |
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| When there is a conflic between NPV and another decision ruule, choose NPV |
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| IRR is unreliable in the following situations |
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Definition
mutually exclusive projects
non-conventional cash flows |
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Term
Profitability Index
PI Rule |
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Definition
measures the value received PER investment dollar
Accept if PI>1 |
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| If you have a budget limit, which decision method do you use |
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Term
When the cost of capital is high,
Funds are ________valuable
Favors _____projects
Favors_____payback |
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Term
| Equivalent Annual Annuity (EAA) |
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Definition
when you evaluate asset replacement with unequal lives
(i.e. purchase a cheap machine that lasts a short period, or an expensive machine that lasts a long time) |
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Term
| Equivalent Annual Annuity process steps |
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Definition
1. calculate PV using NPV in calculator for both
2. plug answer as PV, COC as I, # years as N, COMPUTE PMT
3. The higher EAA is the one you should choose
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Definition
| The price an asset would trade for between rational individuals with all relevant information |
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Definition
| when you hedge risk by matching the life of the asset with the life of the liability |
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Term
temporary current assets require ______ financing
permanent current assets require ________ financing |
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| the level of inventory you always have in stock |
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| inventory that is added for a short period of time (i.e., sunscreen in the summer) |
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Current assets- current liabilities
really just current assets |
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| Capital investment affects tax indirectly due to depreciation because.... |
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Definition
| Depreciation reduces a firm's taxable income |
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| ****Salvage value of depreciated item is TAXED when the item is sold |
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| The higher the growth, the ______the Additional funds Needed will be |
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| The higher the capital intensity ratio (total assets year 0/sales of year 0) the ________ Additional Funds Needed will be |
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| The higher the spontaneous liabilties, the ______ smaller Additional funds needed will be |
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| The higher the profit margin, the __________the additional funds needed will be |
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| The lower the payout ratio, the ___________ the additional funds needed will be |
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Term
| If a firm is operating below capacity and the projected sales are below capacity, then... |
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Definition
| no additioanl property, plant, and equipment is needed |
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Term
| the self supporting growth rate |
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Definition
| the maximum growth a firm could achieve if it had no access to external growth |
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| What are the determinants of GROWTH? |
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Definition
1. Profit Margin
2. Asset turnover rate
3. Financial Leverage
4. Company's divident policy |
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| Operatin Cash Flow Equation |
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Definition
| EBIT- taxes + depreciation |
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Term
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Definition
Applies to options
means that the writer's loss is owner's game and vice versa
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| Intrinsic values in options CANNOT be negative. IF they are "out of the money," they are just $0 |
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Definition
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Term
| When dividends go down, stock prices go down so what does that do to call prices and put prices? |
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Definition
decreases call prices
increases put price |
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Term
| Free Cash Flows template and order of operations |
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Definition
Sales
(expenses)
(fixed)
(depreciation)
Gives you EBIT
(tax)
Gives you Net Income
+Depreciation
Gives you Operating Cash Flows
+/- Capital Investment
+/-NWC investment
Gives you Cash flow |
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