BFIN 300 Final

Corporate Finance (most important question)

Relationship between business decisions and the value of stock in the business

Capital Budgeting

The identification of investment opportunities that are work more to the business then the cost they require

Capital Structure

Concerns itself with financing decisions, such as debt and equity. How much needs to be borrowed? What is the cost of the borrowings? How to raise that money?

Financial managers impact

Capital budgeting, capital structure, working capital management

Sole Proprietorship

A business owned by one person, owner keeps all profits and endures all liabilities.

Partnership

A business owned by two or more people, partners share in profits and liabilities.

Corporation

Considered a legal person, separate and distinct from its shareholders. Shareholders select the board of directors, and the board selects the management team. Most important form of business in the US. Ownership can be easily transferred. Corporations suffer double taxation, pays taxes on its earnings and then shareholders also pay taxes.

Sarbanes-Oxley Act

Enacted by congress, requires each publicly traded company to give an assessment of internal controls and financial reporting, management's report must be reviewed by an independent auditor.

Agency Relationship

The relationship between the management team and the shareholders.

Agency Problem

Conflict of interest between management and shareholders.

Proxy Fight

a technique used to gather enough stockholder votes to control a targeted company

Stakeholder

Someone who potentially has a claim on the cashflow of the company

Who is the biggest stakeholder?

Government

Primary Market

The market in which new securities are originally sold to investors.

Secondary Market

Previously issued securities are traded among investors.

Auction Market

Matches people who want to buy with people who want to sell.

Dealer Market

A market where dealers buy and sell for their own accounts.

Balance Sheet

Snapshot of a business in a moment of time

Balance Sheet Formula

Assets=Liabilities+Stockholders equity

Income Statement

Snapshot of a company's performance

Income Statement Formula

Income=Revenue-Expenses

Statement of Cashflows

Summary of cash coming in and out of the business

Cashflow Formula

Source of Funds Less Use of Funds

Current Asset

Life of less than one year

Fixed Asset

Life more than one year

Liability

Something which is owed, classified as current and long term.

Working Capital

Difference between short term assets and short term liabilities.

Liquidity

The speed of which an asset can be converted to cash.

Parts of Liquidity

Ease of conversion
Loss of value when converted

The more liquid a business is the less likely it is to experience financial distress.
a)true
b)false

a)true

Lots of companies fail more due to insolvency rather than a lack of liquidity.
a)true
b)false

b)false

Financial Leverage

The use of debt in a companies capital structure. Debt acts as a lever, it can magnify earnings, gains, and losses.

Accounting values do not necessarily represent what an asset is worth.
a)true
b)false

a)true

US GAAP

Generally accepted accounting principles, ensures assets are recorded at what they are purchased at rather than what they are worth.

Matching Principle

All revenues are matched with their associated costs.

Taxes are NOT the largest outflow of a profitable business.
a)true
b)false

b)false

Operating Cash Flow

Cash flow from business operations.

Investing Cash Flow

Cash transactions for the purchase and sale of investments and long-term assets.

Financing Cash Flow

Cash flow from debt and equity.

Financial statements at times are the best and most available information about companies
a)true
b)false

a)true

An increase in an asset or decrease in liability=

Use of cash

A decrease in an asset or an increase in a liability=

Source of cash

Liquidity Ratios

Measures a firms ability to pay expenses without stress
-Current
-Quick

Financial Leverage Ratios

Measures a firms ability to meet its financial obligations
-Debt Ratio
-Times Interest Earned(Interest Coverage)

Turnover Ratios

Measure how efficiently a company's assets generate sales
-Inventory Turnover
-Inventory Days

Profitability Ratios

Measure how efficiently a business uses cash and manages its operations
-Profit Margin
-ROA
-ROE

Market Based Ratios

Measure how much an investor is willing to pay per unit of measurement
-P/S Ratio
-P/E Ratio
-P/BV Ratio

