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Fin622
MIDTERM
1­What is the difference between Private Co. and Public unlisted Co?
A public company is one whose stocks are traded by the public whereas a private
company is one whose shares are held by a specific number of shareholders. Public
Unlisted Company and Private Company both are limited liability businesses but the
difference is there in the formation procedure as well as in the operating manners of both

2­What is corporate and incorporate association?

A business may be incorporated or un­incorporated. An unincorporated type of business
is that does not possess a separate legal identity from its owner/owners. The
owner/owners of this type of business bear full liability for any action or inaction of the
business. Unincorporated enterprises usually include sole proprietorships, partnerships.
On the other hand, incorporated type of business is that possesses a separate legal identity
from its owners. The owners of this type of business have limited liability. The term
"Corporate" is related to the corporations which are incorporated type of businesses.
Incorporation is actually a stage of formation of a corporate firm.

3­What is the difference between the discount factor and present value factor?
Discount factor is also known as Present value factor. Both terms have same meanings
and are used alternatively. The discount factor (Present Value Factor) is a multiplication
factor that converts a projected cost or benefit in a future year into its present value.

4­What is the difference between Book value and Market value with help of an example?
Book value is the price paid for a particular asset. This price never changes so long as
you own the asset. On the other hand, market value is the current price at which you can
sell an asset. For example, if you bought a house 10 years ago for Rs. 1,500,000, its book
value for your entire period of ownership will remain Rs. 1,500,000. If you sell the house
today for Rs. 1,800,000, this would be the market value.

5­What is the difference between the Annuity and Perpetuity?

The term "Annuity" refers to any terminating stream of fixed payments over a specified
period of time whereas” Perpetuity" is an annuity that has no definite end, or a stream of
cash payments that continues forever.

6­What is the difference between corporate finance and public finance?

Corporate Finance is an area of finance that deals with the financial decisions of
corporations/companies and it includes all those tools and analysis which are used to
make these decisions. On the other hand, Public Finance is a field of economics that is
concerned with paying for collective or governmental activities, and with the
administration and design of those activities.

7­What is the importance of corporate finance?

Corporate Finance underlies all financial decisions an organization make, forming the
foundation for everything from credit analysis to merger and acquisition activity. Using
theory and practical applications, Corporate Finance provides a foundation in key

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concepts underlying the analysis and execution of financial decisions and demonstrates
how financing decisions impact a firm's value.

8­What is cost of capital?

The cost of capital refers to the cost to borrow or invest capital. It is actually an expected
return that the provider of capital plans to earn on their investment. Simply speaking, the
amount of interest paid for the use of capital is termed as cost of capital.

9­Define Corporate Finance?

Corporate finance is an area of finance dealing with the financial decisions corporations
make and the tools and analysis used to make these decisions.

10­Why we study corporate finance?

The primary goal of corporate finance is to enhance corporate value while reducing the
firm's financial risks. Equivalently, the goal is to maximize the corporations' return on
capital. Although it is in principle different from managerial finance which studies the
financial decisions of all firms, rather than corporations alone, the main concepts in the
study of corporate finance are applicable to the financial problems of all kinds of firms.
The discipline can be divided into long­term and short­term decisions and techniques.
Capital investment decisions are long­term choices about which projects receive
investment, whether to finance that investment with equity or debt, and when or whether
to pay dividends to shareholders. On the other hand, the short term decisions can be
grouped under the heading "Working capital management".

What are the differences between financial statements and corporate finance?

Financial statements:
A financial statement (or financial report) is a formal record of the financial activities of a
business, person, or other entity. For a business enterprise, all the relevant financial
information, presented in a structured manner and in a form easy to understand, are called
the financial statements

Corporate finance:
Corporate finance is the study of planning, evaluating and drawing decisions in the
course of business. Corporate finance is an area of finance dealing with the financial
decisions corporations make and the tools and analysis used to make these decisions.

Who Governed Format of Balance Sheet in Pakistan?

The format of Financial Statements in Pakistan is governed by International Financial

Reporting Standard (IFRS) or International Accounting Standard (IAS).

How many conventions are there for balance sheet construction and what are the
names?
There are two conventions for balance sheet construction.
1. In Pakistan IAS (International Accounting Standard) or IFRS (International
Financial Reporting Standard) (Non­liquid or Illiquid Asset is at top)

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2. In united state Convention GAAP (General Accepted Accounting Principle)
(highly liquid Asset is at top)

What is liquidity explain in your own words and also give example?

