FINA 307 Exam 1

Limited Liability

The owners of the corporation are not personally responsible for its obligations

Plowback Ratio Formula

1 - Payout Ratio = Plowback Ratio

T/F: Financing decisions are used to determine how to raise the cash necessary for investments.

True

Capital Budgeting vs Capital Structure Decisions

Capital Budgeting: Invest in tangible or intangible assets. Deals with long-term investment decisions Capital Structure: Selecting between long-term debt financing and equity financing

Capital Market vs Money Market

Capital Market: Markets for long-term financing, ie a firm's capital Money Market: Market for short-term financing (less than 1 year) ie a debt that matures in 270 days

Double taxation

Corporations are subject to double taxation, because they pay taxes on their profits and the shareholders are taxed again when they receive dividends or sell their shares at a profit

Economic Value Added (EVA) and Market Value Added (MVA)

EVA: aka residual income. Deducts the cost of capital from operating income. If it is positive, then the firm's current operations are adding value for shareholders. MVA: The difference between the market value of firm's equity and its book value.

T/F: The networking capital of a firm will decrease when accrued wages are paid with cash.

False

Investing and Financial Decisions

Investment Decision: aka capital budgeting. Decide which real assets to invest in Finance Decision: Decide how to raise the funds necessary to pay for those investments

Agency Problem

Managers are agents for stockholders, and are tempted to act in their own interests rather than maximizing value

Market Value and Book Value

Market Value: Value of assets or liabilities were they to be resold in a market Book Value: Value of assets or liabilities according to the balance sheet

Short-term financing decisions commonly occur in the _______.

Money markets

Payout Ratio Formula

Payout Ratio + Plowback Ratio = 1

Primary Market vs Secondary Market

Primary Market: Market for sale of newly issued securities Secondary Market: Market in which previously issued securities are traded among investors

ROA Formula

ROA= Aftertax Operating Income / Assets or ROA= Asset Turnover x Operating Profit Margin

Real Assets and Financial Assets

Real Assets: used to produce goods and services Financial Assets: financial claims to income generated by the firm's real assets

A primary market would be utilized when _______.

Securities are initially issued.

Goals of the Corporation

Shareholders desire wealth maximization. Profit maximization. Opportunity cost of capital (aka rate of return investors can earn)

Sustainable Growth Formula

Sustainable Growth (G) = ROE x Plowback Ratio

Opportunity Cost of Capital

The minimum acceptable rate of return on capital investment is set by the investment opportunities available to shareholders in financial markets

Balance Sheet

a snapshot of the firm's assets and liabilities

In 2016, Newbie Corp. has total assets of $1 billion, total current assets of $300 million, total shareholder's equity of $700 million, total current liabilities of $100 million. You are preparing a COMMON-SIZE balance sheet for Newbie Corp, which of the following numbers should be used for "Long-term liabilities" item? a. 20% b. $300 million c. 30% d. $400 million e. $200 million

a. 20%

Which of the following forms of compensation is most likely to align the interests of managers and shareholders? a. A salary that is linked to the total market value of the corporation's stocks b. A fixed salary c. A salary that is linked to next quarter's profits d. A salary that is linked to next quarter's sales

a. A salary that is linked to the total market value of the corporation's stocks

Financial markets and intermediaries: a. Channel savings to real investment. b. Increase risks for businesses. c. Generally reduce the liquidity of securities. d. Prevent the transportation of cash across time.

a. Channel savings to real investment.

A capital investment that generates a 10% rate of return is worthwhile if: a. Corporate bonds of similar risk offer 8% rates of return. b. Corporate bonds of similar risk offer 11% rates of return. c. Top-quality corporate bonds offer 10% rates of return. d. The expected rate of return on the stock market is 12%.

a. Corporate bonds of similar risk offer 8% rates of return.

Which of the following changes in working capital will result in an increase in cash flows? a. Increase in accounts payable b. Increase in inventories c. Increase in accounts receivable d. Decrease in other current liabilities

a. Increase in accounts payable

When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an average quick ratio, and a low inventory turnover. What might you assume about Tri-C? a. Its inventory is too high. b. Its cost of goods sold is too low. c. Its current liabilities are too low. d. Its cash balance is too low.

a. Its inventory is too high.

