D076

Return on equity

What profit/earnings were made for the owners of a firm. Is the company creating value for owners?

Par face value

the final specified amount that is paid to the owner of a coupon bond at the maturity date

Return on assets

What profit was earned on company assets.

Debt ratio

What percent of firms assets are financed with debt. liabilities/assets

Freedom Rock Bicycles has a sales capacity of $10 million. When sales exceed this capacity, the company must invest $200,000 in new equipment. Freedom Rock Bicycles had sales of $9 million in one year, and it projects a sales growth of 10%. The net fixed assets in the year were $500,000. By how much will the company's discretionary financing need increase? $0 $50,000 $200,000 $900,000

$0 Sales Capacity 10 million Sales 9 million Projected growth 10% 10% of 10 million = 1 million 9 million + 1 million = 10 million. No need to increase financing

Which cash flow of a particular project would be a sunk cost? $20,000 market value of equipment at the end of the project $35,000 incremental cash flows for the third year of the project $50,000 marketing study conducted three months ago for the project $100,000 initial investment for the project

$50,000 marketing study conducted three months ago for the project

DuPont Formula

A mathematical break-down that breaks ROE into multiple components: profitability, efficiency ( manage assets), and leverage typically.

A company's officers and board of directors are selling their stocks in the firm at higher prices due to false accounting reports that made the stock seem more valuable than it truly was. Which ethical issue is occurring in this situation? A) Agency problem due to conflicting interests B) Maximizing shareholder value C) The conflict between work and personal affairs Pursuing individual interest over client interests

A) Agency problem due to conflicting interests Correct! Accounting manipulation by management in pursuit of higher stock-related compensation is an example of an agency problem.

Which scenario correctly describes opportunity cost? A) Alexandra decides to spend $50 on some new clothes instead of using that money to pay her electric bill. The opportunity cost is having the electricity turned off. B) Donatello has a side business making sculptures in addition to his regular job. If he spends more time on his side business, the opportunity cost is the money he makes from selling his sculptures. C) Caroline makes $25 an hour. Instead of working one night, she goes to a concert that costs $50 and lasts two hours. The opportunity cost of the concert is $50. D) Buster buys a pizza and with the same amount of money he could have used to buy a hamburger and fries. There is no opportunity cost because they cost the same.

A) Alexandra decides to spend $50 on some new clothes instead of using that money to pay her electric bill. The opportunity cost is having the electricity turned off. Correct! Because she bought new clothes, she did not pay her bills. .

You signed an apartment contract today. You are going to pay $1,500 at the beginning of each month for the next 12 months, starting today. What type of cash flows is this contract? A) An annuity due B) A perpetuity C) An ordinary annuity D) Uneven cash flows

A) An annuity due Correct. An annuity due is a series of equal payments made at the beginning of consecutive periods

Why might a firm prefer to raise debt capital through bonds instead of stocks? A) Bonds do not require a firm to give up any ownership. B) Bonds do not require the firm to pay back its loan. C) Bonds have no expiration date. D) Bonds take advantage of upside potential.

A) Bonds do not require a firm to give up any ownership. Correct! This is attractive to a firm that needs funds for a project but wishes to maintain control.

Why is it appropriate to calculate the value of a bond in the same way that the present value of an annuity is calculated? A) Bonds pay a coupon every six months, pay a constant coupon amount, and have a maturity date. B) The cash flows that come from owning a bond grow at a constant rate every year, and the payments continue forever. C) Even though bonds have a fixed length, the cash flows differ each year. D) A bond is a fixed amount paid each period forever to compensate investors.

A) Bonds pay a coupon every six months, pay a constant coupon amount, and have a maturity date. Correct! Bond cash flows are an annuity, a constant amount paid every period.

What does a net margin of 7% indicate? A) For every dollar of revenue, 7 cents remain for the equity holders after all other costs are covered. B) For every dollar of revenue, 7 cents remain for the debt holders and equity holders after all other costs are covered. C) For every dollar of fixed assets, 7 cents are generated in sales. D) For every dollar of total assets, 7 cents are generated as sales.

