Capital by vegustavo


									                  Financial Terms related to Capital

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Average cost of capital

   • A firm's required payout to the bondholders and to the stockholders expressed as a
   percentage of capital contributed to the firm. Average cost of capital is computed by
   dividing the total required cost of capital by the total amount of contributed capital.


   • Cash or goods accumulated and available for use in producing more cash or

   • The long-term funds of the firm; all items on the right-hand side of the firm's
   balance sheet, excluding current liabilities.

   • Money invested in a firm.

Capital account

   • Net result of public and private international investment and lending activities.                      2|Page

Capital adequacy

   • Banks have to maintain sufficient capital to be able to meet unforeseen
   contingencies. The capital requirements involve minimum equity (Type I capital,
   currently 4% of assets), or equity and long-term debt (Type II capital, currently 8% of
   assets). The minimum capital requirements are stipulated by law.

Capital allocation decision

   • Allocation of invested funds between risk-free assets versus the risky portfolio.

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Capital appreciation

   • A rise in the market price of an asset.

   • The rise in the value of an investment s principal.

Capital asset

   • see Fixed Assets

   • All tangible property -- including securities, real estate, and other property -- held
   for the long term.

   • A fixed asset that is amortized; land; or financial asset (common shares, preferred
   shares, and fixed income securities like bonds) held by a corporation.

Capital asset pricing model

   • Abbreviated CAPM. The basic theory that links together risk and return for all
   assets. The CAPM predicts a relationship between the required return, or cost of
   common equity capital, and the nondiversifiable risk of the firm as measured by the
   beta coefficient.

   • Abbreviated CAPM. An economic theory that describes the relationship between
   risk and expected return, and serves as a model for the pricing of risky securities.
   The CAPM asserts that the only risk that is priced by rational investors is systematic
   risk, because that risk cannot be eliminated by diversification. The CAPM says that                       3|Page

   the expected return of a security or a portfolio is equal to the rate on a risk-free
   security plus a risk premium.

   • Is a tool that relates an asset's expected return to the market's expected return. It
   combines the concepts of efficient capital markets with risk premiums. The idea of
   capital market efficiency assumes immediate instantaneous -response to perfect or
   near perfect information. The risk premiums relate an investment to the market's
   risk-free or riskless rate of return. Typically, this risk-free rate is viewed in terms of
   principal safety for short term U.S. government obligations. Here, beta relates the

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   volatility of an asset to the market.

Capital budget

   • A firm's set of planned capital expenditures.

Capital budgeting

   • The process of choosing the firm's long-term capital assets.

   • The process of evaluating and selecting long-term investments (expected life of
   greater than one year) that are consistent with the firm's goal of owner wealth

   • Consists of five distinct but interrelated steps proposal generation, review and
   analysis, decision making, implementation, and follow-up.

Capital cost allowance

   • Abbreviated CCA. The term for the amortization system that must be used for
   income tax purposes when reporting to Canada Customs and Revenue Agency. It is
   a non-cash expense that increases cash flow.

Capital expenditure

   • Funds used by a company to acquire or upgrade physical assets such as property,
   plants, or equipment.                       4|Page

   • An outlay of funds by the firm that is expected to produce benefits over a period of
   time greater than one year.

   • Amount used during a particular period to acquire or improve long-term assets
   such as property, plant or equipment.

   • Expenditures for fixed assets

Capital flight

   • The transfer of capital abroad in response to fears of political risk.

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Capital gain

   • An increase in the value of a capital asset such as common stock. If the asset is
   sold, the gain is a realized capital gain. A capital gain may be short-term (if the
   security is held one year or less) or long-term (if the security is held more than one

   • The positive difference between the selling price of a capital asset and the asset's
   original cost plus the costs incurred to sell the asset.

   • When a stock is sold for a profit, it's the difference between the net sales price of
   securities and their net cost, or original basis. If a stock is sold below cost, the
   difference is a capital loss.

Capital gains yield

   • The price change portion of a stock's return.

Capital impairment rule

   • The legal rule governing Canadian companies that prevents the payment of
   dividends from the value of common shares on the balance sheet.

Capital lease

   • A lease obligation that has to be capitalized on the balance sheet.                      5|Page

Capital loss

   • The loss incurred when a capital asset, such as a security, is sold for a lower price
   than the purchase price. See also: Capital Gain.

   • The difference between the net cost of a security and the net sale price, if that
   security is sold at a loss.

Capital market

   • The market that trades long-term debt securities and common and preferred equity

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   • The market for trading long-term debt instruments (those that mature in more than
   one year).

