Essentials of Finance

Time Value of Money Concept

money loses value overtime. money you have now can be invested and made to be worth more than money you get later

Opportunity Cost

the second best option that you sacrifice when making a decision

Present Value

the current value of a payment received at a later date

Discounting

finding the current value of payments received in the future

Discount Rate / Opportunity Cost / Cost of Capital / Expected Rate of Return

a factor used to convert a payment received next year into value now

Cost of Capital Definition

the minimum rate of return or profit a business must earn before generating positive value

Returns

the gain or loss an investment generates overtime

Why does the “opportunity cost of capital” equal discount rate?

if you spend an amount, you miss out on its ability to grow by R% if invested

Capitalization

how much capital a company has gained from external investors

Expanded Form of “ETF”

Exchange Traded Fund

ETF

a fund made of multiple securities that can be traded like an individual stock

Amortization

depreciation for intangible assets

Annuity

a finite stream of cash flows of identical magnitude and equal spacing in time

Growing Annuity

a finite stream of cash flows which grow at a constant rate and are equally spaced in time

Perpetuity

an infinite stream of cash flows of identical magnitude and equal spacing in time

Normal Annuity

a type of annuity where cash flow is measured at the end of each period [0]

Annuity Due

a type of annuity where cash flow is measured at the start of each period [1]

Nest Egg

money saved to be used for retirement spending

APY/EAR

a measure of compound interest earned during a year. it is more reflective of a compounding investment’s returns

APR

a measure of interest earned in a year, ignoring compounding within the year

Outstanding Balance

the present value of the remaining payments discounted at the loan rate. this is what a debtor owes to the bank.

Loan Value

the present valye of the remaining payments discounted at the opportunity cost. this is what a loan costs the debtor

Incremental Cash Flow / Marginal Cash Flow

changes in cash flow that are caused by a new projects

The Opportunity Cost of Capital

the returns that a firm sacrifices when they don’t invest cash. Can be found by subtracting your current rate of return from the rate of return of a different investment

Benefits of NPV

measures values added from cash flows, accounts for TVM, can account for risk

IRR (Internal Rate of Return)

measures profitability by finding the opportunity cost that leads your NPV to be zero

Situation when IRR indicates that you should invest in a project

IRR > (required?) rate of return

IRR Sign Rule

IRR wil only be unique fi the sign flips once

Drawbacks of IRR

sign rule, ignores the size of the project

Payback Period

the time required to recover the original cost of an investment (CF_⁰)

When you you accept a certain payback period?

payback period > threshold

Drawbacks of Payback Period Calculation

ignores all cash flows after the payback period

PP&E

property, plant, and equipment

SG&A

selling, general, and administration (indirect costs

Focus of Cash Flow Statement

showing operational costs, financing, and investments

Focus of Income Statement

shows profit or loss

Accrual Accounting

sales and expenses are recognized when they occur rather than when they are received or paid

Effective Tax ate

the percentage of a company’s taxable income that a firm pays

EBITDA

Earnings before interest, taxes, depreciation, and amortization

EDGAR

a database for the annual reports of every business

Common Stock

new shares sold by the company rather than other investors