Excerpt

1

**Chapter**

**1**

**(G**

**ener**

**al**

**Overv**

**iew)**

**Corporate**

**finance**

=

area

of

finance

dealing

with

mon

etary

de

cisions

that

business

enterprises

make

and

the

tools

and

analysis

used

to

make

these

decisions

**Agency**

**pr**

**obl**

**e**

**ms**

=

confli

ct

of

interest

between

shareholders

and

other

stakeholders

**Hur**

**d**

**le**

**rate**

=

the

mi

nim

u

m

rate

of

return

on

a

project

or

investment

required

by

a

manager

or

in

ve

st

or

in

order

to

comp

e

n

sate

for

risk

**Cost**

**of**

**capital**

=

required

return

necessary

to

make

a

capi

tal

b

udg

eting

project

worthwhile

(includes

cost

of

deb

t

&

cost

of

equity

)

**Oppor**

**tu**

**n**

**ity**

**cost**

**of**

**ca**

**p**

**it**

**al**

=

cost

of

an

alternative

th

at

mus

t

be

fo

rgone

in

order

to

pu

rsu

e

a

certai

n

action

**Chapter**

**2**

**(Ho**

**w**

**to**

**calculate**

**pres**

**ent**

**values)**

**PV**

=

cash

flo

w

x

discoun

t

factor

**Discou**

**nt**

**fac**

**tor**

=

**NPV**

=

C

0

+

PV

**FV**

=

CF

(1+r)

t

**Return**

=

**PV**

**(per**

**p.)**

=

**PV**

**(per**

**p.**

**st**

**ar**

**ti**

**n**

**g**

**ye**

**ar**

**t)**

=

x

**PV**

**(ann.)**

=

**EAR**

**=**

(1

+

r)

t

1

**APR**

=

r

x

t

**Prese**

**n**

**t**

**value**

=

current

wor

th

of

a

future

cash

flow

given

a

specif

ic

rate

of

return

**Perp**

**et**

**uity**

**=**

financial

conc

ept

in

w

h

ich

cash

flow

is

theoretically

re

ce

iv

ed

forever

**Annui**

**ty**

**=**

an

asset

that

pa

ys

a

fixed

sum

each

year

for

a

specific

nu

m

b

er

of

years

**Effective**

**a**

**nnu**

**al**

**in**

**te**

**re**

**st**

**ra**

**te**

**(EA**

**R**

**)**=

interest

rate

th

at

is

annualized

using

compo

und

in

te

re

st

**Annu**

**al**

**Perce**

**n**

**tag**

**e**

**Ra**

**te**

**(AP**

**R**

**)**

=

in

te

rest

rate

that

is

annuali

zed

using

simple

in

te

rest

2

**Chapter**

**3**

**(**

**V**

**aluing**

**b**

**o**

**nds**

**)**

**PV**

=

+

+

...

+

.

**YTM**

=

.

=

IR

R

**Price**

**of**

**bond**

=

**PV**

**(bond)**

=

coupon

+

(t=years

to

m

aturity

)

1

+

r

no

m

=

(1

+

r

real

)

(1

+

i)

**Bond**

=

deb

t

in

ve

st

m

ent

in

which

an

in

vest

or

loans

money

to

an

en

ti

ty

(co

rpo

rate

or

governme

ntal)

that

borrows

the

funds

for

a

define

d

period

of

time

at

a

fixed

in

te

re

st

rat

e

**Coupon**

**rate**

**=**

interest

ra

te

of

bond,

ne

ver

chan

ges

within

maturi

ty

**Market**

**yield**

=

ge

neral

interest

level

(companies

pa

y

marke

t

yield

+

individual

risk)

**Yield**

**to**

**ma**

**tur**

**it**

**y**

=

a

long

term

bon

d

yield

expressed

as

an

annual

rate,

the

IRR

on

a

in

te

re

st

beari

n

g

ins

trume

nt

**Spot**

**rate**

=

ac

tu

al

interest

rate

today

**Forwar**

**d**

**ra**

**te**

=

in

te

re

st

rate,

fixed

today

, on

a

loan

mad

e

in

th

e

future

at

a

fixed

ti

me

**Future**

**rate**

=

spot

rate

that

is

ex

p

e

ct

ed

in

the

future

**Dur**

**ati**

**on**

=

w

eighted

avera

ge

of

the

tim

es

when

bon

d

's

cash

pay

m

ents

are

received

**Nominal**

**interest**

**rate**

=

ra

te

you

ac

tu

al

ly

pay

when

you

borrow

mon

ey

**Real**

**in**

**te**

**re**

**st**

**rate**

=

th

eoretical

rate

you

pay

when

yo

u

borrow

mo

ney,

as

deter

m

ined

by

supply

and

demand

including

inflation

**Chapter**

**4**

**(Va**

**lu**

**e**

**of**

**common**

**stocks)**

**P**

**0**

**(n**

**ot**

**cons**

**tant**

**growth)**

=

+

+

...

+

P

H

=

**P**

**0**

**(c**

**ons**

**tant**

**growth)**

=

+

+

...