Liquidity is the nature of an asset that how quickly or easily it can be turned into mean of
payments without losing its value.
Cash, stocks and bonds are highly liquid asset as compare to inventories

What is equity and what are the elements of equity?

Equity represents ownership interest, the investment that owner of the business, shareholders
make in the business (means except all external sources) equity.
Elements of equity
1. Paid up Capital
2. Reserves
3. Profit & Loss

What is Deferred Cost and what is the difference between deferred cost and
deferred income?
Deferred Cost: It is a pre­paid cost incurred in a transaction against which benefit is not
taken and not fully treated as expense until subsequent accounting periods; it is treated as
long term asset in balance sheet.
Deferred Income: It is the un­earned income received in advance of providing some
service or selling some product, therefore not treated as income. It appears in balance
sheet as liability.

How many and what are the kinds of sources of finance

1. Owner’s equity
2. Financial instruments, Loan
3. Creditor
4. Secondary market
5. Leasing

Is Capital Budgeting Decisions Irreversible or not explain your answer with the
proper reason?
Capital Budgeting Decisions are irreversible in nature as these involve planning,
analyzing and acquiring capital assets like Plant and Machinery or Land or Building and
big amount is invested. If we reverse them, that will result in heavy losses.

What are IPO's and what is the main objective of IPO's?

IPO’s stands for Initial Public Offerings and made When Company lunches their shares
in market and offer general Public for Raising capital

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The main objective of IPO’s is the expansion of capital and allows a company to tap a
wide pool of stock market investors to provide it with large volumes of capital for future
growth.

In income statement what we have to work out?

we have to work out profit.

how many terminologies interchangeably used in income statements?

three terminoligies
a­ sales
b­ revenue
c­ turnover

what are three segmants of cash generation in cash flows statements?

following three segments:
a­ operating cash flows
b­ investing cash flows
c­ financing cash flows

what are the problems in comparing?

following are the two problems:
a­ size
b­ reporting currency

What are the tools to compare financial statements?

following are the tools:
a­ make common size statements
b­ ratio analysis

what is the working in making common size statements?

Taking line items of assets and line items of liabilities in %age form and than find out the weight­
ages of current, fix and total assets or liabilities for the purpose of comparison.

What is base year analysis and what is its another name?

This is known as horizontal analysis and in this method we select one year as an base year and
than compare all other years results with that and base year is concider always 100%.

what is ratio analysis?

Ratio analysis is difference between two or more different figures or amounts. we normally
express this in %ages or number of times.

what is short term solvency ratio and what are other two names of short
term solvency ratio?
This is a relationship between current assets and current liabilities.
other two names are current ratio and working capital ratio.
formulla:
Short term solvency/working capital/current ratio= current assets/current liabilities

What is the widely accepted tool of liquidity also explain that?

Acid test ratio or quick ratio is widely accepted tool of liquidity.
This is relation between current assets and current liabilities but we deduct inventory items from

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current assets.
formulla:
Quick Ratio= (Current Assets­ inventories)/ Current liabilities

what are two formulas of total debt ratio?

a)­ T.D.R = Total Debt/Total Assets
b)­ T.D.R= (Total Assets­Total Equity) / Total Assets

Corporate finance is an area of finance dealing with the financial decisions

corporations make and the tools and analysis used to make these decisions. The primary
goal of corporate finance is to maximize corporate value while managing the firm's
financial risks

What does Capital Asset Pricing Model – CAPM Mean?

A model that describes the relationship between risk and expected return and that is used
in the pricing of risky securities.

The general idea behind CAPM is that investors need to be compensated in two ways:
time value of money and risk. The time value of money is represented by the risk­free (rf)
rate in the formula and compensates the investors for placing money in any investment
over a period of time. The other half of the formula represents risk and calculates the
amount of compensation the investor needs for taking on additional risk. This is
calculated by taking a risk measure (beta) that compares the returns of the asset to the
market over a period of time and to the market premium

What Does Weighted Average Cost Of Capital ­ WACC Mean?