Capital market efficiency

   • Reflects the relative amount of wealth wasted in making transactions. An efficient
   capital market allows the transfer of assets with little wealth loss. See: efficient
   market hypothesis.

Capital market imperfections view

   • The view that issuing debt is generally valuable but that the firm's optimal choice of
   capital structure is a dynamic process that involves the other views of capital
   structure (net corporate/personal tax, agency cost, bankruptcy cost, and pecking
   order), which result from considerations of asymmetric information, asymmetric
   taxes, and transaction costs.

Capital market line

   • Abbreviated CML. The line defined by every combination of the risk-free asset and
   the market portfolio.

Capital rationing

   • Placing one or more limits on the amount of new investment undertaken by a firm,                      6|Page

   either by using a higher cost of capital, or by setting a maximum on parts of, and/or
   the entirety of, the capital budget.

   • The financial situation in which a firm has only a fixed number of dollars for
   allocation among competing capital expenditures.

Capital stock

   • Refers to all the common and preferred shares, if any, for a corporation.

   • Ownership shares of a company, consisting of all common and preferred stock.

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Capital structure

   • The mix of long-term debt and equity maintained by the firm.

   • The makeup of the liabilities and stockholders' equity side of the balance sheet,
   especially the ratio of debt to equity and the mixture of short and long maturities.

   • See Capitalization.

Capital surplus

   • Amounts of directly contributed equity capital in excess of the par value.

   • Refers to the accounting difference between the amounts received by the initial
   sale of a corporation's stock less the par value of that stock. Since many new issues
   are sold at prices in excess of the par value, the proceeds component can be
   significant. Other related terms are Paid-In Capital or Paid-In Surplus.


   • The debt and/or equity mix that fund a firm's assets.

   • Also known as Invested Capital or Capital Structure. The sum of a corporation's
   stock, long-term debt, and retained earnings.

Capitalization method

   • A method of constructing a replicating portfolio in which the manager purchases a                         7|Page

   number of the largest-capitalized names in the index stock in proportion to their

Capitalization rate

   • See Discount Rate.

Capitalization ratios

   • Show how a firm has financed the investment in assets. There are three
   capitalization alternatives: debt, preferred equity and common equity.

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   • Also called financial leverage ratios, these ratios compare debt to total
   capitalization and thus reflect the extent to which a corporation is trading on its
   equity. Capitalization ratios can be interpreted only in the context of the stability of
   industry and company earnings and cash flow.

Capitalization table

   • A table showing the capitalization of a firm, which typically includes the amount of
   capital obtained from each source -long-term debt and common equity -and the
   respective capitalization ratios.


   • Recorded in asset accounts and then depreciated or amortized, as is appropriate
   for expenditures for items with useful lives greater than one year.

Capitalized interest

   • Interest that is not immediately expensed, but rather is considered as an asset and
   is then amortized through the income statement over time.

Capitalized lease

   • A financial (capital) lease that has the present value of all its payments included as
   an asset and corresponding liability on the firm's balance sheet, as required by
   generally accepted accounting principles as set out in the CICA Handbook.                       8|Page

Change in net working capital

   • The difference between the change in current assets and current liabilities
   associated with an investment project.

Complete capital market

   • A market in which there is a distinct marketable security for each and every
   possible outcome.

Cost of capital

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   • The required return for a capital budgeting project.

   • The minimum rate of return that a firm must earn on its project investments to
   maintain its market value and attract needed funds. This rate of return is based on
   the mix of debt and common equity financing.

   • This is the price of capital. When corporations borrow, they pay interest, which is
   called the cost of debt capital. In the context of valuing firms, the discount rate is
   called the cost of capital.

Cost of limited partner capital

   • The discount rate that equates the after-tax inflows with outflows for capital raised
   from limited partners.

Debt capital

   • All long-term borrowing incurred by the firm.

Debt to capital ratio

   • The ratio of total debt to total capital ([short + long term debt] / capital). For long-
   term investors, a suggested acceptable percentage is up to 33%. Debt must be
   funded in good times and bad, so a company going through a bad slump has a
   better chance of recovering if its debt load is not too high. Keep in mind that debt
   serves the useful function of helping the company grow. It is up to management to                     9|Page

   use it wisely and increase the sales and earnings.

Dedicated capital

   • Total par value (number of shares issued, multiplied by the par value of each
   share). Also called dedicated value.

Efficient capital market

   • A market in which new information is very quickly reflected accurately in share

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Equity capital

   • The long-term funds provided by the firm's owners, the shareholders.

