Advanced Financial Management Test 1

Operating, Investing, Financing

What are the three activities on the Statement of Cash Flows


Does market value = book value?

Assets - Liabilities

Equity Book Value formula

share price * # of shares outstanding (Market Cap)

Market Value formula

Rule of 72

The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest.


a bond or other security with no fixed maturity date.


a series of payments made at equal intervals, for a fixed period

Growing Perpetuity

is a series of periodic payments that grow at a proportionate rate and are received for an infinite amount of time.

Common Stock

shareholders are owners of the firm, each share has one vote in major company decisions, shares trade on an exchange

Market Order

a request to buy or sell a stock at the current market value

Limit Order

a request to buy or sell a stock when it reaches a specified price

Bid-Ask Spread

the difference between the bid (Buyers) price and the asked (Sellers) price


Limit orders make sense when the bid-ask spread is (small/large)

Realized Returns

what the stock actually earned over a past period

Total Payout Model

If you see "repurchases" in the question, which model should you use to value a stock?

Net Present Value

the difference between the present value of benefits (cash inflows) and the present value of costs (cash outflows)


For the NPV decision rule, when should you accept a project, when NPV (positive/negative)?

Cost of Capital

Return on investments with similar risk, maturity


Does the NPV method always lead to the correct decision?

Internal Rate of Return

the discount rate that sets NPV to zero


IRR rule, accept a project if IRR is (greater/less than) the discount rate?

Payback Rule

rule stating to accept a project if it pay back the investment within a specific time frame, otherwise reject

Ignores TVM, ignores CFs after the payback period, arbitrary payback period

What are the flaws with Payback rule?


When borrowing money, you want as (high/low) rate, or IRR, as possible


When borrowing money, you want IRR to be (greater/less than) cost of capital?

Profitability Index

the present value of an investment's future cash flows divided by its initial cost

NPV/Resources Consumed

Profitability index formula?

Pro Forma

financial statements that contain projections of earnings and cash flows based on hypothetical assumptions

incremental cash flows

the difference between a firm's future cash flows with a project and those without the project

Operating Expenses

ongoing costs from running a product, business, or system

Capital Expenses

cost to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land


is depreciation a cash flow?

Unlevered Earnings

Evaluating a companies earnings as if they will not use debt to finance it (not including interest expense in capital budgeting calculations)

Free Cash Flows

the cash that is actually available for distribution to the investors in the firm after the investments that are necessary to sustain the firm's ongoing operations are made

Dividend Discount Model

One share of stock is worth the present value of expected cash dividend payments

Total Payout Model

Firm's equity is worth the present value of expected amount of share repurchases and cash dividends

Discounted Cash Flow

Valuation method that estimates total (enterprise) value of the firm

Enterprise Value

The total market value of a firm's equity and debt, less the value of its cash and marketable securities. It measures the value of the firm's underlying business.

Weighted Average Cost of Capital

This is used as the cost of capital for a DCF valuation

Valuation Principle

Law of one price, two securities with identical cash flows have the same price

Valuation Multiple

Ratio of firm or equity value to some accounting measure (usually profits)

Price-Earnings Ratio

share price divided by earnings per share

PE Ratio*EPS

How do you estimate a firm's stock price with the P/E Ratio?


For the PE Ratio, higher growth leads to a ____________ PE Ratio