Corporate Finance Exam 2

similar

Accounting breakeven and payback period are (similar/different) measures.

increases, decreases

As the number of units sold (increases/decreases), the degree of operating leverage (increases/decreases).

c.

Assume that the current exchange rate for Japanese Yen and U.S. Dollar is 140 JPY per USD. According to the International Fisher Effect (IFE), if interest rates are higher in the United States than in Japan, what should we expect what for that exchange rate? a. IFE does not apply to this situation. b. We would expect the exchange rate to move above 140 JPY per USD. c. We would expect the exchange rate to move below 140 JPY per USD. d. We should expect no change in the exchange rate.

d.

Assume that the current exchange rate for Japanese Yen and U.S. Dollar is 140 JPY per USD. Considering Interest Rate Parity (IRP), if interest rates are higher in the United States than in Japan, what should we expect what for the forward exchange rate? a. We should expect no change in the forward exchange rate. b. We would expect the forward exchange rate to move above 140 JPY per USD. c. IRP does not apply to this situation. d. We would expect the forward exchange rate to move below 140 JPY per USD.

+$14,536

Bob's Your Uncle Corporation is considering a project and has developed the following estimates: unit sales = 9,200, price per unit = $71, variable cost per unit = $44, annual fixed costs = $15,200. The depreciation is $18,800 per year and the tax rate is 21 percent. What effect would an increase of $2 in the selling price have on the operating cash flow?

Cannot. Earnings per share is reported instead.

Cash flow (can/cannot) be reported as alternative to accounting income.

1

Value of market-to-book ratio less than ____ could mean that the firm has not been successful overall in creating value for its stockholders.

best case, base case, worst case

What alternative assumptions should we consider when doing a scenario analysis?

The firm's needed investment in new assets. The degree of financial leverage the firm chooses to employ. The amount of cash the firm thinks is necessary and appropriate to pay shareholders. The amount of liquidity and working capital the firm needs on an ongoing basis.

What are the basic elements of a firm's financial policy needed to develop an explicit financial plan?

short-term solvency/liquidity, long-term solvency/financial leverage, asset management/turnover, profitability, and market value

What are the financial ratios traditionally grouped as?

operating, investing, financing

What are the three categories in a statement of cash flows?

those that vary directly with sales and those that do not

What are the two groups that the extended version of simple models can separate the income statement and balance sheet into?

debt-equity ratio, equity multiplier

What are the two useful variations of the total debt ratio?

at least 1

What current ratio should you normally expect to see?

high fixed costs

What does a high operating leverage mean?

low fixed costs

What does a low operating leverage mean?

Take a closer look at the project. Do not automatically accept.

What does a positive NPV on a base case mean?

decrease in asset account (on a net basis), or a sale of assets

What is an example of a source of cash?

increasing assets or decreasing liabilities

What is an example of use of cash?

short-term liquidity

What is the current ratio used for?

inventory is omitted from the quick ratio as it is the least liquid current asset

What is the difference between the quick (or acid-test) ratio and the current ratio?

internal and external

What kinds of comparison are ratios used for?

an inefficient use of cash and other short-term assets

What would a high current ratio indicate to a firm?

translation exposure

When a U.S. company calculates its accounting net income and E P S for some period, it must "translate" everything into dollars.

duponte identity

breaks roe into operating efficiency (profit margin), asset use efficiency (total asset turnover), and financial leverage (equity multiplier)

cash breakeven

the sales level that results in a zero operating cash flow. covers operating expenses

accounting breakeven

the sales level when net income is 0. covers capital costs

profit margin

there is a significant variation in ______ ________ across industries

all, all

total debt ratio considers _____ debts of _____ creditors and has two useful variations.

the same

In the simple financial planning model, every item increases at (the same/a different) rate as sales.

accounting breakeven

In which breakeven analysis is operating cash flow equal to depreciation?