   • see Owners' Equity

Exchange rate risk capital budgeting

   • Danger that an unexpected change in the exchange rate between the dollar and
   the currency in which the project's cash flows are denominated can reduce the
   market value of that project's cash flow.

Financial or capital lease

   • A longer-term lease than an operating lease that is noncancelable and obligates
   the lessee to make payments for the use of an asset over a predefined period of
   time; the total payments over the term of the lease are greater than the lessor's initial
   cost of the leased asset.

Gigo garbage in, garbage out in capital budgeting

   • If cash inflows are overestimated and/or the cost of capital underestimated, then
   decisions that prove to be very costly for the firm and the shareholders can result;
   poor forecasts can result in poor capital budgeting decisions.

Hard capital rationing                      10 | P a g e

   • Capital rationing that under no circumstances can be violated.

Human capital

   • The unique capabilities and expertise of individuals.

Invested capital

   • See Capitalization.

Issued share capital

   • Total amount of shares that are in issue. Related: outstanding shares.

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Legal capital

   • Value at which a company's shares are recorded in its books.

Leveraged recapitalization

   • A takeover defense in which the target firm pays a large debt-financed cash
   dividend, increasing the firm's financial leverage and deterring the takeover attempt.

Long term debt to capitalization

   • A ratio that indicates a company's financial leverage. It is calculated by dividing
   long term debt by the capital available to the company. The available capital is the
   sum of long term debt, preferred stock and stocholders' equity.

Long term debt/capitalization

   • Indicator of financial leverage. Shows long-term debt as a proportion of the capital
   available. Determined by dividing long-term debt by the sum of long-term debt,
   preferred stock and common stockholder equity.

Marginal cost of capital

   • Abbreviated MMC. The firm's weighted average cost of capital (WACC) associated
   with its next dollar of total new financing.

Marginal cost of capital schedule                       11 | P a g e

   • Graph that relates the firm's weighted average cost of capital (WACC) to the level
   of total new financing.

Market cap or market capitalization

   • Is a value placed on a company. It is computed by multiplying the number of
   outstanding shares by the current share price.

Market capitalization

   • The total dollar value of all outstanding shares. Computed as shares times current

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   market price. It is a measure of corporate size.

   • The dollar valuation of the total number of shares times the current price. This
   value is sometimes used by investors to classify stocks by size. It is not as reliable
   as classifying by sales dollar value because the price of a stock can be inflated by
   the market and not accurately representative of its size.

Market capitalization rate

   • Expected return on a security. The market-consensus estimate of the appropriate
   discount rate for a firm's cash flows.

Net working capital

   • Current assets minus current liabilities. Often simply referred to as working capital.

   • A measure of liquidity calculated as the difference between the firm's current
   assets and its current liabilities, or, alternatively, the portion of current assets
   financed with long-term funds; can be positive or negative.

   • Net Working Capital refers to the net non-interest bearing short term assets:
   Hence, net working capital equals cash plus inventories plus accounts receivables
   minus accounts payables.

Net working capital recapture

   • A positive cashflow benefit in a capital budgeting analysis that arises with the                     12 | P a g e

   termination of a project. At termination, sales associated with the project cease, and
   the company will recover the originally invested net working capital.

Nondiversifiability of human capital

   • The difficulty of diversifying one's human capital (the unique capabilities and
   expertise of individuals) and employment effort.

Opportunity cost of capital

   • Expected return that is foregone by investing in a project rather than in comparable

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   financial securities.

Optimal capital structure

   • The capital structure at which the weighted average cost of capital is minimized,
   thereby maximizing the firm's value.

Other capital

   • In the balance of payments, other capital is a residual category that groups all the
   capital transactions that have not been included in direct investment, portfolio
   investment, and reserves categories. It is divided into long-term capital and short-
   term capital and, because of its residual status, can differ from country to country.
   Generally speaking, other long-term capital includes most non-negotiable
   instruments of a year or more like bank loans and mortgages. Other short-term
   capital includes financial assets of less than a year such as currency, deposits, and

Outstanding share capital

   • Issued share capital less the par value of shares that are held in the company's

Pecking order view of capital structure

   • The argument that external financing transaction costs, especially those associated                      13 | P a g e

   with the problem of adverse selection, create a dynamic environment in which firms
   have a preference, or pecking-order of preferred sources of financing, when all else
   is equal. Internally generated funds are the most preferred, new debt is next, debt-
   equity hybrids are next, and new equity is the least preferred source.

Perfect capital market

   • A market in which there are never any arbitrage opportunities.

