FIN 3716 Exam 1
The Law of One Price
"If equivalent investment opportunities trade simultaneously in different competitive markets, then they must trade for the same price in both markets." What do we call the above statement? A) The Net Present Value rule B) The Law of One Price C) The Valuation Principle D) The Time Value of Money
Future Value Interest Factor
(1 + r)^t
Rules of Cash Flows
(1) It is only possible to compare or combine values at the same point in time (2) To calculate a cash flow's future value, you must compound it (3) to calculate the value of a future cash flow at an earlier point in time, you must discount it
Accounts Payable Formula
(Accounts payable / (Cost of goods sold / 365)
Annuity
(Answer= Annuity)
Cash Flow Problem
(Answer= Cash Flow Problem)
Computing a Loan Payment
(Answer= Computing a Loan Payment)
Endowing a Growing Perpetuity
(Answer= Endowing a Growing Perpetuity)
Present Value of a Lottery Prize Annuity
(Answer= Present Value of a Lottery Prize Annuity)
Present Value of an Annuity Starting Today
(Answer= Present Value of an Annuity Starting Today)
Retirement Savings with a Growing Annuity
(Answer= Retirement Savings with a Growing Annuity)
Solving for Cash Flows in an Annuity (Loan Payment)
(Answer= Solving for Cash Flows in an Annuity (Loan Payment))
ok Example 4.3
(Answer=ok Example 4.3)
Return on Invested Capital
(EBIT (1 - tax rate)/ (Book value of equity + Net debt)
Return on Equity Formula
(Net income / book value of equity)
Return on Assets Formula
(Net income/ total assets)
Price-Earnings Ratio
(Share price / earnings per share)
Dupont Identity / ROE Formula
(net income / total equity)
Market Capitalization Formula
(shares price) * (shares outstanding)
Advantages of Sole Proprietorship
- Easiest to start - Least regulated - Single owner keeps all the profits - Taxed once as personal income - Single taxation - No separation of ownership and control
EBITDA
- Financial analysts often compute a firm's earnings before interest, taxes, depreciation, and amortization, or EBITDA - Because depreciation and amortization are not cash flows, this subtotal reflects the cash a firm has earned from operations
Earnings Per Share (EPS)
- Fully diluted EPS increases number of shares by: -- Stock options issued to employees --- The right to buy a certain number of shares by a specific date at a specific price -- Shares issued due to conversion of convertible bonds --- Convertible bonds are corporate bonds with a provision that gives the bondholder an option to convert each bond into a fixed number of shares of common stock
Dodd Frank Wall Street Reform
- Mitigate compliance burden on small firms - Broadened the whistle blower provisions of SOX
Which organizational forms give their owners limited liability?
-Limited partnership for limited partners -Corporation Corporations and limited liability companies give owners limited liability. Limited partnerships provide limited liability for the limited partners, but not for the general partners
Partnership
-Multiple owners -All partners are liable for the firms debt -Partnership ends with death or withdrawal of either partner -Can avoid liquidation if agreement provides for alternatives
Ownership of Corporations
-No limit on number of owners -Entire ownership stake of a corporation is divided into shares aka stock
What are the main advantages of organizing a firm as a corporation?
-No limit on the number of owners, allowing the corporation to raise substantial amounts of capital. -The life of the business can continue beyond the death of the owner. -Liability of the owners is limited to amount of their investment in the firm.
Sole Proprietorship
-Straightforward, many businesses use this form -Prinicipal limitation is that there is no separation between the firm and the owner -Can only have one owner -Has unlimited liabilities -If they cant pay a loan, they must sell their personal belongings
How do financial institutions help with risk-bearing?
1. Insurance companies spread out risk by pooling premiums together from policy holders and pay the claims of those who have an accident, fire, medical need or die. This process spreads the financial risk of these events out across a large pool of policyholders and the investors in the insurance company. 2. Mutual funds and pension funds take your savings and spread them out among the stocks and bonds of many different companies, limiting your exposure to any one company. 3. Financial institutions not only assist with risk-bearing of savers and investors, but must also be concerned about their own risk, spreading their loans out among a variety of clientele.
What role do investment banks play in the economy?
1. Investment banks advise companies in major financial transactions such as buying or selling companies or divisions. 2. Investment banks assist companies in raising capital by issue of stocks and bonds on behalf of corporate clients.
Financial manager tasks
1. Make investment decisions 2. Make financing decisions 3. Manage short term cash needs
What is the role of an auditor in financial statement analysis?
1. to ensure that the annual financial statements are prepared accurately 2. to ensure that the annual financial statements are prepared according to Generally Accepted Accounting Principles (GAAP) 3. to verify that the information used in preparing the annual financial statements is reliable
long-term liability
A 30-year mortgage loan is a ________. A) long-term liability B) current liability C) current asset D) long-term asset
$2.11 (Corporate tax = $4.30 × 35% = $1.51 ; Personal tax = $3.00 × 20% = $0.60 Total = $1.51 + $0.60 = $2.11)
A C corporation earns $4.30 per share before taxes. The corporate tax rate is 35%, the personal tax rate on dividends is 20%, and the personal tax rate on non-dividend income is 39%. What is the total amount of taxes paid if the company pays a $3.00 dividend? A) $1.68 B) $2.53 C) $2.11 D) $2.95
$3.40 (Personal tax = $4 × 15% = $0.60 ; Total = $4.00 - $0.60 = $3.40)
A C corporation earns $8.30 per share before taxes and the company pays a dividend of $4.00 per share. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the after-tax amount an individual would receive from the dividend? A) $2.72 B) $4.08 C) $4.76 D) $3.40
$4.14 (Corporate tax = $8.30 × 39% = $3.24 , Personal tax = $6 × 15% = $0.90 Total = $3.24 + $0.90 = $4.14)
A C corporation earns $8.30 per share before taxes. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the total amount of taxes paid if the company pays a $6.00 dividend? A) $3.31 B) $4.96 C) $4.14 D) $5.79
the cost of the courtside advertising at the tennis matches
A U.S.-based manufacturer of sunscreen is contemplating using funds to purchase courtside advertising at major tennis matches such as the French Open and the Australian Open. Advertising at such well viewed international events will then raise the domestic sales of the manufacturers products. Which of the following factors is the most relevant when analyzing this decision? A) the cost of the machine used to produce the sunscreen B) the manufacturing process of the sunscreen C) the cost of the existing advertising campaign D) the cost of the courtside advertising at the tennis matches
hostile takeover
A ________ is when a rich individual or organization purchases a large fraction of the stock of a poorly performing firm and in doing so gets enough votes to replace the board of directors and the CEO. A) shareholder proposal B) leveraged buyout C) shareholder action D) hostile takeover
$24.0 per hour To be competitive, the ditch digger could not charge more than what the backhoe costs; cost per feet of ditch for backhoe = $720 /180 < = $4.0; charge per hour by ditch digger = $4.0 × 6 = $24.0
A backhoe can dig 180 feet of trench per hour and costs $720 per hour to hire and operate. A ditch digger can dig 6 feet of trench per hour. Based on this information, what is the most a ditch digger can charge for per hour when digging ditches? A) $24.0 per hour B) $29.0 per hour C) $4.0 per hour D) $48.0 per hour
$7178
A bank lends some money to a business. The business will pay the bank a single payment of $176,000 in ten yearsʹ time. How much greater is the present value (PV) of this payment if the interest rate is 9% rather than 8%? A) $7178 B) $5742 C) $8613 D) $10,049
6.30% First convert the EAR to APR with semiannually compounding, which equals 12.60 %; now divide this by 2 to get the periodic interest rate = 6.30 %.
A bank pays interest semiannually with an EAR of 13%. What is the periodic interest rate applicable semiannually ? A) 5.04% B) 7.56% C) 6.30% D) 12.60 %
Corporation
A business created as a distinct legal entity and treated as a legal "person"
general partnership.
A business formed by two or more individuals who each have unlimited liability for all of the firm's business debts is called a: A. corporation. B. sole proprietorship. C. general partnership. D. limited partnership. E. limited liability company.
Partnership
A business owned and run by more than one owner
Sole Proprietorship
A business owned and run by one person
sole proprietorship.
A business owned by a solitary individual who has unlimited liability for its debt is called a: A. corporation. B. sole proprietorship. C. general partnership. D. limited partnership. E. limited liability company.
Limited partner.
A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a: -General partner. -Sole proprietor. -Limited partner. -Corporate shareholder. -Zero partner.
6.8%
A businessman wants to buy a truck. The dealer offers to sell the truck for either $120,000 now, or six yearly payments of $25,000 . Which of the following is closest to the interest rate being offered by the dealer? A) 5.8% B) 6.8% C) 7.8% D) 9.8%
Sales
A common-size income statement is an accounting statement that expresses all of a firm's expenses as percentage of:
$113,000
A company intends to install new management software for its warehouse. The software will cost $47,000 to buy and will cost an additional $148,000 to install and implement. It is anticipated that it will save the company $44,000 through reductions in staff and $69,000 in general inventory costs in the first year after installation. What is the total benefit to the company in the first year if they choose to install the software? A) $56,500 B) $45,200 C) $113,000 D) $79,100
a patent for a drug held by the company
A company that produces drugs is preparing a balance sheet. Which of the following would be most likely to be considered a long-term asset on this balance sheet? A) commercial paper held by the company B) the inventory of chemicals used to produce the drugs made by the company C) a patent for a drug held by the company D) the cash reserves of the company
New models will require a lot of money to develop and bring to market before they generate any revenue.
A company that produces racing motorbikes has several models that sell well within the motorcycle racing community and which are very profitable for the company. Despite having a profitable product, why must this company take care to ensure that it has sufficient cash on hand to meet its obligations? A) Profits from the sales of popular models will be lost when returned to the shareholders in the form of dividends. B) New models will require a lot of money to develop and bring to market before they generate any revenue. C) The company will have built up debts which must be repaid in order to bring the current models to market. D) Equity must be raised to finance the development of new models to replace the existing models
Some activities that decrease shareholdersʹ wealth may have intangible benefits which increase the strength of the company overall.
A companyʹs board of directors chooses to provide a comprehensive health care plan for the families of all employees, despite the large cost. They argue that this will not only increase the number of employees who stay with the firm, and thus reduce some costs involved in employee turnover, but also increase the employeesʹ diligence and industry. What general principle is being argued by the board of directors? A) In a conflict between stakeholders in a company, the most important stakeholder is not always the stockholders. B) Some activities that decrease shareholdersʹ wealth may have intangible benefits which increase the strength of the company overall. C) When a conflict of interest arises between shareholders and other stakeholders, in general, the correct solution is the one that creates the greatest good for the greatest number of stakeholders. D) Ethical decisions should be assessed on their moral value, not on their value in dollars and cents.
by the rise in the value of the stock held by the raider when the new board of directors is judged to be superior to the ousted board of directors
A corporate raider gains a controlling fraction of the shares of a poorly managed company and replaces the board of directors. How does the corporate raider hope to make a profit in this case? A) by the sale of the assets held by the company that hold most of its value B) by the rise in the value of the stock held by the raider when the new board of directors is judged to be superior to the ousted board of directors C) by motivating the board of directors and other stakeholders in the company to make difficult short-term decisions that will increase the long-term viability of the company D) by removing the employees expectations of the continued poor performance of the company
How is a corporation different from most of the other forms of business organizations?
A corporation has a separate legal identity from those of its owners. This separation gives the owners limited liability for the actions of the corporation. The down side is the process of double taxation for each dollar earned by the corporation, once when it is earned by the corporation and subsequently when it is passed on to the owners.
revenue received for the delivery of items that have not yet been delivered
A delivery company is creating a balance sheet. Which of the following would most likely be considered a short-term liability on this balance sheet? A) the depreciation over the last year in the value of the vehicles owned by the company B) revenue received for the delivery of items that have not yet been delivered C) a loan which must paid back in two years D) prepaid rent on the offices occupied by the company
by supplying incentives so the agents act in the way principal desires
A factory owner wants his workers to produce as many widgets as they can so he pays his workers based on how many widgets they produce. However, in order to make sure that the workers do not rush and produce a large number of poorly made widgets, he checks the widgets at random at various stages of their manufacture. If a defect is found in a widget, the pay of the entire section of the factory responsible for that defect is docked. How is this factory owner seeking to solve the agency conflict problem in this case? A) by supplying incentives so the agents act in the way principal desires B) by ensuring that all workers co-operate to maximize the gains of their section C) by making the agents into principals themselves D) by maximizing the information that the principal obtains about the behavior of the agents
Real-world decisions are complex and require information from many sources if the decisions are to be valid.
A firm that provides tax services to the public intends to offer a premium tax-return service at a higher price than their current services. The managers of the company ask experts in marketing to determine how much an effective ad campaign for such a service would cost, and by how much sales would increase. They consult experts in economics to calculate the increases in revenue from the success of the campaign, experts in operations to determine the cost of offering the service, and experts in strategy to anticipate possible counter-moves by competitors. Which of the following points about the role of financial managers does this example illustrate? A) Real-world decisions are complex and require information from many sources if the decisions are to be valid. B) Determining the costs associated with making a decision is easier than determining the potential benefits of the decision. C) All of the costs and benefits associated with a decision can never be fully identified. D) Ultimately the decision whether to take a certain course of action rests with the financial managers of a company.
Board of Directors
A group of people elected by shareholders who have the ultimate decision-making authority in the corporation
Present Value of a Growing Annuity
A growing annuity is a stream of N growing cash flows, paid at regular intervals It is a growing perpetuity that eventually comes to an end The following timeline shows a growing annuity with initial cash flow C, growing at a rate of g every period until period N (1) The first cash flow arrives at the end of the first period (2) the first cash flow is before growth The last cash flow reflects only N-1 periods of growth.
Growing Cash Flows
A growing perpetuity is a stream of cash flows that occur at regular intervals and grow at a constant rate forever For example, a growing perpetuity with a first payment of $100 that grows at a rate of 3% has the following timeline:
$145 (Calculate the cash flow as the perpetuity whose PV = $2900 ; hence, annual heating cost = 2900 × 0.05 = $145 .)
