Corporate Finance Lecture Notes Flashcards

Key vocabulary terms and definitions from the lecture notes on corporate finance.

Value

In finance, value is not defined, but wealth is. It considers cash from a company and converts them into the common currency of current shareholder wealth that takes into account whether they are riskier or safer, sooner or later.

Opportunity Cost of Capital

The minimum rate of return on Tesla’s new car in our example. This depends on the investment available to investors in financial markets. Whenever a corporation invests cash in a new project, its shareholders do not invest the cash.

Net Present Value (NPV)

Accept investments that have positive net present values.

Internal Rate of Return (IRR)

Accept investments that offer rates of return in excess of their opportunity costs of capital.

Perpetuity

An investment that pays the same cash flow in perpetuity, with the first cash flow arising one year from now.

Perpetuity Due

A perpetuity that starts immediately

Annuity

An asset that pays a fixed sum each year for a specified number of years.

Amortizing loans

Loans that involve a series of level payments. Part of the regular payment is used to pay interest on the loan and part is used to repay or amortize the loan.

Future Value

The value of a series of cash flows at a specified time in the future

Growing Perpetuities

A perpetual stream of income that keeps pace with the growth rate in costs

Growing Annuity

A stream of cash flows that grows at a constant rate for a specified period of time

Annual Percentage Rate (APR)

Tells you how much interest is paid over the course of the year, ignoring how often it’s paid. But because it ignores compounding, it doesn’t tell us how much interest an investor accumulates over the year.

Effective Annual Rate

Takes into account how often the APR is paid—every six months in the preceding example—and the effect of compounding.

Yield to Maturity

The interest rate investors get if they buy the bond and hold it to maturity

Duration

The weighted average of the times to each of the cash payments. The weight for each year is the present value of the cash flow received at that time divided by the total present value of the bond.

Spot Rate

The rate of interest on a bond that makes a single payment at time t.

Treasury Strips

Simple bonds that make only a single payment at time t.

Expectations Theory

When future interest rates are expected to increase, you often see an upward-sloping term structure.

Earnings Per Share (EPS)

Net income divided by the number of shares held by investors.

Price-Earnings Ratio (P/E)

The ratio of stock price to earnings per share.

Dividend Yield

The ratio of dividend to stock price.

Beta

Indicated risk less than the market-average risk of 1.0.

Book Value

Cumulative investments in its business, less an allowance for depreciation, and then subtracting debt and other liabilities.

Free Cash Flow

The dollar dividends per share

Horizon Value

The ending value of dividends

The Constant-Growth DCF Formula

The cost of equity r, equals the dividend yield (DIV1/P0) plus the expected rate of growth in dividends (g).

Plowback Ratio

The ratio of earnings to book equity was about 13%.

Return on Equity

The ratio of earnings to book equity.

Sustainable Growth Rate

g = plowback rate × ROE.

P/E Ratio with Constant growth

Equals the dividend yield (DIV1/P0) plus the expected rate of growth in dividends (g).

Stock Price

The value of average earnings under a no-growth policy, plus PVGO, the net present value of growth opportunities

Growth Stocks

Stocks of companies where PVGO is high and accounts for a substantial fraction of stock price.

Income Stocks

Stocks of companies where PVGO accounts for a relatively small fraction of stock price.

Free Cash Flow

Cash generated by the company’s operations after all necessary investments have been made for future growth.

Market Capitalization

Share price multiplied by the number of shares outstanding

Profitability Index

The net present value (NPV) per unit of the resource and choose the projects with the highest values of the index.

Sunk Costs

Costs that have already occurred and cannot be recovered.

Working Capital

The difference between a company’s current assets and its current liabilities.

Erosion

A cash-flow side effect caused when a new product steals sales from the firms existing products.

Straight-Line Rate

The consistent way to figure out how long it would take for cumulative cash flow to equal initial investment.

