1) Risk-averse investors require higher rates of return on investments whose returns are
highly uncertain, and most investors are risk averse.
2) Net operating profit after taxes (NOPAT) is the amount of net income a company
would generate from its operations if it had no interest income or interest expense.
3) If we define the “premium” on an option to be the difference between the price at
which an option sells and the exercise value (or the difference between the stock’s
current market price and the strike price), then we would expect the premium to
increase as the stock price increases, other things held constant.
4) A firm constructing a new manufacturing plant and financing it with short-term
loans, which are scheduled to be converted to first mortgage bonds when the plant is
completed, would want to separate the construction loan from its current liabilities
associated with working capital when calculating net working capital.
5) Firm A has a higher degree of business risk than Firm B. Firm A can offset this by
using less financial leverage. Therefore, the variability of both firms’ expected EBITs
could actually be identical.
6) The threat of expropriation creates an incentive for the multinational firm to
minimize inventory holdings in certain countries and to bring in goods only as needed.
7) The AFN equation assumes that the ratios of assets and liabilities to sales remain
constant over time. However, this assumption can be relaxed when we use the
forecasted financial statement method. Three conditions where constant ratios cannot be
assumed are economies of scale, lumpy assets, and excess capacity.
8) Bad managerial judgments or unforeseen negative events that happen to a firm are
defined as “company-specific,” or “unsystematic,” events, and their effects on
investment risk can in theory be diversified away.
9) Net operating working capital is defined as operating current assets minus operating
current liabilities..
10) If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact
that the 28-day DSO is less than the 30-day credit period tells us that the credit
department is functioning efficiently and there are no past-due accounts.