A homeowner in a sunny climate has the opportunity to install a solar water heater in his home for a cost of $2900 . After installation the solar water heater will produce a small amount of hot water every day, forever, and will require no maintenance. How much must the homeowner save on water heating costs every year if this is to be a sound investment? (The interest rate is 5% per year.) A) $145 B) $160 C) $175 D) $190
Corporation
A legally defined, artificial being, separate from its owners
a limited partnership without a general partner
A limited liability company is essentially ________. A) a limited partnership without limited partners B) a limited partnership without a general partner C) just another name for a limited partnership D) just another name for a corporation
Limited Partnership vs. Limited Liability Corporation
A limited partnership is required to have at least one general partner. A limited liability corporation is similar to a limited partnership but without the general partner.
Balance Sheet
A list of a firm's assets and liabilities that provides a snapshot of the firm's financial position at a given point in time
Net Income
A measure of profitability during the period. Also referred to as the earnings of the company
$1200 (Payment = 20,000 × 0.06 = $1200)
A perpetuity has a PV of $20,000 . If the interest rate is 6%, how much will the perpetuity pay every year? A) $600 B) $960 C) $1200 D) $720
Investors believe the companyʹs assets are not likely to be profitable since its market value is worth less than its book value.
A public company has a book value of $128 million. They have 20 million shares outstanding, with a market price of $4 per share. Which of the following statements is true regarding this company? A) Investors may consider this firm to be a growth company. B) Investors believe the companyʹs assets are not likely to be profitable since its market value is worth less than its book value. C) The firmʹs market value is more than its book value. D) The value of the firmʹs assets is greater than their liquidation value.
Since net working capital is negative, the company will not have enough funds to meet its obligations.
A small company has current assets of $112,000 and current liabilities of $117,000. Which of the following statements about that company is most likely to be true? A) Since net working capital is negative, the company will not have enough funds to meet its obligations. B) Since net working capital is high, the company will likely have little difficulty meeting its obligations. C) Since net working capital is very high, the company will have ample money to invest after it meets its obligations. D) Since net working capital is nearly zero, the company is well run and will have little difficulty attracting investors.
as an outflow under investment activities
A software company acquires a smaller company in order to acquire the patents that it holds. Where will the cost of this acquisition be recorded on the statement of cash flows? A) as an outflow under operating activities B) as an outflow under investment activities C) as an outflow under financial activities D) not recorded on the statement of cash flows
one person
A sole proprietorship is owned by ________. A) one person B) two or more persons C) shareholders D) bankers
In general, all shareholders will agree that they are better off if the financial manager works to maximize the value of their investment.
A typical company has many types of shareholders, from individuals holding a few shares, to large institutions that hold very large numbers of shares. How does a financial manager ensure that the priorities and concerns of such disparate stockholders are met? A) The financial manager should seek to make investments that do not harm the interests of the stockholders. B) The decisions taken by the financial manager should be solely influenced by the benefit to the company since, by maximizing its fitness, he or she will also maximize the benefits of that company to the shareholders. C) The financial manager should consider the interests and concerns of large shareholders a priority so the needs of those who hold a controlling interest in the company are met. D) In general, all shareholders will agree that they are better off if the financial manager works to maximize the value of their investment.
Fixed asset turnover ratios indicate that firm A generating fewer sales for the assets it employs than firm B.
Above are portions of the balance sheet and income statement for two companies in 2008. Based upon this information, which of the following statements is most likely to be true? A) Asset turnover ratios indicate that firm A is generating greater revenue per dollar of assets than firm B. B) Fixed asset turnover ratios indicate that firm A generating fewer sales for the assets it employs than firm B. C) Both asset turnover ratios and fixed asset turnover ratios indicate that firm A is generating greater revenue per dollar of assets than firm B. D) Fixed asset turnover ratios indicate that firm A generating more sales for the assets it employs than firm B.
Financial Statements
Accounting reports issued by a firm quarterly and/or annually that present past performance information and a snapshot of the firm's assets and the financing of those assets.) -Must also send an annual report (the yearly summery of business, accompanying or including financial statements, sent by U.S. public companies to their shareholders) with financial statements to shareholders
uses of cash.
Activities of a firm which require the spending of cash are known as: A. sources of cash. B. uses of cash. C. cash collections. D. cash receipts. E. cash on hand
What are the main advantages and disadvantages of organizing a firm as a corporation?
Advantages: 1. There is no limit on the number of owners a corporation may have, thus allowing the corporation to raise substantial amounts of capital. 2. The life of the business can continue beyond the death of any of the owners. 3. The liability of the owners is limited to the amount of their investments in the firm. Disadvantages: 1. Income to a corporation is subject to double taxation, once at the corporate level and again when received by the owners in the form of a dividend. 2. The corporation is more complicated and more expensive to set up than other business entities.
What are the advantages and disadvantages of a sole proprietorship?
Advantages: •It is the easiest business type to start. •It is the least regulated. •Owners keep all the profits and do not have to share the decision-making authority with anyone. •All income is taxed as personal income which is usually in a lower tax bracket than corporate income. Disadvantages: •The proprietor has an unlimited liability for all business debt and financial obligations of the firm. •The amount of capital that can be invested in the firm is limited by the proprietor's wealth. •It is difficult to transfer ownership (requires sale of the business).
What is an agency relationship and what is an agency conflict? How can agency conflicts be reduced in a corporation?
Agency relationships develop when a principal hires an agent to perform some service or represent the firm. An agency conflict arises when the agent's interests and behaviors are at odds with those of the principal. Agency conflicts can be reduced through the following three mechanisms: management compensation, control of the firm, and the board of directors.
$2.34 ($6.00 × 39% = $2.34)
An S corporation earns $6.00 per share before taxes. The corporate tax rate is 35%, the personal tax rate on dividends is 20%, and the personal tax rate on non-dividend income is 39%. What is the total amount of taxes paid if the company pays a $2.00 dividend? A) $1.87 B) $2.81 C) $3.28 D) $2.34
$3.28 ($9.10 × 36% = $3.28)
An S corporation earns $9.10 per share before taxes. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the total amount of taxes paid if the company pays a $5.00 dividend? A) $3.28 B) $3.93 C) $2.62 D) $4.59
$142.67
An annuity pays $10 per year for 98 years. What is the present value (PV) of this annuity given that the discount rate is 7%? A) $85.60 B) $171.20 C) $142.67 D) $199.74
$13,764.85 Using TVM keys input PMT = $13, number of years = 53, and interest rate = 9%; computing PV = $13,764.85 .
An annuity pays $13 per year for 53 years. What is the future value (FV) of this annuity at the end of that 53 years given that the discount rate is 9%? A) $8258.91 B) $16,517.82 C) $19,270.79 D) $13,764.85
$35,000, since this is the difference between purchase and resale price of the Cadillac. (Net value = $87,000 - $52,000 = $35,000)
An elderly relative offers to sell you their used 1958 Cadillac Eldorado for $52,000. You note that very similar cars are selling on the open market for $87,000. You donʹt care for classic cars and would rather buy a new Ford Explorer for $35,000. What is the net value of buying the Cadillac? A) $87,000, since the Cadillac could be sold for this price. B) $52,000, since the Cadillac could be bought for this price. C) $35,000, since this is the difference between purchase and resale price of the Cadillac. D) $35,000, since this is the value of the car that you really want to buy.
Accounts Receivable Days (Average Collection Period or Days Sales Outstanding)
An expression of a firm's accounts receivable in terms of the number of days' worth of sales that the accounts receivable represents
What is the most important difference between a corporation and all other organizational forms?
An important difference among the types of corporate organizational forms is the way they are taxed. Shareholders of a corporation pay taxes twice. This system is sometime referred to as double taxation.
Hostile Takeover
An individual or organization purchases a large fraction of a company's stock and in doing so gets enough votes to replace the board of directors and CEO.
It does not consider whether the $10,000 will be needed elsewhere.
An investor has the opportunity to buy a $10,000 government bond which is guaranteed to yield 6.5% interest in one yearʹs time. The investor decides to make the investment as there is a net difference between the absolute cost and benefit. Which of the following is NOT a reason that the investorʹs decision may be flawed? A) It does not consider the current market interest rate. B) It does not consider the fact that though costs are incurred today, the benefits occur in one yearʹs time. C) It does not consider the value of the $10,000 in one yearʹs time if invested elsewhere. D) It does not consider whether the $10,000 will be needed elsewhere.
$82,550 (Net income = ($687,000 - $492,000 - $26,000 - $42,000) (1 - .35) = $82,550)
Andre's Bakery has sales of $687,000 with costs of $492,000. Interest expense is $26,000 and depreciation is $42,000. The tax rate is 35 percent. What is the net income? A. $42,750 B. $44,450 C. $82,550 D. $86,450 E. $124,550
aggregation
Atlas Industries combines the smaller investment proposals from each operational unit into a single project for planning purposes. This process is referred to as which one of the following? A. conjoining B. aggregation C. conglomeration D. appropriation E. summation
Assets and Liabilities
Balance sheet lists the firms _____ and ______
Different Types of Financial Institutions
Banks and Credit Unions Insurance Companies Hedge Funds Mutual Funds Pension Funds Venture Capital Funds Private Equity Funds
$91,650
Based on the information shown above, what would it cost to buy 1,000 shares of the above stock? A) $91,110 B) $91,300 C) $91,320 D) $91,650
Earnings Before Interest and Taxes (EBIT)
Cash flows from the firm's financial investments are one example of other incomes that would be listed here. After we have adjusted for other sources of income or expenses, we have the firm's earnings before interest and taxes.
Perpetuity
Cash flows in the future are discounted for an ever-increasing number of periods, so their contribution to the sum eventually becomes neglibible
Company A is less likely than Company B to have sufficient working capital to meet its short-term needs.
Company A has current assets of $42 billion and current liabilities of $41 billion. Company B has current assets of $2.7 billion and current liabilities of $1.8 billion. Which of the following statements is correct, based on this information? A) Company A is less likely than Company B to have sufficient working capital to meet its short-term needs. B) Company A has greater leverage than Company B. C) Company A has less leverage than Company B. D) Company A and Company B have roughly equivalent enterprise values.
$1.67
Consider the above Income Statement for CharmCorp. All values are in millions of dollars. If CharmCorp. has 4 million shares outstanding, and its managers and employees have stock options for 2 million shares, what is its diluted EPS in 2008 ? A) $0.83 B) $1.33 C) $1.67 D) $2.00
The ability of Xenon Manufacturing to sell its goods and services for more than the costs of producing them fell between 2008 and 2009.
Consider the above Income Statement for Xenon Manufacturing. All values are in millions of dollars. Calculate the gross margin for 2008 and 2009. What does the change in the gross margin between these two years imply about the company? A) The efficiency of Xenon Manufacturing has significantly risen between 2008 and 2009. B) The ability of Xenon Manufacturing to sell its goods and services for more than the costs of producing them rose between 2008 and 2009. C) The ability of Xenon Manufacturing to sell its goods and services for more than the costs of producing them fell between 2008 and 2009. D) The leverage of Xenon Manufacturing fell slightly between 2008 and 2009.
The efficiency of Xenon Manufacturing has significantly fallen between 2008 and 2009. 24 / 202 = 0.12; 16 / 212 = 0.08
Consider the above Income Statement for Xenon Manufacturing. All values are in millions of dollars. Calculate the operating margin for 2008 and 2009. What does the change in the operating margin between these two years imply about the company? A) The efficiency of Xenon Manufacturing has significantly risen between 2008 and 2009. B) The ability of Xenon Manufacturing to sell its goods and services for more than the costs of producing them rose between 2008 and 2009. C) The efficiency of Xenon Manufacturing has significantly fallen between 2008 and 2009. D) The leverage of Xenon Manufacturing fell slightly between 2008 and 2009.
$0.50 EPS = Net income / Shares outstanding = $10 million / 20 million shares = $0.50 per share
Consider the above Income Statement for Xenon Manufacturing. All values are in millions of dollars. If Xenon Manufacturing has 20 million shares outstanding, what is its EPS in 2008 ? A) $0.50 B) $0.25 C) $0.40 D) $0.60
1. Ensure that employees are paid with company stock/stock options. 2. Ensure that underperforming managers are fired. 3. Write contracts that ensure that the interests of the managers and shareholders are closely aligned. 4. Mount hostile takeovers.
Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than in their own interests. What strategies are available to shareholders to help ensure that managers are motivated to act this way?
C Corporations
Corporations that have no restrictions on who owns their shares or the number of shareholders; they cannot qualify for subchapter S tax treatment and are subject to direct taxation
Capital Structure
Deals with long term liabilities and equity EX) What mixture of debt and equity will the business use?
Working Capital
Deals with short term (current) assets and liabilities EX) will firm purchase supplies on credit or pay cash
Liquid
Describes an investment that can be easily turned into cash because it can be sold immediately at a competitive market price
ok
Each exchange has its own listing standards, outlines of the requirements a company must meet to be traded on the exchange. These standards usually require that the company has enough shares outstanding for shareholders to have a liquid market and to be of interest to a broad set of investors. (Answer=ok)
1. ask 2. bid 3. ask 4. bid 5. lose
Explain why the bid-ask spread is a transaction cost. (Select from the drop-down menus.) Investors always buy at the 1. (ask/bid) and sell at the 2. (ask/bid). Since 3. (ask/bid) prices always exceed 4. (bid/ask) prices, investors "5. (lose/gain)" this difference. It is one of the transaction costs. Since the market makers take the other side of the trade, they make this difference.
