FM1 REVIEWER

Time Value of Money

A method by which one can compare cash flows across time.

Interest

The cost of money that is borrowed or lent.

Time Line

Graphical representation used to show the timing of cash flows.

Future Value (FV)

The amount to which a cash flow or series of cash flows will grow over a given period.

Present Value (PV)

The value today of a future cash flow.

Compounding

The arithmetic process of determining the final value of a cash flow.

Annuity

A series of equal payments at fixed intervals for a specified number of periods.

Ordinary (Deferred) Annuity

An annuity whose payments occur at the end of each period.

Annuity Due

An annuity whose payments occur at the beginning of each period.

Risk

A measure of the uncertainty surrounding the return that an investment will earn.

Return

The total gain or loss experienced on an investment over a given period of time.

Risk Averse

Investors require an increased return as compensation for an increase in risk.

Risk Neutral

Investors choose the investment with the higher return regardless of its risk.

Risk Seeking

Investors prefer investments with greater risk even if they have lower expected returns.

Scenario Analysis

An approach using several possible alternative outcomes to obtain a sense of variability.

Range

Pessimistic outcome return subtracted from optimistic outcome return.

Capital Budgeting

Process of selecting and evaluating long-term investments to maximize owners' wealth.

Capital Expenditure

Outlay of funds expected to produce benefits over a period greater than 1 year.

Operating Expenditure

Outlay of funds resulting in benefits received within 1 year.

Independent Projects

Projects whose cash flows are unrelated; accepting one doesn't eliminate others.

Mutually Exclusive Projects

Competing projects; accepting one eliminates all others serving a similar function.

Unlimited Funds

Firm can accept all independent projects providing an acceptable return.

Capital Rationing

Firm has a fixed number of dollars available for numerous competing projects.

Payback Period

Time required for a firm to recover its initial investment from cash inflows.

Net Present Value (NPV)

Present value of cash inflows minus initial investment, discounted at cost of capital.

Internal Rate of Return (IRR)

Discount rate that equates the NPV of an investment opportunity with $0.

Exchange Rate Risk

Risk that changes in exchange rates will reduce the value of project cash flows.

Political Risk

Risk that the government of the host country may interfere with company operations.

Transfer Pricing

Prices charged when one subsidiary sells goods or services to another.

Probability Distributions

provide more quantitative insights into an asset's risk

Continues Probability Distribution

A probability distribution showing all the possible outcomes and associated probabilities for a given event.

fixed assets

tangible items like building, land, or machinery

non-fixed assets

intangible items like a long term advertising campaign

Proposal Generation

Proposals for new investment projects are made at all levels within a business organization and are reviewed by finance personnel. Proposals that require large outlays are more carefully scrutinized than less costly ones.

Review and Analysis

Financial managers perform formal review and analysis to assess the merits of investment proposals.

Decision Making

Firms typically delegate capital expenditure decision making on the basis of dollar limits. Generally, the board of directors must authorize expenditures beyond a certain amount. Often plant managers are given authority to make decisions necessary to keep the production line moving.

Implementation

Following approval, expenditures are made and projects implemented. Expenditures for a large project often occur in phases.

follow up

Results are monitored, and actual costs and benefits are compared with those that were expected. Action may be required if actual outcomes differ from projected ones.

Risk

the degree of variability of cash flows.

Scenario Analysis

can be used to deal with project risk to capture the variability of cash inflows and NPVs

Scenario Analysis

behavioral approach that uses several possible alternative outcomes (scenarios), to obtain a sense of the variability of returns, measured here by NPV.

Taxes

Companies must consider ________ paid in the foreign country. They also need to determine how those ___________ will affect the parent.

Strategic Considerations

MNC invests in a project even if the project itself does not have a positive NPV because the investment may have a long-term strategic benefit