T. low values indicate low liquidity

T or F: Net working capital to total assets can indicate levels of liquidity.

higher

(higher/lower) operating leverage makes a company more susceptible to forecasting risk.

higher

(lower/higher) P/E ratios often mean the firm has significant prospects for future growth, but it could also mean a firm had no (or almost no) earnings.

fixed

(variable/fixed) costs are like a lever that magnify profits or losses

PM: .1185 (11.85%) X TAT: 2 X EM 1.5

A firm has Sales of $3,000,000, Earnings Before Taxes (EBT) of 15% of revenues, taxes of 21%, total assets of $1,500,000, and a debt-to-equity ratio of 0.5. What is the DuPont Identity (Profit Margin * Total Asset Turnover * Equity Multiplier)?

.237

A firm has Sales of $3,000,000, Earnings Before Taxes (EBT) of 15% of revenues, taxes of 21%, total assets of $1,500,000, and a debt-to-equity ratio of 0.5. What is the return on assets?

.3555

A firm has Sales of $3,000,000, Earnings Before Taxes (EBT) of 15% of revenues, taxes of 21%, total assets of $1,500,000, and a debt-to-equity ratio of 0.5. What is the return on equity?

4.667

A firm has cash of $120 million, fixed assets worth $450 million, inventory worth $180 million, accounts receivable of $100 million, accounts payable and notes payable of $300 million, and long-term debt of $400 million. What is the firm's debt-to-equity ratio?

.733

A firm has cash of $120 million, fixed assets worth $450 million, inventory worth $180 million, accounts receivable of $100 million, accounts payable and notes payable of $300 million, and long-term debt of $400 million. What is the firm's quick ratio?

Enterprise value

EBITDA multiple relates the value of all the operating assets (enterprise value) to a measure of the operating cash flow generated by those assets (EBITDA).

Can. (however, many firms are conglomerates or operate very differently, even in the same sector.)

Financial statements (can/cannot) be compared on a common-size basis/common base year

selling off equipment and outsourcing part of the production.

Firms can decrease operating leverage by

buying more equipment

Firms can increase operating leverage by

NPV

Firms may not be able to take on every positive ______ opportunity.

overall positions

Firms must be conscious of their______ ______ in a foreign currency and make coordinated decisions regarding any hedging strategies

Variable costs

Given Year One Projections Base Case: 20,000 units, $50 price, $30 cost, $125,000 fixed cost Lower Bound: 18,000 units, $40 price, $25 cost, 100,000 fixed costs Upper Bound: 22,000 units, $60 price, $35 cost, $150,000 fixed costs is the company exposed to more risk due to changes in fixed costs or variable costs?

is

Growing intentionally at the right rate (is/is not) important.

increase profit margin, increase asset turnover, use debt optimally

How can you increase ROE?

b.

If inflation is higher in the United Kingdom than in the United States, what would we expect in terms of exchange rates according to Purchasing Power Parity? a. We would expect no change in the exchange rate. b. We would expect the U.S. Dollar to appreciate as compared to the Pound Sterling. c. PPP does not apply in this situation. d. We would expect the Pound Sterling to appreciate as compared to the U.S. Dollar.

Covered Interest Arbitrage

If the change in the forward exchange rate of the JPY and USD in the previous question does not fully account for the difference in interest rates between the two countries, there may be an opportunity for what?

Sensitivity Analysis

If we consider a range of possible values for only one variable in our Net Present Value (NPV) projections, what is that called?

-$474,000

In The Ballpark (ITB) Corporation is considering a project and has developed the following estimates: unit sales = 120,000, price per unit = $220, variable cost per unit = $170, annual fixed costs = $38,000. The depreciation is $25,000 per year and the tax rate is 21 percent. What effect would a decrease of 10% in the unit sales have on the operating cash flow?

cash be < accounting be < financial be

List the types of breakeven analysis from least to greatest.

contribution

Managers are often concerned with the _______ a project will make to the firm's total accounting earnings.

low operating leverage

Many managers prefer ______ ______ ______ to keep the breakeven point lower.