1.35 (140 / ($4.00 × 26) = 1.35)
GenCorp. has a total debt of $140 million and stockholdersʹ equity of $50 million. It also has 26 million shares outstanding, with a market price of $4.00 per share. What is GenCorpʹs market debt-equity ratio? A) 0.67 B) 1.08 C) 2.80 D) 1.35
General Partner vs. Limited Partner
General Partner's are personally liable for the firm's debt obligations. Limited Partner's are limited liability however, their ownership interest is transferable
total sales - cost of sales
Gross profit is calculated as ________. A) total sales - cost of sales - selling, general, and administrative expenses - depreciation and amortization B) total sales - cost of sales - selling, general, and administrative expenses C) total sales - cost of sales D) none of the above
$2,550,000 (Helen will receive 10.2 % of the dividend payment proportional to her ownership: 0.102 × 25,000,000 = $2,550,000)
Helen owns 10.2% of the stock of the Median Corporation. If Median makes a dividend payment of $25,000,000 paid proportionally to its shareholders, how much of this amount would Helen receive, disregarding tax? A) $3,060,000 B) $2,550,000 C) $3,570,000 D) $2,040,000
The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present.
Historically, why were high inflation rates associated with high nominal interest rates? A) Individuals will spend more when they expect their investments to increase in value. B) Growth in investment and savings is encouraged when consumers are judged to be overspending. C) High inflation leads to a decrease in purchasing power and thus increases the attractiveness of investment over consumption in the short term. D) The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present.
by electing members of a board of directors
How do the shareholders of most corporations exercise their control of that corporation? A) by voting on issues that concern them B) by electing members of a board of directors C) by vetting the decisions of the board of directors D) by providing oversight of the day-to-day running of the corporation
4.25 years
How long will it take $50,000 placed in a savings account at 10% interest to grow into $75,000 ? A) 4.25 years B) 3.25 years C) 5.25 years D) 6.25 years
Operating Margin
How much a company earns before interest and taxes from each dollar of sales
$250 (421.25-420.75) x 500 = 250
How much money would a stock exchange make from buying and selling 500 shares of the stock under the conditions shown above? A) $250 B) $3,000 C) $5,875 D) $210,375
$220 (First calculate the APR using an EAR of 14.7% and monthly compounding, which comes to 13.7937 %. Then using a periodic rate of 13.7937 /12, calculate the payment over 48 months that gives a future value (FV) of $14,000 , which is $110.15.)
Howard is saving for a holiday. He deposits a fixed amount every month in a bank account with an EAR of 14.7%. If this account pays interest every month then how much should he save from each monthly paycheck in order to have $14,000 in the account in four yearsʹ time? A) $176 B) $308 C) $220 D) $352
$316.25 (Calculate the NPV using CF keys: input CF0 =-$8000, CF1 = $2400,and F1 =4 using interest = 6%, which gives NPV = $316.25.)
If $8000 is invested in a certain business at the start of the year, the investor will receive $2400at the end of each of the next four years. What is the present value of this business opportunity if the interest rate is 6% per year? A) $158.13 B) $316.25 C) $379.50 D) $506.00
The companyʹs net income in 2008 was negative.
If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in stockholdersʹ equity between 2007 and 2008? A) The company is very profitable because it is obviously collecting receivables faster. B) The company is selling its property, plant and equipment, which may result in a long-term deficiency in production capacity. C) The companyʹs net income in 2008 was negative. D) No conclusions can be drawn regarding stockholdersʹ equity without additional information.
The company is having difficulties selling its product.
If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in the balance sheet between 2007 and 2008? A) The company is having difficulties selling its product. B) The company has reduced its debt. C) The company has added a major new asset in terms of plant and equipment. D) The company has experienced a significant rise in its market value.
$12,635 (N = 24; I = 8; PMT = $1200; FV = 0; Compute PV = $12,635.)
If the current rate of interest is 8%, then the present value (PV) of an investment that pays $1200 per year and lasts 24 years is closest to ________. A) $7581 B) $15,162 C) $12,635 D) $17,689
$330,000
In 2009, an agricultural company introduced a new cropping process which reduced the cost of growing some of its crops. If sales in 2008 and 2009 were steady at $30 million, but the gross margin increased from 2.8% to 3.9% between those years, by what amount was the cost of sales reduced? A) $330,000 B) $660,000 C) $264,000 D) $462,000
the chief executive officer
In most corporations, to whom does the chief financial officer report? A) the shareholders B) the board of directors C) the chief executive officer D) the controller
the relationship between a driver and the passengers in a car regarding the safe driving of that car
In which of the following relationships is an agency conflict problem LEAST likely to arise? A) the relationship between a hire-car company and the persons who hire that companyʹs cars regarding the treatment of those cars B) the relationship between high-level military officers and the soldiers who serve under them regarding the willingness of the soldiery to take risks C) the relationship between a restaurateur and the suppliers of produce to that restaurant regarding the freshness of the produce supplied D) the relationship between a driver and the passengers in a car regarding the safe driving of that car
Its ownersʹ liability is restricted to their investment.
In which of the following ways is a limited liability company like a corporation? A) It was created and developed first in the United States. B) It can choose to be considered a partnership for tax purposes. C) Its ownersʹ liability is restricted to their investment. D) It is directly managed by the owners.
Designed Market Makers
Individuals on the NYSE floor who have an obligation to help maintain liquidity in their assigned stocks
Income Statement Analysis ->Leverage Ratios/Interest Coverage Ratios
Interest coverage ratio or times interest earned (TIE) ratio An assessment by lenders of a firm's leverage, it is equal to a measure of earnings divided by interest. - EBIT/Interest Expense - Operating Income/Interest Expense - EBITDA/Interest Expense
Investment X has a higher growth rate than Investment Y.
Investment X and Investment Y are both growing perpetuities with initial cash flow of $100. Both investments have the same interest rate (r). The present value of Investment X is $5,000, while the present value of Investment Y is $4,000. Which of the following is true? A. Investment X has a lower growth rate than Investment Y. B. Investment X has a higher growth rate than Investment Y. C. The answer cannot be determined without knowing the interest rate for both investments. D. This makes no sense - with the same initial cash flow and the same interest rate, Investment X and Investment Y should have the same present value.
mutual funds
Investments by wealthy individuals and endowments is a major source of money for each of the following EXCEPT ________. A) private equity funds B) hedge funds C) venture capital funds D) mutual funds
Working Capital Management
It is the management of current assets, such as inventory, and current liabilities, such as money owed to suppliers.
$990 (Net income = $1,300 + (-$310) = $990)
Jensen Enterprises paid $1,300 in dividends and $920 in interest this past year. Common stock increased by $1,200 and retained earnings decreased by $310. What is the net income for the year? A. -$210 B. $990 C. $1,610 D. $1,910 E. $2,190
Janeʹs liability for the firmʹs debts consists solely of her investment in the firm.
Joe is a general partner in a limited partnership firm, while Jane is a limited partner in the same firm. Which of the following statements regarding their respective relationships to the firm is correct? A) Joe has no management authority within the partnership. B) Jane is legally involved in the managerial decision making of the firm. C) Janeʹs liability for the firmʹs debts consists solely of her investment in the firm. D) Withdrawal of Jane from the partnership will dissolve the partnership.
Perpetuity
Let's derive a shortcut by creating our own perpetuity. The Valuation principle tells us that the value of a perpetuity must be the same as the cost we incurred to create our own identical perpetuity. Suppose you can invest $100 in a bank account paying 5% interest per year forever. At the end of the year you'll have $105 in the bank - your original $100 plus $5 in interest. Suppose you withdraw the $5 and reinvest the $100 for another year. By doing this year after year, you can withdraw $5 every year in perpetuity.
Three Functions of a Financial Manager
Make Investment decisions Make financing decisions Manage cash flows from operating activities (managing working capital)
NASDAQ
Many companies would start on the
$200,000.00 (PV growth perpetuity = $4000 / (0.09 - 0.07) = $200,000.00)
Martin wants to provide money in his will for an annual bequest to whichever of his living relatives is oldest. That bequest will provide $4000 in the first year, and will grow by 7% per year, forever. If the interest rate is 9%, how much must Martin provide to fund this bequest? A) $100,000.00 B) $160,000.00 C) $200,000.00 D) $240,000.00
What is the principal guiding factor for the financial manager of a firm?
Maximizing stockholder wealth is the paramount guiding factor for a firmʹs financial manager.
Five Variables Used in Financial Calculators
N = number of periods PV = present value PMT = cash flow or "payment" FV = future value I/Y = interest rate
Diluted EPS
Net income / (Shares outstanding + Options contracts outstanding + Shares possible from convertible bonds outstanding)
Earnings Per Share (EPS)
Net income reported on a per-share basis
What is the need for the notes to the financial statements when a firm's operations are already documented in the financial statements?
Not all actions of the firm can be directly converted to an entry on the financial statements. For example, the firm may be involved in off balance sheet transactions, which have to be reported through notes to the financial statements.
Inventory Days
Number of days cost of goods sold represented by inventory
The transaction was between the corporation and investors.
On August 19, 2004 Google IPO offered 19,605,052 shares at a price of U.S. $85 per share, which were sold in an online auction in a bid to make the shares more widely available. Which of the following statements best describes why these are considered a primary market transaction? A) The transaction was between the corporation and investors. B) Shares of Google from this time onward could be traded between investors on a stock exchange. C) The shares were the first to be privately issued by Google. D) Google was at the time a recently founded company seeking capital with which to expand.
NYSE
On the floor of the, market makers (known as specialists) match buyers and sellers. Nevertheless, in today's technology-driven economy, a stock market does not need to have a physical location.
Enron
One of the most fraudulent examples of financial reporting abuse
The off-balance sheet promises to repurchase assets should have been disclosed in management discussion and analysis (MD&A) or notes to the financial statement.
One way Enron manipulated its financial statements was to sell assets at inflated prices to other firms, while giving a promise to buy back those assets at a later date. The incoming cash was recorded as revenue, but the promise to buy back the assets was not disclosed. Which of the following is one of the ways that such a transaction is deceptive? A) The assets should have been listed on the balance sheet as long-term assets. B) Cash raised by selling assets should not be recorded as revenue. C) The cash raised should have been recorded as short-term loans. D) The off-balance sheet promises to repurchase assets should have been disclosed in management discussion and analysis (MD&A) or notes to the financial statement.
Corporations
Over four-fifths of all U.S. business revenue is generated by which type of firms? a. sole proprietorships b. partnerships c. limited partnerships d. corporations
What does the phrase limited liability mean in a corporate context?
Owners' liability is limited to the amount they invested in the firm. Stockholders are not responsible for any encumbrances of the firm; in particular, they cannot be required to pay back any debts incurred by the firm.
Owning the corporation's common stock
Ownership in a corporation is evidenced by A. Owning the corporation's bonds B. Owning the corporation's common stock C. Owning either the corporation's bonds or common D. Being a member of membership of the corporation
Future Value
PV(1+r)^t
planning horizon
Phil is working on a financial plan for the next three years. This time period is referred to as which one of the following? A. financial range B. planning horizon C. planning agenda D. short-run E. current financing period
Balance Sheet
Provides a snapshot of the firms financial position at any given time
II, I, and III
Put the following steps of the financial cycle in the correct order. I. Money flows to companies who use it to fund growth through new products. II. People invest and save their money. III. Moneyflowsbacktosaversandinvestors. A) I, II, and III B) II, I, and III C) III, II, and I D) II, III, and I
The agency problem leads an individual (in your case) and corporate managers (in the corporate setting) to put their own self-interest ahead of the interests of the shareholders (your parents in your case). In both situations there may be a lack of interest in controlling costs if those costs are not borne directly by the person making the decision.
Recall the last time you ate at an expensive restaurant where you paid the bill. Now think about the last time you ate at a similar restaurant, but your parents paid the bill. Did you order more food (or more expensive food) when your parents paid? Explain how this relates to the agency problem in corporations. (Select all the choices that apply.) A. Your situation could never lead to an agency problem since your parents would only want the best for you. B. The agency problem leads an individual (in your case) and corporate managers (in the corporate setting) to put their own self-interest ahead of the interests of the shareholders (your parents in your case). C. In both situations there may be a lack of interest in controlling costs if those costs are not borne directly by the person making the decision. D. While you may be faced with an agency problem (spending more when your parents are buying than you would if you were paying), corporate managers are seldom faced with such decisions.
1.72 D / E = Total debt / Total equity Total Debt = Notes payable (10.5) + Current maturities of long-term debt (39.6) + Long-term debt (231.3 ) = 281.4 million Total equity = 10.2 × $16 = $163.2, so D / E = $281.4 / $163.2 = 1.72
Refer to the balance sheet above. If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then using the market value of equity, the debt -equity ratio for Luther in 2006 is closest to ________. A) 3.45 B) 1.72 C) 0.86 D) 2.41
2.25 D / E = Total debt / Total equity Total debt = Notes payable (10.7) + Current maturities of long-term debt (38.7) + Long-term debt (234.4 ) = 283.8 million Total equity = 125.9 , so D / E = 283.8 /125.9 = 2.25
Refer to the balance sheet above. When using the book value of equity, the debt-equity ratio for Luther in 2006 is closest to ________. A) 4.51 B) 2.25 C) 1.13 D) 3.16
$1.03
Refer to the income statement above. For the year ending December 31, 2006 Lutherʹs earnings per share is closest to ________. A) $0.51 B) $1.03 C) $0.82 D) $1.23
20.36% (Operating margin = Operating income / Sales = $114.6 / $562.8 = 0.2036 or 20.36 %)
Refer to the income statement above. Lutherʹs operating margin for the year ending December 31, 2005 is closest to ________. A) 10.18 % B) 16.29 % C) 20.36% D) 24.43 %
17.43 % ROA = Net income / Total assets This is a little tricky in that Total Assets are not given in the problem. The student must remember the basic balance sheet equation A = L + SE.Total Liabilities and Shareholdersʹ Equity is given and this is the same as Total Assets. So, ROA = $67.405 / $386.7 = 0.1743 or 17.43 %.
Refer to the income statement above. Lutherʹs return on assets (ROA) for the year ending December 31, 2005 is closest to ________. A) 17.43 % B) 34.86 % C) 13.94% D) 1.99%
123.56 % ROE = Net income / Shareholdersʹ equity = $78.585 / $63.6 = 1.2356 or 123.56 %
Refer to the income statement above. Lutherʹs return on equity (ROE) for the year ending December 31, 2005 is closest to ________. A) 247.12 % B) 98.85 % C) 123.56 % D) 148.27 %
$13,333 (9.52 million/102 yen = $93,333; cost = 104,000/1.3 NZD = $80,000; $93,333 - $80,000 = $13,333.)