A calculation of a firm's cost of capital in which each category of capital is
proportionately weighted. All capital sources ­ common stock, preferred stock, bonds and
any other long­term debt ­ are included in a WACC calculation. All else equal, the
WACC of a firm increases as the beta and rate of return on equity increases, as an
increase in WACC notes a decrease in valuation and a higher risk.

Weighted Average Cost of Capital (WACC) is a calculation of a firm's cost of capital

because in it each category of capital is proportionately weighted. All capital sources ­
common stock, preferred stock, bonds and any other long­term debt ­ are included in a
WACC calculation.
In order to arrive at figure of WACC, we need to calculate the individual componenets i.e
cost of equity and cost of debt. So cost of equity can be calculated through individual cost
of equity

Classification of project:

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Projects can be classified on the basis of

1)Benefit acheived from them,
2) Degree of their dependence to each other.
3) By type of cash flow.

The WACC equation is the cost of each capital component multiplied by its proportional
weight and then summing:

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V=E+D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

What Does Cost Of Debt Mean?

The effective rate that a company pays on its current debt. This can be measured in either
before­ or after­tax returns; however, because interest expense is deductible, the after­tax
cost is seen most often. This is one part of the company's capital structure, which also
includes the cost of equity.

What Does Security Market Line ­ SML Mean?

A line that graphs the systematic, or market, risk versus return of the whole market at a
certain time and shows all risky marketable securities.
Also referred to as the "characteristic line".

What Does Capital Budgeting Mean?

The process in which a business determines whether projects such as building a new plant
or investing in a long­term venture are worth pursuing. Oftentimes, a prospective
project's lifetime cash inflows and outflows are assessed in order to determine whether
the returns generated meet a sufficient target benchmark.
Also known as "investment appraisal".

What Does Capital Rationing Mean?

The act of placing restrictions on the amount of new investments or projects undertaken
by a company. This is accomplished by imposing a higher cost of capital for investment
consideration or by setting a ceiling on the specific sections of the budget.

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What Does Return On Investment ­ ROI Mean?
A performance measure used to evaluate the efficiency of an investment or to compare
the efficiency of a number of different investments. To calculate ROI, the benefit (return)
of an investment is divided by the cost of the investment; the result is expressed as a
percentage or a ratio.

The return on investment formula:

What Does Payback Period Mean?

The length of time required to recover the cost of an investment.

Calculated as:

What Does Stock Pick Mean?

A situation in which an analyst or investor uses a systematic form of analysis to conclude
that a particular stock will make a good investment and, therefore, should be added to his
or her portfolio. The position can be either long or short and will depend on the analyst or
investor's outlook for the particular stock's price.

What Does Market Risk Mean?

The day­to­day potential for an investor to experience losses from fluctuations in
securities prices. This risk cannot be diversified away.

Also referred to as "systematic risk".

What Does Systematic Risk Mean?

The risk inherent to the entire market or entire market segment.

Also known as "un­diversifiable risk" or "market risk."

What Does Unsystematic Risk Mean?

Company or industry specific risk that is inherent in each investment. The amount of
unsystematic risk can be reduced through appropriate diversification.

Also known as "specific risk", "diversifiable risk" or "residual risk".

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What Does Active Risk Mean?
A type of risk that a fund or managed portfolio creates as it attempts to beat the returns of
the benchmark against which it is compared. In theory, to generate a higher return than
the benchmark, the manager is required to take on more risk. This risk is referred to as
active risk.

What Does Beta Mean?

A measure of the volatility, or systematic risk, of a security or a portfolio in comparison
to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model
that calculates the expected return of an asset based on its beta and expected market
returns..

Also known as "beta coefficient".

Primary market is the market for issuing new securities. Many companies, especially
small and medium scale, enter the primary market to raise money from the public to
expand their businesses. They sell their securities to the public through an initial public
offering. For example a company decides to raise its capital through initial public
offering “IPO” through Banks so in this case, Banks would be regarded as Primary
market
What Does Leverage Mean?
1. The use of various financial instruments or borrowed capital, such as margin, to
increase the potential return of an investment.
2. The amount of debt used to finance a firm's assets. A firm with significantly more debt
than equity is considered to be highly leveraged.
Leverage is most commonly used in real estate transactions through the use of mortgages
to purchase a home.

What Does Degree Of Operating Leverage ­ DOL Mean?