440 hoodies

Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. What is the quantity needed to reach accounting break-even?

400 hoodies

Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. What is the quantity needed to reach cash break-even?

1,400

Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. What is the quantity needed to reach financial break-even?

$1,000

Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. what OCF would be required in order to reach accounting break-even?

forecasting risk

NPV Calculations are estimates with _______ ______.

Triangular Arbitrage

The U.S. Dollar and Euro are exchanging at parity. Two other current observed exchange rates are $1.14 per GBP and 0.864 GBP per EUR. Given these exchange rates, there may be an opportunity for what?

15-20 range

Price to earnings ratios vary significantly across companies, but in 2020, a typical large company in the U.S. had a PE in the ______________.

P/E ratio is not meaningful due (for example: a firm has negative earnings for extended periods)

Price-sales ratio is useful if ___________

compare

Ratios can be used to _______ companies and firms over time.

international fisher effect

Real Interests Rates should be the same across countries. Over the long term, all else equal, we would expect the country with the higher interest rate to see its currency depreciate.

large

Relatively (small/large) inventories are often a sign of short-term trouble.

18,000 units, $40 price, $35 cost, $150,000 fixed costs

Suppose you are given the following information. What would be the assumptions for the worst case scenario? Year One Projections Base Case: 20,000 units, $50 price, $30 cost, $125,000 fixed cost Lower Bound: 18,000 units, $40 price, $25 cost, 100,000 fixed costs Upper Bound: 22,000 units, $60 price, $35 cost, $150,000 fixed costs

higher

To a creditor, is it better if the current ratio higher or lower?

to a very short term creditor

To whom would a cash ratio possibly be of interest?

difficult

Tobin's Q is (easy/difficult) to calculate with accuracy because estimating the replacement cost of a firm's assets is not an easy task and market values for a firm's debt are often unobservable.

superior

Tobin's Q ratio is (inferior/superior) to the market-to-book ratio because it focuses on what the firm is worth today relative to what it would cost to replace it today.

net importers

Who does a strong dollar favor?

net exporters

Who does a weak dollar favor?

-$79,000

You are analyzing a BLO Corporation project and have developed the following estimates. The depreciation is $15,000 a year and the tax rate is 21 percent. How would a 4% reduction in the price per unit impact the base case operating cash flow? Year One Projections Base Case: 50,000 units, $50 price, $30 cost, $150,000 fixed costs Lower Bound: 45,000 units, $40 price, $25 cost, $100,000 fixed costs Upper Bound: 55,000 units, $60 price, $35 cost, $200,000 fixed costs

$22,900

You are analyzing a BLO Corporation project and have developed the following estimates. The depreciation is $15,000 a year and the tax rate is 21 percent. What is the worst-case operating cash flow? Year One Projections Base Case: 50,000 units, $50 price, $30 cost, $150,000 fixed costs Lower Bound: 45,000 units, $40 price, $25 cost, $100,000 fixed costs Upper Bound: 55,000 units, $60 price, $35 cost, $200,000 fixed costs

financial managers

______ ______ have least control over sales volume, but it can be analyzed numerous ways.

interval measure

______ ______ indicates how long the business can continue.

Ratios

_______ aren't always computed the same way by everyone.

breakeven

_______ helps us to understand the relationship between sales volume and profitability.

Forecasting risk

________ ________ refers to the possibility that errors in projected cash flows will lead to incorrect decisions.

accounting

________ breakeven is often used as an early stage screening number.

cash coverage ratio

a basic measure of the firm's ability to generate cash from operations and is frequently used as a measure of cash flow available to meet financial obligations.

return on equity

a measure of how the stockholders fared during the year, or how much money the company generated in profit for every dollar in equity.