Refer to the table above. An international seafood supplier is offered 9.52 million yen today for 1000 pounds of abalone frozen in the shell. One thousand pounds of abalone can be sourced from various countries at the prices shown above. The current market exchange rates between the United States and the other relevant currencies are also shown. In addition, $1 U.S. = 102 yen. What is the value, in U.S. dollars, of the best deal the international seafood supplier can make? A) $12,333 B) $14,333 C) $14,833 D) $13,333
$3189.80
Salvatore has the opportunity to invest in a scheme which will pay $5000 at the end of each of the next 5 years. He must invest $10,000 at the start of the first year and an additional $10,000 at the end of the first year. What is the present value of this investment if the interest rate is 3%? A) -$3189.80 B) -$5907.57 C) 5907.57 D) $3189.80
Four Types of Firms
Sole proprietorship Limited Liability Company Corporations Partnership
What are the sources and use of money for Hedge Funds?
Source: Investments by wealthy individual and endowments Use of money: Invest in any kind of investment to maximize returns
What are the sources and use of money for pension funds?
Source: Retirement funds collected throughout the workplace Use of money: Very similar to mutual funds except they provide retirement income
$150 (Ask Price - Bid Price) x Shares = Bid-Ask Spread (15.95 - 15.80) x 1000 = 150
Stella places a market order with her broker to buy 1,000 shares of OneWorld Corp. The broker buys 1,000 shares at $15.80 each, and sells them to Stella at $15.95 each. He also charges a commission of $12.00. What is bid-ask spread in this case? A) $162 B) $120 C) $210.00 D) $150
He ignores the fact that the costs and benefits of the investment are not stated in the same terms.
Steve is offered an investment where for every $1.00 invested today, he will receive $1.10 at the end of each of the next five years. Steve concludes that in five years he will have $1.10 for every $1.00 invested and that this investment will increase his personal value. What is Steveʹs major error in reasoning when making this decision? A) He ignores the fact that the costs and benefits of the investment are not stated in the same terms. B) He ignores the benefits of consuming the $1.00 today against the benefits of consuming the $1.00 five years from now. C) He fails to consider the costs of not consuming the $1.00 today. D) He considers that the value of the cash he may have in the future is the same as the value of cash he has today.
NASDAQ
Stock transactions can be made over the phone or by computer network. Consequently, stock markets such as this, which are called over-the-counter (OTC) markets, are a collection of dealers or market makers connected by computer networks and telephones.
$160,463
Suppose that a young couple has just had their first baby and they wish to insure that enough money will be available to pay for their childʹs college education. They decide to make deposits into an educational savings account on each of their daughterʹs birthdays, starting with her first birthday. Assume that the educational savings account will return a constant 9%. The parents deposit $2400 on their daughterʹs first birthday and plan to increase the size of their deposits by 7% each year. Assuming that the parents have already made the deposit for their daughterʹs 18th birthday, then the amount available for the daughterʹs college expenses on her 18th birthday is closest to ________. A) $80,232 B) $160,463 C) $112,324 D) $176,509
Rate of Return
Suppose you have an investment opportunity that requires a $1000 investment today and will pay $2000 in six years What interest rate, r, would you need so that the present value of what you get is exactly equal to the present value of what you give up?
Suppose you are considering renting an apartment. You, the renter, can be viewed as an agent while the company that owns the apartment can be viewed as the principal. What agency conflicts do you anticipate? Suppose, instead, that you work for the apartment company. What features would you put into the lease that would give the renter incentives to take good care of the apartment?
The AGENT (RENTER) will not take the same care of the apartment as the PRINCIPAL (OWNER), because the RENTER does not share in the costs of fixing damages to the apartment. To mitigate this problem, having the RENTER pay a deposit should motivate the RENTER to keep damages to a minimum. The deposit forces the RENTER to share in the costs of fixing any problems that are caused by the RENTER. In addition, the provision in the lease for ANNUAL renewals allows an incentive for a long-term RENTER to maintain the leased apartment.
What will be the effect on the balance sheet if a firm buys a new processing plant through a new loan?
The Assets side will increase under Net property, plant, and equipment with the net effect of the new processing plant, while the Liabilities side will correspondingly show the new debt that was incurred in paying for the plant.
What are the main differences between the NYSE and NASDAQ stock markets?
The NYSE has a physical location, a geographical address where traders gather to trade, but NASDAQ is an electronic market. Moreover, while the NYSE has one specialist in each stock, NASDAQ has multiple market makers serving the functions of both matching buyers and sellers and trading on their own account.
What are some of the differences between the NYSE and the NASDAQ?
The NYSE is an example of a physical market. It is located at 11 Wall Street in New York City. On the floor of the NYSE, market makers (known on the NYSE as specialists) match buyers and sellers. Nevertheless, in today's technology-driven economy, a stock market does not need to have a physical location. Stock transactions can be made over the phone or by computer network. Consequently, stock markets such as NASDAQ, which are called over-the-counter (OTC) markets, are a collection of dealers or market makers connected by computer networks and telephones. An important difference between the NYSE and NASDAQ is that on the NYSE, each stock has only one market maker. Each exchange has its own listing standards, outlines of the requirements a company must meet to be traded on the exchange. These standards usually require that the company has enough shares outstanding for shareholders to have a liquid market and to be of interest to a broad set of investors. The NYSE's standards are more stringent than those of NASDAQ; traditionally, there has been a certain pride in being listed on the NYSE. Many companies would start on the NASDAQ and then move to the NYSE as they grew. However, NASDAQ has retained many big, successful companies such as Starbucks, Apple, and Microsoft.
The Colonial Bank would experience a surge in demand for loans.
The State Bank offers an interest rate of 5.5% on savings and 6% on loans, while the Colonial Bank offers 6.5% on savings and 7% on loans. Which of the following is the LEAST likely outcome of such a situation? A. The State Bank would experience a surge in demand for loans. B. The Colonial Bank would experience a surge in demand for deposits C. The State Bank would experience a fall in demand for deposits D. The Colonial Bank would experience a surge in demand for loans.
1. Cash and Credit 2. Financial Planning 3. Capital Expenditures
The Treasurer's office is responsible for managing the firm's __________, its __________, and its __________
Primary Market; Secondary Market
The __________________ refers to a corporation issuing new shares of stock and selling them to investors. After this initial transaction between the corporation and investors, the shares continue to trade in a ____________________ between investors without the involvement of the corporation.
Investors consider that the firmʹs market value and its book value are roughly equivalent.
The above diagram shows a balance sheet for a certain company. All quantities shown are in millions of dollars. If the company has 5 million shares outstanding, and these shares are trading at a price of $6.39 per share, what does this tell you about how investors view this firmʹs book value? A) Investors consider that the firmʹs market value is worth very much less than its book value. B) Investors consider that the firmʹs market value is worth less than its book value. C) Investors consider that the firmʹs market value and its book value are roughly equivalent. D) Investors consider that the firmʹs market value is worth more than its book value.
Explain some of the measures taken to reduce the agency conflict problem.
The agency conflict problem can be reduced by taking measures that align the managers interests with those of the shareholders. For example, incentive-based compensation, such as employee stock options, helps align the interests of these two constituents.
How does a firm select the date for preparation of its balance sheet?
The balance sheet is prepared on the fiscal closing date for the accounts of a firm that may or may not coincide with the calendar year-end of December 31st.
Net Income
The bottom line of the income statement, which is a measure of its profitability during the period.
Net Working Capital
The capital available in the short term to run the business.
Equity of a Corporation
The collection of all outstanding shares of a corporation
Annuity
The difference between an annuity and a perpetuity is that an annuity ends after some fixed number of payments
Book Value of Equity
The difference between the book value of a firm's assets and its liabilities; also called shareholders' equity and stockholders' equity, it represents the net worth of a firm from an accounting perspective.
United States
The exchanges in which of the following countries or regions do NOT accept the International Financial Reporting Standards set out by the International Accounting Standards Board? A) Germany B) France C) United States D) United Kingdom
by raising the companyʹs equity by encouraging new owners to take a stake in the company
The financial manager of a well-regarded book publishing firm wishes to buy a small Internet publishing company to provide an avenue for sale of its materials online. In order to raise the funds to make this purchase, the financial manager decides to sell more stock in the company. How is the financial manager raising funds in this case? A) by increasing the debt burden carried by the company B) by raising the companyʹs equity by encouraging new owners to take a stake in the company C) by decreasing the ratio of equity to debt held by the company D) by increasing the value of shares held by the existing owners of the company
Perpetuity
The first cash flow does not occur immediately; it arrives at the end of the first period. This timing is sometimes referred to as payment in arrears and is a standard convention in loan payment calculations and elsewhere.
Net Profit Margin
The fraction of each dollar in revenues that is available to equity holders after the firm pays interest and taxes
Net Income
The last line of the income statement shows
1. Riskiness 2. Cash Flows
The market value of an asset depends on which 2 things related to the asset?
What is the most important governing body within a business organization? What responsibilities does it have?
The most important governing body within an organization is the board of directors. Its main role is to represent the shareholders. The board also hires (and occasionally fires) the CEO and advises him or her on major decisions.
Agency Problem
The possibility of conflict of interest between the principal and the agent
Arbitrage
The practice of buying and selling equivalent goods to take advantage of a price difference
Primary Market vs. Secondary Market
The primary market refers to a corporation issuing new shares of stock and selling them to investors. After this initial transaction between the corporation and investors, the shares continues to trade in a secondary market between investors without the involvement of the corporation.
Capital Budgeting
The process of planning and managing a firm's long-term investments
Explain the difference between an S and a C corporation.
The profits and losses of the S corporation are passed directly to shareholders and are not subject to corporate taxes, while the C corporation must first pay taxes on any profits before passing the after-tax profits on to shareholders. In addition, the S corporation can have no more than 100 shareholders, all of whom must be U.S. citizens or residents. The C corporation does not have any such restrictions on its shareholders.
Market-To-Book Ratio (Price-To-Book [P/B] Ratio)
The ratio of a firm's market (equity) capitalization to the book value of its stockholders' equity
market-to-book ratio / price-to-book ratio
The ratio of a firm's market capitalization to the book value of stockholder's equity. This ratio for most successful firms substantially exceeds 1, indicating that the value of the firm's assets when put to use exceeds their historical cost (or liquidation value).
Debt-to-Enterprise Value Ratio
The ratio of a firm's net debt to its enterprise value
Return on Equity (ROE)
The ratio of a firm's net income to the book value of its equity
Debt-Equity Ratio
The ratio of a firm's total amount of short- and long-term debt (including current maturities) to the value of its equity, which may be calculated based on market or book values.
Return on Assets (ROA)
The ratio of net income plus interest expense to the total book value of the firm's assets
Debt-to-Capital Ratio
The ratio of total debt to total debt plus total equity
What is the difference between a public and private corporation?
The shares of a PUBLIC corporation are traded on an exchange (or "over the counter" in an electronic trading system) while the shares of a PRIVATE corporation are not traded on a public exchange.
statement of cash flows.
The sources and uses of cash over a stated period of time are reflected on the: A. income statement. B. balance sheet. C. tax reconciliation statement. D. statement of cash flows. E. statement of operating position
auditor
The third party who checks annual financial statements to ensure that they are prepared according to Generally Accepted Accounting Principles (GAAP) and verifies that the information reported is reliable is the ________. A) NYSE Enforcement Board B) Accounting Standards Board C) Securities and Exchange Commission (SEC) D) auditor
Enterprise Value
The total market value of a firm's equity and debt, less the value of its cash and marketable securities. It measures the value of the firm's underlying business.
Enterprise Value (Balance Sheet Analysis)
The total market value of a firm's equity and debt, less the value of its cash and marketable securities. It measures the value of the firm's underlying business. Enterprise Value = Market Value of Equity + Debt - Cash
Stockholder's Equity -> Market value of equity (Market capitalization)
The total market value of equity; equals the market price per share times the number of shares Market price per share x Number of shares outstanding -> cannot be negative
Market Value
The true value of any asset or the amount of cash we would get if we actually sold said asset. This is extremely important for financial managers.
What are the terms for the two types of prices quoted for a stock on an exchange?
The two quotes associated with a stock quoted on the exchange are bid price and ask price.
Agency Costs
This refers to costs of the conflict of interest between the stockholders and management
S Corporations
Those corporations that elect sub chapter S tax treatment and are exempted by the U.S. Internal Revenue Service's tax code from double taxation
Growing Perpetuity
To derive the formula for the present value of a growing perpetuity, we follow the same logic used for a regular perpetuity: Compute the amount you would need to deposit today to create the perpetuity yourself. In the case of a regular perpetuity, we created a constant payment forever by withdrawing the interest earned each year and reinvesting the principal. To increase the amount we can withdraw each year, the principal that we reinvest each year must grow. Therefore, we withdraw less than the full amount of interest earned each period, using the remaining interest to increase our principal.
Perpetuity
To generalize, suppose we invest an amount P at an interest rate r Every year we can withdraw the interest we earned, C=r × P, leaving P in the bank Because the cost to create the perpetuity is the investment of principal, P, the value of receiving C in perpetuity is the upfront cost, P Rearranging C=r ×P to solve for P, we have P = C/r
False
True or False: A dollar today and a dollar in one year may be considered to be equivalent.
False
True or False: Cash flows from an annuity occur every year in the future.
True
True or False: Corporations have come to dominate the business world through their ability to raise large amounts of capital by sale of ownership shares to anonymous outside investors.
True
True or False: Costs and benefits must be put in common terms if they are to be compared.
True
True or False: Dollar amounts received at different points in time cannot be compared in absolute terms.
False
True or False: Financial decisions require that you weigh alternatives in strictly monetary terms.
False
True or False: Financial statements are optional accounting reports issued periodically by a firm which present information on the past performance of the firm, a summary of the firmʹs assets and the financing of those assets, and a prediction of the firmʹs future performance.
