Exam #4
What is GAAP?
Generally Accepted Accounting Principles; financial statements have to be made in accordance with them
What is sunk cost?
a cost that has already been paid should not be considered in an investment decision
Which examples involve only implicit opportunity costs (not explicit costs)?
a firm withholding licensing rights from others to gain a competitive advantage; a rental estate company using a rental apartment as its own office; a company using a spare machine for a new project
What is cash flow to owners?
a firm's dividend payments less net new equity raised
What is financial leverage?
a ratio of debt to equity or debt to total assets
What are financial statements the language of?
accountants, auditors, analysts, examiners, creditors, investors
Total asset turnover is a measure of:
asset use efficiency
The balance sheet shows a company's:
assets and liabilities at one point in time
What is the stand-alone principle?
assumption that evaluating a project is as simple as considering the project's incremental cash flows
What are stock variables?
balance sheet and statement of changes in owners' equity
What value are financial statements stated at?
book
What are examples of current assets?
cash accounts receivable inventory
What is free cash flow?
cash flow available to pay creditors and owners
What is cash flow identity?
cash flow from assets equals cash flow to creditors plus cash flow to owners
According to the cash flow identity, cash flow from assets must equal:
cash flow to shareholders and creditors
Common-size statements are useful for comparing:
companies of different sizes a company's performance over time different companies in the same industry
What is net working capital (NWC)?
current assets - current liabilities
What are examples of current liabilities?
current portion of long-term debt accrued wages accounts payable
What is a current liability?
debt that needs to be paid in cash within a year
Which of these items does not add to or subtract from incremental cash flow by its full amount? taxes opportunity costs side effects depreciation
depreciation
What is cash flow?
difference between the amount of money that is collected and dispersed; inflows minus outflows
What is incremental cash flows?
difference between the firm's existing cash flows without the new project versus its cash flows with the new project
Cash flow to shareholders equals:
dividends paid minus net new equity issued
What are fixed assets and long-term liabilities?
everything else
What is liquidity?
how quickly/easily you can convert something to cash
Financial ratios are useful:
if they can be compared to historical ratios or other companies' ratios
When determining relevant cash flows for project evaluation, we should:
ignore interest and other financing expenses
What are flow variables?
income statement and cash flow
What are the 4 types of financial statements?
income statement, balance sheet, statement of cash flows, statement of owner's equity
Cash flow to creditors equals:
interest paid minus net new borrowing
What is common-sized financial statements?
listed in percentages instead of dollar values
What value does finance care about?
market
Which are components of cash flow to assets?
net capital spending change in net working capital operating cash flow
How is book value stated?
net of any charges or adjustments (depreciation, amortization, charge-offs, write-downs, etc.)
What is cash flow from assets?
operating cash flow + capital spending + change in net working capital
When calculating incremental cash flows, we should include:
opportunity costs
What are uses of the cash flow from assets generated by a company?
pay dividends to shareholders reinvest the money in the company pay interest and principal to creditors
What are statements of changes in owner's equity?
shows estimated changes in overall firm equity; shares and classes of stock, retained earnings and accumulated other comprehensive income
What is statement of cash flows?
standard financial accounting statement that discloses a firm's cash flows
What is project cash flows?
what cash flows should we include?; how we determine whether to undertake or not based on the cash flows the project will generate
What is market value?
whatever price it will bring in the market
What is cash flow erosion?
when cash flows are lost due to investing in a new project
What is a proforma financial statement?
"what might be"
What is relevant cash flows?
any change in the firm's overall future cash flows that come directly from a new project
What is a current asset?
anything that can be converted to cash in a year
What is cost?
anything you give up
What is operating cash flow?
cash generated from a firm's normal business activities; approximately equal to EBITDA; EBIT + depreciation - taxes
What is opportunity cost?
cost of the next best alternative that we give up
What is cash flow to creditors?
firm's interest payments to creditors less net new borrowing
Sunk costs are costs that:
have been incurred in the past and cannot be recouped fully
What is another name for book value of assets?
historical cost
What is another name for book value of debt and equity?
issue price
Even though depreciation is not a cash outflow, we should consider it in capital budgeting because:
it changes tax liabilities, which are a cash outflow
What are audited financial statements?
required to issue and trade most financial instruments
The income statement shows a company's:
revenue and expenses over a period of time