Market Cap

Total shares outstanding multiplied by price per share

DuPont Identity

States that ROE can be increased by adding debt

Time Value of Money

How much money today becomes in the future and vice versa

A dollar in hand today is worth more than a dollar in the future
a)true
b)false

a)true

Future Value

Principle x (1+r)^t

Simple Interest

Interest only earned on the principle

Stock price is the present value of its future cash flows
a)true
b)false

a)true

Present value of future cash flows is discounted at a
a)interest rate
b)stock price
c)premium
d)coupoon

a)interest rate

Present Value

FV / (1 + r)^n

FV = Future Value
R = Rate of return
N = Number of periods

Most investments have

Multiple cashflows

Present value is

Discounted

Future value is

compounded

Annuity Stream

A series of constant level cash flows that occur at the end of each period for a fixed number of periods.

Perpetuity

An annuity stream that goes on forever
Ex. Preferred shares

Perpetuity Formula

Cash flow/interest rate

Stated Interest Rate

Interest rate expressed in the terms of interest payments make each period

Effective Annual Rate (EAR)

Interest rate expressed as if it was compounded once per year

Annual Percentage Rate (APR)

Rate charged per period multiplied by number of periods a year

Pure Discount Loan

Simplest form of a loan, borrower receives money today and pays one lump sum in the future
Ex. Treasury Bill

Interest Only Loan

A borrower pays interest every period for a set number of periods and the principle
Ex. Corporate bond

Markets exist so

Excess money from investors can be transferred to businesses who have a shortage of funds

The user of the funds

sell a security

Security

Claim on assets or cashflows of an entity

Financial markets provide

Liquidity

The stock holder has a right to

The residual value of the firm

Residual Value

Value of the firm after enough assets have been sold to cover all liabilities

What determines stock price?

Supply and demand

The current price of a security is

The equilibrium point

Factors of Security Prices

Interest rate
Inflation
Economic events
A company's financial performance
Industry performance

The principle regulator of the securities market is

The SEC

The SEC is responsible for

Licensing security professionals
Enforce securities laws
Provide investors with accurate information

What is the role of investment banks?

They work with issuers of new securities in the primary market and find buyers for those securities. They advise the firm, find the best timing and price for the offer, and sell the shares to the public. They can also buy the shares themselves.

Underwriting

When investment banks buy some shares of the new stock themselves.

Exchanges

Places where securities are traded.

Money Markets

Debt securities with originally maturities less than one year. Investors park excess cash in here for short terms (treasury bills, certificates of deposit, etc.). Typically sold in very large denominations, have a low default risk. Interest rates in money markets are generally lower.

Capital Markets

Trading of long-term securities. Price fluctuation can be substantial due to long-term nature of the securities.

Foreign Exchange Market

A market in which currencies of different countries are bought and sold

Deriavtive

When a value of a security is based on the value of another security, such as a stock option.

How do corporations raise long term money?

By issuing stocks and bonds.

Do debt securities or equity securities have a higher claim on cashflow?

Debt securities

Coupon

Payments on the bond every period

Fixed coupon bond

Firms pay a certain amount every period then at the end the corporation repays the principle.

Zero coupon bond

Debt security that only has one payment, at maturity.

Variable rate bond

The coupon varies, typically tied to the interest rate.

Perpetual Bond

Fixed coupon bond that has no maturity.

Income Bond

Firm only pays coupon when earnings are sufficiently high.

Convertible Bond

Allows security holder to convert the security into another security (usually equity).

Callable Bond

Like a fixed coupon bond, except the company have a right to repurchase the bond at a specified price.

Sukuk Bond

Bond issued in Islamic society. Islam prohibits interest so this bond adapts to that rule.

Equity holders are considered

Owners of the firm, they have a say in the operating decisions of the firm by voting for the board.

How do stockholders receive money.

They can receive dividend payments on their stocks, also they can receive money when they sell the stock.

Preferred Shares

Has features of both debt and equity. Payment made after debt holders but before common stockholders.

Private Placement

The direct sale of new securities by the issuing company.