Business Finance Exam Revision Flashcards

Business Finance Exam Flashcards

Advantages of organizing a business as a corporation

Limited liability, liquidity, infinite life, unlimited number of owners

Disadvantages of organizing a business as a corporation

Separation of ownership and control, more complicated and expensive to set up

Net Income Formula

Sales * Profit Margin

ROE Formula

Net Income/Book Equity

ROA Formula

Net Income/Book Assets

Assets Formula

Liabilities + Equity

What does ROE measure?

Measures the net income (to shareholders) as a percentage of the book value of their investment.

What does ROA measure?

Measures the net income (to shareholders) as a percentage of the book value of all the assets used to generate the income.

Annuity

A stream of constant cash flows paid every period for a finite amount of time.

Perpetuity

A stream of constant cash flows paid every period, forever.

APR

Annual percentage rate (the rate of interest earns in one year before the effect of compounding

EAR

Effective annual rate (the rate that the amount of interest actually earns)

Nominal Interest Rate

The rate quoted by a bank or other financial institutions

Real interest rate

Rate of growth of purchasing power , after adjusting for inflation.

Term structure of interest rate

Used to illustrate the relationship between (1) Yields and (2) Time to Maturity.

Expectations Theory

In equilibrium, investors should expect to earn the same return (for a given investment horizon) whether they invest in long-term bonds or a series of shorter term bonds.

Liquidity Preference

States that the slope of the yield curve is influenced not only be expectations, but also by the liquidity premium that investors require on long-term bonds.

Preferred Habitat Theory

A theory that recognises that the shape of the yield curve may be influenced by investors who prefer to purchase bonds having a particular maturity.

Ordinary shares

Voting rights, dividends vary with profitability of firm

Preferred shares

No Voting rights, Preference above ordinary shares to dividend, Usually set payment

Diversification

Elimination of risk by combining multiple assets into a portfolio.

Two types of risk

Systematic and Unsystematic

Systematic Risk

Risk that is perfectly correlated and affects all securities

Unsystematic Risk

Risk that is uncorrelated and affects a particular security

Diversification

The averaging out of independent risks in a large portfolio

NPV

Net Present Value - equivalent to receiving its NPV in cash today.

IRR

Internal Rate of Return

Payback period

The amount of time it takes for a project to pay back the initial investment.

IRR

Is the discount rate that causes the net present value of a project to equal to zero.

Profitability index

How much do you get for how much you invested

Efficient Markets Hypothesis

Implies that securities will be fairly priced, based on their future cash flows, given all information that is available to investors.