EXAM 1 Fin 2303-300 PART 1-Study

Notes Receivable and Notes Payable are considered __________________ assets and liabilities.

"Non-Operating"

The submarket for long-term Debt and Equity Instruments is called

"the Capital Market".

The submarket for Short-Term Debt Instruments is called ______________________________________.

"the Money Market"

____________________________________________ is one way to measure the value of each share of common stock, which reflects the historical cost of the Assets (because the balance of Total Owners' Equity = the balance of Total Assets (measured at historical cost) less the balance of Total Liabilities.

Book Value per share

Uses of Cash

Increase in any Asset Decrease in any Liability Net Losses on I/S Income Taxes Paid Dividends Paid Repurchase or Retirement of Stock

net earnings

aka net income, measured by GAAP

What is a Financial Institution (aka Financial Intermediary)?

an organization existing for long-term service which simultaneously raises funds by selling/issuing financial instruments and then taking the proceeds and buying/investing in portfolios of financial instruments.

Another important measure shown on the Income Statement is: _____________________

"Earnings Per Share" (roughly equal to Net Income divided by the average number of the total shares of common stock outstanding.

financial instrument

(1) a set of legal rights for the owner/buyer of the instrument, including the general right/opportunity to receive cash flows/value in the future (2) a set of legal obligations for the seller/issuer of the financial instruments to pay money/value in the future

So, the Net Savers have positive net cash flow, and they invest their savings by purchasing financial instruments ("FIs") from two possible options:

(1) directly from businesses, governments, and households and/or (2) indirectly by purchasing financial instruments ("FIs") sold/issued by one or more financial intermediaries.

What are the only two reasons why the balance of Retained Earnings should change?

(1) dividends declared are subtracted (2) net earnings from the Income Statement are transferred into this account at yearend to closeout the 2021 Income Statement.

What are the two kinds of investing going on in a business:

(1) investing in financial instruments (i.e., debt: notes and bonds) by capital providers; and, (2) investing in business assets to support productive business projects by the business owners/management.

Productive Project Investors sustain and drive the economy, so we all want to make sure they have :

(a) enough capital, (b) at reasonable cost, (c) no disruptions.

The Cash Flow Statement measures the actual dollar value of transactions (activity) over a designated period of time (i.e., month, quarter, year) for:

- Adjustments to Net (Gross Cash Flow From Operations) Income to make morelike a Cash Flow measure - Investing Activities (Investments in Assets) - Financing Activities (Debt and Equity Financings)

What are the 5 things owners can do with their Free Cash Flow profits?

- Optional Growth Investing and Acquisitions - Debt Service (Principal and Interest) - Dividend Payments or Stock Repurchases - Extraordinary Compensation to Employees - Charitable and Other Contributions

The Income Statement measures the actual dollar value of transactions (activity) over a designated period of time (i.e., month, quarter, year) for:

- Selling Activities (Sales) - Expense Activities (Expenses)

The standard format prescribed by GAAP has 3 sections:

-Cash Flow from Operating Activities (This is Net Income adjusted to CF) -Cash Flow used for Investing Activities -Cash Flow provided by Financing Activities

-How much Free Cash Flow should AFP have aimed to produce in 2021? -The best way to answer that question would be to take the estimated market value for AFP's Total Assets, then subtract the balance of Current Liabilities. The net result can be called AFP's "Total Capital". Then, multiply the balance of Total Capital times AFP's WACC, and the number you get would be a rough estimate of how much Free Cash Flow AFP needed to produce for 2021.

-How much Free Cash Flow should AFP have aimed to produce in 2021?

.2. Indirect Transfers through Investment Banks

-Investment Banks work with Productive Project Investors and Financial Intermediaries to create and underwrite offerings of Financial Instruments sold by Productive Project Investors and sold by Financial Intermediaries, which are bought by Financial Intermediaries and Net Savers.

What are the commonly calculated financial ratios? (which are not an exhaustive set of all meaningful ratios for a company)

-Liquidity Ratios -Asset Management Ratios -Debt management Ratios -Profitability Ratios -Market Value Ratios

3. Indirect Transfers through Financial Intermediaries

-Net Savers buy Financial Instruments sold by Financial Intermediaries .-Financial Intermediaries buy Financial Instruments sold by Productive Project Investors.

