MBA 702 - Financial Mgt and Time Value of Money

What is the Net Capital Spending Formula? Ending net fixed assets - beginning net fixed assets +

+ depreciation

What is the Operating Cash Flow formula? Earnings Before Interest and Taxes (EBIT ) + Depreciation -

- Taxes

What is the cash flow to creditors formula ? Interest paid -

- net new borrowing

What are 3 actions stockholders can take to make sure mgt and stockholder's interest align

1) good accommodation pckges 2) direct shareholder intervention (fire poor perform mgrs) 3) takeover threat

4 advantages of a partnership

1. 2 or more owners 2. More capital available 3. easy to start 4. Income taxed once as personal income

3 characteristics of partnership

1. 2 or more owners. 2. all the partners share in gains or losses 3. all have unlimited liability for all debts.

3 characteristics of Net Working Capital

1. = Current Assets - Current Liabilities 2. Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out 3. Usually positive in a healthy firm

4 characteristics of a Corporation

1. A legal "person" separate and distinct rom its owners. 2.. Can borrow money and own property 3. can sue and be sued, and can enter into contracts. 4. Most important form in terms of size.

2 examples of Dealer Markets

1. Bonds and foreign exchanges trade primarily in dealer markets 2. Stock trading on the Nasdaq

3 types of financial management decisions

1. Capital Budgeting 2. Capital Structure 3. Working Capital Management

6 terms for Interest rate (r)

1. Discount rate 2. Cost of capital 3. Opportunity cost of capital 4. Required return 5. Terminology depends on usage 6. "Exchange rate" between earlier money and later money

Disadvantages of a Corporation

1. Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

2 types of Compound interest

1. Interest on interest 2. interest earned on principle and on interest received

5 Advantages of a Corporation

1. Limited liability 2. Unlimited life 3. Separation of ownership and management 4. Transfer of ownership is easy 5. Easier to raise capital

4 disadvantages of Sole Proprietorship

1. Limited to life of owner 2. Equity capital limited to owner's personal wealth 3. Unlimited liability 4. Difficult to sell ownership interest

3 characteristics of GAAP Matching Principle

1. Recognize revenue when it is fully earned 2. In practice, recognized at the time of sale 3. Match expenses required to generate revenue to the period of recognition

3 ways capital can be transferred

1. Stock bond savers - no financial institution 2. Investment bank underwriters who then sells to savers 3. Financial Intermediary - obtain funds from savers using own securities

4 characteristics of Market Value

1. True value 2. the price at which the assets, liabilities, or equity can actually be bought or sold 3. important for the decision-making process 4. reflective of the cash flows that would occur today

3 disadvantages of partnership

1. Unlimited liability - General partnership - Limited partnership 2. Partnership dissolves when one partner dies or wishes to sell 3. Difficult to transfer ownership

Direct Agency Costs

1. benefit management but involve a cost to the stockholders 2. the purchase of something by management that can't be justified from a risk-return standpoint, and monitoring costs.

3 characteristics of Agency Relationship

1. between stockholders and management 2. Principal hires an agent to represent interests 3. Stockholders (principals) hire managers (agents) to run the company

What are examples of direct agency costs

1. bonuses 2. stock options 3. perquisites (fringe benefits)

4 cash flow calculations?

1. cash flow identity 2. cash flow from assets 3. cash flow to creditors 4 cash flow to owners

3 examples of capital structure decision

1. determining how much debt should be assumed to fund a project 2. where will the money come from 3. Will you bring in other owners or will you borrow the money

2 characteristics of Current Asset

1. life of less than one year 2. normally convert to cash within 12 months

Example of working capital management

1. modifying the firm's credit collection policy with its customers 2. collecting from customers paying suppliers

2 characteristics of limited partnership

1. one or more partners are not active in the daily running of the business 2. liability for the partnership's debt is restricted to the amount invested in the business

3 examples of financial markets

1. stock market 2. bond market 3. commodities market

3 Examples of capital budgeting decision

1. whether or not to purchase a new machine for the production line. 2. what lines of business will you be in 3. what sorts of buildings, machinery, and equipment will you need

4 advantages of a sole proprietorship

1.Easiest to start 2. Least regulated 3. Single owner keeps all the profits 4. Taxed once as personal income

Sole Proprietorship

A business owned by one person. This is the simplest type of business to start. It is the least regulated form of organization. There is no distinction between personal and business income, so all business income is taxed as personal income.

