costs that can’t be avoided relating to ending or abandoning a project or investment.

a liability for an expense that has occurred but has not yet been paid.

an accounting procedure that reduces the cost of an intangible item, including the premium or discount of debt, over time. It is similar to the accounting charge for depreciation on a fixed asset.

buying an asset in one place and simultaneously (or in a very short period of time) selling it at a higher price elsewhere where the transaction cost of buying and selling is less than the difference in the prices.

the situation where one party has more information about a firm’s prospects than another.

an accounting statement representing the firm’s assets, liabilities, and net worth (equity) at a point in time. Assets are listed on the left side (or sometimes top) of the page. Liabilities and net worth or owners’ equity are listed on the right side (or sometimes bottom) of the page. The accounting equation is: assets = liabilities + owners’ equity.

a legal process to determine how to restructure or liquidate a firm when it is in violation of its debt contracts.

a descriptive term describing the risk of a firm’s operations. It is related to the probability that a firm’s cash flows will fluctuate. The fluctuations may be due to general economic conditions, competitive conditions within the industry which the firm operates, or internally how the firm operates.

a measure of how a firm’s stock prices moves in relationship to the market. It is computed as the covariance of a stock or portfolio’s returns in relation to the returns of a market index. A beta greater (less) than 1 indicates the firm’s stock will increase (decrease), on average, more (less) than the market and is therefore more (less) volatile than the market as a whole. The Standard & Poor’s 500 Stock Index is often viewed as the market, and would therefore have a beta of 1.

an interest-bearing security requiring the issuer to pay the bond holder interest and principal at specified times.

an evaluation of the likelihood a firm’s debt will be repaid under the terms of its debt contract. The ratings are classified along a spectrum with a classification such as AAA representing the highest rating (and indicating a firm is highly unlikely to miss a contractual payment) to D (indicating the firm is currently in default, meaning the firm has already missed a contractual payment). Bonds rated BBB and above are considered “investment grade” a classification generally considered to indicate high quality. Bonds rated below BBB are considered below investment grade, or “junk.” The three main firms providing these ratings are Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings.

the accounting value of an item on a balance sheet. Net book value is the accounting value of equity (also calculated as assets less liabilities).

the rate at which a firm uses up its cash balances.

the right of a firm to redeem a security or obligation (normally a bond or preferred share) before the scheduled maturity.

spending to acquire or maintain capital assets. This can be calculated directly or as the change in property plant and equipment plus any reduction due to depreciation (CAPEX = PP&E_end-of-year + depreciation expense – PP&E_{start-of-year}).

the difference between an asset’s selling price and its initial cost.

a measure of the effectiveness of a firm’s use of its resources. It can also be thought of as the required investment to generate $1.00 in revenue. It is often calculated as sales/total assets.

how a firm is financed. It is usually couched in terms of debt and equity and can also be expanded into the nature and type of debt (short-term, long-term, convertible, callable, etc.) and the nature and type of equity (preferred stock, common stock, etc.). The percentage of debt-to-equity is also referred to as the debt ratio or leverage ratio.

a business generating cash flows well above those needed to sustain the business.

the cash generated and used by a business. The accounting Cash Flow Statement breaks the firm’s cash flows into three categories: Cash from Operations, Cash from Investing, and Cash from Financing. In corporate finance, valuing a firm or project is often done by estimating the cash flows to the firm (or project).

short-term debt, normally with a maturity of less than 270 days, issued by firms or financial institutions.

an ownership unit of a firm. At least one class of common shares (there can be many different classes with different rights) is entitled to vote for the board of directors who choose and oversee a firm’s management. Common shares may receive dividends and any residual in a liquidation after all other claimants are paid.

a market where financial positions on all future states of the world can be created with existing assets and no transaction costs.

interest on interest. That is, assume an initial $100.00 bank deposit earns 5% interest per year. At the end of two years with compounding the bank account would have $110.25. Of that amount, $0.25 is due to earning interest on the first year’s interest in the second year (5% interest on the $5 prior year-end first year’s interest).

corporate securities (usually bonds or preferred shares) that can be exchanged (converted) into a set number of shares of common stock. Convertible debt has a lower interest rate than nonconvertible debt since it also offers the holder a potentially valuable option to exchange the convertible into common stock.

a firm’s policy regarding the amount and timing of dividends it expects to provide to shareholders.

the cost, normally expressed as an interest rate, of a firm’s financing. It is often used with regard to the cost of debt (before-tax or after-tax), the cost of equity, or a blended rate (the weighted average cost of capital or WACC).

