Finman Theories

CHAPTER 5 ● Uneven (Nonconstant) Cash Flows - a series of cash
flows where the amount varies from one period to the

● Time Line - an important tool used in time value analysis; next
it is a graphical representation used to show the timing of ● Payment (PMT) - this term designates equal cash flows
cash flows coming at regular intervals
● Future Value (FV) - the amount to which a cash flow or ● Cash Flow (𝐶𝐹𝑡) - this term designates a cash flow that is
series of cash flows will grow over a given period of time not part of an annuity
when compounded at a given interest rate ● Annual Compounding - the arithmetic process of
● Present Value (PV) - the present value of a future cash determining the final value of a cash flow or series of
flow or series of cash flows cash flows when interest is added once a year
● Compounding - the arithmetic process of determining ● Semiannual Compounding - the arithmetic process of
the final value off a cash flow or a series of cash flows determining the final value of a cash flow or a series of
when compound interest is applied cash flows when interest is added twice a year
● Compound Interest - occurs when interest is earned on ● Nominal (Quoted/Stated) Interest Rate, 𝐼𝑁𝑂𝑀 - the
prior periods’ interest
● Simple Interest - occurs when interest is not earned on contracted interest rate
interest ● Annual Percentage Rate (APR) - the periodic rate times
● Opportunity Cost - the rate of return you could earn on the number of periods per year
an alternative investment of similar risk ● Effective (Equivalent) Annual Rate (EFF% or EAR) -
● Discounting - the process of finding the present value of the annual rate of interest actually being earned, as
a cash flow or a series of cash flows; the reverse of opposed to the quoted rate
compounding ● Amortized loan - a loan that is repaid in equal payments
● Annuity - a series of equal payments at fixed intervals over its life
for a specified number of periods ● Amortization Schedule - a table showing precisely how
● Ordinary (Deferred) Annuity - an annuity whose a loan will be repaid; it gives the required payment on
payments occur at the end of each period each payment date and a breakdown of the payment,
● Annuity Due - an annuity whose payments occur at the showing how much is the interest and how much is the
beginning of each period repayment of principal
● 𝐹𝑉𝐴𝑁 - the future value of an annuity over N periods
● 𝑃𝑉𝐴𝑁 - the present value of an annuity over N periods
● Perpetuity - a stream of fixed payments at fixed intervals
expected to continue forever
CHAPTER 11 ● Weighted Average Cost of Capital (WACC) - a
weighted average of the component costs of debt,
● Capital Components - one of the types of capital used
preferred stock, and common equity
by firms to raise funds
● Flotation Cost, F - the percentage cost of issuing new
● Before-tax Cost of Debt, 𝑟𝑑 - interest rate on firm’s new
common stock
debt ● Flotation Cost Adjustment - the amount that must be
● After-tax Component Cost of Debt, 𝑟𝑑(1 - T) - where T added to 𝑟𝑠 to account for flotation costs to find 𝑟𝑒
is the firm’s marginal tax rate; relevant cost of new debt ● Retained Earnings Breakpoint - the amount of capital
taking into account the tax deductibility of interest raised beyond which common stock must be issued
● Cost of Preferred Stock, 𝑟𝑝 - found as the yield
investors expect to earn more on the preferred stock; rate

of return investors require on firm’s preferred stock;
dividend divided by current price
● Cost of Retained Earnings, 𝑟𝑠 - component cost of
common equity raised by retained earnings or internal

equity; rate of return required by stockholders on a firm’s
common stock
● Cost of New Common Stock, 𝑟𝑒 - component cost of
external equity or common equity raised by issuing new

stock; based on the cost of retained earnings, but
increased for floatation costs necessary to issue new
common stock
● 𝑤𝑑, 𝑤𝑝, 𝑤𝑐 - target weights of debt, preferred stock, and
common equity
CHAPTER 12 ● Crossover Rate - the cost of capital at which the NPV
profiles of two projects cross and, thus, at which the
● Strategic Business Plan - a long-run plan that outlines project’s NPVs are equal
in broad terms the firm’s basic strategy for the next 5 to ● Payback Period - the length of time required for an
10 years investment’s cash flows to cover its cost
● Net Present Value (NPV) - a method of ranking ● Discounted Payback - the length of time required for an
investment proposals using the NPV, which is equal to investment’s cash flows, discounted at the investment’s
the present value of the project’s free cash flows cost of capital, to cover its cost
discounted at the cost of capital
● Independent Price - projects with cash flows that are not
affected by the acceptance or non-acceptance of other
projects
● Mutually Exclusive Projects - a set of projects where
only one can be accepted
● Interest Rate of Return (IRR) - the discount rate that
forces a project's NPV to equal zero
● Multiple IRRs - the situation where a project has two or
more IRRs
● Modified IRR (MIRR) - the discount rate at which the
present value of a project’s cost is equal to the present
value of its terminal value, where the terminal value is
found as the sum of the future values of the cash inflows,
compounded at the firm’s cost of capital
● Net Present Value Profile - a graph showing the
relationship between a project’s NPV and the firm’s cost
of capital
CHAPTER 13 ● Best-Case NPV - the NPV when sales and other input
variables are set equal to their most likely (or base-case)
● Incremental Cash Flows - cash flows that will occur if values
and only if the firm takes on a project ● Scenario Analysis - a risk analysis technique in which
● Sunk Cost - a cash outlay that has already been “good” and “bad” sets of financial circumstances are
incurred and that cannot be recovered regardless of compared with a most likely, or base-case, situation
whether the project is accepted or rejected ● Base-Case Scenario - an analysis in which all of the
● Opportunity Costs - the best return that could be input variables are set at their most likely values
earned on assets the firm already owns if those assets ● Worse-Case Scenario - an analysis in which all of the
are not used for the new project input variables are set at their worst reasonably
● Externalities - effects on the firm or the environment that forecasted values
are not rejected in the project’s cash flows ● Best-Case Scenario - an analysis in which all of the
● Cannibalization - the situation when a project reduces input variables are set at their best reasonably forecasted
cash flows that the firm would otherwise have had values
● Stand-Alone Risk - the risk an asset would have if it ● Monte Carlo Simulation - a risk analysis technique in
were a firm’s only asset and if the investors owned only which probable future events are simulated on a
one stock; measured by the variability of the asset’s computer, generating estimated rates of return and risk
expected returns indexes
● Corporate (Within-Firm) Risk - risk considering the ● Replacement Chain (Common Life Approach) - a
firm’s diversification, but not stockholder diversification; it method of comparing projects with unequal lives that
is measured by a project’s effect on uncertainty about the assumes that each project can be repeated as many
firm’s expected future returns times as necessary to reach a common life; the NPVs
● Market (Beta) Risk - Considers both firm and over this life are then compared, and the project with the
stockholder diversification; measured by the project’s higher common-life NPV is chosen
beta coefficient ● Equivalent Annual Annuity (EAA) Method - a method
● Risk-adjusted Cost of Capital - the cost of capital that calculates the annual payments that a project will
appropriate for the given project, given the riskiness of provide if it is an annuity; When comparing projects with
that project; the greater the risk, the higher the cost of unequal lives, the one with the higher EAA should be
capital chosen
● Sensitivity Analysis - percentage change in NPV
resulting from a given percentage change in an input
variable, other things held constant

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CHAPTER 5 ● Uneven (Nonconstant) Cash Flows - a series of cash

flows where the amount varies from one period to the

investors expect to earn more on the preferred stock; rate

common equity raised by retained earnings or internal

external equity or common equity raised by issuing new

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