Corporate financing comes from: a. Savings by households and foreign investors. b. Cash generated from the firm's operations. c. The financial markets and intermediaries. d. The issue of shares in the firm.

a. Savings by households and foreign investors.

Which one of these parties cannot invest in a hedge fund? a. Small retail investors b. Pension funds c. Insurance companies d. Wealthy individuals

a. Small retail investors

In general, what is changing as you read down the LEFT hand side of a balance sheet? a. The assets are becoming less liquid. b. All current assets are tangible and all fixed assets are intangible. c. The assets are growing in value. d. Current assets are funded by debt financing and fixed assets are funded by equity financing.

a. The assets are becoming less liquid.

According to ACCRUAL accounting, when goods are not sold until the month after they were produced in March, then the cost of goods sold: a. Will be recognized in April b. Will be recognized in March c. Will be recognized when payment is received d. Will be split between both months

a. Will be recognized in April

In 2016, Newbie Corp. has total assets of $1 billion, total current assets of $300 million, total shareholder's equity of $700 million, total current liabilities of $100 million. You are preparing a balance sheet for Newbie Corp, which of the following numbers should be used for "Total liabilities" item? a. 30% b. $300 million c. 40% d. $400 million

b. $300 million

What is the ROA of a firm with $150,000 in receivables, which represents 60 days sales, assets of $750,000, and an operating profit margin of 6%? a. 6.08% b. 7.30% c. 10.95% d. 16.70%

b. 7.30% ROA = Asset turnover * Operating PM Asset turnover = Sales / Assets Average collection period = AR/daily sales daily sales = 150000/60 = 2500 Sales = 2500 * 365 Asset turnover = 2500 * 365 /750000 =1.2167 ROA = 1.2167 * 6% = 7.3%

Which one of the following would be considered a capital budgeting decision? a. Planning to issue common stock rather than issuing preferred stock b. Deciding to expand into a new line of products, at a cost of $5 million c. Repurchasing shares of common stock d. Issuing debt in the form of long-term bonds

b. Deciding to expand into a new line of products, at a cost of $5 million

Which of the following is not typically considered a function of financial intermediaries? a. Providing a payment mechanism b. Investing in real assets c. Accumulating funds from smaller investors d. Spreading, or pooling risk among individuals

b. Investing in real assets

An example of a firm's financing decision would be: a. Deciding whether or not to increase the price of its products. b. Issuing 10-year versus 20-year bonds. c. Acquiring a competitive firm. d. Determining how much to pay for a specific asset.

b. Issuing 10-year versus 20-year bonds.

A share of IBM stock is purchased by an individual investor for $75 and later sold to another investor for $125. Who profits from this sale? a. IBM b. The first investor c. The second investor d. IBM and both investors

b. The first investor

What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of equity of $3,000,000, and a market/book ratio of 3? a. $30.00 b. $60.00 c. $90.00 d. $105.00

c. $90.00 Book value of equity per sh = 3,000,000/100,000 = 30 M/B = 3 Market value of equity per sh = 30 *3

Net Corp. has an ROE of 20% and would like to see earnings grow at a 8% annual rate. What percent of earnings can they afford to pay out as dividends? a. 40% b. 50% c. 60% d. 75%

c. 60% Growth rate = ROE * Plow back ratio 8% = 20% * .4 Dividend payout ratio = 1 - .4

Which of the following is a financial asset? a. A patent b. An iPhone c. A share of Google's stock d. New brand of potato chips

c. A new share of Google's stock

Which of the following will allow your firm to achieve its targeted 15% ROA with an asset turnover of 2.0? a. A leverage ration of 1/5 b. A P/E ratio of 2 c. An operating profit margin of 7.5% d. An operating profit margin of 5%

c. An operating profit margin of 7.5%

A company can pay for its expansion in all the following ways except: a. By using the earnings generated from its sale of obsolete equipment. b. By persuading a director's mother to make a personal loan to the company. c. By purchasing bonds in the secondary market. d. By selling stock certificates for a new subsidiary

c. By purchasing bonds in the secondary market.

Which of the following will occur in the statement of cash flows as a result of paying cash dividends? a. Cash flows from operations will increase. b. Cash flows from investment will decrease. c. Cash flows from financing activities will decrease. d. Cash balances will not be affected.

c. Cash flows from financing activities will decrease.