a clause in a debt contract meant to protect lenders by setting restrictions on a firm’s actions. For example, covenants can restrict the amount of additional debt a firm can issue, the amount of dividends the firm can pay or require certain financial ratios be maintained. Violations of covenants normally provide the debt holder with the right to demand immediate repayment of the debt.

a clause in a debt contract whereby if a firm defaults on one debt contract it triggers an automatic default on another.

an analysis of a firm relative to its industry or principal competitors.

a debt obligation unsecured by assets; for example, an unsecured bond.

common name for a promissory contract where a borrower owes payment to a lender.

a bond with a put option (the debtholder can force the firm to repurchase the debt) and a conversion feature (the debtholder can exchange the bond for shares in the firm) in addition to periodic interest payments.

the situation where a firm’s current level of debt is greater than the value of the firm, creating a disincentive for the firm to finance additional debt.

the ratio between interest-bearing debt and equity alone or between debt and total financing (i.e., debt and equity).

the failure to fulfill a provision of a debt agreement (usually used to mean the failure to make an interest payment on time).

a reduction in earnings per share and book value per share due to the conversion of debt into equity or the issuance of additional stock on the exercise of stock options or stock warrants. Sometimes used when new stock is issued to describe its effect on the old (current) stockholders in regard to ownership percentage.

the method of computing the value of future cash flows to an earlier point in time (normally the present). It is the decrease in value from a future time to the present (the opposite of compounding). For example, assume a promise of a cash payment in the amount of $110.25 in two years. If the appropriate risk-adjusted rate on this payment is 5%, the discounted value today would be $100.00 (computed as $110.25/1.05²).

the forced sale of assets due to economic necessity (and therefore normally at lower prices than would otherwise be obtained).

a distribution of profits to shareholders (normally paid in cash, but sometimes paid in additional shares or in the form of the firm’s products). Firms have no legal obligation to pay dividends.

the percentage of net income paid to shareholders via dividends.

a plan where shareholders can agree to automatically reinvest cash dividends they would have received into additional shares of the firms. These plans often price the additional shares at a discount to the market price of the shares and/or waive transaction fees.

the annual dividend on one share of preferred or common stock divided by the market stock price.

deconstructing a firm’s return on equity into three parts: the profit margin (computed as net income/sales), the capital intensity (or sales) turnover ratio (computed as sales/total assets), and leverage (computed as total assets/equity).

a stock tender offering where either the quantity of shares to be repurchased is set with a range of prices the firm is willing to pay, or the price is set with a range of the quantity of shares to be repurchased.

earnings before interest expenses and taxes have been deducted (therefore equal to net income plus corporate tax plus interest expense).

earnings before interest expenses, taxes, depreciation or amortization have been deducted (therefore equal to net income plus corporate tax plus interest expense plus depreciation plus amortization).

the profit per share of common stock. If a firm has convertible bonds, options, or warrants, two computations must be done. The first, basic EPS, ignores the impact of the convertibles, options, and warrants. The second (fully) diluted EPS, includes the impact of those convertibles, options, and warrants as if they were converted/exercised.

a plan where a firm’s shares are owned by its employees.

a stock purchase program offered by a firm to its employees to purchase shares in the firm.

the value of the owner’s interest in a firm. In accounting it is defined as: the amount shareholders gave the firm in exchange for shares (contributed capital), plus the cumulate earnings of the firm less the cumulative dividends paid by the firm (retained earnings), and the amount a firm paid, if any, to repurchase shares from its owners (treasury stock). In finance, it is often used to mean the market value of a firm’s common shares.

the difference in a firm’s actual production level and the amount the firm could produce. A firm’s average cost per unit normally decreases as its production approaches its capacity.

the amount and form of financing at the time of an investment or purchase.

when a firm obtains funds by selling its receivables (at a discount) to an independent agent.

an opinion rendered by an investment banker on the “fairness” of the price being offered in a merger or acquisition. Fairness opinions provide the board of directors with protection against shareholder lawsuits over whether a price was inadequate.

an inaccurate indication of the future economic prospects of a firm.

an individual or firm who is charged with investing wisely on behalf of another.

a firm’s criteria or choices regarding its financial decision on the level of debt and equity, the nature of the debt (short-term, long-term, convertible, callable, etc.), the payment of dividends, the issue or repurchase of equity, etc.

the amount of additional debt a firm can easily issue plus any excess (not required) cash available for new projects and investments.

an inventory costing method based on when the inventory was purchased with the oldest purchased units costed first (leaving the last purchased units on the Balance Sheet).