False
True or False: If broker will buy a share of stock from you at $3.85 and sell it to you at $3.87, the ask price would be $3.85.
True
True or False: In general, if an action increases a firmʹs value by providing benefits with a value greater than any costs involved, then that action is good for the firmʹs investors.
False
True or False: In most corporations, the owners exercise direct control of a corporation.
False
True or False: In the United States, publicly traded companies can choose whether or not they wish to release periodic financial statements.
False
True or False: International Financial Reporting Standards are taking root throughout the world. However, it is unlikely that the U.S. will report according to IFRS before the second half of the 21st century.
False
True or False: It is generally not the duty of financial managers to ensure that a firm has the cash it needs for day-to-day transactions.
False
True or False: Joe borrows $100,000 and agrees to repay the principal, plus 7% APR interest compounded monthly, at the end of three years. Joe has taken out an amortizing loan.
True
True or False: Market forces determine interest rates based ultimately on the willingness of individuals, banks, and firms to borrow, save, and lend.
False
True or False: Partnerships are the most common type of business firms in the world.
True
True or False: Price-earnings ratios tend to be high for fast-growing firms.
True
True or False: Quality adjustments to changes in the CPI most often result in reductions to the inflation rate calculated from it.
False
True or False: Raising new capital by issuing bonds is an example of a commercial banking activity.
True
True or False: Stock markets provide liquidity for a firmʹs shares.
True
True or False: Stockholdersʹ equity is the difference between a firmʹs assets and liabilities, as shown on the balance sheet.
True
True or False: The Law of One Price states that if equivalent goods or securities are traded simultaneously in different competitive markets, they will trade for the same price in each market.
True
True or False: The Valuation Principle shows how to make the costs and benefits of a decision comparable so that we can evaluate them properly.
False
True or False: The annual percentage rate indicates the amount of interest, including the effect of any compounding
False
True or False: The balance sheet shows the assets, liabilities, and stockholdersʹ equity of a firm over a given length of time.
False
True or False: The fact that corporationsʹ shares are easily traded within the market has a net effect of acting as a disincentive for managers to favor the interests of shareholders over their own interests.
True
True or False: The income statement reports the firmʹs revenues and expenses, and it computes the firmʹs bottom line of net income, or earnings.
True
True or False: The one-year discount factor is the discount at which we can purchase money in the future.
True
True or False: The present value (PV) of a stream of cash flows is just the sum of the present values of each individual cash flow.
True
True or False: The principal goal of a financial manager is to maximize the wealth of the stockholders.
False
True or False: The real interest rate is the rate of growth of oneʹs purchasing power due to money invested.
False
True or False: The shares of private corporations are traded on a stock market.
False
True or False: The term "opportunity" in opportunity cost of capital comes from the fact that any worthwhile opportunity for investment will have a cost: the risk to the capital invested.
False
True or False: To enable costs and benefits to be compared, they are typically converted into cash value at the time the benefit is received.
False
True or False: When there are large numbers of people looking to save their money and there is little demand for loans, one would expect interest rates to be high.
True
True or False: When you borrow money, the interest rate on the borrowed money is the price you pay to be able to convert your future loan payments into money today.
True
True or False: Whenever a good trades in a competitive market, the price determines the value of the good.
True
True or False:The opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.
10-K
U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form? A) 10-A B) 10-K C) 10-Q D) 10-SEC
Debt-Equity Ratio
Used to assess a firm's leverage
Price-Earnings Ratio
Used to assess where a stock is over or under valued based on the idea that the value of a stock should be proportional to the earnings it can generate
$41.93
Using the above information, how much would you pay for a share of BHP Billiton stock? A) $41.91 B) $41.93 C) $41.65 D) $41.59
$677.62
Using the above information, how much would you receive if you sold a share of Washington Post stock? A) $683.00 B) $677.62 C) $678.50 D) $677.64
Perpetuity
Using the formula for present value, the present value of a perpetuity with payment C and interest rate r is given by: Notice that all the cash flows are the same because the cash flow for a perpetuity is constant Also, the first cash flow starts at time 1 (there is no cash flow at time 0 (C₀=0))
$105,875 Corporate tax paid on $3.4 earnings = $3.4 × 0.35 = 1.190 earnings after-tax = 3.4 - 1.190 = $2.210 earnings distributed as dividends = $2.210 - $1 = $1.2100 taxes paid on dividends by a shareholder = 1.2100 × 0.125 = 0.1513 after-tax dividends per share = 1.2100 - 0.1513 = $1.0588 hence a holder of 100,000 shares receives 1.0588 × 100,000 = $105,875
Valiant Corp. is a C corporation that earned $3.4 per share before it paid any taxes. Valiant Corp. retained $1 of after-tax earnings for reinvestment and distributed what remained in dividend payments. If the corporate tax rate was 35% and dividend earnings were taxed at 12.5%, what was the value of the dividend earnings received after-tax by a holder of 100,000 shares of Valiant Corp.? A) $105,875 B) $127,050 C) $148,225 D) $84,700
How do we decide on opportunity cost when we have several opportunities that need to be foregone?
We rank all the foregone opportunities, and opportunity cost is the second best opportunity that we forego. Thus we select the best opportunity and rank all the alternative opportunities and use the cost of the second best opportunity as opportunity cost.
a market in which a good can be bought and sold at the same price
What is a competitive market? A) a market in which goods have a different ask price and bid price B) a market in which a good can be bought and sold at the same price C) a market in which a good is sold at a lower price than that for which it can be bought D) a market in which a good is bought for a lower price than that for which it can be sold
the difference between sales revenues and the costs
What is a firmʹs gross profit? A) the difference between the sales and other income generated by the firm, and all costs, taxes, and expenses incurred by a firm in a given period B) the difference between sales revenues and the costs C) the difference between sales revenues and cash expenditures associated with those sales D) all of the above
all of the above
What is a firmʹs net income? A) the difference between the sales and other income generated by a firm, and all costs, taxes, and expenses incurred by the firm in a given period B) the last or "bottom" line of the income statement C) a measure of the firmʹs profitability over a given period D) all of the above
3 cents
What is the bid-ask spread on the stock shown above? A) 1 cent B) 3 cents C) 6 cents D) 12 cents
the difference in price available for an immediate sale of a stock and the immediate purchase of the stock
What is the bid-ask spread? A) the difference in price available for an immediate sale of a stock and the immediate purchase of the stock B) all of the costs and fees that a stock exchange charges in order to process a transaction C) the rise or fall in the value of a stock between the time it is acquired by an investor and sold by that investor D) the difference in the selling price of a stock between different exchanges
Primary Market; Secondary Market
What is the difference between a primary and a secondary market? (Select from the drop-down menus.) The 1. (secondary market/primary market) refers to a corporation issuing new shares of stock and selling them to investors. After this initial transaction between the corporation and investors, the shares continue to trade in a 2. (secondary market/primary market) between investors without the involvement of the corporation.
It is the interest rate that would earn the same interest with annual compounding.
What is the effective annual rate (EAR)? A) It is the interest rate that would earn the same interest with annual compounding. B) It is the ratio of the number of the annual percentage rate to the number of compounding periods per year. C) It is the interest rate for an n-year time interval, where n may be more than one year or less than or equal to one year (a fraction). D) It refers to the cash flows from an investment over a one-year period divided by the number of times that interest is compounded during the year.
$287,174.56 (Calculate the FV with PV = $50,000,interest = 6%, and N = 30, which = $287,174.56.)
What is the future value (FV) of $50,000 in thirty years, assuming the interest rate is 6% per year? A) $32,500.00 B) $244,098.38 C) $258,457.10 D) $287,174.56
Valuable assets such as the companyʹs reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet.
What is the main problem in using a balance sheet to provide an accurate assessment of the value of a companyʹs equity? A) Valuable assets such as the companyʹs reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet. B) The balance sheet does not accurately represent the book value of assets held by the company. C) The equity shown on the balance sheet does not reflect the market capitalization of the company. D) Knowing at a single point in time what assets a firm possesses and the liabilities a firm owes does not give any indication of what those assets can produce in the future.
It makes it easier to compare the financial results of different firms.
What is the main reason that it is necessary for public companies to follow the rules and format set out in the Generally Accepted Accounting Principles (GAAP) when creating financial statements? A) It ensures that the market value of assets and debt are reported accurately. B) It ensures that information on the performance of public companies is reported on cash-basis accounting. C) It ensures that important budgetary information is not omitted. D) It makes it easier to compare the financial results of different firms.
All of the above are advantages that a corporation has over other business forms.
What is the major advantage corporations have over other business entities? A) It is easier for a corporation to raise capital than other forms of businesses. B) A corporation is treated as a separate legal entity for tax and legal purposes. C) A corporationʹs shares can be freely traded among its shareholders. D) All of the above are advantages that a corporation has over other business forms.
The owners of a limited liability company can take an active role in running the company.
What is the major way in which the roles and obligations of the owners of a limited liability company differ from the roles and obligations of limited partners in a limited partnership? A) The owners of a limited liability company have personal obligation for debts incurred by the company. B) There is no separation between the company and its owners in a limited liability company. C) The owners of a limited liability company can withdraw from the company without the company being dissolved. D) The owners of a limited liability company can take an active role in running the company.
sole proprietorships
What is the most common type of firms in the United States and the world? A) sole proprietorships B) partnerships C) limited partnerships D) corporations
by minimizing the number of decisions that a manager makes where there is a conflict between the managers interests and those of the shareholders
What is the most common way that agency conflict problems are addressed in most corporations? A) by minimizing the number of decisions that a manager makes where there is a conflict between the managers interests and those of the shareholders B) by terminating the employment of employees who are found to have put their own interests above those of the company C) by using disinterested outside bodies to adjudicate between managers and shareholders when such conflicts arise D) by prosecuting managers who have been found to have illegally used company moneys for their own benefit
to make investment decisions
What is the most important duty of a firmʹs financial officer? A) to ensure that the firm has enough cash on hand to meet its commitments at any given time B) to decide how to pay for investments C) to manage working capital D) to make investment decisions
The financial manager's most important job is to make the firm's investment decisions. (Within the corporation, the financial manager has three main tasks. The first is to make decisions regarding which investments or projects the firm should take on. The second is to make financing decisions to pay for the company's projects. The third is to manage cash flow from operating activities to ensure that the firm has enough cash on hand to meet its obligations from day to day. Of these, making investment decisions is the most important. The financial manager must weigh costs and benefits of each investment or project and decide which of them qualify as good uses of the money stockholders have invested in the firm. These investment decisions fundamentally shape what the firm does and whether it will add value for its owners.)
What is the most important type of decision that the financial manager makes? A.The financial manager's most important job is to make the firm's investment decisions. B.The financial manager's most important job is to make the firm's dividend decisions. C.The financial manager's most important job is to make the firm's financing decisions. D.The financial manager's most important job is to make the firm's payment decisions.
The corporation is taxed on the profits it makes, and the owners are taxed when this profit is distributed to them.
What is the process of double taxation for the stockholders in a C corporation? A) Their shares are taxed when they are both bought and sold. B) The corporation is taxed on the profits it makes, and the owners are taxed when this profit is distributed to them. C) The owners of a corporation are taxed when they receive dividend payments and when they make a profit from the sale of shares. D) The corporation must pay taxes on any profits it makes, and the capital raised by the sale of shares is also subject to taxation.
Book Value
What the firm paid for an asset (less accumulated depreciation) no matter how long ago they were purchased or how much they are worth today. It is typically shown as historical cost.
Accounts Payable
What would a supplier look at on the balance sheet to see how promptly the firm pays its bills?
You should adjust the discount rate to match the interval between cash flows.
When computing a present value, which of the following is TRUE? A) You should adjust the discount rate to match the interval between cash flows. B) You should adjust the future value to match the present value. C) You should adjust the time period to match the present value. D) You should adjust the cash flows to match the time period of the discount rate.
pricet
Whenever a good trades in a competitive market, the ________ determines the value of the good. A) supply B) price C) demand D) cost
Capital Budgeting
Where does this question fall under: What long-term investments or projects should the business take on?
Continuous
Which compounding periods will yield the smallest present value given a stated future value and annual percentage rate?
I, II, and IV only
Which of the following accounts are included in working capital management? I. accounts payable II. accounts receivable III. fixed assets IV. inventory A. I and II only B. I and III only C. II and IV only D. I, II, and IV only E. II, III, and IV only
the amount of deferred tax liability held by the company
Which of the following amounts would be included on the right side of a balance sheet? A) the value of government bonds held by the company B) the cash held by the company C) the amount of deferred tax liability held by the company D) the amount of money owed to the company by customers who have not yet paid for goods and services they have received
I, III, and IV only
Which of the following are cash flows from a corporation into the financial markets? I. repayment of long-term debt II. payment of government taxes III. payment of loan interest IV. payment of quarterly dividend A. I and II only B. I and III only C. II and IV only D. I, III, and IV only E. I, II, and III only
Assets - Current liabilities = Long-term liabilities
Which of the following balance sheet equations is INCORRECT? A) Assets - Liabilities = Shareholdersʹ equity B) Assets = Liabilities + Shareholdersʹ equity C) Assets - Current liabilities = Long-term liabilities D) Assets - Current liabilities = Long-term liabilities + Shareholdersʹ equity
to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business
Which of the following best describes why a firm produces financial statements? A) to use as a tool when planning future investments within a firm B) to increase the intrinsic value of a firm C) to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business D) to show the daily activities a firm has undertaken in the previous financial year, and what activities are planned for the near future
It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly.
Which of the following best describes why the Valuation Principle is a key concept in making financial decisions? A) It shows how to assign monetary value to intangibles such as good health and well -being. B) It allows fixed assets and liquid assets to be valued correctly. C) It gives a good indication of the net worth of a person, item, or company and can be used to estimate any changes in that net worth. D) It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly.
The assets must equal liabilities plus stockholdersʹ equity because stockholdersʹ equity is the difference between the assets and the liabilities.