1. Direct Transfers from Net Savers Productive Project Investors

-Net Savers provide Capital directly to Productive Project Investors.-Net Savers buy Financial Instruments sold by Productive Project Investors

What are the three sections/components for free cash flow

-Operating Cash Flow. -Capital Expenditures, which represents the total amount funds expended to purchase new long-term assets. -the Change in "Net Operating Working Capital".

-The Income Statement and Cash Flow Statement standard financial statements are measuring the financial impact of a company's activities over a defined period of time, in the following four areas:

-Selling Activities; -Expense Activities; -Investing Activities; -Financing Activities.

Corporate Income Tax Code

-Tax Rates Are Progressive and are [Higher/Lower] than the Individual Income Tax Code, plus Several Surtaxes May Apply -Loss Carry-back and Carry-forward Provisions May/May Not Apply -Many Investment Incentives Provided (e.g., Accelerated Depreciation, etc.) -Corporation Income is Taxable Separately from Dividend Income (and possibly 70% of Dividend Income is Not Taxable to a Corporation thatowns stock in another company) -Applies to Incorporated Businesses (except for permitted exceptions, like "S" Corporations and LLCs) -Tax Cuts and Jobs Act of 2017 Substantially Reduced Highest Tax Rate from 35% to 21%, Permits 100% Expensing of Some Assets Purchased

Individual/Personal Income Tax Code

-Tax Rates are Progressive and are [Lower/Higher] than the Corporate Income Tax Code -No Loss Carry-back or Carry-forward Provisions (They Do Not Apply) -Dividend Income is Taxable -Applies to Unincorporated Businesses -Can Apply to "S" Corporations and Limited Liability Companies (LLCs)

Free Cash Flow is an after-tax measurement, so anything that can legally reduce cash payments for income taxes will increase Free Cash Flow. Here, we are understanding Free Cash Flow as one of the primary factors that can strongly influence a company's common stock price/value.

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Overall: all financial instruments ("FIs") derive their cash-on-cash returns from the cash flows coming from productive projects. One thing permeates the whole chart is the fact that the individual actors in the system are acting on the basis of a government-regulated and industry-regulated free market system.

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he corporate income tax codes may have higher or lower marginal income tax rates (compared to the individual income tax codes), but corporate income tax codes generally contains more incentives to pursue valuable business investment activities; and,

.

Financial ratio analysis focuses on three areas:

1. Evaluating a company's investment in, and financing of, balance sheet assets .2. Evaluating a Management's ability to manage a company's profitability. 3. Analyzing a company's historical actual financial performance with certain, commonly-calculated financial ratios (which are not an exhaustive set of all meaningful ratios for a company) in five categories:-Liquidity Ratios-Asset Management Ratios-Debt management Ratios-Profitability Ratios-Market Value Ratios

Examples of Financial Institutions (DICFIC)

:1. Depository Institutions (commercial banks, credit unions, savings & loans) 2. Contractual Savings Institutions (insurance companies, pension funds) 3. Investment Intermediaries (mutual funds, private equity funds, finance cos.) 4. Investment Banks (as advisors and underwriters of securities offerings) 5. Financial Service Corporations (combinations of one or more of the above, like JP Morgan Chase, Citigroup, Bank of America) 6. Central Banks (national government, U.S. Federal Reserve Bank System)

In the U.S., the instructor has estimated that currently there are at least __________ companies which have received permission from the S.E.C. to sell their common stock to the investing public.

12000

All equity financial instruments (including both preferred stock and common stock) would account for only about __% of the annual trading volume.

20

There have been fewer than____________ IPOs per month In the U.S., historically

40 (forty)

All economies are made up of ____ sectors:

4; households, businesses, governments, and foreigners.

Short-term debt instruments alone would account for about __% of the annual trading volume

50

-Among these, there are only about _______companies which are listed on the NASDAQ and New York Stock Exchange. Fewer than _________ of these companies' stocks are actively traded on a daily basis. Used to be 8100 in 1995

6000

Short-term and long-term debt instruments would account for roughly __% of the annual trading volume

80

three types of transactions for equity instruments (although, technically, the same kinds of transactions could describe the types of transactions for debt instruments)

:(1) Secondary market for seasoned equity offerings ("SEOs"); (2) Primary market for SEOs; (3) Primary market for new equity offerings (i.e., initial public offerings, "IPOs")

Free Cash Flow (FCF)

= OCF less Capital Expenditures minus the Change in Net Operating Working Capital [which is equal to ( Change in Current Operating Assets less Change in Current Operating Liabilities ) ]

Total Debt to Total Capital Ratio

= Total Debt / Total Capital (Debt + Equity) the lower the ratio the better

Operating Cash Flow (OCF)

=EBIT + depreciation - taxes. This accounts for all fixed and variable costs, taxes, depreciation, and the depreciation tax shield. OCF does not consider interest expense.

Times Interest Earned Ratio

=EBIT / Interest

Operating Profit Margin

=EBIT/Sales

Basic Earning Power Ratio

=EBIT/Total Assets

Return on Common Equity

=Net Income/Common Equity

Profit Margin

=Net Income/Sales

Return on Total Assets

=Net Income/Total Assets

Days Sales Outstanding Ratio

=Receivables / (Annual Sales/365)

Total Assets Turnover Ratio

=Sales / Total Assets

Inventory Turnover Ratio

=cost of goods sold/average inventory

Market-to-Book Ratio

=stock price/book value per share*

Price/Earnings Ratio

=stock price/earnings per share

uses of cash

A firm's activities in which cash is spent. Also called applications of cash.

Financial Market

A place of exchange (physical location or electronic network)where Financial Instruments are bought and sold, either on a wholesale basis or retail basis.

What can AFB do to improve its performance:?

AFP could sell excess assets (it seems to have too many assets from its Asset Management Ratios) and use the proceeds to pay down its debt.

How could AFP improve these ratios?

By holding fewer Current Liabilities, or by holding more in Current Assets, or both.

The Balance Sheet also tells us how the company has financed its purchase of all _________

Assets

what is the cumulative historical amounts of capital (Liabilities, Debt or Owner's Equity) that was raised as of the stated calendar date for the report?

Assets

Liquidity Ratios

Current Ratio = Current Assets / Current Liabilities

Sources of Cash

Decrease in any Asset Increase in any Liability Net Profits on I/S Depreciation and other Non-Cash Charges Sale of Stock

Debt Management Ratios answers what question?

Does the Company have enough or too much Debt? to what extent does the company use debt to finance its total assets, and (b) to what extent can the company cover its interest payments owing on its debt.

Asset Management Ratios answers what question?

Does the Company have enough or too much in Assets?

Profitability Ratios answers what question?

Does the Company produce enough Profit?

Market Value Ratios answers what question?

Does the Company produce enough value for the common stockholders?

Liquidity ratios are intending to help answer what question?

Does the company have enough cash to cover its short-term liabilities?

Return on Invested Capital

EBIT (1-T)/ (debt + Equity)

__________________ _______________ can be traded on a large-scale wholesale basis through a bricks-and-mortar, physical location, exchange business, like the New York Stock Exchange in New York City or the Midwest Exchange in Chicago, or the Pacific Exchange in San Francisco.

Financial instruments

Where does a corporation find debt investors and equity investors?

Financial markets are places of exchange where financial instruments are offered for sale by companies, governments and households, and investors buy and sell them.

The Capital Allocation Process

In a well-functioning economy, capital flows efficiently from those who supply capital to those who demand it. the movement of funds from all "savers" to all businesses (as well as to individuals and governments).

The________________ _______________ for AFP shows the financial impact in 2021 of Selling activities and Expense activities on AFP's financial condition.

Income Statement

What is a debt financial instrument?

It provide the debtholder with the legal right to receive the principle repaid in cash on a defined future maturity date, and the legal right to receive a defined cash return usually on defined dates in the future.

