Brealey Myers & Allen chapter 3
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48 Terms
What is the fundamental principle of finance?
The optimal balance of risk and return.
What is Net Present Value (NPV)?
The difference between the present value of cash inflows and the present value of cash outflows.
How is NPV calculated?
NPV = (Cash inflow at time t / (1 + r)^t) - Initial investment, where r is the discount rate.
What does a positive NPV indicate?
A project is expected to generate more cash than it costs, thus adding value.
What is the concept of opportunity cost?
The cost of forgoing the next best alternative when making a decision.
What is the Internal Rate of Return (IRR)?
The discount rate that makes the NPV of a project equal to zero.
How is the IRR expressed?
As a percentage rate that reflects the project's profitability.
What is the relationship between IRR and NPV?
If IRR exceeds the required rate of return, NPV will be positive.
Define payback period.
The time it takes for an investment to generate an amount of cash equivalent to the original investment.
What are the limitations of the payback period method?
It does not consider the time value of money and ignores cash flows after the payback period.
What is the profitability index (PI)?
The ratio of the present value of future cash flows to the initial investment.
How do you interpret a profitability index greater than 1?
The project is expected to generate more value than its cost.
What is meant by the cost of capital?
The return rate that investors expect from an investment in a company.
How does the weighted average cost of capital (WACC) affect investment decisions?
It serves as the discount rate used to evaluate new projects.
What is capital budgeting?
The process of planning and evaluating investments in long term assets
What factors should be considered in capital budgeting decisions?
Cash flows, project risk, financing options, and strategic fit.
What role do financial projections play in corporate finance?
They help in assessing potential profitability and cash flow requirements.
How does market efficiency relate to corporate finance decisions?
In efficient markets, securities prices reflect all available information.
What are the main types of corporate financing?
Debt financing and equity financing.
How does leverage affect a company’s profitability?
Leverage can amplify returns but also increases risk.
What is the Modigliani-Miller theorem?
In a perfect market, the value of a firm is unaffected by its capital structure.
What are the implications of the Modigliani-Miller theorem?
Capital structure decisions should not impact firm value in an ideal market.
Define corporate governance.
The system by which companies are directed and controlled.
What are key components of corporate governance?
Board structure, shareholder rights, and regulatory compliance.
What is the fundamental principle of finance?
The optimal balance of risk and return.
What is Net Present Value (NPV)?
The difference between the present value of cash inflows and the present value of cash outflows.
How is NPV calculated?
NPV = Σ (Cash inflow at time t / (1 + r)^t) - Initial investment, where r is the discount rate.
What does a positive NPV indicate?
A project is expected to generate more cash than it costs, thus adding value.
What is the concept of opportunity cost?
The cost of forgoing the next best alternative when making a decision.
What is the Internal Rate of Return (IRR)?
The discount rate that makes the NPV of a project equal to zero.
How is the IRR expressed?
As a percentage rate that reflects the project's profitability.
What is the relationship between IRR and NPV?
If IRR exceeds the required rate of return, NPV will be positive.
Define payback period.
The time it takes for an investment to generate an amount of cash equivalent to the original investment.
What are the limitations of the payback period method?
It does not consider the time value of money and ignores cash flows after the payback period.
What is the profitability index (PI)?
The ratio of the present value of future cash flows to the initial investment.
How do you interpret a profitability index greater than 1?
The project is expected to generate more value than its cost.
What is meant by the cost of capital?
The return rate that investors expect from an investment in a company.
How does the weighted average cost of capital (WACC) affect investment decisions?
It serves as the discount rate used to evaluate new projects.
What is capital budgeting?
The process of planning and managing a firm's long-term investments.
What factors should be considered in capital budgeting decisions?
Cash flows, project risk, financing options, and strategic fit.
What role do financial projections play in corporate finance?
They help in assessing potential profitability and cash flow requirements.
How does market efficiency relate to corporate finance decisions?
In efficient markets, securities prices reflect all available information.
What are the main types of corporate financing?
Debt financing and equity financing.
How does leverage affect a company’s profitability?
Leverage can amplify returns but also increases risk.
What is the Modigliani-Miller theorem?
In a perfect market, the value of a firm is unaffected by its capital structure.
What are the implications of the Modigliani-Miller theorem?
Capital structure decisions should not impact firm value in an ideal market.
Define corporate governance.
The system by which companies are directed and controlled.
What are key components of corporate governance?
Board structure, shareholder rights, and regulatory compliance.