Intro (Week 1)

Question 1

What is managerial finance?

Answer 1

The analysis of financial decisions from the perspective of firms. Firms are suppliers of financial claims (or assets).

Question 2

Going concern

Answer 2

A business that is operating and making a profit.

Question 3

Three ways for financing funding needs?

Answer 3

Debt (term loans or credit lines),
Equity (public/private shares, retained earnings)
and Hybrid securities (preferred shares, convertible bonds)

Question 4

Term Loans

Answer 4

• A term loan provides borrowers with a lump sum of cash upfront in exchange for specific borrowing terms.
• Borrowers agree to pay their lenders a fixed amount over a certain repayment schedule with either a fixed or floating interest rate.
• Term loans are commonly used by small businesses to purchase fixed assets, such as equipment or a new building.
• Borrowers prefer term loans because they offer more flexibility and lower interest rates.

Question 5

Credit Lines

Answer 5

• A line of credit is a flexible loan from a financial institution that consists of a defined amount of money that you can access as needed and repay either immediately or over time.
• Interest is charged on a line of credit as soon as money is borrowed.
• Lines of credit are most often used to cover the gaps in irregular monthly income or finance a project whose cost cannot be predicted up front.

Question 6

Retained Earnings

Answer 6

• Retained earnings (RE) is the amount of net income left over for the business after it has paid out dividends to its shareholders.
• The decision to retain the earnings or distribute them among the shareholders is usually left to the company management.
• A growth-focused company may not pay dividends at all or pay very small amounts because it may prefer to use retained earnings to finance expansion activities.

Question 7

What is equity?

Answer 7

• Equity represents the value that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debts were paid off.
• We can also think of equity as a degree of residual ownership in a firm or asset after subtracting all debts associated with that asset.
• The calculation of equity is a company’s total assets minus its total liabilities, and it’s used in several key financial ratios such as ROE.

Question 8

Hybrid Securities

Answer 8

• A hybrid security is a single financial security that combines two or more different financial instruments.
• Hybrid securities, often referred to as “hybrids,” generally combine both debt and equity characteristics.
• The most common type of hybrid security is convertible bond.

Question 9

Preferred Shares

Answer 9

• They are two types of equity: common and preferred.
• Preferred shareholders have a higher claim to dividends than common shareholders,
• Unlike common shareholders, preferred shareholders have limited rights which usually does not include voting.
• Preferred stock combines features of debt (it pays fixed dividends) and equity (has the potential to appreciate in price). This appeals to investors seeking stability in potential future cash flows.
• Preferred shareholders have a prior claim on a company’s assets if it is liquidated (though they remain subordinate to bondholders).
• However, failing to pay a dividend to preferred shareholders does not mean a company is in default. They do not enjoy the same guarantees as creditors.

Question 10

Convertible Bonds

Answer 10

• A convertible bond pays fixed-income interest payments, but can be converted into a predetermined number of common stock shares.
• The conversion from the bond to stock happens at specific times during the bond’s life and is usually at the discretion of the bondholder.
• A convertible bond offers investors a type of hybrid security that has features of a bond, such as interest payments, while also having the option to own the underlying stock.

Question 11

Hyperbolic discounting

Answer 11

Given two similar rewards, humans show a preference for one that arrives sooner rather than later. Humans are said to discount the value of the later reward, by a factor that increases with the length of the delay.

Question 12

Leveraged Buyout (LBO)

Answer 12

• A leveraged buyout occurs when the acquisition of another company is completed almost entirely with borrowed funds.
• In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity.
• LBOs have acquired a reputation as a ruthless and predatory business tactic, especially since the target company’s assets can be used as leverage against it.