MGT 8803 FINANCE MODULE

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Flashcards covering key vocabulary and definitions from the lecture on Capital Investment Analysis and Stock Valuation.

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24 Terms

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Relevant Cash Flows

Cash flows that are different between two worlds: one where the investment is made and one where it is rejected.

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Accrual Accounting

Accounting method where revenues and expenses are recognized when they are earned or incurred, not when cash changes hands.

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Timeline Recognition

Recognizing cash flows only when the money actually moves, not when the accountant says money is accruing.

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Sunk Costs

Costs that have already been incurred and cannot be recovered, thus irrelevant to future investment decisions.

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Erosion Costs

The reduction in cash flows from existing projects when a new project is introduced (e.g., customers shifting from an existing Home Depot to a new one).

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Opportunity Costs

The potential benefits a company misses out on when choosing one alternative over another (e.g., potential lease revenue from a property if not used for a new project).

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Working Capital

The investment in current assets (e.g., inventory) required for a project, typically a cash outflow at the beginning and inflow at the end.

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Depreciation

A non-cash expense; projects net income statements which is revenue minus cost minus depreciation times one minus tax rate.

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Free Cash Flow

Operating cash flow minus capital requirements, used in NPV computations and discounted at the cost of capital.

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NPV (Net Present Value)

The present value of all future cash flows, discounted at the cost of capital; a key metric for investment decisions.

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Nominal Rate of Return

The percentage change in the amount of money you have.

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Real Rate of Return

The percentage change in the amount of stuff you can actually buy.

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Fisher Effect

The relationship between nominal return, real return, and the inflation rate: 1 + Nominal Return = (1 + Real Return) * (1 + Inflation Rate).

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Sensitivity Analysis

Asking 'what if' questions to assess how changes in key variables (e.g., market share, costs) impact project NPV.

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Simulation

Using computer software (e.g., @RISK) to model uncertainty by assigning probability distributions to key variables and running thousands of iterations to estimate the range of potential NPVs and IRRs.

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Stock Valuation

The present value of all future expected cash flows.

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Zero Growth Model

A valuation model that assumes a company's dividends will remain constant for the foreseeable future, often used for preferred stock valuation. Stock valuation is simply the present value of all future cash flows.

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Constant Growth Model

A valuation model that assumes dividends will grow at a steady rate (g) indefinitely. The formula simplifies to Dividend 1 / (R - g).

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Differential Growth Model

A valuation model that accounts for varying growth rates in the early part of a company's life cycle before settling into a constant growth rate.

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Retention Ratio

1 - Dividend Payout Ratio which multiplied by the return on retained earnings give you growth rate.

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Cash Cow

A company that pays all of its earnings as dividends and has no growth opportunities; its stock price is simply EPS / R.

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Price-Earnings (P/E) Ratio

Price per share divided by earnings per share, often used to compare company values.

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Enterprise Value (EV)

Market value of equity + market value of debt - cash; used in valuation ratios like EV/EBITDA.

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EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization