Accelerated cost recovery system (ACRS) A system used to depreciate assets for tax purposes. The current system, enacted by the 1986 Tax Reform Act, is very similar to the ACRS established in 1981. The current system specifies the depreciable lives (recovery periods) and rates for each of several classes of property.
Accounts payable Money the firm owes to suppliers.
Accounts receivable Money owed to the firm by customers.
Accounts receivable financing A secured short-term loan that involves either the assigning of receivables or the factoring of receivables. Under assignment, the lender has a lien on the receivables and recourse to the borrower. Factoring involves the sale of accounts receivable. Then the purchaser, called the factor, must collect on the receivables.
Accounts receivable turnover Credit sales divided by average accounts receivable.
Additions to net working capital Component of cash flow of firm, along with operating cash flow and capital spending.
Adjusted present value Net present value adjusted for taxes, financial distress costs and other financial side-effects.
Amortization Repayment of a loan in installments.
Annual percentage rate The interest rate in annual terms.
Annualized holding-period return The annual rate of return that when compounded T times, would have given the same T-period holding return as actually occurred from period 1 to period T.
Annuity A level stream of equal dollar payments that lasts for a fixed time. An example of an annuity is the coupon part of a bond with level annual payments.
Annuity factor The term used to calculate the present value of the stream of level payments for a fixed period.
Appropriate discount rate The discount rate used in valuation that properly reflects risk.
Arbitrage Buying an asset in one market at a lower price and simultaneously selling an identical asset in another market at a higher price. This is done with no risk and after all costs are properly accounted for.
Arbitrage pricing theory (APT) An equilibrium asset pricing theory that is derived from a factor model by using diversification and arbitrage. It shows that the expected return on any risky asset is a linear combination of various factors.
Arithmetic average The sum of the values observed divided by the total number of observations—sometimes referred to as the mean.
Asset beta The sensitivity of a firm’s asset value to that of the overall economy.
Assets Anything that the firm owns that generates future benefits.
Autocorrelation The correlation of a variable with itself over successive time intervals.
Availability float Refers to the time required to clear a check through the banking system.
Average (mean) Usually refers to the arithmetic mean (see also the geometric mean).
Average accounting return (AAR) The average project earnings after taxes and depreciation divided by the average book value of the investment during its life.
Average collection period Average amount of time required to collect an account receivable. Also referred to as days sales outstanding.
Average cost of capital A firm’s required payout to the bondholders and the stockholders expressed as a percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total required cost of capital by the total amount of contributed capital.
Average daily sales Annual sales divided by 365 days.
Balance sheet A statement showing a firm’s accounting
value on a particular date. It reflects the equation, Assets _Liabilities _ Stockholders’ equity.
Basic IRR rule Accept the project if IRR is greater than the discount rate; reject the project if IRR is less than the discount rate.
Benchmark An index or average whose movement is considered a general indicator of the direction of the overall market.
Beta coefficient A measure of the sensitivity of a security’s return to movements in an underlying factor. It is a measured systematic risk.
Bond A long-term debt of a firm. In common usage, the term bond often refers to both secured and unsecured debt.
Book cash A firm’s cash balance as reported in its financial statements. Also called ledger cash.
Book value The firm’s total assets minus the total liabilities (i.e., net worth).
Book value per share Per-share accounting equity value of a firm. Total accounting equity divided by the number of outstanding shares.
Break-even analysis Analysis of the level of sales at which a project would make zero profit.
CAPM Capital asset pricing model.
Call premium The price of a call option on common stock.
Call price of a bond Amount at which a firm has the right to repurchase its bonds or debentures before the stated maturity date. The call price is always set at equal to or more than the par value.
Callable Refers to a bond that is subject to be repurchased at a stated call price before maturity.
Capital-asset-pricing model (CAPM) An equilibrium asset pricing theory that shows that equilibrium rates of expected return on all risky assets are a function of their covariance with the market portfolio.
Capital budgeting Planning and managing expenditures for long-lived assets.
Capital gains The positive change in the value of an asset. A negative capital gain is a capital loss.
Capital market line The efficient set of all assets, both risky and riskless, which provides the investor with the best possible opportunities.
Capital markets Financial markets for long-term debt and for equity shares.
Capital rationing The case where funds are limited to a fixed dollar amount and must be allocated among competing projects.
Capital structure The mix of the various debt and equity capital maintained by a firm. Also called financial structure. The composition of a corporation’s securities used to finance its investment activities; the relative proportions of shortterm debt, long-term debt, and owners’ equity.
Capital surplus Amounts of directly contributed equity capital in excess of the par value.
Cash budget A forecast of cash receipts and disbursements expected by a firm in the coming year. It is a short-term financial planning tool.
Cash cycle In general, the time between cash disbursement and cash collection. In net working capital management, it can be thought of as the operating cycle less the accounts payable payment period.
Cash flow Cash generated by the firm and paid to creditors and shareholders. It can be classified as (1) cash flow from operations, (2) cash flow from changes in fixed assets, and (3) cash flow from changes in net working capital.
Cash flow after interest and taxes Net income plus depreciation.
Cash-flow time line Line depicting the operating activities and cash flows for a firm over a particular period.
Change in net working capital Difference between net working capital from one period to another.
Changes in fixed assets Component of cash flow that equals sales of fixed assets minus the acquisition of fixed assets.
Commercial paper Short-term, unsecured promissory notes issued by corporations with a high credit standing. Their maturity ranges up to 270 days.
Common equity Book value.
Common stock Equity claims held by the “residual owners” of the firm, who are the last to receive any
distribution of earnings or assets.
Compound interest Interest that is earned both on the initial principal and on interest earned on the initial principal in previous periods. The interest earned in one period becomes in effect part of the principal in a following period.
Continuous compounding Interest compounded continuously, every instant, rather than at fixed intervals.
Conversion premium Difference between the conversion price and the current stock price divided by the current stock price.
Conversion price The amount of par value exchangeable for one share of common stock. This term really refers to the stock price and means the dollar amount of the bond’s par value that is exchangeable for one share of stock.
Conversion ratio The number of shares per $1,000 bond (or debenture) that a bondholder would receive if the bond were converted into shares of stock.
Conversion value What a convertible bond would be worth if it were immediately converted into the common stock at the current price.
Convertible bond A bond that may be converted into another form of security, typically common stock, at the option of the holder at a specified price for a specified period of time.
Correlation A standardized statistical measure of the dependence of two random variables. It is defined as the covariance divided by the standard deviations of two variables.
Cost of equity capital The required return on the company’s common stock in capital markets. It is also called the equityholders’ required rate of return because it is what equityholders can expect to obtain in the capital market. It is a cost from the firm’s perspective.
Coupon The stated interest on a debt instrument.
Covariance A statistical measure of the degree to which random variables move together.
Cross rate The exchange rate between two foreign currencies, neither of which is generally the U.S. dollar.
Cumulative abnormal return (CAR) Sum of differences between the expected return on a stock and the actual return that comes from the release of news to the market.
Current asset Asset that is in the form of cash or that is expected to be converted into cash in the next 12 months, such as inventory.
Current liabilities Obligations that are expected to require cash payment within one year or the operating period.
Current ratio Total current assets divided by total current liabilities. Used to measure short-term solvency of a firm.
Days in receivables Average collection period.
Days sales outstanding Average collection period.
De facto Existing in actual fact although not by official recognition.
Debenture An unsecured bond, usually with maturity of 15 years or more. A debt obligation backed by the general credit of the issuing corporation.
Debt Loan agreement that is a liability of the firm. An obligation to repay a specified amount at a particular time.
Debt capacity Ability to borrow. The amount a firm can borrow up to the point where the firm value no longer increases.
Debt displacement The amount of borrowing that leasing displaces. Firms that do a lot of leasing will be forced to cut back on borrowing.
Debt ratio Total debt divided by total assets.
Debt service Interest payments plus repayments of principal to creditors, that is, retirement of debt.
Deep-discount bond A bond issued with a very low coupon or no coupon and selling at a price far below par value. When the bond has no coupon, it is also called a purediscount or original-issue-discount bond.
Default risk The chance that interest or principal will not be paid on the due date and in the promised amount.
Deferred taxes Noncash expense.
Depreciation A noncash expense, such as the cost of plant or equipment, charged against earnings to write off the cost of an asset during its estimated useful life.
Depreciation tax shield Portion of an investment that can be deducted from taxable income.
Dilution Loss in existing shareholders’ value. There are several kinds of dilution: (1) dilution of ownership, (2) dilution of market value, and (3) dilution of book value and earnings, as with warrants and convertible issues. Firms with significant amounts of warrants or convertible issues outstanding are required to report earnings on a “fully diluted” basis.
Direct lease A lease under which a lessor buys equipment from a manufacturer and leases it to a lessee.
Discount If a bond is selling below its face value, it is said to sell at a discount.
Discount rate Rate used to calculate the present value of future cash flows.
Discounted payback period method An investment decision rule in which the cash flows are discounted at an interest rate and the payback rule is applied on these discounted cash flows.
Discounting Calculating the present value of a future amount. The process is the opposite of compounding.
Diversifiable risk A risk that specifically affects a single asset or a small group of assets. Also called unique or unsystematic risk.
Dividend Payment made by a firm to its owners, either in cash or in stock. Also called the income component of the return on an investment in stock.
Dividend growth model A model wherein dividends are assumed to be at a constant rate in perpetuity.
Dividend payout ratio Amount of cash paid to shareholders expressed as a percentage of earnings per share.
Dividend yield Dividends per share of common stock divided by market price per share.
Dividends per share Amount of cash paid to shareholders expressed as dollars per share.
Double-declining balance depreciation Method of accelerated depreciation.
DuPont system of financial control Highlights the fact that return on assets (ROA) can be expressed in terms of the profit margin and asset turnover.
Duration The weighted average time of an asset’s cash flows. The weights are determined by present value factors.
Effective annual interest rate The interest rate as if it were compounded once per time period rather than several times per period.
Equity Ownership interest of common and preferred stockholders in a corporation. Also, total assets minus total liabilities, or net worth.
Equity beta The asset beta adjusted for leverage.
Financial lease A long-term noncancelable lease, generally requiring the lessee to pay all maintenance fees.
Financial leverage Extent to which a firm relies on debt. Financial leverage is commonly measured by the ratio of long-term debt to long-term debt plus equity.
Financial risk The additional risk that the firm’s stockholders bear when the firm is financed with debt as well as equity.
Firm’s net value after debt Total firm value minus value of debt.
Fixed asset Long-lived property owned by a firm that is used by a firm in the production of its income. Tangible fixed assets include real estate, plant, and equipment. Intangible fixed assets include patents, trademarks, and customer recognition.
Fixed cost A cost that is fixed in total for a given period of time and for given volume levels. It is not dependent on the amount of goods or services produced during the period.
Free cash flow Cash flow after taxes, interest and all positive NPV opportunities.
Geometric mean Annualized holding-period return.
Gilts British and Irish government securities.
Growth stock portfolio A portfolio of stocks perceived to have high growth prospects (in cash flows, etc.).
Income bond A bond on which the payment of income is contingent on sufficient earnings. Income bonds are commonly used during the reorganization of a failed or failing business.
Incremental cash flows Difference between the firm’s cash flows with and without a project.
Incremental IRR IRR on the incremental investment from choosing a large project instead of a smaller project.
Inflation An increase in the amount of money in circulation, resulting in a fall in its value and rise in prices.
Inflation-escalator clause A clause in a contract providing for increases or decreases in inflation based on fluctuations in the cost of living, production costs, and so forth.
Information-content effect The rise in the stock price following the dividend signal.
Interest coverage ratio Earnings before interest and taxes divided by interest expense. Used to measure a firm’s ability to pay interest.
Interest on interest Interest earned on reinvestment of each interest payment on money invested.
Interest rate The price paid for borrowing money. It is the rate of exchange of present consumption for future consumption, or the price of current dollars in terms of future dollars.
Interest rate on debt The firm’s cost of debt capital. Also called return on the debt.
Interest-rate–parity theorem The interest rate differential between two countries will be equal to the difference between the forward-exchange rate and the spot-exchange rate.
Interest-rate risk The chance that a change in the interest rate will result in a change in the value of a security.
Internal financing Net income plus depreciation minus dividends. Internal financing comes from internally generated cash flow.
Internal rate of return (IRR) A discount rate at which the net present value of an investment is zero. The IRR is a method of evaluating capital expenditure proposals.
Inventory A current asset, composed of raw materials to be used in production, work in process, and finished goods.
Inventory loan A secured short-term loan to purchase inventory. The three basic forms are a blanket inventory lien, a trust receipt, and field warehouse financing.
Inventory turnover ratio Ratio of annual sales to average inventory that measures how quickly inventory is produced and sold.
Lease A contractual arrangement to grant the use of specific fixed assets for a specified time in exchange for payment, usually in the form of rent. An operating lease is generally a short-term cancelable arrangement, whereas a financial, or capital, lease is a long-term noncancelable agreement.
Leveraged equity Stock in a firm that relies on financial leverage. Holders of leveraged equity face the benefits and costs of using debt.
Leveraged lease Tax-oriented leasing arrangement that involves one or more third-party lenders.
Liabilities Debts of the firm in the form of financial claims on a firm’s assets.
Liquidity Refers to the ease and quickness of converting ssets to cash. Also called marketability.
Liquidity-preference hypothesis Theory that the forward rate exceeds expected future interest rates.
Long-term debt An obligation having a maturity of more than one year from the date it was issued. Also called funded debt.
Low-grade bond Junk bond. A bond with a value below investment grade.
© The McGraw−Hill Companies, 2001
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