finance

Disadvantage of Profit Maximization Financial managers may be induced to make decisions which can harm the firms’s long-term financial performance
Sole Proprietorship characterized by the non-existence of agency problems between owners and managers bc the owner and manager are usually one and the same
If markets are semi-strong efficient an earnings announcement revealing higher than expected earnings will result in a quick increase in stock price to reflect the full effect of this new information
Depreciation expense affects a company’s taxable income so that an increase in depreciation expense will lead to lower taxable income and then higher operating cash flow
interest rates and value have an inverse relationship
Compounding the process of converting present values to future values
3 Major factors are determinants of the value of any asset 1. size (magnitude) of expected cash flows2.Timings of expected cfs3. Risk of expected cfs
Simple or Compounding Interest Investments and loans base their int. calculations one of the two possible methods
All other variables held constant, investments paying simple int. have to pay significantly higher int. rates to earn the same amt of int as an act earning compound int.
The process of earning comp. int. allows a depositor to earn int. on any int. earned in prior periods
After the end of the 2nd year and all other factors remaining equal, a future value based on comp. int. will exceed a future value based on simple int.
Annuities ordinary annuities make fixed payments at the end of each period for a certain time
Annuities an annuity due earns more int. than an ordinary annuity of equal time
Annuities a perpetuity is a constant, infinite stream of equal cash flows that can be thought of as an infinite annuity
A retirement fund can be set up to pay a series of regular payments
Mortgages — differences between total payment and the int. due the payment allocated toward principal an amortized loan is the residual balance
Mortgages example of amortized loans
The ending balance of an amortized loan contract will be zero
Amortization Suppose you take out a loan. Process in which your liability will be gradually eliminated through regular payments over time
Present Value of Perp. is calculated payment/opportunity int. rate
perpetuity series of regularly timed, equal cash flows that is assumed to continue indefinitely into the future
Annuities contracts that allow investors to delay payments, income, installments, or lump-sum amount until the investor decided to receive them, if the payments begin more than 1 yr in the future
Coupon Payment int. payment or payments paid by bond
A bond issuer is said to be in DEFAULT if it does not pay the int. or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issues restrictive covenants
Sinking Fund Provision A bond contract feature that requires the issuer to retire a specified portion of the bond issue each year
Call Provision gives the issuer the right to call, or redeem, a bond at specific times and under specific conditions
Floating Rate Bond if the coupon int. rate is 4.375% for the first 6 months and changes to a rate equal to the 10 yr. treasury bonds plus 1.3% thereafter
Call Provision Feature of a bond contract allows the issuer to redeem bonds under specified terms prior to maturity
Deferred Call Provision the issuer is prevented from calling a portion or the entire issue for several yrs. during the early yrs. of the bond issue
Bonds current market price= Present or discounted value of its coupon int. payments and its maturity value
A bonds coupon rate partially determines the int. based return that a bond WILL pay, and a bond holders required return reflects the return that a bondholder WOULD LIKE to receive from a given instrument
Trade at par When the bonds coupon rate is= to the required return, the bonds intrinsic value will equal its par value and the bond will trade at par
Premium When the coupon rate is> required return the bonds intrinsic value EXCEED its par value and the will trade at premium
Discount When the coupon rate is < required return, the intrinsic value will be less than its par value bond will trade at a discount
Debt -dividends are fixed in amount-it has a par or face value
Common Stock failure to pay its dividend does not send the firm into bankruptcy
Sinking Fund Provision required to repurchase and retire 5% of its preferred stock each year (pref. stock agreements)
For the same issuing firm and on the same day of issuance, DEBT tends to have a lower after-tax cost to the issuer b/c its int. payments are tax deductible
Depreciation exp directly affects a company’s taxable income such that an increase in depreciation exp will lead to lower taxable income and therefore higher operating cash flow
Disadvantage of the goal of profit maximization ignores both the timing and the risk of the firms expected cash flows
of the three basic forms of businesses, corps have the greatest potential for owner-manager agency problems because of the separation of ownership and control
Bid-Ask Spread the difference between the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell the security
Greenmail an anti-takeover measure where the target company pays a premium over the stock’s current market price to buy-back a large block of the firm’s stock from an entity who threatens an unfriendly takeover
Sole Proprietorship characterized by the non-existence of agency problems between owners and managers bc the owner and the manager are usually the one and the same.
If markets are semi-strong efficient an earnings announcement revealing higher than expected earnings will result in a quick increase in stock price to reflect the full effect of this new info
Depreciation Exp affects a company’s taxable income so than an increase in depreciation exp will lead to lower operating cash flow
Inverse relationship between int. rates and value
Advantage of profit maximization fundamental goal of businesses is to make a profit, and profit maxim. is consistent with shareholder wealth maxim.
Maximize shareholder wealth widely accepted objective of the firmby maximizing the present value of the expected future returns to the shareholders
Maximize stockholder wealthnet present value of the firmcommon stock price per share
shareholder= # of shares of common stock outstanding*market price per share
value of equity= market capitalization
market cap = # of shares*price
Profit Maximization lacks time and ignores risk
Determines Value sizetimingriskof cash flows
Holding period Returnaka holding period yieldaka realized rate of return =ending price-beginning price+distribution received/Beginning price*(100%)
call option gives the holder (owner) right to buy
Put option gives the holder right to sell

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