the amount of cash a firm generates from its assets or returns to its capital providers.

an accounting adjustment for the excess amount paid by an acquiring company over the market value of the net assets (assets less liabilities) purchased.

the situation where the market has high or low demand for the issue of securities (usually stock).

a set minimum rate of return required before a project or investment will be undertaken. The greater the risk of the project, the higher the hurdle rate.

a security with a combination of debt and equity attributes.

a financial statement (also called the Statement of Profit and Loss) reflecting a firm’s revenues earned during a period (normally a year) less the costs incurred to generate the revenue resulting in a net profit or loss.

bonds issued by a government entity with the funds being used by a private or public firm. The firm is obligated to repay the bonds. The bonds are tax-exempt at the local, state, and sometimes federal level. Due to the tax-exemption and government backing, the bonds pay below market rates, thereby providing a subsidy to the firm receiving the funds.

a market where prices do not incorporate all available information. As a result, investors with greater information can exploit their knowledge.

the initial offering of stock to the public by a firm.

an asset with no physical (tangible) form. Intangible assets include trademarks, trade names, patents, copyrights, etc.

a measure of a firm’s ability to pay the interest on its debt. It is calculated as EBIT divided by the interest payment.

a note is a debt contract with a priority of payment that is below other “senior” notes.

bonds that are issued with lower ratings (below BBB) are colloquially referred to as “junk.”

an inventory costing method based on when the inventory purchase was made with the last purchased units costed first (leaving the oldest purchased units on the Balance Sheet).

an agreement where the lessee (rentor) agrees to pay the lessor (owner) for the use of an asset.

the sale of a firm’s assets and subsequent leaseback of the assets. It is used to finance a firm’s operations.

an acquisition (usually taking a public firm private) where a high level of debt is issued to finance the acquisition.

the ability to quickly sell an asset at a fair price.

the ability of a firm to meets its contractual obligations as they come due in the short term.

an increase in the price of a security because it can be more easily bought and sold. A security is considered illiquid, and will sell at a lower price, if it cannot be easily traded.

an adjustment in the accounting value of an asset or liability to its current market value. Accounting normally does not require (but often does allow) assets or liabilities to be adjusted to market value.

an estimate of firm value, specifically the value of the firm’s equity. It is calculated by taking the market share price times the number of shares outstanding.

the date a debt’s last principal repayment is due. Maturity (matured) may also refer to a firm or market indicating it is no longer expected to experience a growth rate above the economy as a whole.

a method to value a firm by multiplying a firm’s earning or cash flow metric (e.g., EPS, EBIT, or EBITDA) by a set value. The set value is obtained by comparing other firms to the metric. For example, dividing a firm’s stock price by its EPS gives the P/E multiple, dividing a firm’s total value (debt and equity) by its EBIT gives an EBIT multiple.

a professionally managed fund where investors’ contributions are pooled to purchase a set of securities.

the discounted cash flows of an investment, project, or firm. This is usually composed to three items: an initial cash outlay (e.g., the price), the discounted estimated future cash flows, and a discounted future terminal value.

current assets minus non–interest bearing current liabilities, often listed as one item on the asset side of the Balance Sheet.

defined as current assets minus non–interest bearing current liabilities (also cash + accounts receivable + inventory – accounts payable). Often referred to as working capital.

the accounting value of the equity value of a firm (also computed as assets less liabilities). Also referred to as net assets or simply equity. (For individuals, net worth is the total value of all possessions less the total value of all debts.)

a rate of interest that includes estimated inflation. This is the rate observed in the market.

the lost benefits caused by choosing one of several mutually exclusive alternatives. It can also be viewed as the value of the next-highest use of a resource.

a positive difference between a debt instrument’s maturity value (i.e., par or stated value) and its price at the time of issue. (A negative difference would be called a premium.)

the number of a firm’s shares held by the public (the number of shares issued by the firm less any shares repurchased by the firm).

postulates that because of asymmetric information firms will prefer to finance first with internal funds, next with external debt, and last with new equity

the portion of a firm’s financing from debt. Finance professionals normally calculate this as the amount of debt divided by total financing (debt plus equity). Also referred to as the debt ratio or leverage.

a never-ending periodic stream of future cash flows. The formula to determine the present value of a simple perpetuity at a point in time is the future payment divided by the discount rate. (PV_perpetuity = free cash flow/discount rate.) The formula to determine the value of a perpetuity where the future cash flows grow at a constant rate over time is the next cash payment divided by the discount rate less the growth rate (PV_{perpetuity-with-growth} = free cash flow * (1 + the growth rate) / (discount rate – growth rate)).