Which of the following best describes why the left and right sides of a balance sheet are equal? A) In a properly run business, the value of liabilities will not exceed the assets held by the company. B) By definition, the assets plus the liabilities will be the same as the stockholdersʹ equity. C) The assets must equal liabilities plus stockholdersʹ equity because stockholdersʹ equity is the difference between the assets and the liabilities. D) By accounting convention, the assets of a company must be equal to the liabilities of that company.
Earnings from a corporation are taxed only once.
Which of the following features of a corporation is LEAST accurate? A) The ownersʹ identity is separate from a corporation. B) The owners of a corporation are not liable for any obligations the corporation enters into. C) Changes in ownership do not result in the dissolution of the corporation. D) Earnings from a corporation are taxed only once.
a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals
Which of the following firms would be expected to have a high ROE based on that firmʹs high profitability? A) a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals B) a low-end retailer that has a low mark-up on all items it sells C) a brokerage firm that has high levels of leverage D) a grocery store chain that has very high turnover, selling many multiples of its assets per year
a grocery store chain that has very high turnover, selling many multiples of its assets per year
Which of the following firms would be expected to have a high ROE? A) a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals B) a high-end fashion retailer that has a very high mark-up on all items it sells C) a brokerage firm that has high levels of leverage D) a grocery store chain that has very high turnover, selling many multiples of its assets per year
day-to-day running of the company
Which of the following is NOT a function of the board of directors? A) determining how top executives should be compensated B) monitoring the performance of the company C) answering to shareholders of the company D) day-to-day running of the company
These investment decisions determine the corporationʹs mix of debt and equity.
Which of the following is NOT a reason why a firmʹs financial managers must take great care when making investment decisions? A) These investment decisions determine whether the firm will add value for its owners. B) These investments determine the long-term directions in which the company may move. C) These investment decisions determine the corporationʹs mix of debt and equity. D) These investment decisions typically involve substantial costs which must be carefully weighed against their potential benefits.
printing money for borrowers
Which of the following is NOT a role of financial institutions? A) moving funds from savers to borrowers B) spreading out risk-bearing C) printing money for borrowers D) moving funds though time
unlimited liability
Which of the following is NOT an advantage of a sole proprietorship? A) single taxation B) ease of setup C) unlimited liability D) no separation of ownership and control
interest expense
Which of the following is NOT an operating expense? A) interest expense B) depreciation and amortization C) selling, general, and administrative expenses D) research and development
corporate taxes
Which of the following is NOT considered to be an operating expense on the income statement? A) administrative expenses and overhead B) corporate taxes C) salaries D) depreciation and amortization
the statement of activities
Which of the following is NOT one of the financial statements that must be produced by a public company? A) the balance sheet B) the income statement C) the statement of cash flows D) the statement of activities
by forcing companies to audit financial statements they release
Which of the following is NOT one of the ways that the Sarbanes-Oxley Act sought to improve the accuracy of information given to both boards and shareholders? A) by increasing the penalties to firms for providing false information B) by increasing the independence of auditors and clients C) by decreasing the non-audit fees that an auditor can receive from a client D) by forcing companies to audit financial statements they release
all of the above
Which of the following is a major duty of a financial manager? I. To make investment decisions II. To make financing decisions III. To manage cash flow from operating activities A) I only B) I and II only C) I and III only D) all of the above
S&P 500
Which of the following is a measure of the aggregate price level of collections of pre-selected stocks? A) NASDAQ B) S&P 500 C) NYSE D) Euronext
Determining whether to pay cash for a purchase or use the credit offered by the supplier.
Which of the following is a working capital management decision? a. determining the amount of equipment needed to complete a job. b. Determining whether to pay cash for a purchase or use the credit offered by the supplier. c. Determine the amount of long-term debt requires to complete a project. d. Determining the number of shares of stock to issue to fund an acquisition. e. Determining whether or not a project should be accepted.
An investor, seeing that the price of palladium on the metals exchange in two different countries is slightly different, buys on one and sells on the other to make a profit.
Which of the following is an example of arbitrage? A) An inventor of a new hydrocarbon cracking technology based on palladium buys this metal knowing that its price will rise when the technology is adopted. B) A metals merchant is offered $108,000 in one year for $100,000 of palladium today, when the interest rate is 10%. C) An investor, seeing that the price of palladium on the metals exchange in two different countries is slightly different, buys on one and sells on the other to make a profit. D) A firm buys $250,000 of palladium today, with an option to sell it at $275,000 in one year if interest rates rise above 10%
Decisions should increase the value of the firm to its investors
Which of the following is the overarching principal that a financial manager should follow when making decisions? A. Decisions should be on behalf of the firm's owners that give the greatest benefit to those owners, the firm's employees, and the firm's other stakeholders B. Decisions should provide benefit to the firm without incurring costs greater than those benefits to others C. Decisions should increase the value of the firm to its investors D. Decisions should generate the greatest benefits for the firm
Decisions should increase the value of the firm to its investors.
Which of the following is the overarching principle that a financial manager should follow when making decisions? A. Decisions should generate the greatest benefits for the firm. B. Decisions should provide benefit to the firm without incurring costs. C. Decisions should be on behalf of the firms' owners that give the greatest benefit to those owners, the firm's employees and the firm's other stakeholders. D. Decisions should increase the value of the firm to its investors.
Since a perpetuity generates cash flows every period infinitely, the cash flow generated equals the PV times the interest rate.
Which of the following is true about perpetuities? A) Since a perpetuity generates cash flows every period infinitely, the cash flow generated equals the PV times the interest rate. B) Since a perpetuity generates cash flows every period infinitely, initial cash outflow must be discounted to calculate the present value. C) Since a perpetuity generates cash flows every period infinitely, there is no way to solve for the cash flow using the present value and the interest rate. D) Since a perpetuity generates cash flows every period infinitely, its FV is the same as its PV.
The amount of money that can be raised by such firms is limited by the fact that the single owner must make good on all debts.
Which of the following is typically the major factor in limiting the growth of sole proprietorships? A) The organizational structure of such firms tends to become extremely complicated over time. B) It is extremely difficult to transfer control of such firms to a new owner if the present owner dies or wishes to sell the firm. C) The amount of money that can be raised by such firms is limited by the fact that the single owner must make good on all debts. D) Investors have a great deal of control over the day-to-day running of such firms, leading to confusion when conflicts in direction arise.
None of the above statements is unique.
Which of the following is unique for an S corporation? A) The profits and losses of an S corporation are not taxed at the corporate level, but shareholders must include these profits and losses on their individual tax returns. B) The shareholders of an S corporation must include the firmʹs profit and losses in their individual income taxes even if no money is distributed to them. C) There is a maximum limit on the number of shareholders for an S corporation. D) None of the above statements is unique.
Only I is true.
Which of the following is/are TRUE? I. The EAR can never exceed the APR. II. The APR can never exceed the EAR. III. The APR and EAR can never be equal. A) Only I is true. B) Only II is true. C) Only II & III are true. D) Only I & III are true.
C corporation
Which of the following organization forms has the most revenue? A) S corporation B) limited partnership C) C corporation D) limited liability company
limited partners in a limited partnership
Which of the following people may not manage the operations of a firm in which they are part or full owners? A) stockholders in S corporations B) stockholders in C corporations C) limited partners in a limited partnership D) general partners in a limited partnership
The loan values are very sensitive to changes in market interest rates.
Which of the following reasons for considering long-term loans inherently more risky than short-term loans is most accurate? A) There is a greater chance that inflation may fall in a longer time-frame. B) The penalties for closing out a long term loan early make them unattractive to many investors. C) Long-term loans typically have ongoing costs that accumulate over the life of the loan. D) The loan values are very sensitive to changes in market interest rates.
II and IV only
Which of the following represent cash outflows from a corporation? I. issuance of securities II. payment of dividends III. new loan proceeds IV. payment of government taxes A. I and III only B. II and IV only C. I and IV only D. I, II, and IV only E. II, III, and IV only
Exposure to taxation of both corporate earnings and stockholder dividend income.
Which of the following represents a significant disadvantage to the corporate form of organization? A. Level of difficulty corporations face in obtaining large amounts if capital in financial markets. B. Difficulty in transferring ownership C. Exposure to taxation of both corporate earnings and stockholder dividend income. D. Degree of liability to which corporate owners and managers are exposed.
It can be easily bought and sold and the selling price is very close to the buying price at a given point in time.
Which of the following should be true for an asset to be considered liquid? A) It pays regular dividends. B) It can be bought and sold at an organized stock market or bourse. C) It is offered for sale on both primary and secondary markets. D) It can be easily bought and sold and the selling price is very close to the buying price at a given point in time.
The equivalent after-tax interest rate is r(1 - π).
Which of the following statements is FALSE? A) The actual return kept by an investor will depend on how the interest is taxed. B) The equivalent after-tax interest rate is r(1 - π). C) The highest interest rate for a given horizon is the rate paid on U.S. Treasury securities. D) It is important to use a discount rate that matches both the horizon and the risk of the cash flows.
For a risk-free project, the opportunity cost of capital will typically be greater than the interest rate of U.S. Treasury securities with a similar term.
Which of the following statements is FALSE? A) The opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term of the cash flows being discounted. B) Interest rates we observe in the market will vary based on quoting conventions, the term of investment, and risk. C) The opportunity cost of capital is the return the investor forgoes when the investor takes on a new investment. D) For a risk-free project, the opportunity cost of capital will typically be greater than the interest rate of U.S. Treasury securities with a similar term.
When a bond is underpriced, the arbitrage strategy involves selling the bond and investing some of the proceeds.
Which of the following statements regarding arbitrage and security prices is INCORRECT? A) We call the price of a security in a normal market the no-arbitrage price for the security. B) In financial markets it is possible to sell a security you do not own by doing a short sale. C) When a bond is underpriced, the arbitrage strategy involves selling the bond and investing some of the proceeds. D) The general formula for the no-arbitrage price of a security is Price(security) = PV(all cash flows paid by the security).
We assume that r < g for a growing perpetuity.
Which of the following statements regarding growing perpetuities is FALSE? A) We assume that r < g for a growing perpetuity. B) PV of a growing perpetuity = C/(r - g) C) To find the value of a growing perpetuity one cash flow at a time would take forever. D) A growing perpetuity is a cash flow stream that occurs at regular intervals and grows at a constant rate forever.
PV of a perpetuity = r/C (PV of a perpetuity = C/r)
Which of the following statements regarding perpetuities is FALSE? A) To find the value of a perpetuity by discounting one cash flow at a time would take forever. B) A perpetuity is a stream of equal cash flows that occurs at regular intervals and lasts forever. C) PV of a perpetuity = r/C D) One example of a perpetuity is the British government bond called a consol.
An important property of the Law of One Price is that it holds even in markets where arbitrage is possible.
Which of the following statements regarding the Law of One Price is INCORRECT? A) At any point in time, the price of two equivalent goods trading in different competitive markets will be the same. B) One useful consequence of the Law of One Price is that when evaluating costs and benefits to compute a net present value (NPV), we can use any competitive price to determine a cash value, without checking the price in all possible markets. C) If equivalent goods or securities trade simultaneously in different competitive markets, then they will trade for the same price in both markets. D) An important property of the Law of One Price is that it holds even in markets where arbitrage is possible.
The balance sheet reports liabilities on the left-hand side.
Which of the following statements regarding the balance sheet is INCORRECT? A) The balance sheet provides a snapshot of a firmʹs financial position at a given point in time. B) The balance sheet lists a firmʹs assets and liabilities. C) The balance sheet reports stockholdersʹ equity on the right-hand side. D) The balance sheet reports liabilities on the left-hand side.
In the absence of competitive markets, we can use one-sided prices to determine exact cash values.
Which of the following statements regarding the cost-benefit analysis is NOT correct? A. The first step in evaluating a project is to identify its costs and benefits. B. In the absence of competitive markets, we can use one-sided prices to determine exact cash values. C. Competitive market prices allow us to calculate the value of a decision without worrying about the tastes or opinions of the decision maker. D. Because competitive markets exist for most commodities and financial assets, we can use them to determine cash values and evaluate decisions in most situations.
The income statement shows the cash flows and expenses at a given point in time.
Which of the following statements regarding the income statement is INCORRECT? A) The income statement shows the cash flows and expenses at a given point in time. B) The income statement shows the flow of revenues and expenses generated by a firm between two dates. C) The last or "bottom" line of the income statement shows a firmʹs net income. D) The first line of an income statement lists the revenues from the sales of products or services.
sole proprietorships
Which of the following types of firms does NOT have limited liability? A) sole proprietorships B) limited partnerships C) corporations D) none of the above
The loan will be for a long period of time.
Which of the following would be LEAST likely to lower the interest rate that a bank offers a borrower? A) The number of borrowers seeking funds is low. B) The expected inflation rate is expected to be low. C) The borrower is judged to have a low degree of risk. D) The loan will be for a long period of time.
Bill chooses to pursue a risky investment for the companyʹs funds because his compensation will substantially rise if it succeeds.
Which of the following would be best considered to be an agency conflict problem in the behavior of the following financial managers? A) Bill chooses to pursue a risky investment for the companyʹs funds because his compensation will substantially rise if it succeeds. B) Sue instructs her staff to skip safety inspections in one of the companyʹs factories, knowing that it will likely fail the inspection and incur significant costs to fix. C) James ignores an opportunity for his company to invest in a new drug to fight Alzheimerʹs disease, judging the drugʹs chances of succeeding as low. D) Michael chooses to enhance his firmʹs reputation at some cost to its shareholders by sponsoring a team of athletes for the Olympics.
overseeing accounting and tax functions
Which of the following would be more typically the responsibility of a controller rather than a treasurer? A) overseeing accounting and tax functions B) capital budgeting C) managing credit D) making investment decisions
Deutsche Börse
Which of the stock markets listed below is the smallest, as judged by trading volume? A) Deutsche Börse B) London Stock Exchange C) NASDAQ D) NYSE Euronext (US)
Corporation.