Perfect market view of capital structure

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   • Analysis of a firm's capital structure decision, which shows the irrelevance of
   capital structure in a perfect capital market.

Personal tax view of capital structure

   • The argument that the difference in personal tax rates between income from debt
   and income from equity eliminates the disadvantage from the double taxation
   (corporate and personal) of income from equity.

Pie model of capital structure

   • A model of the debt/equity ratio of the firms, graphically depicted in slices of a pie
   that represent the value of the firm in the capital markets.

Planned capital expenditure program

   • Capital expenditure program as outlined in the corporate financial plan.

Pro forma capital structure analysis

   • A method of analyzing the impact of alternative capital structure choices on a firm's
   credit statistics and reported financial results, especially to determine whether the
   firm will be able to use projected tax shield benefits fully.

Real capital

   • Wealth that can be represented in financial terms, such as savings account
   balances, financial securities, and real estate.                       14 | P a g e

Real options capital budgeting

   • Opportunities that are embedded in capital projects that enable managers to alter
   their cash flows and risk in a way that affects project acceptability (NPV). Also called
   strategic options.

Regulatory capital

   • Is the amount of capital available for trading or position taking purposes by financial
   institutions. The total capital base is adjusted for memberships, various fixed assets,
   type and/or maturity of securities as well as other factors.

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Risk capital budgeting

   • The chance that the inputs into the analysis of an investment project will prove to
   be wrong.

Soft capital rationing

   • Capital rationing that under certain circumstances can be violated or even viewed
   as made up of targets rather than absolute constraints.

Sophisticated approaches to capital budgeting

   • Capital budgeting techniques that integrate time value procedures, risk and return
   considerations, and valuation concepts to select capital projects that are consistent
   with the firm's goal of maximizing owners' wealth.

Static theory of capital structure

   • Theory that the firm's capital structure is determined by a trade-off of the value of
   tax shields against the costs of bankruptcy.

Target capital structure

   • The desired optimal mix of debt and equity financing that most firms attempt to
   achieve and maintain.

Taxable capital gain                       15 | P a g e

   • The percentage of net capital gains (the difference between capital gains and
   capital losses) that are included as taxable income, currently 50 percent.

Total capital

   • Gives information about how the company is financed or capitalized. This can be a
   combination of stock -- preferred and common shares -- and debt.

Uniform net capital rule

   • Securities and Exchange Commission requirement that member firms as well as

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   nonmember broker-dealers in securities maintain a maximum ratio of indebtedness
   to liquid capital of 15 to 1; also called net capital rule and net capital ratio.
   Indebtedness covers all money owed to a firm, including margin loans and
   commitments to purchase securities, one reason new public issues are spread
   among members of underwriting syndicates. Liquid capital includes cash and assets
   easily converted into cash.

Venture capital

   • An investment in a start-up business that is perceived to have excellent growth
   prospects but does not have access to capital markets. Type of financing sought by
   early-stage companies seeking to grow rapidly.

Weighted average cost of capital

   • Abbreviated WACC. Reflects the expected average future cost of funds for the
   upcoming year; found by weighting the cost of each specific type of capital by its
   proportion in the firm's capital structure.

   • The average cost of all capital used by a firm. In the context of valuing firms, if the
   capital is a mixture of debt and equity. The discount rate is called weighted average
   cost of capital.
   WACC = (1 - tc) * Rd * D/(D+E) + Re * E/ (D+E)
   Where tc is the corporate tax rate , Rd is the contractual interest rate on (new) debt,                       16 | P a g e

   Re is the discount rate on equity, D and E are the market values of debt and equity
   respectively. The return of all projects accepted by the corporation must exceed the
   weighted average cost of capital (WACC) to create value for the shareholders.

   • Expected return on a portfolio of all the firm's securities. Used as a hurdle rate for
   capital investment.

Working capital

   • Current assets, which represent the portion of investment that circulates from one
   form to another in the ordinary conduct of business.

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   • Current assets minus current liabilities

   • Also known as net working capital. It is calculated by subtracting current liabilities
   from current assets. If a company's current assets do not exceed its current
   liabilities, then it may be unable to meet its short-term liabilities with its current
   assets (such as cash, accounts receivable, and inventory).

   • Defined as the difference in current assets and current liabilities (excluding short-
   term debt). Current assets may or may not include cash and cash equivalents,
   depending on the company.

Working capital management

   • The management of current assets and current liabilities to maximize short-term

Working capital ratio

   • Working capital expressed as a percentage of sales.

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