Internal Rate of Return

Discount rate that makes NPV = 0

Equivalent Annual Cost

The cost per year to own and operate

Macaulay Duration

The weighted average of the times to each of the cash payments.

Horizon

This is a stopping point where it is assumed that things will continue at a steady value.

Certainty Equivalent

Is the guaranteed payoff made at the risk-free rate

Event Study

An analysis of stock market data to measure the impact of an event will have on the company.

Diversifiable Risk

A risk that can be gotten rid of through diversification.

Unique Risk

Specific risk; those that affect only a single risk.

Systematic Risk

Market risk; those that are shared by most businesses.

Efficient Frontier

The combinations of risk and return that can be achieved by different pairings of two stocks.

Tangency Portfolio

The best stock portfolio to combine with a risk-free asset (Treasury Bills).

Capital Market Line

The new investment opportunity line.

Beta

How sensitive a stock is to market movements.

Security Market Line (SML)

Expresses the expected return on an investment as a function of (1) the time value of money, (2) a reward for taking on risk, and (3) the amount of risk.

Arbitrage Pricing Theory (APT)

An alternative model to the CAPM

After-Tax Weighted Average Cost of Capital

The cost of debt multiplied by the total payments

Certainty Equivalent Cash-Flow Model

Determines a present value (PV) by adjusting cash flows to compensate for time value and risk.

Straight Rule

Calculate NPV's state costs and benefits consistently and separately.

Scenario Analysis

When analysts look at alternative versions of the business model to test their effects.

Break-Even Analysis

How bad thing can get to make project a loser.

Strategic Options

A choice, one that can be evaluated as an option

Sensitivity Analysis

Break project down into key variables; analyze consequences of misestimating those variables.

Real Options

An option that consists of a tangible asset for use in operations.

Abandonment Value

The cash it could generate for the company if the project were rejected.

Information Ratio

This measures the active return that can be attributed to the manager's skill.

Weak Efficient Market

Where only past prices reflect value.

Semi-Strong Efficient Market

Where all public data reflects value.

Strong Efficient Market

Where no one can beat value.

Hedge Funds

A pool investment that manages money for their investors.

Technical Analysts

Traders who use charts on past runs.

Underwrite

To manage and take on a financial risk.

Red Herring

A small and temporary set of losses that won't affect anything else.

Seasoned Equity Offerings

A secondary and late offering of stocks after a company has already been introduced.

Rights Issue

The company offers a share to existing stockholders only and a set price.

Cum-Dividend

Selling stock before dividend is released.

Ex-Dividend

Selling stock after dividend is released.

Convertible Bonds

Have the option to turn into a stock.

Warrants

The ability to buy stock at the set price.

Over-The-Counter Market

Buying and selling stocks through negotiations.

Credit Rating

The opinion on how well a firm can pay all required lending.

Financial Distress

Condition where a firm cannot meet its obligations to lenders.

Debenture

Unsecured loan.

Protective Covenants

Action to control company risk, by restricting what lender can do after receiving the money.

Seniority

In loan context, a 'pay-first' clause.

Asset-Backed Security

Selling claim to a receivable.

Loan Commitment

The bank promises to provide financing in the future.

Term Loan

Long-term loan with set payments.

Prime Rate

Benchmark lending rate.

Commercial Paper

Unsecured loan.

Leasing

Renting.

Lessee

The user of the asset.

Lessor

The owner of the asset.

Depreciation

Spreading cost over a long period.

Unsubsidized Loans

Loans backed by good word only.

Welfare Analysis

When costs and benefits are analyzed.

Economic Rents

What the company can expect to earn as it is starting up.

Dynamic Value

Changes that will inevitably appear over the life of a business.

Overconfidence Bias

When proposed costs for projects are too low.

Economic Income

In any year is equal to the cash flow plus the change in the asset’s present value

Agency View of Financial Markets

Is where it it best to have a company all equity, for financial health.