return on assets

a measure of profit per dollar of assets

percentage of sales approach

a planning method in which accounts are varied depending on a firm's predicted sales levels.

aggregation

a process by which small investment proposals of each of a firm's operational units are added up and treated as one big project.

high

all other things equal, a relatively (low/high) profit margin is desireable.

sensitivity analysis

an investigation of what happens to NPV when only one variable is changed.

short-run exposure

characterized by day-to-day fluctuations in exchange rates creating short-run risks for international firms.

long-run exposure

characterized by fluctuations in the value of a foreign operation because of unanticipated changes in relative economic conditions.

simulation analysis

combination of scenario and sensitivity analysis, wherein we allow all items to vary at the same time.

market-to-book ratio

compares the market value of the firm's investments to their costs.

operating leverage

degree to which firm or project relies on fixed costs

relative purchasing power parity

does not tell us what determines the absolute level of the exchange rate, but rather what determines the change in the exchange rate over time.

Planning dimensions

examine interactions, explore options, avoid surprises, ensure feasibility, and foster internal consistency are all what?

pro forma statements

financial plan will have a forecast balance sheet, income statement, and statement of cash flows. These are called _____ ______ ___________

high

firms with ______ Q ratios tend to be those with attractive investment opportunities or significant competitive advantages (or both)

profit margin x total asset turnover x financial leverage

formula for ROE using the dupont identity

0, 1

if fixed costs equals ___, then the degree of operating leverage is equal to ____.

Enterprise value

is an estimate of the market value of the company's operating assets, which include all assets of the firm except cash.

long-term debt ratio

long-term debt/(long-term debt + total equity)

2-5

long-term planning is typically __________ years out

historical costs

market-to-book ratio focuses on ______ _____, which are less relevant.

NWC turnover

measures how much "work" we get out of our working capital

price to earnings ratio

measures how much investors are willing to pay per dollar of current earnings

times interest earned ratio (tie)

measures how well a company has its interests obligations covered, and is often called the interest coverage ratio

profit margin

measures how well a company makes money, aka how much money it generates in profit for every dollar in sales

sales forecast

nearly all financial plans require an externally supplied _______ ______. It will often be given as the growth rate in sales.

asset requirements

plan will describe projected capital spending and, at a minimum, the projected balance sheet will contain changes in total fixed assets and net working capital

economic assumptions

plan will explicitly state the economic environment in which the firm expects to reside over plan's life

financial requirements

plan will include a section about the necessary financing arrangements

breakeven analysis

popular and commonly used tool for analyzing the relationship between sales volume and profitability.

financial model

sales forecast, proforma statements, asset requirements, financial requirements, the plug, and economic assumptions are all elements of a ____________ ___________

financial breakeven

the sales level that results in a zero NPV. covers financial costs (required return)

days' sales in inventory

shows how many days inventory sits (on average) before it is sold.

receivables turnover

shows how many times a firm collects outstanding credit accounts and reloans the money

Inventory turnover

tells how many times the firm sold off/turned over the entire inventory

total assets turnover

tells how much the company generates in sales for every dollar in assets

fixed asset turnover

tells how much the company generates in sales for every dollar in fixed assets

the plug

the designated source of external financing needed to deal with any shortfall (or surplus) in financing and thereby bring the balance sheet into balance

scenario analysis

the determination of what happens to NPV estimates when we ask what-if questions.

absolute purchasing power parity

the idea that a commodity costs the same regardless of what currency is used to purchase it or where it is selling.

purchasing power parity (PPP)

the idea that the exchange rate adjusts to keep purchasing power constant among currencies

forecasting risk

the possibility that errors in projected cash flows will lead to incorrect decisions

straight line

the relationship between sales volume and operating cash flow is a _____ _____. If sales volume increases ocf increases.

political risk

the risk related to changes in value that arise because of political actions

exchange rate risk

the risk related to having international operations in a world where relative currency values vary.