Finance Quiz 1 (CH 1-3)

limited partnership

a business organization that offers liability protection to some of its owners, but NOT ALL advantage: losses are limited to the capital invested

Sole Proprietorship

a business owned and managed by a single individual (100% owner and manager) one is personally liable for all the debts of said business

long-term liability

a debt that is not due in the coming year, for example a loan that a firm will pay off in five years

corporation

a firm that is a separate legal entity and the parties responsible for said business do NOT have personal liability for the firm's debts, even if they have a 75/25 partnership - legal entity separate from owners - advantage: ability to raise larger sums of equity capital than other organizational forms

auction market

a market where all traders meet at one place to buy or sell an asset (Wall Street) the primary purpose is to match those who wish to sell with those who wish to buy

private placement

a negotiated sale involving a specific buyer

proxy fight

a technique used to gather enough stockholder votes to control a targeted company and possibly replace existing management

ease of conversion (liquidity)

an asset can be converted to cash quickly if we cut the price enough

assets

are classified as current or fixed

Listed on right hand side of balance sheet

The firm's liabilities are the first thing listed on this side and are classified as either current or long term

How is a sole proprietorship taxed?

The profits are taxed as personal income and obtaining additional equity is dependent on the owner's personal finances

Working capital questions:

- how much cash or inventory is kept on hand - should we sell on credit to customers - how will we obtain any needed short-term financing - if we borrow on the short term, how and where should we do it

fixed assets

can either be tangible (truck or computer) or intangible (trademark or patent) has relatively long life

Tim just got a promotion and is now in charge of all fixed asset purchases, which means he is in charge of

capital budgeting

shareholder preferences/management priorities alignment

compensating managers with shares of stock that must be held for a minimum of 3 years

net working capital

current assets - current liabilities

net working capital is positive when

current assets exceed current liabilities

dealer market (2nd)

dealers buy and sell for themselves at their own risk (car dealer) OTC markets since most debt security trading takes place over the counter

Working capital management

decisions related to current assets and current liabilities

The value of the firm's assets is:

equal to the sum of its liabilities and shareholders equity Assets = Liabilities + Equity

Current ratio

= Current assets/current liabilities

Short-Term Solvency Ratio

financial ratio for measuring a company's ability to pay immediate debts (liquidity measure) - focuses on current assets and liabilities - measure of short term liquidity - the unit of measurement is either dollars or times - to a creditor (short term or supplier) the higher the current ratio the better - to the firm, a higher current ratio indicates liquidity, but could also mean that cash is inefficiently used as well as other short term assets

Working capital

firms short term assets, such as inventory and short term liabilities such as cash owed to suppliers

Will and Bill both enjoy sunshine, water, and surfboards. Thus, the two friends decided to create a business together renting surfboards, paddle boats, and inflatable devices in California. Will and Bill will equally share in the decision making and in the profits or losses. Which type of business did they create if they both have full personal liability for the firm's debts?

general partnership

controller

handles cost and financial accounting, tax payments, and management information systems

Corporate shareholders:

have the ability to change the corporation's bylaws

high liquidity vs low liquidity

high: one that can be quickly sold without significant loss of value low/illiquid: asset that cannot be converted to cash without a substantial price reduction

working capital decision

how much cash the firm should keep in reserve

capital budgeting

involves calculating the size, timing, and risk of future cash flows

current liabilities

like current assets, have a life of less than one year (will be paid in less than a year) and are listed before long-term liabilities - example is accounts payable (money the firm owes to its suppliers)

bonds

long term debt

bondholders

long-term creditors

secondary market

market for reselling financial assets ex. when you place an order to sell 300

primary market

market for selling financial assets that can only be redeemed by the original holder

secondary markets

markets in which securities and other financial assets are traded among investors after they have been issued by corporations (bought and sold after original sale)

What is the goal of financial management for a partnership?

maximize the market value of the equity

Financial management goals:

maximize the market value of the existing owners' equity

Which one of the following decreases net income, but does not affect the operating cash flow of a firm that owes no taxes for the current year? A) indirect cost B) direct cost C) noncash item D) period cost E) variable cost

non-cash item

agency conflict

personal conflict of interest between a firm's owners and its manager - scenario: creates agency conflict is basing a management bonus on the length of employment

net working capital is usually (positive/negative?) with a healthy firm?