Some of these sectors are____ _________ meaning their annual revenues exceed their total expenditures (for expenses and for expenditures to purchase assets).

Net Savers

NOWC

Net operating working capital; Current Assets - (Current liabilities - notes payable)

Operating Cash Flow less Capital Expenditures less the Change in NOWC equals Free Cash Flow.

OCF - Capital expenditures - change in NOWC = FCF

______________ markets are the markets for new issues of securities where the seller/issuers receive the proceeds from the sale of the securities (like the new car market where the auto manufacturer receives payment)

Primary

PPI

Productive Project Investors - create/maintain products, jobs, and tax revenues

______________ markets are where the investor-owners of securities sell their securities to other investors (like the used car market).

Secondary

_____ ____________ are markets where the trade is made "today" for the current date.

Spot markets

What tells us the balances of cumulative historical costs paid (or accrued) by the company for all assets in service as of a stated calendar date?

The Balance Sheet (B/S)

Free Cash Flow does not subtract Interest Expense and Debt Principal payments because there is a critical assumption, which is what assumption?

The company will always maintain good credit ratings so it can re-finance any Debt Service payments (at the option of the company).

T or F: the Balance Sheet does not present the current market value for its long-term assets or long-term liabilities and equity capital (short-term assets and short-term liabilities are generally carried at their market value because they are turned over frequently).

True

Sources of Cash

a firm's activities that generate cash

The _____________ _______________ legally own the net earnings (aka net income, measured by GAAP), and this means the common stockholders also own net earnings that have not yet been distributed to them in the form of dividends (the balance of Retained Earnings).

common stockholders

A _________ is a broker which also maintains inventories of securities.

dealer

What are the two broad categories of financial instruments

debt and equity

What is a equity financial instrument?

does not provide such legal rights. Both debt instruments and equity instruments can be customized to contain different features/characteristics. The term "financial instrument" is a generic term and a synonym would be "securities".

The business activities measured on the Income Statement and Cash Flow Statement ______________________the changes to the Balance Sheet account balances.

drive and create

Professionals who work in Business Finance (aka Corporate Finance) work on managing a company's _____________ activities and day-to-day cash management activities.

financing

______ ___________ are markets for instruments that are to be traded at a designated date in the future.

futures markets

For AFP, a quick and dirty example (because we do not have all the information needed to get to a more precise amount, and assuming AFP's WACC equals 8.00% on an annual basis): -Total Assets at yearend 2021 less Current Liabilities = Total Capital-$2,000 million less $310 million = $1,690 million-Minimum Required Free Cash Flow = $1,690 million x 0.08 = $135.2 million.- So, AFP's minimum required Free Cash Flow for 2021 (very rough estimate)would be $ 135.2 million.-AFP's actual Free Cash Flow for 2021 was $(71.5) million.-So, AFP's short-fall for Free Cash Flow for 2021 = $ 206.7 million [$206.7 million = $135.2 million + $71.5 million).AFP Management needs to review their future Sales, Operating Expenses, and Income taxes, and their future investments in long-term and short-term assets to consider how they can improve AFP's financial performance (if we are focusing on increasing the Market Value of AFP's common stock price as a meaningful measure).

https://canvas.ou.edu/courses/261095/files/55296596?module_item_id=4350800

Financial institutions are ____________ in the supply chain for credit and capital, so most financial institutions can also be referred to as financial intermediaries.

middlemen

Free Cash Flow is a combination of ____________________________, in order to get to a measure of after-tax cash flow from operations minus investments needed in long-term and short-term assets to help maintain the company's operations.

parts of the Income Statement and parts of the Cash Flow Statement

the Balance Sheet shows ___________ __________ balances and does measure financial activities over a defined period of time.

static, passive

the basic definition for Free Cash Flow

the amount of cash that the business owners can take out of their company without harming its ability to operate and to produce future cash flows.

___________________________________________________ = the balance of Total Assets - the balance of Total Liabilities.

the balance of Total Owners' Equity

One of the main purposes of the Income Statement and Statement of Cash Flows is

to provide a more detailed understanding of all the business activities which occurred in AFP that had a financial impact on AFP.