CPA PEP Finance Elective key terms

The blended after-tax rate a company expects to pay for all its long-term funding, weighting the cost of debt and equity by their share of total capital. It is used as the discount rate for projects of average risk.

The return shareholders require to hold a company's shares, reflecting the risk they bear. Because it is not contractually paid, it is estimated using models such as the capital asset pricing model or dividend growth.

The effective interest rate a company pays on borrowed funds, usually measured after tax because interest is deductible. It reflects the lender's required yield given the borrower's credit risk and the term of the borrowing.

A method for estimating required equity return as the risk-free rate plus beta multiplied by the market risk premium. It prices only systematic risk, assuming investors can diversify away company-specific risk.

A measure of how much a stock's returns move relative to the overall market. A beta above one means the stock amplifies market swings; below one means it is less sensitive. Unlevered beta strips out financing effects.

The extra return investors expect from holding a diversified market portfolio instead of risk-free assets. It is an economy-wide estimate, often based on long-run historical equity returns over government bond yields.

The mix of debt, preferred shares, and common equity a company uses to fund its assets. The chosen mix affects cost of capital, financial flexibility, and the risk borne by each class of investor.

The use of fixed-cost debt to magnify returns to shareholders. It raises expected earnings per share when returns on assets exceed after-tax interest cost, but it also magnifies losses and default risk.

The idea that firms balance the tax shield from debt against rising bankruptcy and agency costs. An optimal debt level exists where the marginal benefit of extra debt equals its marginal cost.

A financing hierarchy arguing that firms prefer internal funds first, then debt, then new equity, because of information asymmetry and issuance costs. It explains why profitable firms often borrow little.

The reduction in income tax achieved by deducting an expense, most commonly interest on debt or capital cost allowance. Its present value is a real cash benefit that lowers the effective cost of borrowing.

Direct and indirect costs arising when a firm nears default, including legal and advisory fees, lost customers, supplier tightening, and employee departures. These costs offset the tax advantage of high debt levels.

The sum of a project's expected future cash flows discounted at the required rate, minus its initial outlay. A positive NPV means the investment is expected to add value to shareholders.

The discount rate at which a project's net present value equals zero. It is compared with the hurdle rate, but can mislead when cash flow signs change or when comparing projects of different scale.

The change in a company's total cash flow caused directly by accepting a project, including opportunity costs and working capital effects but excluding sunk costs and allocated overhead that would occur anyway.

Money already spent that cannot be recovered regardless of the decision taken. It should be ignored in capital budgeting because it does not differ between accepting and rejecting a project.

The minimum return a company requires before committing capital to an investment. It is usually set from the weighted average cost of capital, adjusted upward for projects riskier than the firm's average.

The value forgone when a resource is used in one way rather than its best alternative use. In project analysis it is a relevant cash flow, such as lost rent when owned space is repurposed.

The time required for cumulative cash inflows to recover an initial investment. It is simple and highlights liquidity risk, but ignores cash flows after the cutoff and the time value of money.

The time needed for the present value of cash inflows to equal the initial outlay. It accounts for the time value of money but still ignores value created after the payback point.

The value of managerial flexibility embedded in a project, such as the option to expand, delay, abandon, or switch inputs. Traditional discounted cash flow analysis often understates project value by ignoring these choices.

A technique that recalculates project or forecast outcomes under several coherent sets of assumptions, such as base, upside, and downside cases. It shows the range of possible results rather than a single point estimate.

Testing how an output such as net income or NPV changes when one input is varied while others are held constant. It identifies which assumptions most strongly drive the result and deserve tighter monitoring.

Cash generated by operations after reinvestment in working capital and fixed assets, available to debt and equity holders. It is a core input to valuation because it reflects cash rather than accounting profit.

Estimating an asset's value by projecting future free cash flows and discounting them at a rate reflecting risk. The result depends heavily on terminal value assumptions and the discount rate chosen.

The estimated value of all cash flows beyond the explicit forecast horizon, often computed with a perpetuity growth formula or an exit multiple. It frequently dominates a DCF result and must be tested for reasonableness.

A valuation ratio, such as enterprise value to EBITDA, applied to a company's final forecast-year metric to estimate terminal or sale value. It is drawn from comparable transactions or trading multiples.

Valuing a business by applying trading multiples of similar public companies, such as price-to-earnings or enterprise value to EBITDA, to the target's metrics. It reflects market pricing but depends on truly comparable peers.