positive

liquidity ratio

These are sometimes called liquidity measures. The primary concern is THE FIRM'S ABILITY TO PAY ITS BILLS OVER THE SHORT RUN WITHOUT UNDUE STRESS. Advantage: book and market values are likely to be similar Disadvantage: like any type of near cash, current assets and liabilities can and do change fairly rapidly, so today's amount may not be a reliable guide to the future

liquidity

This is a measure of how quickly a financial instrument can be converted to cash.

limited liability

A company primarily designed to provide limited liability while avoiding double taxation

current asset

This kind of asset has a life of less than one year, meaning that the asset will normally convert to cash within 12 months - inventory since it is purchased and sold within a year -cash -accounts receivable (money owed to the firm by its customers)

primary market

refers to the original sale of securities by governments and corporations

balance sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

financial ratios

relationships determined from a firm's financial information and used for comparison purposes

treasurer

responsible for managing the firm's cash and credit, its financial planning, and capital expenditures

In a primary market transaction, the corporation is the:

seller and the transaction raises money for the corporation (two types: public offerings and private placements)

public offering

selling securities in the primary market to the general public

Cash ratio

A short term creditor might be interested in this ratio Cash ratio = Cash / Current liabilities

common-size statements

A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statement items as a percentage of sales.

Which one of the following actions will increase the current ratio, all else constant? Assume the current ratio is greater than 1.0. A. Cash payment of an account payable B. Cash purchase of inventory C. Cash payment of an account receivable D. Credit sale of inventory at cost E. Cash sale of inventory at a loss

A. cash payment of accounts payable (increases liabilities section)

Given the DuPont framework, the smaller the equity multiplier (all other things equal)... A. the smaller ROE is (positive or negative) B. the larger ROE is (positive or negative) C. ROE will always equal ROA D. No relation: ROE depends on equity, not debt

A. the smaller the ROE (see equation on page 3.3 DUPont book)

Use the following info to answer this question: Taxable Income ~ Tax Rate % $0-50,000 ~ 15% $50,001-75,000 ~ 25% $75,001-100,000 ~ 34% $100,001-335,000 ~ 39% $335,001-10,000,000 ~ 34% Bait and Tackle has a taxable income of $111,562. How much does it owe in taxes? A. $26,759 B. $34,000 C. $39,931 D. $41,756 E. $43,509

Total tax = ($50,000)(.015) + ($25,000)(.25) + ($25,000)(.34) + ($111,562 - $100,000)(.39) = $26,759

If a firm has debt and positive profits... A. ROE and ROA are equal B. ROE is larger than ROA C. ROA is larger than ROE D. There is no relationship between ROA and ROE

B. Return on Equity is larger than Return on Assets - ROE is the true bottom line measure of performance, meaning that the company is fairly healthy

shareholder's equity/common equity/owner's equity

By definition, this is the difference between the total value of assets (current or fixed) and the total value of the liabilities (current and long-term) this feature of the balance sheet is intended to reflect the fact that, if a firm were to sell all its assets and use the cash to pay off debts, then whatever residual value remained would belong to the shareholder's. So the balance sheet "balances" because the value of the left hand side ALWAYS equals the value of the right side

stakeholder

some other than a stockholder or creditor who potentially has a claim on the cash flows of the firm and this group might try to exert control over the firm, perhaps to the detriment of the owners

listing

stocks that trade on an organized market are said to be listed and must meet minimum criteria (ex. asset size and # of shareholders) New York Stock Exchange has the most stringent requirements for sales

capital structure decision

the decision-making process with funding choices and the mix of long-term sources of funds or establishing the preferred debt-equity level

profit maximization

the goal of financial management and firms - the goal of financial management is to maximize the current value per share of existing stock

Capital structure

the mixture of a firm's debt and equity financing (ex. Upmarket is financed with 45% debt and 55% equity)

agency problem

the possibility of conflict of interest between the stockholders and management of a firm

financial management

the primary goal is to maximize the value of existing stock, increasing market value of firm, and increasing market value per share

capital structure

the specific mixture of long-term debt and equity the firm uses to finances its operations - how much should firm borrow - what is the least expensive source of funds for the firm - how should I raise these funds

financial manager

top officer of the firm (CFo) or VP of finance - coordinate activities of the treasurer and controller