A type of leverage ratio summarizing the effect a particular amount of operating leverage
has on a company's earnings before interest and taxes (EBIT). Operating leverage
involves using a large proportion of fixed costs to variable costs in the operations of the
firm. The higher the degree of operating leverage, the more volatile the EBIT figure will
be relative to a given change in sales, all other things remaining the same. The formula is
as follows:

Liquid assets are those assets which are readily convertible to cash e.g. cash, A/C
receivable etc are regarded as liquid assets because they can easily be converted to cash.

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Working capital is a measure of both a company's efficiency and its short­term financial
health. The working capital ratio is calculated as:

Working capital = Current Assets – Current Liabilities

Positive working capital means that the company is able to pay off its short­term
liabilities. Negative working capital means that a company currently is unable to meet its
short­term liabilities with its current assets (cash, accounts receivable and inventory).
An Annuity is a series of fixed payments, which might be over a fixed number of
years, or over the lifetime of an individual, or both. The commonly known types of
annuities we see are the monthly rent, and monthly mortgage payments, or insurance
premiums.
There are two types of annuities:
1. An ordinary annuity, also known as deferred annuity, consists of a series of equal
payments at the end of each period, and
2. An annuity due consists of a series of equal payments at the beginning of each period.

Difference between Annuity and perpetuity:

The term "Annuity" refers to any terminating stream of fixed payments over a
specified period of time whereas” Perpetuity" is an annuity that has no definite end,
or a stream of cash payments that continues forever.

The formula for present value of an annuity is as follows:

Present Value of Annuity = PVA = C x [1­{1/(1+r)t}] / r
C = Cash flow per period
r = Interest rate
n = Number of payments
You are further advised to consult handouts and recommended books to further clarify
your concepts.

A valuation method used to estimate the attractiveness of an investment opportunity.

Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts
them (most often using the weighted average cost of capital) to arrive at a present value,
which is used to evaluate the potential for investment. If the value arrived at through DCF
analysis is higher than the current cost of the investment, the opportunity may be a good
one.

DCF = CF1 + CF2 +……..+ CFn

(1+r)1 (1+r)2 (1+r)n

CF = Cash flow
r = discount rate

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Discount factor is also known as Present value factor. Both terms have same
meanings and are used alternatively. The discount factor (Present Value Factor) is a
multiplication factor that converts a projected cost or benefit in a future year into its
present value

Economic health
Institutions tend to move investments out of weakening economies and into ones
perceived to be strengthening. So an economy whose indicators (like growth, inflation
and debt burden) are positive tends to see more demand for its currency and see its
exchange rate strengthen

Official interventions
Governments or central banks could intervene to prop up a currency – for political or
economic reasons ­ by buying it on the international markets, or by raising interest rates.
Besides above factors, Many more factors influence exchange rates which you can search
on internet.

Lucrative opportunities are regarded as some profitable opportunities which have

the potential to make good returns for the business.

What Does Yield Mean?

The income return on an investment. This refers to the interest or dividends received
from a security and is usually expressed annually as a percentage based on the
investment's cost, its current market value or its face value.

What Does Yield To Maturity ­ YTM Mean?

The rate of return anticipated on a bond if it is held until the maturity date. YTM is
considered a long­term bond yield expressed as an annual rate. The calculation of YTM
takes into account the current market price, par value, coupon interest rate and time to
maturity. It is also assumed that all coupons are reinvested at the same rate. Sometimes
this is simply referred to as "yield" for short.

What Does Current Yield Mean?

Annual income (interest or dividends) divided by the current price of the security. This
measure looks at the current price of a bond instead of its face value and represents the
return an investor would expect if he or she purchased the bond and held it for a year.
This measure is not an accurate reflection of the actual return that an investor will receive
in all cases because bond and stock prices are constantly changing due to market factors.

Also referred to as "bond yield", or "dividend yield" for stocks.

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Normal Yield Curve is a yield curve in which short­term debt instruments have a
lower yield than long­term debt instruments of the same credit quality. This gives the
yield curve an upward slope. This is the most often seen yield curve shape.

Flat Yield Curve is a yield curve in which there is little difference between short­term
and long­term rates for bonds of the same credit quality. This type of yield curve is often
seen during transitions between normal and inverted curves.

Inverted Yield Curve exists in an interest rate environment in which long­term debt
instruments have a lower yield than short­term debt instruments of the same credit
quality. This type of yield curve is the rarest of the three main curve types and is
considered to be a predictor of economic recession.