Valuing a company using multiples paid in past acquisitions of similar businesses. Because transaction prices include control premiums, results typically exceed trading multiples for the same sector.

The extra amount a buyer pays above the market price of shares to acquire a controlling stake. It reflects the value of control rights, including the ability to set strategy and replace management.

Additional value created when two businesses combine, such as cost savings or revenue gains neither could achieve alone. Synergies justify acquisition premiums only if they are quantified, achievable, and not already priced in.

A test of whether an acquisition increases or decreases the buyer's earnings per share. It compares combined pro forma earnings with the acquirer's standalone earnings, accounting for financing costs and new shares issued.

The process of assigning an acquisition's cost to acquired tangible and intangible assets and liabilities at fair value, with any excess recorded as goodwill. It determines future amortization and impairment exposure.

A write-down when the carrying amount of a cash-generating unit, including goodwill, exceeds its recoverable amount. It reduces profit and assets without a cash outflow but signals that an acquisition underperformed.

A transaction in which an acquirer obtains control of one or more businesses. Accounting requires identifying the acquirer, the acquisition date, and fair values of assets acquired and liabilities assumed.

The portion of a subsidiary's equity not owned by the parent, presented separately within consolidated equity. It arises when the parent holds control but less than full ownership of a subsidiary.

Combining a parent and its controlled subsidiaries into one set of financial statements, eliminating intercompany balances and transactions. It presents the economic group as a single reporting entity.

The degree to which reported profit reflects sustainable operating performance rather than one-time items, accounting estimates, or accrual manipulation. Analysts examine accruals, revenue recognition, and reserves when assessing it.

Recognition of revenue or expense when the underlying economic event occurs, regardless of when cash changes hands. Accruals improve matching but require estimates that can be managed or reversed.

The principles determining when and how much revenue is recorded, generally when performance obligations are satisfied and control transfers. Timing judgments can materially shift profit between periods.

Earnings before interest and taxes divided by interest expense, showing how many times operating profit covers financing costs. A falling ratio signals growing leverage risk and tighter lender covenants.

A contractual restriction in a lending agreement requiring the borrower to maintain specified financial ratios or limiting actions such as dividends and additional borrowing. Breach can trigger default or renegotiation.

The difference between the yield on a corporate bond and a comparable government bond, compensating lenders for default and liquidity risk. Widening spreads raise new borrowing costs and signal deteriorating credit conditions.

A position taken to offset exposure to a price, interest rate, or currency movement. Effective hedges reduce volatility but can create basis risk and require disclosure of hedge accounting treatment.

A contract in which two parties exchange fixed and floating interest payments on a notional amount. Companies use it to convert fixed-rate debt to floating or vice versa without renegotiating the underlying loan.

The risk that currency movements affect reported results or cash flows, arising from transactions, translation of foreign operations, or economic competitiveness. Each type is managed and disclosed differently.

A financial contract whose value depends on an underlying asset, rate, or index, such as a forward, option, or swap. Derivatives are measured at fair value and may qualify for hedge accounting.

A three-level ranking of inputs used to measure fair value: quoted prices for identical assets, observable market inputs, and unobservable inputs. More unobservable inputs mean greater estimation uncertainty.

A reduction in an asset's carrying amount when its recoverable amount falls below book value. It applies to goodwill, intangibles, and long-lived assets and often reveals overly optimistic past assumptions.

A projection of future financial results built from explicit operating assumptions about volumes, prices, costs, and capital needs. It supports budgeting, valuation, and covenant testing.

Comparing actual results with budgeted or forecast amounts and decomposing the gap into volume, price, and mix effects. It directs management attention to the drivers that caused performance to differ from plan.

A conflict of interest when managers or agents pursue their own goals rather than those of shareholders or principals. Governance mechanisms such as independent boards and incentive alignment aim to reduce it.

The system of board oversight, controls, disclosure, and accountability that directs how an organization is run. Strong governance protects stakeholders and reduces the likelihood of fraud and poor strategic decisions.

A deal between a company and someone closely connected to it, such as a director or major shareholder. Such transactions require scrutiny, disclosure, and often independent approval because they may not be at arm's length.

An attitude of questioning assumptions and corroborating information rather than accepting it at face value. It is essential when evaluating management forecasts, valuations, and unusual transactions.