Earth Fare Foods has total assets of $229,800, net fixed assets of $71,500, long-term debt of $52,000, and total debt of $78,700. If inventory is $45,000, what is the current ratio? A. 0.20 B. 0.46 C. 0.84 D. 1.18 E. 5.93

Current Ratio = Current Liabilities/Current Assets (inventory is not relevant in this calculation) (229800 - 71500) / (78700 - 52000) = 5.93 This is a measure of SHORT TERM LIQUIDITY

An increase in which one of the following will increase operating cash flow for a profitable, tax-paying firm? A. Fixed expenses B. Interest earned C. Net capital spending D. Inventory E. Depreciation

Depreciation

The Rainbow Company has total sales of $713,200 and a profit margin of 8.5 percent. Currently, the firm has 12,500 shares outstanding. What are the earnings per share? A. $2.98 B. $3.31 C. $3.56 D. $4.58 E. $4.85

E. 4.85 Profit Margin = Net Income/Sales Net Income = (Net Income/Sales) * Sales = Profit Margin * Sales = 8.5% * $713,200 = 60,622 Earnings Per Share = Net Income/Number of shares outstanding = 60622/12500 = 4.8498 = 4.85 (Choice E)

Kelso's Pharmacy generates $2 in sales for every $1 the firm has invested in total assets. Which one of the following ratios would reflect this relationship? A. Receivables turnover B. Equity multiplier C. Profit margin D. Return on assets E. Total asset turnover

E. total asset turnover

General partnership

two partners entering into a business venture in which BOTH parties share decision-making responsibility and business profit/losses both parties have full responsibility over the firm's debts, even if they are unaware of these debts

Daily financial operations of a firm are primarily controlled by managing the

working capital

Managerial Compensation

Incentives can be used to align management and stockholder interests The incentives need to be structured carefully to make sure that they achieve their goal

Quick (or Acid Test) Ratio

Inventory is often the least liquid current asset and book values are least reliable measures of its market value because the quality of the inventory is not considered. Sometimes inventory is slow moving because the product is not commercially viable This ratio is computed like the current ratio, except inventory is omitted Quick ratio = (Current Assets - Inventory) / Current Liabilities ** using cash to buy inventory does NOT affect the current ratio, but it reduces the quick ratio **

Depreciation does which one of the following for a profitable firm? A. Increases net income B. Increases net fixed assets C. Decreases net working capital D. Lowers taxes E. Has no effect on net income

Lowers taxes

A firm has inventory of $11,400, accounts payable of $9,800, cash of $850, net fixed assets of $12,150, long-term debt of $9,500, accounts receivable of $6,600, and total equity of $11,700. What is the common-size percentage for the net fixed assets? A. 19.60 percent B. 26.67 percent C. 39.19 percent D. 42.08 percent E. 48.75 percent

Net Fixed Asset common-size percent = Net Fixed Asset/Total Assets = Net Fixed Asset/(Current Assets + Net Fixed Assets) = Net Fixed Asset/(Cash+ Accounts Receivables Inventory + Net Fixed Assets) =$12,150/($850 + $6,600 + $11,400 + $12,150) = $12,150/($850 + $6,600 + $11,400 + $12,150) =$12,150/$31,000 =0.3919 Or 39.19 percent

An increase in which one of the following will increase net income? A. Fixed costs B. Depreciation C. Marginal tax rate D. Revenue E. Dividends

Revenue

The Plaza Cafe has an operating cash flow of $78,701, depreciation expense of $8,960, and taxes paid of $21,590. A partial listing of its balance sheet accounts is as follows: What is EBIT given the information above? A. $30,550 B. $57,111 C. $61,487 D. $87,661 E. $91,331

Revenue - Expenses = EBIT (cash flow/78701) + (taxed paid/21590) - (depreciation expense/8960) = 91,331

Control of the firm rests with:

STOCKHOLDERS, they elect the board of directors who hires and fires management

The current ratio is affected by various types of transactions

Suppose a firm borrows over the long term to raise cash. The short run effect would be an increase in cash from the issue proceeds and an increase in long term debt current liabilities would not be affected, so the current ratio would RISE