##### BUS Finance Exam_1
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#### Complete list of Terms and Definitions for BUS Finance Exam_1

Terms Definitions
SML(graphical representation):   Security market line
Chapter 6: Bond Valuation: describes the basic valuation model to bonds and the impact of required return and time to maturity on bond's value
Chapter 3 Ratio Analysis
Equity Includes: Common stock Additional paid in capital Retained Earnings
Chapter 7 Stock Valution: helps to understands how investors value corporate stocks
Depreciation: MACRS:  Depreciation Expense = Cost × % determined by life   Straight Line: Depreciation Expense = (Cost - Salvage) / Life period
Chapter 9 Cost of Capital
Liquidity Ratios: Current Ratio Quick Ratio Average Collection Period Account Receivable turnover Inventory Turnover
Quick Ratio: Current Assets - Inventory _____________________________   Current Liabilities
Diversification Spreading your investments in different assets to reduce the risk and this depends on the relation between the different assets in the portfolio. (correlation)
Duration An index of price sensitivity. Literally a weighted Average time to maturity. Interpreted as the % change in price for 1% change in rates.
Chapter 2 Accounting and Financial Statement Review
DuPont Decomposition = Net Profit Margin × Asset Turnover × Leverage Multiplier   = Net Income × Sales     ×  Assets  Sales Assets Equity
Assets Current Assets + Long Term Assets
Returns Generally reported as an annualized percentage.
Income Statement: Income statement describes the revenues and expenses associated with company's operations for a given period of time.
Example of using the SML to identify overvalued and undervalued assets:   In the CAPM , inflation shifts SML upward and risk aversion shifts SML downward.
Terminal Cash Flows:     Terminal Cash Flow Realizable salvage Value +/- Tax effects of capital gain/loss +Recapture of Net Working Capital = Terminal Cash Flow   Cash flow at the end of the life of the project: Last year's differential cash flow + Terminal cash flow
Total Risk Calculate the standard deviation of returns. Greater SD means higher risk of security.
Income Statement:               Revenues - Cost of Goods Sold = Gross Profit - Operating Expenses =  Earnings before Interest and Taxes (EBIT) -  Interest Expenses =  Earning before taxes (EBT ) -  Tax Expenses =   Net Income
Beta ß Measures the amount of systematic risk inherent in comparison with the market
Retained Earnings:   Money generated from the the operations of the company that is plowed back ( or retained ) in the business.
Calculation of DCF: Calculated as: Or:             T                                          Vfirm = ∑    FCFFt / (1+ WACC)t                 t=1
The process of finding the present value of some future amount is often called: discounting PV= FV/(1+r)
Unsystematic Risk A company's labor force goes on strike A company's top management dies in a plane crash An oil tank brusts and floods a company's production area Business , financial risk (diversifiable) . Which mean we can decrease this risk by choosing the right combination of assets.
Equity: Residual claim on the earnings and the assets of the company.  Residual claims are money that the company should pay back to the stock holders.
Cost of Equity: Equity Risk Premium(Rerp) = Exp. Return on Market(Rm) - Risk Free Rate(Rf)
SML continued: (In previous graph) If we compare required returns to expected returns, investments A and B are undervalued and investments C and D are overvalued. Graphically, this means investments A and B plot above the security market line and investments C and D plot below the security market line
Risks Market risk ( systematic risk) + Firm Systematic (or non- systematic risk)
Examine Capacity Constraints Lowering the amount of assets deceases DFN
Increase Net Margin: Higher earnings lead to more cash earning per dollar of sales  and more cash retention
Discretionary Financing Needed: = Projected Assets  - Projected Liabilities - Projected Owner's Equity
CAPM continue: The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken.
Financing Leverage:   Use of fixed cost sources of financing ( debt, preferred stock) rather than variable cost sources of financing ( common stock) Firms with lots of fixed cost (debt) will have high financial leverage.