this is a balancing figure, the required amount so that the pro forma (estimated) Balance Sheet balances. Often the plug figure is the amount of debt financing (or cash balance) required in a pro forma estimation.

preferred stock with a limited convertible upside feature and a set redemption date and value.

a class of equity that has preferences over other classes of equity. A key preference is the right to receive a set dividend prior to any dividends being paid to another class of equity. The dividends can be cumulative (the nonpayment of a dividend in one year is added to the amount that must be paid in a future year before any dividends are paid to any other classes of shares) or not. Preferred shares can have voting rights but normally do not. Preferred shares can be convertible or not.

the ratio of the market price of a firm’s stock to its earnings per share (EPS).

the interest rate banks charge their lowest-risk corporate customers.

a rate of interest that has been adjusted (reduced) for estimated inflation.

a utility (normally a firm that supplies energy or water) that is subject to government rules regarding its operations including how it sets prices and how it sets its capital structure.

calculated as net income divided by the amount of book equity. (Your authors note the amount of equity should be the value at the start-of-the-year. In practice, and many other textbooks, the value often, incorrectly, uses an average or year-end amount.)

safe debt has no risk of default (or a risk so low it is not significant). U.S. government debt is often referred to as “safe” or “risk-free” debt.

the yearly variations in a firm’s sales and activities due to the nature of its business (e.g., higher toy sales in November and December, higher sales of chocolate before Valentine’s Day, higher sales of farm equipment in spring and early summer, etc.).

an issue of shares to the public by a firm that has previously done an IPO.

a fiduciary acting on his own behalf instead of on behalf of his clients.

senior means priority of payment over other “junior” notes.

a unit of ownership in a firm, usually in the form of common stock.

short sales selling borrowed shares, which have to be repurchased and returned after the price has hopefully gone down.

in a financial sense, the message sent by management to investors through a financial policy action (e.g., issuance of debt or equity, payment of dividends, repurchase of equity, etc.).

a financial statement analyzing how funds flow into and out of a corporation. This is the predecessor to the current Statement of Cash Flows (which public firms had to issue from 1988 onwards).

an inventory costing method where the cost of the actual unit sold is used (i.e., matched to the revenue).

when a firm divests a division or subsidiary by creating a new entity and then giving the shares of the new entity to its shareholders.

a financial statement analyzing how cash flows entered and exited a firm during the period (normally a year). The statement is broken down into three categories: cash from operations, cash from investing, and cash from financing.

see common stock.

a depreciation or amortization method where the cost of an asset less its salvage value (residual value at the end of its life) or certain liabilities is reduced evenly over the assets’ or liabilities’ life.

a technique where the investor buys a “strip” of several different securities (e.g., senior debt, junior debt, preferred shares, common shares) simultaneously. The securities in the strips can either be separable or not.

debt whose priority of payments are made after paying those on senior debt.

a cost that has been incurred, cannot be recovered, and does not affect future cash flows.

a growth rate above the cost of capital. It can occur for a short period of time when a firm is starting. Supernormal growth rates cannot be sustained over longer periods and should always be suspect in pro formas.

measure of how much a firm can grow without additional external financing, holding all else constant. Measured as ROE * (1 – the dividend payout rate).

a firm’s desired level of debt and equity.

the tax savings on allowed deductions from taxes. The tax shield is the allowed deduction (e.g., interest, depreciation, amortization, etc.) times the tax rate. The higher the tax rate, the greater the tax shield.

an offer by an individual or firm to purchase shares of a publicly traded firm.

the value of an asset (including securities) at a specified future date. The three common approaches to computing a terminal value are using an earnings multiple, an asset multiple, or a perpetuity growth formula.

prior year, historical earnings (as contrasted with estimated future earnings).

U.S. debt with a short-term maturity (up to a year).

the interest rate paid on Treasury bills.

an offering of more than one security linked together. The securities can be either detachable or undetachable.

see regulated utility.

an interest rate that fluctuates, usually with changes in the economy.

a source of financing for startups or turnaround ventures. Usually provided by wealthy individuals, investment banks. or groups set up to pool funds for this type of financing. Also referred to as risk capital.

expressions (or sayings) that reflect the opinions or “wisdom” of investment professionals who work on Wall Street.

an option security that entitles the holder to buy stock at a predetermined price. Warrants can be sold with other types of securities, usually bonds.

the weighted percentage of the after-tax cost of debt plus the weighted percentage of the cost of equity.

see net working capital.