CMA Sri Lanka SL2 Financial Strategy & Valuation Exam flashcards

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

Sustainable growth rate

Maximum sales growth a firm can finance from retained earnings while holding leverage and dividend payout constant. It equals ROE multiplied by the retention ratio, which is one minus the dividend payout ratio.

Ansoff growth matrix

Grid of four strategic options: market penetration, market development, product development and diversification. Risk increases as the firm moves further from its existing products and existing markets.

Value driver

Operational or financial variable that materially changes shareholder value, such as sales growth, operating margin, capital intensity or cost of capital. Financial strategy is built around managing these levers.

Agency problem

Conflict arising when managers, acting as agents, pursue their own interests rather than those of shareholders. It is controlled through monitoring, bonding arrangements, incentive contracts and the market for corporate control.

Stakeholder theory

Proposes that a firm should be managed in the interests of all parties affected by it, including employees, customers, suppliers, lenders and communities, rather than for shareholders alone.

Value for money (3Es)

Public-sector objective measured through economy (cost of inputs), efficiency (output per unit of input) and effectiveness (achievement of intended outcomes). Used where profit is not the primary organisational objective.

Modigliani–Miller Proposition I

In perfect markets without taxes, a firm's total value is independent of its capital structure; the value of the levered firm equals the value of the identical unlevered firm.

Interest tax shield

Tax saving obtained from deducting interest payments. In the Modigliani–Miller model with corporate tax, firm value increases by the corporate tax rate multiplied by the market value of debt.

Pecking order theory

Firms prefer internal funds first, then debt, then hybrid securities, and issue new equity last, because information asymmetry makes equity issues costly and interprets them as unfavourable news.

Financial distress costs

Direct costs include legal and administrative fees of restructuring; indirect costs include lost sales, withdrawal of supplier credit and staff departures. They offset the interest tax shield at high gearing.

Weighted average cost of capital

Required return on the firm's assets, calculated as the market-value-weighted average of after-tax cost of debt and cost of equity using target weights. It is used to discount free cash flow to the firm.

Capital asset pricing model

Cost of equity equals the risk-free rate plus beta multiplied by the market risk premium: Ke = Rf + beta (Rm − Rf). Beta measures the security's systematic risk relative to the market portfolio.

Hamada equation

Formula that unlevers and relevers equity beta: levered beta = unlevered beta × [1 + (1 − tax rate)(debt/equity)]. It is used to derive a project discount rate from pure-play comparable companies.

Marginal cost of capital

Cost of raising the next unit of finance. New investment should be appraised against this rate rather than the historical average, because raising additional funds pushes the cost of capital upwards.

Net present value

Sum of discounted incremental after-tax cash flows less the initial investment outlay. A positive NPV at the required return adds shareholder value, making it the preferred method for mutually exclusive projects.

Internal rate of return

Discount rate at which a project's net present value equals zero. Accept if it exceeds the required return; it is unreliable for non-conventional cash flows, which can generate multiple internal rates of return.

Equivalent annual cost

A project's net present value divided by the annuity factor for its life. Used to compare assets with unequal lives or different replacement cycles on a consistent annual cost basis.

Sensitivity analysis

Varies one input at a time to find the change that reduces NPV to zero, giving each variable's margin of safety. It ignores probabilities and any correlation between the variables.

Certainty equivalent method

Converts risky expected cash flows into risk-free equivalents using a coefficient, then discounts them at the risk-free rate. It avoids the arbitrary premium used in the risk-adjusted discount rate approach.

Real option

Right, but not obligation, to alter a project, for example to defer, expand, contract, abandon or switch inputs. It adds value beyond static NPV and is valued using option pricing models.

Economic value added

NOPAT minus the product of WACC and invested capital. A positive figure indicates that the firm earned more than its cost of capital and therefore created value during the period.

Free cash flow to firm

NOPAT plus depreciation, less capital expenditure, less the increase in net working capital. It is discounted at WACC to derive enterprise value in a discounted cash flow valuation.

Terminal value

Value of a business at the end of the explicit forecast period, usually the final year's cash flow grown at a constant rate and divided by WACC minus growth, or an exit multiple.

Market value added

Market value of the firm minus the book value of capital invested in it. It equals the present value of all expected future economic value added and measures cumulative value creation.

Theoretical ex-rights price

Market value of the company before a rights issue plus the cash raised, divided by the total number of shares after the issue. Used to value the rights and assess the issue discount.

Convertible bond

Debt that the holder may exchange for a fixed number of shares. It carries a lower coupon than straight debt in return for the equity option and dilutes existing shareholders on conversion.

Finance lease

Lease transferring substantially all risks and rewards of ownership to the lessee. Under IFRS 16 the lessee recognises a right-of-use asset and a lease liability at the present value of payments.

Cash conversion cycle

Inventory days plus receivable days minus payable days. It measures how long cash is tied up in operations; shortening the cycle releases cash and reduces short-term funding requirements.

Economic order quantity

Order size that minimises the combined ordering and holding costs, calculated as the square root of two times annual demand times cost per order, divided by holding cost per unit.

Forward rate agreement

Over-the-counter contract that fixes an interest rate for a future period on a notional principal. It is cash-settled against a reference rate and used to hedge borrowing or deposit rates.

Interest rate swap

Agreement between two parties to exchange fixed and floating interest payments on a notional principal for a set period, converting fixed-rate exposure to floating or the reverse.

Value at risk

Maximum expected loss over a stated time horizon at a given confidence level, estimated from historical or model-based distributions. It says nothing about losses beyond that threshold.