If a financial manager increases current profits that lowers value f companies equity (assets - liabilities) is an example of?

An agency problem

What is the change in NWC (Networking Capital)? Ending NWC -

Beginning NWC

Agency Problem

Conflict of interest between principal and agent

Noncash items refer to: A. fixed expenses. B. inventory items purchased using credit. C. the ownership of intangible assets such as patents. D. expenses which do not directly affect cash flows. E. sales which are made using store credit.

D. expenses which do not directly affect cash flows

Noncash Items

Expenses charged against revenues that do not affect cash flow, such as depreciation

GAAP

Generally Accepted Accounting Principles

Working Capital Management

How will you manage your everyday financial activities such as collecting from customers and paying suppliers?

Simple Interest

Interest only earned original principal

What is the goal of financial management?

Maximize the current value of the stock (per share of the existing stock)

When calculating Operating Cash Flow do you include depreciation and interest?

NO it is a depreciation is not a cash flow and interest is a financing expense

Is a fixed asset a current asset?

No

Treasurer

Oversees cash management, credit management, capital expenditures, and financial planning

Controller

Oversees taxes, cost accounting, financial accounting and data processing

Financial Markets

Primary market and secondary market

Benchmarking

Ratios need to be compared to something - Time-trend analysis Look for significant changes from one period to the next How the firm's performance is changing through time Internal and external uses - Peer group analysis Compare to similar companies or within industries SIC and NAICS codes

Agency Cost

Refers to the cost of the conflict of interest between stockholders and management

Three major forms os business organization in the United States

Sole Proprietorship, Partnership, Corporation

T/F Construction of a new restricted access highway located between the store and the residential areas can cause market value to be less than book value

TRUE

T/F How much inventory should be on hand for immediate sale is a working capital management decision

TRUE

Time value of money relationship

Time and PV are inversely related, all else held constant.

What is the Rule of 72? How is it calculated?

Time to double your money (72/r%) periods or (72/t)%

Captial Budgeting

What long-term investments should you take on? What lines of business will you be in and what sorts of buildings, machinery, and equipment will you need?

Capital Structure

Where will you get the long-term financing to pay for your investment? Will you bring in other owners or will you borrow the money?

Can networking capital be negative?

Yes

The decision to issue additional shares of stock is an example of:

a capital structure decision

2 examples of secondary market

a. New York Stock Exchange b. NASDAQ if you want to buy Apple stock, you would purchase the stock from investors who already own the stock rather than Apple.

Future Value: Important Relationships

a. The longer the time period, the higher the future value b. The higher the interest rate, the large the future value

Sarbanes-Oxley Act is gov't response to

a. deregulation of stock exchange b. A law passed by Congress that requires the CEO and CFO to certify that their firm's financial statements are accurate.

As the degree of financial leverage increases, the: A. probability a firm will encounter financial distress increases B. amount of a firm's total debt decreases C. less debt a firm has per dollar of total assets D. number of outstanding shares of stock increases E. accounts payable balance decreases

a. probability a firm will encounter financial distress increases

When is a stock said to be in equilibrium?

a. the actual market price = intrinsic value b. investors are indifferent between buying and selling stock. c. no pressure to change the stock price. d. At any given point, most stocks are reasonably close to their intrinsic values and close to equilibrium

Example of indirect agency cost

a. the shareholders a project might add value to the stock but management may think that it will lead to erosion of stock value. b. In the conflict, shareholders may lose a valuable and important opportunity.