+

x

**r**

=

+

g

=

divi

dend

yield

+

g

=

**ROE**

**=**

**g**

=

RO

E

x

plo

w

back

ra

tio

**PV**

**(busi**

**n**

**ess)**

=

...

+

PV

(f

ree

cash

flows)

PV

(

h

orizon/value)

**Common**

**st**

**ock**

**=**

ownership

shares

in

a

publi

cly

held

corporation

**Prima**

**ry**

**market**

**=**

mar

ket

for

the

sale

of

new

securities

by

corporations

**Secondary**

**ma**

**rk**

**et**

**=**

mark

et

in

which

pr

eviously

issued

securities

ar

e

trades

among

investors

**Book**

**va**

**lu**

**e**

**=**

net

worth

of

the

fir

m

a

cco

rding

to

the

balance

sheet

(backward

lo

oking

measur

e)

**Market**

**value**

**=**

depe

nds

on

future

divid

ends

that

shareholders

expect

to

receive,

forw

ard

looking

**Dividen**

**d**

**=**

period

ic

cash

d

istribution

fr

om

firm

to

shareholders

**Market**

**value**

**bal**

**ance**

**sheet**

**=**

fina

ncial

statement

using

market

value

of

assets

and

lia

bilities

**Expec**

**ted**

**re**

**turn**

**=**

perc

en

tag

e

yield

that

investor

forecasts

from

a

specific

inves

tment

over

a

set

period

of

time

(=

marke

t

ca

pitaliza

tion

rate)

**Dividen**

**d**

**yield**

=

shows

how

mu

ch

com

p

any

pays

out

in

divide

nds

each

year

relative

to

its

share

price

**Payo**

**ut**

**rati**

**o**

=

fraction

of

earning

paid

out

as

divid

e

nds

**Plo**

**w**

**b**

**ack**

**ratio**

**=**

fraction

of

earnings

re

ta

in

ed

by

th

e

firm

3

**PVGO**

=

P

0

**Horiz**

**o**

**n**

**Va**

**lue**

**=**

value

of

a

bond

at

maturity

or

of

an

asset

at

a

spe

cified

date,

ta

king

in

to

account

in

te

re

st

rates

&

current

value

of

the

ass

et

(assuming

stable

growth

ra

te)

**Prese**

**n**

**t**

**value**

**of**

**growth**

**oppor**

**tu**

**n**

**iti**

**e**

**s**

**(PVGO)**

=

net

present

value

of

a

firm's

future

in

ve

st

m

ent

**Chapter**

**5**

**(N**

**PV**

**an**

**d**

**ot**

**her**

**inves**

**tment**

**cr**

**it**

**e**

**ria**

**)**

0

=

C

0

+

+

+

...

+

**Internal**

**rate**

**of**

**re**

**turn**

**(I**

**R**

**R**

**)**

=

is

th

e

"r"

that

mak

es

the

NPV

=

0

**Investment**

**eva**

**lu**

**at**

**ion**

**tec**

**hniq**

**u**

**es**

**:**

**NPV**

**IRR**

**(l**

endi

ng/

borrowing,

multiple

Ro

R)

**Payb**

**ack**

(acc

epts

proje

cts

that

pay

ba

ck

in

desired

ti

me

frame,

but

ignores

la

ter

cash

flow

s

&

inflation)

**Book**

**rat**

**e**

**of**

**return**

(avera

ge

income

di

vided

by

average

book

value,

but

no

inflation)

**Profi**

**tability**

**Index**

**(NPV**

di

vided

by

inve

stment,

bu

t

what

happens

wi

th

unuse

d

cash)

**Capital**

**rationing**

=

limit

se

t

on

the

am

ount

of

fu

nds

available

for

investment

**Soft**

**ra**

**ti**

**o**

**n**

**ing**

**=**

limi

ts

on

available

funds

imposed

by

manage

me

nt

(fo

r

bigger

firms)

**Har**

**d**

**ra**

**ti**

**o**

**n**

**ing**

**=**

li

mits

on

available

funds

imposed

by

unavailabili

ty

of

funds

in

ca

pit

al

market

(fo

r

smaller

fir

m

s)

**Chapter**

**6**

**(Investment**

**decisions**

**wi**

**th**

**the**

**NPV**

**ru**

**le**

**)**

**Working**

**Capital**

=

current

assets

current

liabilities

**Real**

**discoun**

**t**

**ra**

**te**

=

1

**Equival**

**e**

**n**

**t**

**annu**

**al**

**ann**

**u**

**ity**

=

**Annui**

**ty**

**fa**

**cto**

**r**

=

**Equival**

**e**

**n**

**t**

**annu**

**al**

**ann**

**u**

**ity**

=

the

cash

fl

ow

per

period

with

the

same

present

value

as

the

actual

cash

flow

of

the

project

(e.g.

an

nual

costs

for

machin

e)