Which one of the following business types is best suited to raising large amounts of capital? A. General partnership. B. Corporation. C. Sole proprietorship. D. Limited liability company. E. Limited partnership.
deciding whether or not to purchase a new machine for the production line
Which one of the following is a capital budgeting decision? A. determining how many shares of stock to issue B. deciding whether or not to purchase a new machine for the production line C. deciding how to refinance a debt issue that is maturing D. determining how much inventory to keep on hand E.determining how much money should be kept in the checking account
determining how much debt should be assumed to fund a project
Which one of the following is a capital structure decision? A. determining which one of two projects to accept B.determining how to allocate investment funds to multiple projects C. determining the amount of funds needed to finance customer purchases of a new product D. determining how much debt should be assumed to fund a project E.determining how much inventory will be needed to support a project
sale of a new share of stock to an individual investor
Which one of the following is a primary market transaction? A. sale of currently outstanding stock by a dealer to an individual investor B. sale of a new share of stock to an individual investor C. stock ownership transfer from one shareholder to another shareholder D. gift of stock from one shareholder to another shareholder E. gift of stock by a shareholder to a family member
determining whether to pay cash for a purchase or use the credit offered by the supplier
Which one of the following is a working capital management decision? A. determining the amount of equipment needed to complete a job B. determining whether to pay cash for a purchase or use the credit offered by the supplier C. determining the amount of long-term debt required to complete a project D. determining the number of shares of stock to issue to fund an acquisition E. determining whether or not a project should be accepted
Auction markets match buy and sell orders.
Which one of the following statements is generally correct? -Private placements must be registered with the SEC. -All secondary markets are auction markets. -Dealer markets have a physical trading floor. -Auction markets match buy and sell orders. -Dealers arrange trades but never own the securities traded.
Agency Problem
Which one of the following terms is defined as a conflict of interest between the corporate shareholders and the corporate managers? A. Articles of Incorporation B. Corporate Breakdown C. Agency Problem D. Bylaws E. Legal Liability
capital budgeting
Which one of the following terms is defined as the management of a firm's long-term investments? A. working capital management B. financial allocation C. agency cost analysis D. capital budgeting E. capital structure
Capital Structure
Which one of the following terms is defined as the mixture of a firm's debt and equity financing? -Working capital management. -Cash management. -Cost analysis. -Capital budgeting. -Capital structure.
capital structure
Which one of the following terms is defined as the mixture of a firm's debt and equity financing? A. working capital management B. cash management C. cost analysis D. capital budgeting E. capital structure
Determining the minimum level of cash to be kept in a checking account.
Which one of these is a working capital management decision? A.Determining the best method of producing a product. B. Determining the number of employees needed to work during a particular shift. C. Determining when to replace obsolete equipment. D. Determining if a competitor should be acquired. E. Determining the minimum level of cash to be kept in a checking account.
Limited partnership for limited partners only and Corporation
Which organizational forms give their owners limited liability? A. Sole proprietorship. B.Partnership. C.Limited partnership for general partners only. D.Limited partnership for limited partners only. E.Corporation
debt-equity or equity multiplier ratio
Which ratio would you use to measure the financial health of a firm by assessing that firmʹs leverage? A) debt-equity or equity multiplier ratio B) market-to-book ratio C) market debt-equity ratio D) current or quick ratio
operating cash flow
Which term relates to the cash flow which results from a firm's ongoing, normal business activities? A. operating cash flow B. capital spending C. net working capital D. cash flow from assets E. cash flow to creditors
Sole Proprietorship vs. Partnership
While a sole proprietor has the same identity as its single owner, a partnership of general partners has the same identity as its partners. Each general partner is responsible for the decisions taken by that partner as well as any other general partner.
the stockholders who have risked their money to become owners of the company
Whose interests should a financial manager consider paramount when making a decision? A) the stockholders who have risked their money to become owners of the company B) the employees and associated stakeholders who are employed by the company C) the public who consume the companyʹs goods and services D) the senior management and associated colleagues at the executive level within the company
Once investors take advantage of the opportunity, prices will respond so that the buying and selling price become equal.
Why are arbitrage opportunities short-lived? A. Federal regulations will kick in to restrict trade and effectively shut the opportunity down. B. Prices will fluctuate up and down as traders take advantage of the opportunity, resulting in the net present value (NPV) fluctuating between positive and negative values. C. Once investors take advantage of the opportunity, prices will respond so that the buying and selling price become equal. D. Arbitrage opportunities need a lot of information processing, which is very slow to arrive.
All of the decisions by the financial manager are made within the context of the overriding goal of financial management—to maximize the wealth of the owners, the stockholders. The stockholders have invested in the corporation, putting their money at risk to become the owners of the corporation.
Why do all shareholders agree on the same goal for financial manager? A. All of the decisions by the financial manager are made within the context of the overriding goal of financial management—to maximize the wealth of the owners, the stockholders. B. All of the decisions by the financial manager are made within the context of the overriding goal of financial management—to maximize the wealth of the corporation. C.The stockholders have invested in the corporation, putting their money at risk to become the managers of the corporation. D. The stockholders have invested in the corporation, putting their money at risk to become the owners of the corporation.
There are often many owners, and they can often change as they buy and sell stock.
Why in general do financial managers make financial decisions in a corporation, rather than the owners making these decisions themselves? A) It is best for the control of the finances of a corporation to be in the hands of a disinterested third party. B) The interests of the various owners may conflict with each other. C) The owners may not be U.S. citizens or residents. D) There are often many owners, and they can often change as they buy and sell stock.
Shares sold on it are exchanged between investors without any involvement of the issuing corporation.
Why is a stock exchange like NASDAQ considered a secondary market? A) It trades the second largest volume of shares in the world. B) Shares sold on it are exchanged between investors without any involvement of the issuing corporation. C) The exchange has rules that attempt to ensure that bid and ask prices do not get too far apart. D) NASDAQ is called a secondary market because NYSE is considered a primary market.
There is no organized market for its shares.
Why is it difficult to determine the market price of a private corporationʹs shares at any point in time? A) It is difficult to obtain enough information to accurately value such a company. B) The price of its shares is fixed by the owners. C) It has a limited number of owners. D) There is no organized market for its shares.
It is a legally defined, artificial entity that is separate from its owners.
Why is it possible for a corporation to enter into contracts, acquire assets, incur obligations, and enjoy protection against the seizure of its property? A) The number of owners, and hence the spread of risk among these owners, is not limited. B) Its owners are liable for any obligations it enters into. C) The state in which a corporation is incorporated provides safeguards against any wrongdoing by the corporation. D) It is a legally defined, artificial entity that is separate from its owners.
In most investment projects, costs are incurred up front, but benefits are received in the future.
Why is it usually necessary to use the time value of money when performing a cost-benefit analysis? A) For an investment project to be considered, costs must have a higher dollar value than benefits. B) In most investment projects, costs are incurred up front, but benefits are received in the future. C) For practical purposes, a dollar today may be considered to be equal to a dollar at some future time. D) Although costs and benefits generally occur concurrently, the benefits will accrue value over time, due to interest
Both decisions should be made based upon the tradeoff benefits and costs across time.
Why is the personal decision a financial manager makes as to whether to buy or to rent an apartment as a personal residence most like the professional decision that manager makes as to whether her firm should try to acquire a stake in a fast growing new Internet-based company? A) Both decisions involve the purchase of assets that are essential for the existence of the investor B) Both decisions involve the rental of a useful asset. C) Both decisions have the potential to affect the firm. D) Both decisions should be made based upon the tradeoff benefits and costs across time.
In general, people want to invest in a well-managed corporation, which will drive up the price of shares.
Why is the stock price of a company an indication of the performance of the companyʹs senior managers? A) Well-run companies are invariably highly profitable, which leads to a higher share price. B) In general, people want to invest in a well-managed corporation, which will drive up the price of shares. C) Investors who can see that a company is well-run will hold on to their shares, even if the company faces setbacks, since they know that the stock price will likely rise again. D) Larger companies tend to be better run and so have higher stock prices.
Share price is a quantity related to equity holders, while operating income is an amount that is related to the whole firm.
Why must care be taken when comparing a firmʹs share price to its operating income? A) Both share price and operating income are related to the whole firm. B) Share price is a quantity related to the entire firm, while operating income is an amount that is related solely to equity holders. C) Both share price and operating income are related solely to equity holders. D) Share price is a quantity related to equity holders, while operating income is an amount that is related to the whole firm.
Because they have been hired to represent the interests of the current shareholders.
Why should financial managers strive to maximize the current value per share of the existing stock? A. Because managers often receive shares of stock as part of their compensation. B. Doing so increases employee salaries. C. Because they have been hired to represent the interests of the current shareholders. D. Because this will increase the current dividends per share. E. Doing so guarantees the company will grow in size at the maximum possible rate.
Most investment opportunities bear far greater risk than those offered by U.S. Treasury securities.
Why, in general, do investment opportunities offer a rate greater than that offered by U.S. Treasury securities for the same horizon? A) Most investment opportunities bear far greater risk than those offered by U.S. Treasury securities. B) The return from U.S. Treasury securities generally attracts less tax than the returns from other investments. C) The opportunity cost of capital for a given horizon is generally based on U.S. Treasury securities with that same horizon. D) U.S. Treasury securities are generally considered to be the best alternative to most investments.
by raising its reported earnings
WorldCom classified $3.85 billion in operating expenses as long-term investments. How would this make WorldComʹs financial statements more attractive to investors? A) by decreasing depreciation B) by reducing capital expenditures C) by raising its reported earnings D) by boosting its cash flows
First the corporation pays the taxes. After taxes, is left to pay dividends. Once the dividend is paid, personal tax on this must be paid, which leaves . So after all the taxes are paid, you are left with $0.84.
You are a shareholder in a C corporation. The corporation earns $2 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. How much is left for you after all taxes are paid?
$1.16
You are a shareholder in a C corporation. The corporation earns $2.49 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. Assume the corporate tax rate is 38% and the personal tax rate on (both dividend and non-dividend) income is 25%. How much is left for you after all taxes are paid?
$1.75 (6-1=5; 5*0.35=$1.75)
You are a shareholder in a corporation which has elected subchapter S tax treatment. The corporation announces a profit of $6 per share, of which it retains $1 for reinvestment and distributes the rest as dividend payments. Given that the personal tax rate is 35%, how much tax must you pay per share? A) $0 B) $2.10 C) $1.75 D) $2.52
$1.65
You are a shareholder in an S corporation. The corporation earns $2.29 per share before taxes. As a pass through entity, you will receive $2.29 for each share that you own. Your marginal tax rate is 28%. How much per share is left for you after all taxes are paid?
6.0% PV = -496.97 FV = 1000 PMT = 0 N = 12 Compute I = 6.0%.
You are considering investing in a zero-coupon bond that will pay you its face value of $1000 in twelve years. If the bond is currently selling for $496.97 , then the internal rate of return (IRR) for investing in this bond is closest to ________. A) 5.0% B) 7.1% C) 6.0% D) 8.2%
$3193 PV = 290,000 I=1 N = 240 FV = 0 Compute payment = $3193.15 .
You are considering purchasing a new home. You will need to borrow $290,000 to purchase the home. A mortgage company offers you a 20-year fixed rate mortgage (240 months) at 12% APR (1% month). If you borrow the money from this mortgage company, your monthly mortgage payment will be closest to ________. A) $2554 B) $4470 C) $3193 D) $5109
The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B.
You are given two choices of investments, Investment A and Investment B. Both investments have the same future cash flows. Investment A has a discount rate of 4%, and Investment B has a discount rate of 5%. Which of the following is true? A) The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B. B) The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B. C)The present value of cash flows in Investment A is equal to the present value of cash flows in Investment B. D) No comparison can be madewe need to know the cash flows to calculate the present value
The present value of cash flows in Investment A is higher than the present value of cash flows in investment B.
You are given two choices of investments, Investment A and Investment B. Both investments have the same future cash flows. Investment A has a discount rate of 4%, and Investment B has a discount rate of 5%. Which of the following is true? A. The present value of cash flows in Investment A is higher than the present value of cash flows in investment B. B. The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B. C. The present value of cash flows in Investment A is equal to the present value of cash flows in Investment B. D. No comparison can be made - we need to know the cash flows to calculate the present value.
$685 PV = 33,000 I = 0.75 N = 60 FV = 0 Compute payment = $685.03 .
You are interested in purchasing a new automobile that costs $33,000 . The dealership offers you a special financing rate of 9% APR (0.75% per month) for 60 months. Assuming that you do not make a down payment on the auto and you take the dealerʹs financing deal, then your monthly car payments would be closest to ________. A) $548 B) $685 C) $959 D) $1096
$12,000 NPV = PV benefits - PV of costs $2,278 = $10,000 / (1.10)1 + X / (1.10)2 + $15,000 / (1.10)3 - $28,000 $30,278 = $10,000 / (1.10)1 + X / (1.10)2 + $15,000 / (1.10)3 $30,278 = $9,091 + X / (1.10)2 + $11,270 $9,917 = X / (1.10)2 X = 11,999.57
You are offered an investment opportunity that costs you $28,000, has a net present value (NPV) of $2278, lasts for three years, has interest rate of 10%, and produces the following cash flows: The missing cash flow from year 2 is closest to ________. A) $12,500 B) $12,000 C) $13,000 D) $10,000
It will have no effect on the future value.
You are scheduled to receive $10,000 in one year. What will be the effect of an increase in the interest rate on the future value of this cash flow? A) It will cause the future value to fall. B) It will cause the future value to rise. C) It will have no effect on the future value. D) The effect cannot be determined with the information provided.
It will cause the present value to fall.
You are scheduled to receive $10,000 in one year. What will be the effect of an increase in the interest rate on the present value of this cash flow? A) It will cause the present value to fall. B) It will cause the present value to rise. C) It will have no effect on the present value. D) The effect cannot be determined with the information provided.
There is an ethical dilemma when the CEO of a firm has opposite incentives to those of the shareholders. In this case, you (as the CEO) have an incentive to potentially overpay for another company (which would be damaging to your shareholders) because your pay and prestige will improve.
