afin1002 cheat sheet Cheatsheet by zenari

Core Principles

Financial Goals

Financial Assets
 Firms pay for these real assets by selling claims on then and the cash flows they will
generate. These claims are called financial assets.
o Examples
 Debt – Bank loan: A bank provides a firm with cash in exchange for the firm
repaying the loan with interest
 Debt – Bond: A firm sells (issues) a bond to investors in exchange for
promising to pay interest payments and principal at maturity
 Equity – Shares: A firm sells (issues) shares in exchange for ownership in the
company and residual cash flows
 The two key decisions faced by financial managers are:

Investment decision

Purchase of real assets

Financing decision

Issue of financial assets

Maximizing Shareholder Wealth: The primary goal of corporate finance. Achieved through strategic investment and financing decisions.

Efficient Capital Allocation: Deploying capital to projects that generate the highest risk-adjusted returns.

Time Value of Money

Present Value (PV): Value of future cash flows discounted to today.
Future Value (FV): Value of an asset at a specified date in the future based on the rate of growth.
Annuity: A series of equal payments made at equal intervals.

Risk and Return

Risk: The uncertainty of future returns.

Return: The gain or loss on an investment over a period.

Diversification: Reducing risk by investing in a variety of assets.

Capital Asset Pricing Model (CAPM): A model used to determine the required rate of return for an asset.

Capital Budgeting

Investment Criteria

Net Present Value (NPV): The sum of the present values of all cash flows from a project, minus the initial investment. Accept projects with NPV > 0.

Internal Rate of Return (IRR): The discount rate that makes the NPV of all cash flows from a project equal to zero. Accept projects with IRR > cost of capital.

Payback Period: The time it takes for a project to recover its initial investment. Shorter payback periods are generally preferred.

Cash Flow Estimation

Incremental Cash Flows: The changes in a company’s cash flows that are a direct consequence of accepting a project.

Sunk Costs: Costs that have already been incurred and cannot be recovered. These should not be included in capital budgeting decisions.

Opportunity Costs: The potential benefits a company misses out on when choosing one alternative over another. These should be included.

Project Analysis

Sensitivity Analysis: Examining how changes in one variable affect the NPV of a project.

Scenario Analysis: Evaluating the NPV of a project under different scenarios (e.g., best case, worst case, most likely case).

Simulation Analysis (Monte Carlo): Using computer simulations to model the uncertainty of project cash flows.

Capital Structure

Sources of Financing

Debt: Borrowing money that must be repaid with interest. Examples include bonds, loans.

Equity: Ownership in a company. Examples include common stock, preferred stock.

Internal Funds: Profits that are reinvested in the company.

Optimal Capital Structure

Trade-off Theory: Balancing the tax benefits of debt with the costs of financial distress.

Pecking Order Theory: Firms prefer internal financing first, then debt, and lastly equity.

Agency Costs: Costs associated with conflicts of interest between managers and shareholders (or between debt and equity holders).

Cost of Capital

Weighted Average Cost of Capital (WACC): The average rate of return a company is expected to pay to finance its assets.

Working Capital Management

Key Components

Cash Management: Optimizing cash balances to meet short-term obligations.

Accounts Receivable Management: Managing credit policies and collection efforts to minimize bad debts.

Inventory Management: Balancing inventory levels to meet customer demand while minimizing storage and obsolescence costs.

Accounts Payable Management: Optimizing payment terms with suppliers to maximize cash flow.

Working Capital Metrics

Current Ratio: Current Assets / Current Liabilities. Measures a company’s ability to pay short-term obligations.

Quick Ratio (Acid Test): (Current Assets - Inventory) / Current Liabilities. A more conservative measure of liquidity.

Cash Conversion Cycle: The length of time between a company’s outlay of cash for raw materials and the inflow of cash from collecting accounts receivable.