Relevant cost is a cost that affects the future cash flow. A relevant cost directly affects
our decision. For example opportunity cost is a relevant cost.

Non relevant cost is a cost that do not affect our decision or that do not affect our
future cash flows is regarded as non relevant cost. In other words, a cost that remains
same irrespective of the outcome of decision is called as irrelevant cost. For example
sunk cost is not relevant cost to decision making because it will not affect our future cash
flows and hence our decision.

With the bottom­up approach, investors focus directly on a company’s basics, or

fundamentals. Analysis of such information as the company’s products, its competitive
position, and its financial status leads to an estimate of the company’s earnings potential
and, ultimately, its value in the, market.
Whereas
in top­down approach is the opposite of the bottom­up approach.
Investors begin with the economy and the overall market, considering such important
factors as interest rates and inflation. They next consider future industry prospects or
sectors of the economy that are likely to do particularly well (particularly poorly).
Finally, having decided that macro factors are favorable to investing, and having
determined which parts of the overall economy are likely to perform well, individual
companies are analyzed.

Committed cost is a cost related either to the long­term investment in plant and
equipment of a business or to the organizational personnel whom top management deem
permanent; a cost that cannot be changed without long run detriment to the organization

Break up value is the sum of parts value of a publicly traded company. This value is
derived by analyzing each business segment of a company independently. This is usually
applied to large cap stocks that are likely to operate in several different markets or
industries. A breakup value analysis may be brought about by investors if the market cap
of the stock is less than the breakup value for a prolonged period of time.

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As real Interest Rate is the interest rate adjusted for expected inflation. It is
calculated by deducting inflation rate from nominal rate

The front door margin is obtained by deducting cost of goods sold and cost of doing
business i.e. operating cost from sales or revenue whereas gross profit is simply obtained
by deducting cost of goods sold from sales.

Profitability index is the ratio of the present value of expected future cash flows after
initial investment divided by the amount of the initial investment.
Whereas
Profitability ratios are used to assess a business's ability to generate earnings as
compared to its expenses and other relevant costs incurred during a specific period of
time. Some examples of profitability ratios are profit margin, return on assets and return
on equity etc.

Accounting rate of return on an investment is simply the net income generated

during the specific time period from that investment.
It is calculated by dividing Net income by the book value of the investment (In fixed
asset) at the start of the accounting period.

Sensitivity analysis is a technique used to determine how different values of an

independent variable will impact a particular dependent variable under a given set of
assumptions. This technique is used within specific boundaries that will depend on one or
more input variables, such as the effect that changes in interest rates will have on a bond's
price.

A bond is a debt investment in which an investor loans money to an entity (corporate or

governmental) that borrows the funds for a defined period of time at a fixed interest rate

Debenture is a type of debt instrument that is not secured by physical asset or

collateral. Debentures are backed only by the general creditworthiness and reputation of
the issuer. Both corporations and governments frequently issue this type of bond in order
to secure capital. Like other types of bonds, debentures are documented in an indenture

Prize bonds is a form of liquid cash and its not regarded as corporate bond.

Hybrid dividend policy is a policy that contains feature of both the stable and
constant dividend policies. Dividend consists of stable base amount and %age of
increment in fat income years. This is more flexible policy but increases uncertainty of
future cash flow or return to investors. The extra slice of %age is only paid when there is
high jump in income. So it is not regularly paid.

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The capital impairment rule is a state­level legal restriction on corporate dividend

policy. The rule, which applies in most U.S. states, basically limits the amount of
dividends a company can pay out to shareholders. The limit is described as either a limit
per capital stock or a limit as per the par value of the firm. Essentially, the rule says that
for a given amount of capital stock or a given firm value, there is a maximum limit to the
value of dividends that a company can distribute to stockholders.

Venture capital (VC) is financial capital provided to early­stage, high­potential,

growth Startup companies. The venture capital fund makes money by owning equity in
the companies it invests in.

Direct financing is financing done without the use of an underwriter or broker. In the
situation of direct financing, the securities are sold directly to investors in order to avoid
the cost of underwriting. Underwriters are usually investment banks
Whereas
Indirect finance is where borrowers borrow funds from the financial market through
indirect means, such as through a financial intermediary.

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