Finance vs. Accounting
Finance needs to know the true cash flows. In addition, we are interested in timing of cash flows and the risk of cash flows.
Cash flow does not equal GAAP net income!
What is GAAP Net Income versus True Cash Flows?
The rate that compensates you for the lost opportunities
What is the Real Rate of Return?
sources of a company's cash flows
What Assets?
Refers to the amount an investment will grow after one or more periods
Revenue minus expenses
What is Income?
Measure of how much of true, real cash a firm (or a project) produced in a given year
What is Free Cash Flow?
•There are several potential projects
•Only one project has to be chosen
–Either don’t need more than one
–Not enough money
What are mutually exclusive projects?
Claims on the company's assets; who invested in the company and how much
What are Liabilities + Stock Holder's Equity?
The preferred project in this case depends on the discount rate, not the IRR.
What is the Timing Problem?
Earnings before interest, taxes, depreciation, and amortization
What is EBITDA?
A fixed percentage of the original asset book value. I.e. we depreciate the same amount of money every year
What is straight-line depreciation?
firms ability to meet short-term obligations and stay solvent
What is the Liquidity Ratio?
Current Assets
What Can be turned into cash within 1 year?
The difference between the market value of a project and its cost
What is Net Present Value?
series of cash flows that increase at a constant rate g% forever
During the project’s life, additional assets sometimes need to be bought, and/or some assets need to be replaced
What is project capital spending?
–Don’t arbitrarily exclude any costs or benefits from the analysis.
–Allow for time value of money and for the risk involved.
–If forced to choose among proposals, select the one that does shareholders the most good.
What is decision making criteria?
expected to be held and used in the long run
What are fixed assets?
multiple cash flows starting with $C and growing at a constant rate of g% per period
What is a Growing Annuity?
The discount rate that makes the present value of future cash flows equal to the initial cost of the investment. In other words, the discount rate that gives a project a zero NPV
What is the Internal Rate of Return (IRR)?
A cash flow already paid or already promised to be paid (e.g. consulting fees).
What are sunk costs?
•Projects are not competing with each
•Free to choose multiple projects
•Accepting or rejecting one project doesn’t affect the other projects
What are independent projects?
Measures a company's performance over a specific period of time
What is an Income Statement?
The length of time until the accumulated cash flows from the investment equal or exceed the original cost
What is the Payback Period?
The first cash flow (the initial investment) is negative and all the remaining cash flows are positive
What are Conventional Cash Flows?