DSST Principles of Finance flashcards

33 cards. Read the term and the definition here. The deck at the top of this page is optional.

Balance sheet identity

Total assets always equal total liabilities plus stockholders' equity. The statement is a snapshot of a firm's financial position at a single date, unlike the income statement, which covers a period.

Free cash flow

Operating cash flow minus capital expenditures minus the change in net working capital. It measures cash available to creditors and shareholders after the firm funds operations and required investment.

Sustainable growth rate

Return on equity multiplied by the retention ratio (one minus the dividend payout ratio). It estimates how fast a firm can grow using only internally generated funds and existing debt capacity.

DuPont identity

ROE equals net profit margin times total asset turnover times the equity multiplier. It separates profitability, operating efficiency, and financial leverage as distinct drivers of shareholder returns.

Common-size financial statement

A statement where each line is shown as a percentage: income statement items as a percent of sales, balance sheet items as a percent of total assets. It enables comparison across firms of different size.

Future value of lump sum

FV equals PV times (1 + r) raised to the power n, where r is the periodic rate and n the number of periods. It compounds a present amount forward in time.

Present value of annuity

PV equals PMT times [1 minus (1 + r)^-n] divided by r. It values a level stream of end-of-period payments, such as loan installments or lease payments.

Effective annual rate

EAR equals (1 + APR/m)^m minus 1, where m is the compounding periods per year. It converts a nominal quoted rate into the true annual rate actually earned or paid.

Annuity due

A stream of equal payments made at the beginning of each period rather than the end. Each payment compounds one extra period, so value is (1 + r) times the ordinary annuity value.

Growing perpetuity

Value equals the next payment divided by (r minus g), where g is the constant growth rate. The formula is valid only when the discount rate exceeds the growth rate.

Rule of 72

An approximation for doubling time: divide 72 by the annual percentage rate. At 8 percent interest, money doubles in roughly nine years rather than requiring exact logarithmic calculation.

Cash conversion cycle

Inventory period plus receivables collection period minus payables deferral period. It measures how many days cash is tied up in operations before customers pay and suppliers are paid.

Quick ratio

Current assets minus inventory, divided by current liabilities. It tests short-term liquidity using only the most liquid assets, since inventory may be difficult to convert to cash quickly.

Economic order quantity

The order size that minimizes total inventory cost, balancing ordering costs against carrying costs. Total carrying cost rises with order size while ordering cost falls with fewer orders.

Cost of foregoing discount

Discount percentage divided by (one minus discount percentage), multiplied by 365 divided by the days between discount date and final due date. It annualizes the cost of paying late.

Credit terms 2/10 net 30

The buyer may deduct 2 percent by paying within 10 days; otherwise the full invoice is due in 30 days. Skipping the discount implies expensive implicit short-term borrowing.

Net working capital

Current assets minus current liabilities. A positive balance indicates short-term assets exceed obligations coming due within one year, a basic measure of liquidity.

Bond price versus yield

Bond prices move inversely to market interest rates. When the coupon rate equals the yield to maturity the bond sells at par; a higher yield pushes price below par.

Constant growth dividend model

Price equals next year's dividend divided by (required return minus growth rate). It values common stock assuming dividends grow forever at a constant, sustainable rate below the required return.

Cumulative preferred stock

Preferred shares whose unpaid dividends accumulate in arrears. All missed preferred dividends must be paid before common shareholders can receive any dividend distribution.

Interest rate risk and duration

Longer maturities and lower coupon rates produce greater bond price sensitivity to rate changes. Duration summarizes this sensitivity in years and rises with both factors.

Net present value rule

Accept a project when the present value of its future cash flows exceeds the initial investment. NPV measures the dollar increase in shareholder wealth from undertaking the project.

Internal rate of return

The discount rate at which a project's NPV equals zero. Accept when IRR exceeds the required return, but prefer NPV for mutually exclusive projects because of scale and timing conflicts.

Profitability index

Present value of future cash flows divided by initial investment. When capital is rationed, rank independent projects by this ratio to maximize value per dollar invested.

Sunk cost

A cost already incurred that cannot be recovered regardless of the decision. It must be excluded from incremental capital budgeting analysis because it does not change with the project choice.

Operating cash flow with taxes

Operating cash flow equals (sales minus costs) times (1 minus tax rate), plus depreciation times the tax rate. Depreciation adds back because it shields income from taxation without using cash.

Weighted average cost of capital

WACC equals equity weight times cost of equity plus debt weight times after-tax cost of debt. Weights should use market values of debt and equity, not book values.

After-tax cost of debt

The pre-tax yield on debt multiplied by (1 minus the corporate tax rate). Interest is tax-deductible, so the government effectively subsidizes part of the borrowing cost.

Capital asset pricing model

Required return equals the risk-free rate plus beta times the market risk premium. Beta captures systematic risk, the portion of volatility that diversification cannot remove.

Flotation costs

Fees paid to investment bankers and lawyers when issuing new securities. They reduce net proceeds, raising the effective cost of new equity and lowering a project's net present value.

Systematic versus unsystematic risk

Systematic risk affects the whole market and cannot be diversified away; unsystematic risk is firm-specific and can be eliminated. Only systematic risk earns a risk premium.

Portfolio beta

The weighted average of the betas of the individual securities in the portfolio, using market value weights. Portfolio beta measures the portfolio's sensitivity to overall market movements.

Sharpe ratio

Portfolio return minus the risk-free rate, divided by the portfolio's standard deviation. It measures excess return earned per unit of total risk borne.