22 Questions
What is the concept that describes the idea that investors demand higher returns in exchange for taking on higher levels of risk?
Risk-return trade-off
What is the value of an asset at a point in the future, calculated using the formula FV = PV x (1 + k)^n?
Future value
What is the value of a series of cash flows at a point in time, calculated using the formula PV = ΣCFt / (1 + k)^t?
Present value
What is the rate of return required by investors to justify an investment, taking into account the risk-free rate and the market risk premium?
Required rate of return
What is the type of cash flow that occurs at regular intervals for a fixed period of time?
Annuity
What is the profit earned by a firm above its opportunity cost, calculated as Economic Profit = Accounting Profit - Opportunity Cost?
Economic profit
What is the economic profit, in the context of a business?
The difference between actual and desired remuneration
In the formula AR = BV(ROE-Ke), what does BV represent?
Book value of equity
What is the goodwill in the context of economic profit?
The ability to generate extra profit
What is the value of equity in the example provided, assuming perpetuity?
150
Why are DCF and multiples often used by practitioners?
Because other methods can always be traced back to the logic of DCF
What determines the value of an asset, according to the formula?
Cash flows, time, uncertainty, and risk exposure
What is the formula for calculating the present value of an asset?
Valore = ∑(CF / (1 + i)^t)
What is the risk exposure of an initiative dependent on?
Uncertainty, general risk, and specific risk
What is the main reason financial statements are analyzed?
To evaluate investment opportunities
What is the concept that states that money received today is worth more than the same amount of money received in the future?
Time value of money
What is the primary role of financial reporting in capital markets?
To provide information to external stakeholders
What is the purpose of financial statements?
To measure and summarize economic consequences of business activities
What is the term for the idea that investors demand higher returns for taking on more risk?
Risk-return tradeoff
What are the three main financial statements?
Income statement, balance sheet, and cash flow
What is the term for the process of evaluating investment opportunities based on financial statements?
Financial analysis
Why are information intermediaries important in capital markets?
They assure the quality of financial statement representations
Study Notes
Economic Profit and Goodwill
- Economic profit is the difference between actual and desired remuneration (expected remuneration - acceptable remuneration)
- Goodwill is the ability to generate extra profit
- Example: Book value of equity (BV) = 100, Cost of equity (Ke) = 10%, Return on equity (ROE) = 15%, Abnormal return (AR) = 5, Equity value = 150, Goodwill = 50
Valuation Methods
- DCF (Discounted Cash Flow) and Multiples are the most used methods by practitioners
- Other methods can be traced back to the logic of DCF
- Methods used in different industries:
- Industrial sector: Income, Embedded value, MKT Multiples, DCF, EVA
- Start-ups: DCF, EVA, Others
Value Determinants
- Cash flows
- Time (growth)
- Uncertainty and exposure to risk (general and specific)
- Formula: Valore = ∑ CFt / (1 + i)^t
Risk and Uncertainty
- Risk exposure of an initiative depends on:
- Sensitivity to macroeconomic variables and cyclicality (market risk)
- Exposure to specific risk factors (specific or unique risk)
- Ability to protect themselves in the event of adverse events
- Risk-return trade-off: Ri = Rf + Risk
Valuation Approaches
- Formula: Valore = ∑ CFt / (1 + wacc)^t
- Steady state, steady growth, and more than one stage approaches
Importance of Finance
- To make informed economic decisions
- To make informed personal and business investment decisions
- To make informed career decisions based on a basic understanding of business finance
Six Principles of Finance
- Money has a time value
- Higher returns are expected for taking on more risk
- Diversification of investments can reduce risk
- Financial markets are efficient in pricing securities
- Manager and stockholder objectives may differ
- Reputation matters
Financial Statements
- Financial statements are an important source of information to the capital markets and business analysts
- Analyzing financial statements addresses a number of issues of interest to external stakeholders and company insiders
Financial Reporting and Capital Markets
- Financial reporting provides much needed information to capital market participants
- Financial intermediaries depend on the information in financial statements to evaluate investment opportunities
- Information intermediaries assure the quality of financial statement representations
- Relevant and reliable financial information is essential for the functioning of capital markets
How Capital Markets Function
- Financial statements measure and summarize the economic consequences of business activities
- Types of financial statements:
- Income statement
- Balance sheet
- Cash flow
- Other comprehensive income: items not included in I.S.
Understand the concept of economic profit, its relation to invested capital, and how it differs from desired remuneration. Learn about goodwill and its impact on business profits.
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