HKICPA QP Module 7 Financial Management flashcards

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

Agency problem

Conflict where managers pursue personal goals rather than shareholder wealth. Mitigated by share-based pay, monitoring, takeover threat, and debt covenants that constrain managers.

Wealth maximisation objective

Maximising the present value of expected future cash flows to shareholders. Preferred over profit maximisation because it accounts for timing, risk, and cash rather than accounting accruals.

Weak-form efficiency

Share prices already reflect all historical price and volume data. Technical analysis cannot earn abnormal returns; fundamental analysis may still add value if markets are only weak-form efficient.

Semi-strong efficiency

Prices reflect all publicly available information, including financial statements and announcements. Neither technical nor fundamental analysis yields abnormal returns; only private information could.

Value for money

Public-sector objective assessed by economy, efficiency, and effectiveness. Economy is lowest input cost; efficiency is output per unit input; effectiveness is whether stated objectives are actually achieved.

Financial intermediary role

Banks and funds pool savings, reduce transaction costs, and resolve information asymmetry between savers and borrowers. They channel funds from surplus units to deficit units efficiently.

Net present value

Sum of discounted future cash flows minus initial outlay. Accept projects with NPV above zero; it measures absolute value added and assumes reinvestment at the cost of capital.

Internal rate of return

Discount rate at which NPV equals zero. Accept if IRR exceeds the cost of capital, but beware multiple IRRs when cash flow signs change more than once.

Discounted payback period

Time for discounted cash flows to recover the initial outlay. It accounts for time value but still ignores cash flows arising after the payback date.

Profitability index

Present value of future cash flows divided by initial investment. Used to rank divisible projects when capital is rationed, since it measures value per unit of scarce capital.

Relevant cash flow

Incremental, future cash flow arising only because the project is undertaken. Exclude sunk costs and apportioned overheads; include opportunity costs and working capital changes.

Fisher effect

Relationship between nominal and real rates: (1 + nominal) = (1 + real) x (1 + inflation). Discount nominal cash flows at nominal rates and real flows at real rates.

Equivalent annual cost

NPV of one replacement cycle divided by the annuity factor for that cycle's life. Choose the asset with the lowest equivalent annual cost when lives differ.

Sensitivity analysis

Calculates how far one input variable can change before NPV reaches zero, holding others constant. It identifies critical variables but ignores correlations between them.

Dividend growth cost of equity

Ke = D1 / P0 + g, where g is the expected growth rate. D1 equals D0 x (1 + g); g may be estimated as retention ratio times return on reinvested funds.

CAPM cost of equity

Ke = risk-free rate + beta x market risk premium. Beta captures systematic risk only, because unsystematic risk is diversified away and earns no premium.

After-tax cost of debt

Pre-tax yield multiplied by (1 minus tax rate). For redeemable debt, the yield is the IRR of after-tax interest and redemption proceeds against current market price.

Weighted average cost of capital

WACC = (E/V) x Ke + (D/V) x Kd x (1 - t), using market value weights. Use target or marginal weights for appraising new investment projects.

MM with tax

Modigliani-Miller proposition: debt interest is tax-deductible, so firm value increases and WACC falls as gearing rises, ignoring financial distress costs.

Trade-off theory of gearing

Optimal capital structure balances the tax shield benefit of debt against rising financial distress and agency costs. Beyond the optimum, firm value falls as gearing increases.

Pecking order

Financing preference order driven by information asymmetry: retained earnings first, then debt, then new equity last, since equity issues signal overvaluation to investors.

Theoretical ex-rights price

TERP = (market value of existing shares + rights issue proceeds) / total shares after issue. It is the theoretical price after the rights issue is completed.

Residual dividend theory

Dividends are paid only from earnings left after funding all positive-NPV projects at the target capital structure. Dividend levels therefore fluctuate with investment opportunities.

Cash operating cycle

Inventory days plus receivable days minus payable days. It measures the period between paying suppliers and collecting from customers; shortening it releases working capital.

Economic order quantity

EOQ = square root of (2 x annual demand x order cost / holding cost per unit). At this order size, total ordering and holding costs are minimised.

Aggressive working capital policy

Finances fluctuating and some permanent current assets with short-term debt. It offers higher returns but greater liquidity and refinancing risk than a conservative policy.

Matching funding policy

Maturity matching: long-term finance funds non-current and permanent current assets, while short-term finance funds fluctuating current assets. It balances risk and return.

Transaction exposure

Risk that exchange rate movements change the value of known future foreign currency cash flows. Managed by forwards, futures, options, money market hedges, or leading and lagging.

Economic exposure

Long-term risk that exchange rate changes affect a firm's competitive position and future cash flows. Strategic responses include relocating production and diversifying markets.

Forward exchange contract

Agreement to buy or sell currency at a fixed rate on a future date. It removes uncertainty for known amounts but offers no upside and carries counterparty risk.

Interest rate swap

Exchange of fixed and floating interest payments between parties. Used to convert fixed-rate exposure to floating or vice versa, matching debt obligations to expected cash flows.

Forward rate agreement

Contract fixing an interest rate for a future borrowing or deposit period. Settlement is the difference between the agreed rate and the reference rate, discounted.

Centralised treasury function

Pools group cash, nets intercompany flows, and manages liquidity, funding, and currency risk centrally. It reduces idle balances and improves bargaining power with banks.