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Interest Rate Parity

The interest rate parity theorem implies that there is a strong relationship between the spot exchange rate and the forward exchange rate based on the interest rate differential between two countries. As a result, investors in both countries are ...

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Purchasing Power Parity

The theory of purchasing power parity or PPP claims that the currency exchange rate between two countries adjusts to changes in the price of a basket of the same goods and services in both countries. In turn, the theory derives from the low of one price that states that ...

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Efficient Market Hypothesis

In the 1960s, Eugene F. Fama and Paul A. Samuelson independently suggested the efficient market hypothesis (EMH). This theory implies that all available information is already reflected in stock prices. Therefore, it is impossible for any investor in the long term to get returns substantially higher than ...

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Sensitivity Analysis in Capital Budgeting

Sensitivity analysis is used to evaluate how sensitive the output variable is to the change in one of the variables while other input variables remain unchanged. Sensitivity analysis is widely used in ...

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Inflation and Capital Budgeting Analysis

Inflation affects capital budgeting analysis. It drives an increase in both revenue and costs, affecting future cash flows of a project. Inflation is also one of the components of interest rates ...

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Capital Rationing

Capital rationing is a technique used in capital budgeting that helps select the most profitable capital projects when the ability of a company to raise additional capital is limited, and a company sets a ...

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Optimal Capital Budget

The optimal capital budget is an amount of investment that allows shareholder value to be maximized. It can be determined by plotting the marginal cost of capital (MCC) schedule and ...

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Investment Opportunity Schedule

The investment opportunity schedule is a list of projects arranged in descending order of internal rate of return. As the main objective of a company’s management is to maximize shareholder value ...

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Marginal Cost of Capital

The marginal cost of capital (MCC) is a concept used in financial management for capital budgeting purposes. Actually, it is the weighted average cost of the last $1 of new capital raised ...

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Net Operating Income Approach of Capital Structure

The net operating income approach claims that valuation of a firm is irrelevant to capital structure. In other words, the market value of a firm will be the same regardless of ...

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Modigliani-Miller Theories of Capital Structure

The Modigliani-Miller theory of capital structure proposes that the market value of a firm is irrelevant to its capital structure, i.e., the market value of a levered firm equals the market value of ...

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Traditional Approach to Capital Structure

The traditional approach to capital structure assumes that an increase in the proportion of debt to some extent does not result in an increase in the cost of equity, i.e., it remains fixed or grows slightly ...

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EBIT-EPS Analysis

EBIT-EPS analysis is a technique used to determine the optimal capital structure in which the value of earnings per share (EPS) has the highest amount for a given amount of ...

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Retained Earnings Breakpoint

When management of a company intends to raise additional funds, it attempts to maintain its target capital structure. At the same time, such a strategy is limited by the amount ...

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Stock Repurchase

Stock repurchase or buyback is a way to return cash to investors, which is an alternative to dividend payout. In other words, a corporation offers to buy current stockholders’ shares ...

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Stock Splits

Stock split is a corporate action usually taken when the management of a company believes that the stock price is too high for investors. There are several reasons why a split is made ...

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Stock Dividends

Stock dividends payout does not cause a cash outflow. It is the distribution of additional shares among current stockholders. This may happen when management of a corporation does not ...

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Tax Preference Theory

The tax preference theory of dividends was developed by Robert H. Litzenberger and Krishna Ramaswamy. This theory claims that dividend policy affects investor behavior due to the difference in ...

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Bird-in-hand Theory

The bird-in-hand theory of dividend policy were developed by Myron Gordon and John Lintner in response to the dividends irrelevance theory by Modigliani and Miller. The last one states that dividend policy has ...

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Dividend Irrelevance Theory

The dividend irrelevance theory was created by Modigliani and Miller in 1961. The authors concluded that dividend policy has no effect on the market value of a company or its capital structure ...

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Dividend Payment Procedures and Dates

There are four major dates when a company pays out cash dividends. Let’s take a look at dividend payment procedures using an example ...

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Trade Credit

Trade credit is the most common source of spontaneous short-term finance for a business. In such an agreement, the seller is the lender, allowing the buyer to pay at a later date than ...

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Effective Interest Rate

The concept of effective interest rate is widely used in finance to assess the interest expense of debt financing or interest income for financial assets. Moreover, IFRS require ...

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Miller-Orr Model

The Miller-Orr model of cash management is developed for businesses with uncertain cash inflows and outflows. This approach allows lower and upper limits of cash balance to be set ...

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Cash Budget

A cash budget is a financial statement with itemized projected cash inflows and cash outflows, and a projected cash balance at the end of a budget period. It is necessary to know in advance about any ...

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ABC Analysis of Inventory

ABC analysis is a technique of categorization based on the Pareto principle. This technique is used in inventory management to categorize inventory in terms of annual consumption value ...

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Factoring of Accounts Receivable

Factoring of accounts receivables is a way of raising funds to meet emerging working capital needs. A business sells its accounts receivable to a financing company on a recourse or nonrecourse basis at some discount ...

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Cash Management

Cash and marketable securities management is the primary objective of the treasury and financial department. This includes financing working capital needs, managing debts, paying vendor bills ...

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Cash Conversion Cycle

The cash conversion cycle measures the period of time in days from the moment inventories are paid until the moment accounts receivable is collected. In other words, it is the duration of working capital turnover ...

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