A) For every dollar of revenue, 7 cents remain for the equity holders after all other costs are covered. Correct! Net margin tells us the percentage of sales that will become net income, which is the amount remaining for the equity holders.

What is the rate at which the average price level of particular goods and services in an economy increases over a period of time? A) Inflation rate B) Opportunity cost C) Nominal rate D) Real rate

A) Inflation rate Correct. The question stem is the definition of inflation rate.

Which type of economic indicator is the consumer price index? A) Lagging indicator B) Forecasting indicator C) Coincident indicator D) Leading indicator

A) Lagging indicator Correct! CPI usually changes after the economy as a whole changes.

Which type of account does not vary with sales and is left to management's discretion? A) Non-spontaneous accounts B) Accounts receivable accounts C) Fixed assets accounts D) Spontaneous accounts

A) Non-spontaneous accounts Correct! Non-spontaneous, or discretionary, accounts do not vary automatically with sales but are left to the discretion of management.

What is used to measure total risk? A) Standard deviation B) Beta C) Bond ratings D) Holding period return

A) Standard deviation Correct. Standard deviation is used to measure the total risk of securities

You are considering a project that has a profitability index of 1. What does this mean? A) The project has an internal rate of return equal to the cost of capital B) The project has a positive net present value. C) The project has a negative net present value. D) The benefit outweighs the cost of the project by the exact same amount as the initial cost.

A) The project has the internal rate of return equal to the cost of capital. Correct! PI = 1 means that the break-even point is the estimated cost of capital; in other words, the cost of capital and the rate of return should be exactly the same.

You are considering a project that has a profitability index of 1. What does this mean? A) The project has an internal rate of return equal to the cost of capital. B) The project has a positive net present value. C) The project has a negative net present value. D) The benefit outweighs the cost of the project by the exact same amount as the initial cost.

A) The project has the internal rate of return equal to the cost of capital. Correct! PI = 1 means that the break-even point is the estimated cost of capital; in other words, the cost of capital and the rate of return should be exactly the same.

Why are ratios useful for analyzing and comparing company performance between firms of different sizes? A) They provide standardization. B) They allow for performance evaluation. C) They provide flexibility. D) They help us focus.

A) They provide standardization. Correct! Ratios standardize financial data to make them comparable

A financial analyst for the company Bobby's Books has been asked to evaluate a potential investment using a method that considers the time value of money. Is there more than one way to do this? A) Yes, the analyst could use both the NPV and the IRR. B) No, there are no valuation methods that take into account the time value of money. C) Yes, the analyst could use the current ratio and could compare cost of capital rates. D) No, the analyst could only use cash budgeting to evaluate the project.

A) Yes, the analyst could use both the NPV and the IRR. Correct! Both NPV and IRR take into account the time value of money.

What does inventory turnover assess? A)The inventory management of a firm B)The proportion of inventory financed by equity C)How well a company is doing overall D)How well a firm can meet short-term obligations through sales

A)The inventory management of a firm Correct! Inventory turnover tells us how well a firm is managing its inventory.

Why are ratios useful for analyzing and comparing company performance between firms of different sizes? A)They provide standardization. B)They allow for performance evaluation. C)They provide flexibility. D)They help us focus.

A)They provide standardization. Correct! Ratios standardize financial data to make them comparable across firms, even those of distinctly different sizes.

Types of activity ratios

Account receivable Turnover Average Collection Period Inventory Turnover Total Assets Turnover Fixed asset turnover Operating income return on investment

In which way is accounting different from finance?

Accounting is backward looking, while finance is focused on the future.

What are the advantages and disadvantages of stocks?

Advantages: Never has to be repaid Not required to pay dividends on common stocks Disadvantages: Dividends are not tax deductible Dilutes ownership higher risk and higher rates.

What are the advantages and disadvantages of bonds?

Advantages: The interest payments are tax deductible They do not dilute ownership They are the lowest risk and lowest rate Disadvantages: Requires repayment increases firms debt/equity ratio

Net profit

All operating a none operating costs minus percentage of profit coming to firm after all expenses.

