Finance Chapter 1An Overview of Financial Management
Quick ratio =
(CA − Inventory)/CL = (30,000 - 16,000) / 22,000 = 0.64
The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint, than the return on total assets (ROA).
False
What is the relationship between economics, finance and accounting?
Finance grew out of economics and accounting and people working in finance need to know something about economics and accounting.
Is maximizing shareholder value inconsistent with being socially responsible?
Most managers recognize that being socially responsible is not inconsistent with maximizing shareholder value.
What is the firm's P/E ratio?
P/E ratio = Stock price/Earnings per share = $43.39/$3.62 = 12.0
Sarbanes-Oxley Act
Passed due to corporate scandals. Requires the CEO and CFO to certify that their firm's financial statements are accurate. To impose sanctions on executives who sign financial statements later found to be false.
Types/forms of Business Organizations
Proprietorship Partnership Corporation (LLC) Limited Liability Company (LLP) Limited Liability Partnership - accounting, law, and architecture firms.
What is the firm's ROE?
ROE = Net income/Common equity = 1,808/13,000 = 13.91%
Economics and finance
the social science studying supply and demand. Microeconomics examines the behavior of firms and consumers and the role of government. Macroeconomics looks at inflation, unemployment, industrial production, and the role of government.
Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength. T or F
True
How is finance divided?
1) Corporate finance 2) Financial markets and institutions 3) Investments
What three trends affect business management in general and financial management in particular?
1. Increased mobilization of business 2. Forever improving technology - effects financial management. 3. Corporate governance, the way the top managers operate and interface with stockholders.
Proprietorships and Partnerships
Advantages: Ease of formation Subject to few regulations No corporate income taxes Disadvantages: Difficult to raise capital Unlimited liability Limited life OFTEN SET UP THROUGH LLCs AND LLPs
Limited Liability Company (LLC)
Advantages: Limited Liability No corporate income taxes Disadvantages: Difficult to raise capital Limited life
Corporation
Advantages: Unlimited life Easy transfer of ownership Limited Liability Ease of raising capital Disadvantages: Double taxation Cost of set up and report filing
Intrinsic value
An estimate of a stock's "true" value based on accurate risk and return data. It can be estimated but not measured precisely.
Corporate raider
An individual who targets a corporation for takeover because it is undervalued.
Marginal Investor
An investor whose views determine the actual stock price.
Who is the CFO, where does this individual fit into the corporate hierarchy, and what are some of his or her responsibilities?
Chief Financial Officer CFO - Usually senior vice president & third ranking officer in charge of accounting, financing, credit policy, decisions regarding asset acquisitions and investor relations that involve communications with stock holders and the press.
What is the firm's dividends per share?
DPS = Common dividends paid/Shares outstanding =$632.73/500 = $1.27
What is the firm's days sales outstanding? Assume a 365-day year for this calculation.
DSO = Accounts receivable/(Sales/365) = 11,500/(87,500/365) = 47.97
What is the firm's debt/assets ratio?
Debt ratio = Total debt/Total assets =37,000/50,000 = 74.0%
What is the firm's EPS (earnings per share)?
EPS = Net income/Shares outstanding = $1,808/500 = $3.62
Which of the following are advantages of the LLC (limited liability company) form of business ownership? I. limited liability for firm debt II. no corporate income taxes III. easy to raise capital IV. unlimited firm life
I and II only
Should managers estimate intrinsic values or leave that to outside security analysts? Explain
Managers have the best information about a firm's future prospects, so their estimates are better than outside investors. However their estimates can be wrong.
Do stocks have known and "provable" intrinsic values, or might different people reach different conclusions about intrinsic values? Explain.
No, Intrinsic values are estimates and different analysts with different data have different views.
Equilibrium
Situation in which the actual market price equals the intrinsic value, so investors are indifferent between buying or selling a stock.
If a firm could maximize either its current market price or its intrinsic value, what would stockholders (as a group) want managers to do? Explain.
Stockholders would want firms to maximize the intrinsic value not the current market value.
Hostile takeover
The acquisition of a company over the opposition of its management.
What's the difference between a stock's current market price and its intrinsic value?
The intrinsic value is an estimate of the stock's "true" value as calculated by analysts with the best data. The market price is the actual market price based on perceived but possibly incorrect data determined by a marginal investor (who determines the actual price).
Shareholder Wealth Maximization
The primary goal of managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firms common stock.
Market Price
The stock value based on perceived but possibly incorrect information as seen by the marginal investor.
Finance within the organization order
Top- Board of directors 1) (CEO) Chief executive Officer 2) (COO) Chief operating officer (CFO) Chief financial officer 3) Marketing, Production, Human Resources, and other Operating departments. (Under COO) Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations. (Under CFO)
Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of examining changes in a firm's performance over time. T or F
True
If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much. T or F
True
The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.
True
The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being less risky and/or more likely to enjoy higher growth in the future.
True
The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as being less risky and/or more likely to enjoy higher growth in the future.
True
Should a firm's mangers help investors improve their estimates of the firm's intrinsic value? Explain.
Yes, they should provide information to investors to help them make better estimates of the firm's intrinsic value, to help keep stock prices closer to equilibrium.
What is finance?
addresses how businesses, individuals and other organizations allocate and use money. Mixture of finance, economics and accounting.
Accounting and finance
provides the information of firms.
What is management's primary goal?
shareholder wealth maximization.
S Corporation
special designation that allows businesses that meet qualifications to be taxed as if they were a proprietorship or a partnership rather than a corporation.
Business ethics
thought of as a company's attitude and conduct toward its employees, customers, community, and stockholders.
Dodd-Frank Act
to implement an aggressive overhaul of the U.S. financial regulatory system aimed at preventing reckless actions that would cause another financial crisis and business schools trying to inform students about proper versus improper business actions.
