FINA EXAM REVIEW

What is the relationship between risk and return?

The higher the risk the higher the return

What happens when an investment has less risk?

Lower risk corresponds with lower expected returns.

Why is a dollar today worth more than a dollar tomorrow?

The time value of money concept emphasizes that money can interest, so having it now gives you the potential to grow it over time.

What is leverage and how does it apply to a private equity firm?

Leverage is the fixed costs or payments that show up on a firm’s income statement. Adding leverage translates to adding risk to the returns for the shareholders in a firm.

Do all firms maximize wealth?

No, not all firms maximize wealth. Some of these outliers include inefficient firms, disruptors, and non-profit organizations.

What does residual claim mean regarding common equity?

Residual claim is a feature of equity that basically means debt holders, then preferred stock holders get paid first before common shareholders.

What does the term preemptive right mean?

A Preemptive Right is when a shareholder in a firm has the right to purchase additional shares in the corporation/firm

What does Diversification mean?

Overall risk can decline by investing in multiple opportunities.

Strengths of Sole Propiertorship

Own Boss, Fewer Gov regulations, Easy and Inexpensive to form

Weaknesses of Sole Proprietorship

Unlimited liability, Difficult to raise capital, life of business limited to owner

Strengths of Corporations

Easier to raise capital, limited liability, unlimited life

Weaknesses of Corporations

Double Taxation, Greater Gov regulation

Why do investors favor Corporations?

Less risk, and firms need capital to grow

What does Investment Banking focus on?

Investment banking focuses on valuation, mergers and acquisitions, etc.

What happens when a business experiences financial difficulties or goes bankrupt?

Debt holders are paid first in the event of liquidation because they have a legal claim to the firm’s assets

What do efficiency ratios measure?

Efficiency ratios measure how effectively a firm is using its assets to generate sales

Accounts Receivable Turnover

This ratio allows us to assess whether the firm’s sales are being tied up in receivables

Collection Period

How quickly receivables are converted to cash