FINC3630 exam 1

what are the three aspects of cash flows that affect company value?

-amount of expected cash flows

-timing of the cash flow stream

-risk of the cash flows

the corporate form of business is

the standard method for solving the problems encountered in raising large amounts of cash

what are the different forms businesses can take?

-proprietorship

-partnership

-corporation

proprietorship

-unincorporated business owned by one individual

-largest in number but smallest in sales

advantages of proprietorship

ease of formation; subject to few regulations; no corporate income taxes → only personal income taxes

disadvantage of proprietorship

limited life; unlimited liability; difficult to raise capital

general partneship

similar advantages to proprietorships but with more than one owner; equal control with other partners

limited partnerships

requires a GP, limited liability to investment, no control over

limited liability companies

does not require a GP, multiple LPs

corporation

a legal entity that is separate from its owners and managers, with many owners

advantages of corporation

unlimited life; easy transfer of ownership; limited liability; ease of access to capital→ the risk is very small

disadvantages of corporation

double taxation; cost of setup (initial public offering-IPO) and reporting requirements

the goal of financial management

-shareholder wealth maximization

-equivalent to maximizing the stock price

what does the law require?

-a fiduciary duty to shareholders

-shareholders have the claim to profits, but no direct day-to-day control over operations

rule 1

only values at the same point in time can be compared or combined - captures the preference for early CFs, all else equals

rule 2

to move a cash flow forward in time, you must compound it - compound factor: (1+r)^t

rule 3

to move a cash flow backward in time, you must discount it - discount factor: 1/(1+r)^t

EAR

is the annual rate that would give us the same end-of investment wealth after 3 years

perpetuity

a stream of constant cash flows that lasts forever

growing perpetuity

a streaming of cash flows that grows at a constant rate forever

annuity

a stream of constant cash flows that lasts for a fixed number of periods

growing annuity

a stream of cash flows that grows at a constant rate that lasts for a fixed number of periods

What do investment returns measure?

the financial results of an investment

What is underlying an investment return number?

a timeline of cash flows and interest rates

What are the two ways investment returns can be expressed?

-Dollars gained or lost

-Percentage gained or lost

Do investors prefer certainty or uncertainty?

investors prefer certainty

What is a risk premium?

compensation for taking on uncertainty or risk.

What two things affect the risk premium?

-quantity of risk

-risk aversion

normal distribution is defined by two parameters

-the mean (or average)

-the standard deviation

what is the standard deviation a measure of?

risk