Company A Net Profit Margin: 20% Total Asset Turnover: 1.5 Leverage Multiplier: 2.5 Return on Equity: 75% Company B Net Profit Margin: 15% Total Asset Turnover: .83 Leverage Multiplier: 2.0 Return on Equity :25% Company C Net Profit Margin: 10% Total Asset Turnover: 0.5 Leverage Multiplier: 3.0 Return on Equity: 15% Given the table info, what does the DuPont framework indicate about return on assets? All returns are based on the firm's profitability and efficiency. The firm's market ratio helps determine the price of the stock. Return on assets is based on the amount of the firm's debt and equity. A firm can still have a high return on assets with low net income.

All returns are based on the firm's profitability and efficiency.

Leverage ratios

Also known as debt. It is how the firm is financed and how much debt the company has. We use this ratio to determine if the company can stay financially healthy in the long term, pay interest on loans and pay off long term debt. Note that having debt can provide a company with tax breaks.

Activity ratio

Also known as efficiency ratios. It's how well a company uses it's assets to generate sales or cash. Evaluates operational efficiency by analyzing inventories, fixed assets and accounts receivable. Example; a companies sales increase dramatically but the amount of assets stays the same. You might ask how this will effect the profits and wonder is we have enough inventory so customers do not need to wait.

Which action is based upon moral standards? Although there is no company policy regarding it, a financial manager chooses not to accept gifts from the company's clients to ensure that she does not create a conflict of interest. Since it is generally accepted in the company that no personal information about clients should be released without written permission, a financial manager denies the request for a third party to access its data. As mandated by government regulations, a financial manager files a registration statement with the U.S. Securities and Exchange Commission (SEC) before offering equity securities for sale. As outlined in the company's policies, a financial manager hires a third-party entity to review all annual report filings to ensure they are compliant with applicable generally accepted accounting principles (GAAP).

Although there is no company policy regarding it, a financial manager chooses not to accept gifts from the company's clients to ensure that she does not create a conflict of interest.

Operating Margin

What profit to the firm is coming from operations as a percentage of total sales. Compares companies with different capital structures.

Why do fixed assets increase as a lump sum instead of in proportion to sales growth? A) A firm purchases fixed assets in proportion to sales. B) A firm must purchase an entire fixed asset rather than just the portion needed to increase production. C)A factory or a piece of equipment must be purchased as a whole. D)A firm needs more fixed assets only when the DFN is negative. E)A firm will outsource production until it can use an entire production facility.

B) A firm must purchase an entire fixed asset rather than just the portion needed to increase production. Correct!.

Why is it important to consider the cost of capital in an ideal evaluation method of capital investment? A) Because it cannot be determined how a potential project enhances the firm's value without considering every cash flow of the project B) Because cash flows for a project may be uncertain C) Because the value of a cash flow today is different from the value of a cash flow of the same amount of in 10 years D) Because if you can receive money earlier, you can reinvest the cash into different projects earlier

B) Because cash flows for a project may be uncertain Correct! This is the reason why you should consider the cost of capital.

Why is it important to consider the time value of money in an ideal evaluation method for capital investment? A) Because each project has a different amount of risk B) Because the value of a cash flow today is different from the value of a cash flow of the same dollar amount in 10 years. C) Because a project's cash flows may be uncertain D) Because without considering every cash flow of a potential project, you do not know how the project would enhance the firm's value

B) Because the value of a cash flow today is different from the value of a cash flow of the same dollar amount in 10 years Correct! You cannot directly compare dollar amounts received at different times.

What is operating margin useful for? A) Assessing whether a firm can meet short-term obligations without raising external capital B) Comparing the profitability of firms with different capital structures C) Understanding production cost-efficiency Identifying how efficiently firms are using their assets to generate sales

B) Comparing the profitability of firms with different capital structures Correct! Operating margin is calculated pre-interest, so you can frequently use it to compare firms with different capital structures.