Standard Deviation (σ ) √ ∑ ( Ri - Rmean) 2 × Pi where P represent possibility
Junk Bonds: Bonds with a rating of BB or below.  More likely to default.
Efficiency Ratios:  Measure how well the company uses its assets to generate sales or profits.
Net Present Value (NPV): The sum of the present values (PVs) of the individual cash flows. Sum of (CF/(1+r)^t )-initial investment
Degree of Financial Leverage (DFL):     DFL = EBIT/( EBIT -1)
If you invest money today and you want it to grow for retirement, what process are you counting on? compounding
What does a nonrevolving line of credit entail? Fixed-rate (non-adjustable) pre-arranged financing from a bank.
Cost of Capital Also referred as weighted cost of capital (WACC)   Every company has a capital structure - a general understanding of what percentage of debt comes from retained earnings, common stocks, preferred stocks, and bonds. By taking a weighted average, we can see how much interest the company has to pay for every dollar it borrows. This is the weighted average cost of capital.
Degree of Financial Leverage (DFL): With high financial leverage (high DFL) a small change in operating income is magnified into a large change in net income and earnings per share
Sustainable Growth Rate (SGR): SGR is a function of : Profitability ( Net Margin) Asset usage Efficiency (Asset Turnover) Leverage (Assets / Equity) Plow back (Dividends)
Sustainable Growth Rate: Only growth rate which allows the firm to maintain its present financial ratios and avoid the sale of new equity.   = ROE (1- Dividends/ Net Income)
Tax on Sales Equipment: Calculate Book Value = Cost - Accumulated Depreciation If Book Value < sale price , then tax on gain If Book Value > sales price , then taxable loss ( for future tax back)
Security Market Line (SML): The securities market line (SML) is a straight line that graphs the relationship between risk and return.The X-axis represents the risk (beta), and the Y-axis represents the expected return. The market risk premium is determined from the slope of the SML.
Statement of Cash Flows: Explains the sources and uses of cash for the company
Weighted cost of capital: A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation.
Degree of Operating leverage (DOL): Percent change in EBIT over the percent change in sales.  DOL= (Sales - Variable Costs)/ EBIT
Four possible ways to decreasing DFN: 1. Slow sales growth 2. Examine capacity constaints 3. Lower dividend payment 4. Increase net margin
Price- Yield Relationship: If the coupon rate = discount rate , the bond will sell at par value If the coupon rate > discount rate , the bond will sell at premium If the coupon rate discount
The retention ratio is calculated as: the additions to retained earnings divided by net income
What is the difference between the DuPont breakdown of ROE and SGR? SGR includes the dividend policy
IRR Decison Rules: - If IRR is greater than or equal to required rate of return, Accept - If IRR is less than the required rate of return, Reject
Any external financing need is generally covered by: adjusting the level of debt or equity
Value of stock (V0) (Single Holding period)   V1 + D1  / ( 1 + Kcs)   Here V0 and V1 are value of the stock at time 0 and time 1, respectively, D1 is the dividend paid in time 1 and Kcs is the required rated of return
Example: What will be the required return on a stock given that the risk-free rate is 8%, the expected return on the market portfolio is 12%, and the beta of the stock is 2? CAPM   r   =   Rf   +   beta x (Km - Rf) r   =    8% + 2 x (12% - 8%) r   =    16 %
The sustainable growth rate of a firm is best described as the: maximum growth rate achievable without using any external equity financing, and while maintaining a constant debt-equity ratio
Example of WACC: Weight of Debt: 60%Cost of Debt: 10% Weight of Equity (Common Stock): 40% Cost of Equity (Common Stock): 18% Tax Rate: 35%   t WACC = Weight of Debt * Cost of Debt (1-Tax Rate) + Weight of Equity * Cost of Equity = (.6) * (.1)*(1-.35) + (.4) * (.18)= .111 or 11.1% So, WACC  was 11.1%