Why might a stock at any point in time not be in equilibrium?

a. undervalued or overvalued b. investor optimism/pessimism + imperfect knowledge of true intrinsic value = difference in actual price and intrinsic price

Two kinds of secondary markets

auction markets and dealer markets

Which 1 will produce the lowest PV interest factor? a. 6%, n=5 b. 8%, n= 10 c. 6%, n=8 d. 6%, n=10 e. 8%, n= 5

b. 85, n=10

You are promised $10k for college, if you speed up your high school grad date the PV of gift will: a. remain constant b. increase c. decrease d. equal to $10k e. be less than $10k

b. increase

Which of the following is the financial statement that shows the accounting value of a firm's equity as of a particular date? a. Income statement b. Creditor's statement c. Balance sheet d. Statement of cash flows e. Dividend statement

c. Balance sheet

Which one of the following will increase the cash flow from assets, all else equal? a. decrease in cash flow to stockholders b. decrease in operating cash flow c. decrease in change in networking capital d decrease in cash flow to creditors e. increase in capital spending

c. decrease in change in networking capital

discount

calculate the present value of some future amount

Operating Cash Flow

company's net income (NI) from its primary business activities

The cash flow that is available for distribution to a corporation's creditors and stockholders is called the: a. operating cash flow b. net capital spending c. net working capital d. cash flow from assets e. cash flow from stockholders

d. cash flow from assets

Cash flow from assets is also known as the firm's: a. capital structure b. equity structure c. hidden cash flow d. free cash flow e. historical cash flow

d. free cash flow

The process of determining the PV of FV Cash Flows in order to know the PV is referred to as?

discounted cash flow evaluation

Terry is calculating the PV of a bonus he will receive next year. The process he is using is called:

discounting

The cash flow related to interest payments less any net new borrowing is called the: a. operating cash flow b. capital spending cash flow c. net working capital d. cash flow from assets e. cash flow to creditors

e. cash flow to creditors

Which one of the following increase PV of a set $ to be received in future? a. Increase in time $ received b. Decrease in FV c. Decrease in both FV and # of periods d. Increase in discount rate e. Decrease in I/Y

e. decrease in I/Y

Shareholders' Equity a. is referred to as a firm's financial leverage b. is equal to total assets plus total liabilities c. decreases value whenever new shares of stock are issues d. includes patents preferred stock and common stock e. represents the residual value of a firm

e. represents residual value of a firm

Annuity

finite series of equal payments that occur at regular intervals

annuity due

if the first payment occurs at the beginning of the period

Ordinary annuity

if the first payment occurs at the end of the period

Dealer markets

in stocks and long-term debt are called over-the-counter (OTC) markts

The growth of both sole proprietorships and partnerships is frequently limited by the firm's:

inability to raise cash

perpetuity

infinite series of equal payments

Example of a primary market

initial public offering, or IPO, - issues shares of stock to the public for the first time

interest on interest

interest earned on the reinvestment of previous interest payments

Indirect Agency Costs

management's tendency to forgo risky or expensive projects that could be justified from a risk-return standpoint.

Income statement

measures performance over some period of time, usually a quarter or a year.

A firm's short-term assets and its short-term liabilities are referred to as the firm's:

networking capitol

Primary Market

securities are sold by the company

Secondary Market

securities that have already been issued are traded between investors

What is the formula for cash flow identity? cash flow to creditors (bondholders) + cash flow to

stockholders (owners)

Corporate dividends are

taxed at both the corp and personal level when paid out

Present Value: Important Relationships

the longer the time period, the lower the present value the higher the interest rate, the smaller the present value

Changes in Net Working Captial

the net increase or decrease in current assets over current liabilities

Capital Spending

the net spending on fixed assets

compounding

the process of accumulating interest on an investment over time to earn more interest

discount rate

the rate used to calculate the present value of future cash flows

Financial Managers should primarily focus on

the shareholders

discounted cash flow (DCF) valuation

valuation calculating the present value of a future cash flow to determine its value today