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Questions and Answers
What is the primary objective of business finance?
Which financial statement provides a snapshot of a company's financial position at a specific point in time?
What is the formula for calculating the present value of future cash flows?
What does a positive NPV indicate about an investment?
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What is the purpose of diversification in investing?
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What is the NPV rule in capital budgeting?
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What is the formula for calculating the Weighted Average Cost of Capital (WACC)?
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What is the cost of debt reduced by in the WACC formula?
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Study Notes
Business Finance Overview
- Business finance is the management of money and investments for a business
- Involves financial planning, budgeting, and forecasting
- Key objective: maximize shareholder value
Financial Statements
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Balance Sheet: snapshot of a company's financial position at a specific point in time
- Assets, liabilities, equity
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Income Statement: summary of revenues and expenses over a specific period
- Revenues, cost of goods sold, operating expenses, net income
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Cash Flow Statement: summary of cash inflows and outflows over a specific period
- Operating, investing, financing activities
Time Value of Money
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Present Value: current value of future cash flows
- Formula: PV = FV / (1 + r)^n
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Future Value: future value of current cash flows
- Formula: FV = PV x (1 + r)^n
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Net Present Value: sum of present values of cash inflows and outflows
- NPV > 0: investment is profitable; NPV < 0: investment is unprofitable
Risk and Return
- Risk: uncertainty of an investment's return
- Return: profit or loss on an investment
- Risk-Return Tradeoff: higher potential returns often come with higher risk
- Diversification: spreading investments to reduce risk
Capital Budgeting
- Capital Budgeting: process of evaluating and selecting investments
- NPV Rule: accept investments with NPV > 0
- IRR Rule: accept investments with IRR > cost of capital
- Payback Period: time it takes for an investment to generate cash flows equal to its cost
Cost of Capital
-
Weighted Average Cost of Capital (WACC): weighted average of debt and equity costs
- WACC = (E/V x Re) + (D/V x Rd x (1 - T))
- Cost of Debt: cost of borrowing money
- Cost of Equity: cost of raising capital through equity issuance
Business Finance Overview
- Business finance involves managing money and investments to maximize shareholder value
- Key activities include financial planning, budgeting, and forecasting
Financial Statements
- Balance Sheet: provides a snapshot of a company's financial position at a specific point in time
- Composed of assets, liabilities, and equity
- Income Statement: summarizes revenues and expenses over a specific period
- Breaks down into revenues, cost of goods sold, operating expenses, and net income
- Cash Flow Statement: summarizes cash inflows and outflows over a specific period
- Divided into operating, investing, and financing activities
Time Value of Money
- Present Value: current value of future cash flows
- Calculated using the formula PV = FV / (1 + r)^n
- Future Value: future value of current cash flows
- Calculated using the formula FV = PV x (1 + r)^n
- Net Present Value: sum of present values of cash inflows and outflows
- Indicates investment profitability if NPV > 0, and unprofitability if NPV < 0
Risk and Return
- Risk: uncertainty of an investment's return
- Return: profit or loss on an investment
- Risk-Return Tradeoff: higher potential returns often come with higher risk
- Diversification: spreading investments to reduce risk
Capital Budgeting
- Capital Budgeting: process of evaluating and selecting investments
- NPV Rule: accept investments with NPV > 0
- IRR Rule: accept investments with IRR > cost of capital
- Payback Period: time it takes for an investment to generate cash flows equal to its cost
Cost of Capital
- Weighted Average Cost of Capital (WACC): weighted average of debt and equity costs
- Calculated using the formula WACC = (E/V x Re) + (D/V x Rd x (1 - T))
- Cost of Debt: cost of borrowing money
- Cost of Equity: cost of raising capital through equity issuance
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Description
A comprehensive overview of business finance, including financial planning, budgeting, and forecasting. Learn about financial statements, balance sheets, and income statements.