An asset's liquidity measures its: a. Potential for generating a profit. b. Cash requirements. c. Ease and cost of being converted to cash. d. Proportion of debt financing.

c. Ease and cost of being converted to cash.

Which of the following correctly states the difference between debt and equity? a. Shareholders do not have voting rights while lenders have voting rights. b. A share of Microsoft stock is a financial obligation to Microsoft. c. Equity represents ownership. d. A firm will have to file for bankruptcy if this firm misses a dividend payment.

c. Equity represents ownership.

Which of the following statements best distinguishes the difference between real and financial assets? a. Real assets have less value than financial assets. b. Real assets are tangible; financial assets are not. c. Financial assets represent claims to income that is generated by real assets. d. Financial assets appreciate in value; real assets depreciate in value.

c. Financial assets represent claims to income that is generated by real assets.

Retained earnings result from: a. The sale of additional shares of stock to investors d. An excess of assets over liabilities c. Income not paid to shareholders d. An excess of equity over liabilites

c. Income not paid to shareholders

Which of the following should be the goal of the corporation? a. Triple Bottom Line b. Maximize profit c. Maximize the market value of the shareholders' investment in the firm. d. Maximize market share

c. Maximize the market value of the shareholders' investment in the firm.

Which of the following information is not provided by the financial markets? a. The price of 6 ounces of gold b. The cost of borrowing $500,000 for 5 yrs c. Microsoft's earnings in 2016 d. The cost of one million yen in US dollars

c. Microsoft's earnings in 2016

If the balance sheet of a firm indicates that total assets equals current liabilities plus shareholders' equity, then the firm has: a. No retained earnings b. No accumulated deprecation c. No long-term debt d. No current assets

c. No long-term debt

A primary market would be utilized when: a. Investors buy or sell existing securities. b. Shares of common stock are exchanged. c. Securities are initially issued. d. A commission must be paid on the transaction

c. Securities are initially issued.

How does the Du Pont system help identify the determinants of the firm's return on its assets and equity? a. The formula states that the return on equity is the product of the firm's leverage ratio, asset turnover, operating profit margin, and debt burden. b. The formula states that the return on assets is the product of the firm's asset turnover and operating profit margin. c. both A and B are correct. d. None are correct

c. both A and B are correct.

Calculate the EBIT for a firm with $4 million total revenues, $3.2 million cost of goods sold, $500,000 depreciation expense, and $120,000 interest expense. a. -$120,000 b. $0 c. $180,000 d. $300,000

d. $300,000

Which of the following items is not a current asset? a. Marketable securities b. Cash c. Inventories d. Accounts payable

d. Accounts payable

A firm should only purchase real assets only if the assets ________. a. Increase market share b. Increase profits c. Increase productivity d. Add value to the firm

d. Add value to the firm

The minimum, acceptable rate of return on corporate investments is determined by: a. The financial manager b. Information from the accounting statements c. The government d. Investors in financial markets

d. Investors in financial markets

Which of the following statements is most likely correct for a firm with an average collection period of 90 days? a. Its average daily sales are low. b. Its average daily sales are high. c. Its current ratio will be high. d. It is providing financing for approximately 25% of its annual sales.

d. It is providing financing for approximately 25% of its annual sales.

Which of the following would be considered an ADVANTAGE of a corporation? a. Double taxation b. Managers of a corporation cannot be owners of this corporation. c. No separation between management and ownership d. Limited liability

d. Limited liability

Which of the following would be most detrimental to a firm's current ratio if that ratio is currently 2.0? a. Buy raw materials on credit b. Sell marketable securities at a cost c. Pay off accounts payable with cash d. Pay off a portion of long-term debt with cash

d. Pay off a portion of long-term debt with cash

The DuPont Sysytem

links financial ratios together to explain the return on assets and equity. ROA is the product of asset turnover and operating profit margin. ROE is the product of the leverage ratio, asset turnover, operating profit margin, and debt burden

Income Statement

measures the profitability of the company during the year. It shows the difference between revenues and expenses

Statement of Cash Flows

measures the sources and uses of cash during the year. The change in the company's cash balance is the difference between sources and uses