FINAL EXAM TERMS

Common stock

basic (“common”) stock of the company sold to stockholders, rights by state law

Preferred stock

hybrid stock (may possess bonk like characteristics) sold to specific investors; rights by contract

Milton Friedman quote

A society that puts equality...ahead of freedom will end up with neither equality nor freedom... a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality

Authorized stock

stock authorized for sale by stockholders in the Article of Incorporation

Issued stock

sold or exchanged for value

Treasury stock

stock bought back by the company

outstanding stock

issued minus treasury stocks; stock held by investors

What kind of stock is the most important?

Outstanding stocks because those are the stockholders who vote and receive dividends (if declared)

Cash discount

prompt payment discount—to get customers to pay faster (interest expense on I/S)

Trade discount

reduction from retail price to get wholesale price (not on financial statements

Capital gain

sale of non-operating asset at greater than book value

Capital loss

sale of non-operating asset at less than book value

What is the only operating asset?

inventory

dividend + where on financial statements

distribution to stockholders from retained earnings; S/H Equity on B/S

expense + where on financial statements

expired asset; SG&A on I/S

Basis (tax term)

value from which tax gains and tax losses are measured (similar to book value)

fair (general usage)

unit of emotional measure without objective reference

fair (accounting)

estimate of value based on references to other objective values (e.g. fair value accounting) and/or auditors’ opinion after considering all management assertions in the financial statements (e.g. presents fairly)

fair (baseball)

a ball hit on the ground between first and third base

Rule of 72

to estimate roughly how long it will take of an investment to double in value, divide the interest rate as a number into 72

Hurtle rate

required minimum rate of return

WACC (acronym)

Weighted average cost of capital

What causes the premium or discount in bond pricing?

The market rate of interest differs from the coupon rate of interest

Weighted average cost of capital definition

economic cost of liability and equity components weighted for their presence in the capital structure; frequently approximated by “10%” or the incremental borrowing rate

Risk Adjust Rate of Return

arbitrarily defined (higher) rate of return due to the uncertainties of the cash flows

DCF (acronym)

discounted cash flow

APIC (acronym)

additional paid in capital, paid-in capital in excess of par

book value of a company

common stockholder’s equity; >0, increasing over time

Solvency

capacity to pay bills (e.g. debt/equity, current ratio)

Liquidity

ability to pay bills (e.g. quick ratio, DSO)

current ratio

current assets divided by current liabilities; 1 to 2: if > 2 than 2 may have bad A/R or obsolete inventory

working capital

current assets minus current liabilities; >0, as high as possible

A/R turnover

365 divided by DSO; trending higher, not decreasing

DSO = days sales outstanding

avg net A/R divided by avg daily net sales; 1.5 x credit terms

Inventory turnover

365 divided by DSI; trending higher, not decreasing

DSI = days sales in inventory

avg inventory divided by avg COGS; as low as possible

debt/equity

total debt divided by total equity; 1 to 1: if >2 then may have debt service problems

NCF - Net cash flow

NIAT + non-cash charges; >0, as high as possible

ROE - return on common stockholders’ equity

NIAT divided by total common stockholders’ equity; s&P500: 15-20%

ROS - return on sales (profit margin)

net income divided by net sales; S&P500: 5-10%

asset turnover

net sales divided by average total assets; increasing over time

gross profit percentage

gross profit divided by net revenue; trends over time, at least flat over time

EBITDA (acronym)

earnings before interest, taxes, depreciation, and amortization 

Quick ratio

cash plus marketable securities plus net A/R divided by current liabilities; as close or greater than 1

EBITDA

operating income plus non-cash charges; >0, as high as possible

book value per share

common stockholder’s equity divided by weighted average shares outstanding

What does capital budgeting focus on?

focus is on after-tax rate of return on invested cash

Why does capital budgeting use cash and not accounting data?

accounting data is based on transactions and has non-cash charges; NCF = NIAT - non-cash charges

NPV (acronym)

net present value

Net present value

at assumed discount rate; PV of CFI minus PV of CFO

What is profit and loss based on?

accrual accounting (accounting concept)

What is rate of return (aka DCF) based on?

time value of money and cash in/out (finance concept)

Assumptions of DCF analysis

all cash flows occur at the end of the period and are immediately reinvested at the discount rate

reinvestment rate fallacy

all cash flows will actually be reinvested and earn the discount rate

annuity

same cash flow in or out over multiple periods

ordinary annuity

cash flow at the end of the period (most common)

annuity due

cash flow at the beginning of the period (e.g. leases and lottery)

Luca Pacioli quote

Without mathematics there is no art