You are the CEO of a company and you are considering entering into an agreement to have your company buy another company. You think the price might be too high, but you will be the CEO of the combined, much larger company. You know that when the company gets bigger, your pay and prestige will increase. What is the nature of the agency conflict here and how is it related to ethical considerations?
$48.85
You are watching TV late one night and see an ad from Ronco for the Dial-o-matic food slicer. You learn that the Dial-o-matic sells for $29.95. Ronco also includes a set of Ginsu steak knives worth $10.95 and another free gift worth $7.95 in this deal. Assuming that there is a competitive market for Ronco items, at what price must Ronco offer this three item Dial-o-matic deal to ensure the absence of an arbitrage opportunity and uphold the Law of One Price?
-$300 ((-57 × 1000) + (900 × 63) = -$300)
You own 1000 shares of Newstar Financial stock, currently trading for $57 per share. You are offered a deal where you can exchange these stocks for 900 shares of Amback Financial Group stock, currently trading at $63 per share. What is the value of this trade, if you choose to make it? A) -$320 B) -$340 C) -$300 D) $300
-$300 ((-57 × 1000) + (900 × 63) =-$300)
You own 1000 shares of Newstar Financial stock, currently trading for $57 per share. You are offered a deal where you can exchange these stocks for 900 shares of Amback Financial Group stock, currently trading at $63 per share. What is the value of this trade, if you choose to make it? A) -$320 B) -$340 C) -$300 D) $300
Consol
a bond that promises its owner a fixed cash flow every year, forever
Growing Perpetuity
a cash flow stream that occurs at regular intervals and grows at a constant rate forever
Generally Accepted Accounting Principles (GAAP)
a common set of rules and a standard format for public companies to use when they prepare their financial reports
EBITDA
a computation of a firm's earnings before interest, taxes, depreciation, and amortization are deducted
EBIT
a firm's earnings before interest and taxes are deducted
Operating Income
a firm's gross profit less its operating expenses
Earnings Per Share (EPS)
a firm's net income divided by the total number of shares outstanding
Liabilities
a firm's obligations to its creditors
Inventories
a firm's raw materials as well as its work-in-progress and finished goods
Corporation
a legal entity authorized under a state charter. 15% of all businesses are corporations. Corporations can be public or private advantages: -stockholders have limited liability for debts and othe obligations of the corporations disadvantages: taxed on the income it earns and then also on the dividends it pays
Limited Liability Company (LLC)
a limited partnership without a general partner
Timeline
a linear representation of the timing of (potential) cash flows
Income Statement
a list of a firm's revenues and expenses over a period of time
Amortizing Loan
a loan on which the borrower makes monthly payments that include interest on the loan plus some part of the loan balance
Competitive Market
a market in which a good can be bought and sold at the same price
Dealer Market
a market where dealers buy and sell for their own accounts
Auction Market
a market where share prices are set through direct interaction of buyers and sellers
Over-The-Counter (OTC) Market
a market without a physical location, in which dealers are connected by computers and telephones
Equity Multiplier
a measure of leverage equal to total assets divided by total equity
Leverage
a measure of the extent to which a firm relies on debt as a source of financing
Auditor
a neutral third party, which corporations are required to hire, that checks a firm's annual financial statements to ensure they are prepared according to GAAP, and provides evidence to support the reliability of the information
Limited Partnership
a partnership with two kinds of owners: general partners and limited partners
Yield Curve
a plot of bond yields as a function of the bonds' maturity date
Management Discussion and Analysis (MD&A)
a preface to the financial statements in which a company's management discusses the recent year (or quarter), providing a background on the company and any significant events that may have occurred
Stream of Cash Flows
a series of cash flows lasting several periods
Hostile Takeover
a situation in which an individual or organization - sometimes referred to as a corporate raider - purchases a large fraction of a company's stock and in doing so gets enough votes to replace the board of directors and its CEO
Annuity
a stream of N equal cash flows paid at regular intervals
Growing Perpetuity
a stream of cash flows that occurs at regular intervals and grows at a constant rate forever
Growing Annuity
a stream of cash flows, growing at a constant rate and paid at regular intervals, that end after a specified number of periods
Annuity
a stream of equal cash flows arriving at a regular interval and ending after a specified time period
Perpetuity
a stream of equal cash flows that occurs at regular intervals and lasts forever
Depreciation
a yearly deduction a firm makes from the value of its fixed assets (other than land) over time, according to a depreciation schedule that depends on an asset's life span.
Financial Statements
accounting reports issued by a firm quarterly and/or annually that present past performance information and a snapshot of the firm's assets and the financing of those assets
Stockholder's Equity
also called book value of equity The sum of the current liabilities and long-term liabilities is total liabilities. The difference between the firm's assets and liabilities is the stockholder's equity; it is also called book value of equity. Book value of assets - Book value of liabilities -> could be positive or negative
Accounts Receivable
amounts owed to a firm by customers who have purchased goods or services on credit
Shareholders/Stockholders Equity
an accounting measure of a firm's net worth that represents the difference between the firm's assets and its liabilities
Statement of Stockholder's Equity
an accounting statement that breaks down the stockholders' equity computed on the balance sheet into the amount that came from issuing new shares versus retained earnings
Statement of Cash Flows
an accounting statement that shows how a firm has used the cash it earned during a set period
Interest Coverage Ratio or Times Interest Earned (TIE) Ratio
an assessment by lender's of a firm's leverage, it is equal to a measure of earnings divided by interest
Accounts Payable Days
an expression of a firm's accounts payable in terms of the number of days' worth of cost of goods sold that the accounts payable represents
Inventory Days
an expression of a firm's inventory in terms of the number of days' worth or cost of goods sold that the inventory represents
Dilution
an increase in the total number of shares that will divide a fixed amount of earnings
Shareholder (also stockholder or equity holder)
an owner of a share of stock or equity in a corporation
Long-Term Debt
any loan or debt obligation with a maturity of more than a year
Arbitrage Opportunity
any situation in which it is possible to make a profit without taking any risk or making any investment
Agency Conflict Problem
arises out of the principal-agent relationship existing between the shareholders and managers of a corporation. Although managers are required to put the shareholders interest ahead of their own, in practice they tend to put their own interest ahead of the shareholdersʹ interests.
Book Value of Equity
assets - liabilities
Long-Term Assets
assets that produce tangible benefits for more than one year
Current Assets
cash or assets that can be converted into cash within one year
Compounding
computing the return on an investment over a long horizon by multiplying the return factors associated with each intervening period
Convertible Bonds
corporate bonds with a provision that gives the bondholder an option to convert each bond owned into a fixed number of shares of common stock
Net Debt
debt in excess of a firm's cash reserves
Financial Cycle
describes how money flows from savers to companies and back. In the financial cycle, (1) people invest and save their money; (2) that money, through loans and stock, flows to companies who use it to fund growth through new products, generating profits and wages; and (3) the money then flows back to the savers and investors.
NYSE
each stock has only one market maker.
Financial Institutions
entities that provide financial services, such as taking deposits, managing investments, brokering financial transactions, or making loans
DuPont Identity
expresses return on equity as the product of profit margin, asset turnover, and a measure of leverage
Discounting
finding the equivalent value today of a future cash flow by multiplying by a discount factor, or equivalently, dividing by 1 plus the discount rate
Growth Stocks
firms with high market-to-book ratios
Value Stocks
firms with low market-to-book ratios
NASDAQ
has retained many big, successful companies such as Starbucks, Apple, and Microsoft.
Law of One Price
in competitive markets, securities with the same cash flows must have the same price
Transaction Cost
in most markets, an expense such as a broker commission and the bid-ask spread investors must pay in order to trade securities
Annual Percentage Rate (APR)
indicates the amount of interest earned in one year without the effect of compounding
Simple Interest
interest earned without the effect of compounding
Nominal Interest Rate
interest rates quoted by banks and other financial institutions that indicate the rate at which money will grow if invested for a certain period of time
NYSE
is an example of a physical market. It is located at 11 Wall Street in New York City
Fisher Equation
is the expected, not the reported or actual, annualized change in commodity prices (∆Pe). It is used to protect the buying power from changes in inflation, and it is incorporated into a loan contract by adding it to the real interest rate that would exist in the absence of inflation
Rate of Return
is the rate at which the present value of the benefits exactly offsets the cost
Sarbanes-Oxley Act (SOX)
legislation passed by Congress in 2002, intended to improve the accuracy of financial information given to both boards and shareholders
Current Liabilities
liabilities that will be satisfied within one year
Assets
list the firm's cash, inventory, property, plant and equipment, any other investments -What the company owns
Notes Payable (Short-Term Debt)
loans that must be repaid in the next year
Market Value of Equity (Market Capitalization)
market price per share x number of shares
Secondary Market
markets, such as NYSE or NASDAQ, where shares of a corporation are traded between investors without the involvement of the corporation
Interest Rate Factor
one plus the interest rate, it is the rate of exchange between dollars today and dollars in the future. It has units of "$ in the future/$today."
Stock Market (also stock exchange or bourse)
organized market on which the shares of many corporations are traded
Listing Standards
outlines of the requirements a company must meet to be traded on the exchange
Dividend Payments
payments made at the discretion of the corporation to its equity holders
Retained Earnings
profits made by the firm, but retained within the firm and reinvested in assets or held as cash
Capital Expenditures
purchases of new property, plant, and equipment
Marketable Securities
short-term, low-risk investments that can be easily sold and converted to cash
Valuation Principle
shows how to make the costs and benefits of a decision comparable so that we can evaluate them properly.
Stakeholder
someone other than an owner who has a claim on the cash flows of the firm: managers, employees, suppliers, government, creditors all make their money by the firm doing well.
NYSE
standards are more stringent
Book Value
the acquisition cost of an asset less its accumulated depreciation
Bid-Ask Spread
the amount by which the ask price exceeds the bid price
Common Stock and Paid-In Surplus
the amount that stockholders have directly invested in the firm through purchasing stock from the company
Accounts Payable
the amounts owed to creditors for products or services purchased with credit
Discount Rate
the appropriate rate to discount a cash flow to determine its value at an earlier time
Opportunity Cost of Capital or Cost of Capital
the best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted; the return the investor forgoes on an alternative investment of equivalent risk and term when the investor takes on a new investment
Assets
the cash, inventory, property, plant, and equipment, and other investments a company has made
Equity
the collection of all the outstanding shares of a corporation
Inventory Turnover Ratio
the cost of goods sold divided by either the latest cost of inventory or the average inventory over the year, it shows how efficiently companies turn their inventory into sales
Net Working Capital
the difference between a firm's current assets and its current liabilities that represents the capital available in the short term to run the business
Time Value of Money
the difference in value between money received today and money received in the future; also, the observation that two cash flows at two different points in time have different values
Diluted EPS
the earnings per share a company would have based on the total number of shares including the effects of all stock options and convertible bonds
Compound Interest
the effect of earning "interest on interest"
Managing Working Capital
the financial manager must ensure that the firm has enough cash on hand to meet its financial obligations at each point in time -this job is also called (BLANK)
Risk-Free Interest Rate
the interest rate at which money can be borrowed or lent without risk over a given period
Net Income or Earnings
the last or "bottom" line of a firm's income statement that is a measure of the firm's income over a given period of time
Federal Funds Rate
the overnight loan rate charged by banks with excess reserves at a federal reserve bank to banks that need additional funds to meet reserve requirements
Stock
the ownership or equity of a corporation divided into shares
Chief Executive Officer (CEO)
the person charged with running the corporation by instituting the rules and policies set by the board of directors
Bid Price
the price at which a market maker or specialist is willing to buy a security
Ask Price
the price at which a market maker or specialist is willing to sell a security
Interest Rate
the rate at which money can be borrowed or lent over a given period
Real Interest Rate
the rate of growth of purchasing power, after adjusting for inflation
PEG Ratio
the ratio of a firm's P/E to its expected earnings growth rate
Payout Ratio
the ratio of a firm's dividends to its net income
Cash Ratio
the ratio of cash to current liabilities
Quick Ratio ("Acid Test Ratio")
the ratio of current assets other than inventory to current liabilities
Current Ratio
the ratio of current assets to current liabilities
Gross Margin
the ratio of gross profit to revenues (sales), it reflects the ability of the company to sell a product for more than the sum of the direct costs of making it
Net Profit Margin
the ratio of net income to revenues, it shows the fraction of each dollar in revenues that is available to equity holders after the firm pays its expenses, plus interest and taxes
Operating Margin
the ratio of operating income to revenues, it reveals how much a company has earned from each dollar of sales before deducting interest and taxes
Asset Turnover
the ratio of sales to total assets
Return on Invested Capital (ROIC)
the ratio of the after-tax profit before interest to the book value of invested capital not being held as cash (book equity plus net debt)
Price-Earnings Ratio (P/E)
the ratio of the market value of equity to the firm's earnings, or its share price to its earnings per share
Term Structure
the relationship between the investment term and the interest rate
Stock Options
the right to buy a certain number of shares of stock by a specific date at a specific price
Gross Profit
the third line of an income statement that represents the difference between a firm's sales revenues and its costs
Effective Annual Rate (EAR) or Annual Percentage Yield (APY)
the total amount of interest that will be earned at the end of one year
Market Capitalization
the total market value of equity; equals the market price per share times the number of shares
Future Value (FV)
the value of a cash flow that is moved forward in time
Present Value (PV)
the value of a cost or benefit computed in terms of cash today
Liquidation Value
the value of a firm after its assets are sold and liabilities paid
Discount Factor
the value today of a dollar received in the future
Annual Report (10-K)
the yearly summary of business, accompanying or including financial statements, sent by U.S. public companies to their shareholders
NYSE
there has been a certain pride in being listed on the
Off-Balance Sheet Transactions
transactions or arrangements that can have a material impact on a firm's future performance yet do not appear on the balance sheet
Report to CFO
treasurer, risk manager, controller, and internal auditor
Primary Market
when a corporation issues new shares of stock and sells them to investors
Limited Liability
when an investor's liability is limited to her investment
Agency Problem
when managers, despite being hired as the agents of shareholders, put their self-interest ahead of the interests of those shareholders