**Chapter**

**7**

**(In**

**troducti**

**on**

**to**

**risk**

**and**

**re**

**turn)**

**Market**

**prem**

**ium**

=

return

stock

market

risk

free

rate

**Treasury**

**bills**

**(T**

**Bills)**

=

short

term

US

govern

m

en

t

bon

d

(3

4

year

s),

risk

free,

bu

t

still

uncer

tainty

ab

ou

t

in

flation

**Common**

**st**

**ock**

=

normal

stock

**Vari**

**ance**

=

th

e

variance

of

the

marke

t

return

is

th

e

exp

ec

te

d

squared

4

**Vari**

**ance**

=

((expected

return

actual

re

tu

rn

)²

x

pro

b

ability

)

**St**

**andard**

**de**

**via**

**tio**

**n**

=

variance

**Expec**

**ted**

**Po**

**rt**

**fo**

**lio**

**Re**

**tu**

**rn**

=

(

x

1

r

1

)

+

(x

2

r

2

)

**Por**

**tfoli**

**o**

**Vari**

**ance**

=

x

1

2

1

2

+

2(x

1

x

2

p

12

1

2

)

+

x

2

2

2

2

**Beta**

=

deviation

fro

m

the

ex

p

e

ct

ed

return

**St**

**andard**

**de**

**via**

**tio**

**n**

=

is

the

square

root

of

the

variance

(risk!

)

**Diversification**

=

strategy

d

esigned

to

re

duce

risk

by

s

p

reading

th

e

portfolio

across

many

inve

stments

(at

le

ast

reduce

m

acroeconomi

c

influences)

**Uniq**

**ue**

**risk**

=

risk

factors

affecting

only

that

fir

m

, als

o

called

*diver*

*sifiabl*

*e*

*risk*

**Market**

**ri**

**sk**

=

economy

wid

e

sources

of

risk

that

affect

the

overall

stock

market,

also

called

*sys*

*tem*

*atic*

*risk*

**Market**

**portf**

**o**

**lio**

=

portfolio

of

all

assets

in

the

econo

m

y

**Beta**

=

se

nsiti

vity

of

a

stock's

return

to

the

return

on

the

marke

t

portfolio

(cal

culates

how

one

chosen

fluctuates

in

com

p

arison

to

market)

**Chapter**

**8**

**(**

**P**

**ortf**

**olio**

**theory**

**&**

**capital**

**asset**

**pricing**

**model)**

**Sharpe**

**rati**

**o**

=

**SML**

**(CA**

**P**

**M**

**/**

**cost**

**of**

**e**

**quity**

**/**

**exp**

**e**

**cte**

**d**

**return)=**

return

at

risk

free

rate

+

bet

a

(marke

t

retur

n

retur

n

at

risk

free

rate)

**Markowi**

**tz**

**Portf**

**o**

**lio**

**Theory**

=

combi

n

ing

stocks

into

portfolios

can

reduce

st

andard

deviation

(risk

)

throug

h

correlation

coefficie

n

ts

**Efficient**

**frontier**

=

portfolios

on

this

li

ne

will

offer

th

e

hig

h

est

expecte

d

return

for

any

level

of

risk

**Securit**

**y**

**ma**

**rk**

**e**

**t**

**line**

**(SML)=**

co

mbinati

o

n

of

risk

free

bonds

&

stock

portfolio

(in

question:

required

ROI

or

opportunity

cost

of

capital,

retur

n

)

=

relationship

betw

een

return

&

ris

k

**Sharpe**

**rati**

**o**

=

ratio

of

risk

premium

to

standard

deviation

(gives

us

the

one

portfolio

which

gives

us

the

SM

L)

**Capital**

**ass**

**e**

**t**

**pricing**

**mo**

**d**

**e**

**l (CAPM)**

=

mod

el

tha

t

desc

rib

es

the

relationship

betwee

n

risk

and

ex

p

e

ct

ed

retur

n

**Arbitrage**

**pri**

**cing**

**model**

=

assumes

that

each

stock's

return

d

epend

s

partly

on

pervasive

macroeconomic

infl

uences

and

on

events

that

are

uniqu

e

to

the

compa

n

y

**Risk**

**pr**

**emiu**

**m**

=

The

retur

n

in

excess

of

the

risk

free

rate

of

return

that

an

investment

is

ex

p

e

ct

ed

to

yield

(fo

rm

of

comp

ensa

tion

for

inves

tors

who

tolerate

the

extra

risk)

**Three**

**Fa**

**ct**

**or**

**Model**

=

factors

that

appear

to

de

termi

n

e

ex

p

e

ct

ed

returns:

**Market**

**fa**

**ctor**

(re

turn

on

market

risk

free

rate)

**Size**

**factor**

(r

eturn

on

small

return

on

large

firm

stocks)

**Book**

**to**

**ma**

**rk**

**e**

**t**

**fac**

**tor**

(r

e

turn

on

hi

gh

return

on

low

book

to

market

ratio

stocks)

Excerpt out of 9 pages

- Quote paper
- Laura Herrmann (Author), 2012, Corporate Finance. Summary of "Principles of Corporate Finance" by Brealey et al.(11th edition)", Munich, GRIN Verlag, https://www.grin.com/document/277872

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