Which term describes the reduction in sales of a company's own products due to the introduction of another similar product? A) Interest cost B) Cost of cannibalization. C) Sunk costs D) Opportunity cost

B) Cost of cannibalization Correct! The cost of cannibalization is the reduction in sales of a company's own products due to the introduction of another similar product.

What are long-term financial forecasts used for? A)Cash budgeting B) Developing savings, income, and expense strategies Making investment and financing decisions C)Determining short-term operating needs D) Incorrect. This is where cash budgets are of primary use.

B) Developing savings, income, and expense strategies Making investment and financing decisions Correct! Whatever growth a firm anticipates must eventually be financed one way or another. Any investment in capital that exceeds what the firm retains from profit generates a discretionary financing need.

Why is understanding the definition of finance important in managing personal finances? A) It helps individuals understand legal issues related to finance. B) It helps individuals compare the costs and benefits of an action to determine whether to take that action. C) It helps individuals act ethically with regard to finances. It allows individuals to find an investment with the highest return possible.

B) It helps individuals compare the costs and benefits of an action to determine whether to take that action. Correct! Any financial decision should make sense in terms of its costs and benefits.

If two projects are mutually exclusive, which decision-making criterion will help you make the best decision about which project to accept? A) Initial outlay (IO) B) Net present value (NPV) C) Internal rate of return (IRR) D) Profitability index (PI)

B) Net present value (NPV) Correct! When only one project can be chosen, the PI is not useful because it does not indicate the dollar value that a project will add to or take away from a firm.

What is the difference between return on assets (ROA) and return on equity (ROE)? A) ROA considers the liquidity of a company, while ROE does not. B) ROE considers the capital structure of a company, while ROA does not. C) ROA considers asset use efficiency, while ROE does not. D) ROE considers the profitability of a firm, while ROA does not.

B) ROE considers the capital structure of a company, while ROA does not. Correct! DuPont framework tells you that ROE is ROA times leverage multiplier. The leverage multiplier represents the capital structure of the company.

What is the name for the minimum rate of return that an investor or lender will accept for investments? A) Inflation rate B) Required rate of return C) Simple interest D) Growth rate

B) Required rate of return Correct. This is the rate that investors accept as compensation for risk, opportunity cost, and inflation.

What does the term ethical refer to? A) Following the laws and rules set by an authority An idea or thing used as a measure, norm, or model in comparative evaluations B) The accepted standards of conduct that guide a person's behavior C) One's beliefs about right and wrong, good and bad, or just and unjust

B) The accepted standards of conduct that guide a person's behavior Correct! Ethical refers to the accepted standards of conduct that guide a person's behavior

What is the envelope method of budgeting? A) Paying all expenses during the month by check through the physical mailing system to ensure that obligations are met in a timely manner B) Withdrawing cash at the beginning of the period and then allowing only a certain amount to be available for each category of spending C) Using a spreadsheet to track both your digital and physical expenditures of cash during the month D) Tracking your credit and debit expenditures by updating and categorizing purchases that appear on your bank statement

B) Withdrawing cash at the beginning of the period and then allowing only a certain amount to be available for each category of spending Correct! The envelope method involves putting a specific portion of your budget in cash in each envelope and only spending this amount during the period.

Why are activity ratios also called efficiency ratios or asset use efficiency ratios? A)Because they consider how a firm's assets are financed. B)Because they measure how well a company uses its assets to generate sales or cash. C)Because they are used to evaluate the current value of a company. D)Because they are used to directly judge how well management is doing at maximizing owner wealth.

B)Because they measure how well a company uses its assets to generate sales or cash.

What is the rate at which a firm can grow without issuing new equity? A)Discount rate B)Sustainable growth rate C) Internal rate of return D) Retention rate

B)Sustainable growth rate Correct! The sustainable growth rate is the growth rate that allows a firm to maintain its present financial ratios without issuing new equity.

Firm A has an average collection period of 67 days, and the industry norm is 40 days. What can the firm do in order to be competitive with accounts receivable management in the industry? A) Pay suppliers more quickly. B) Tighten the credit standards for its customers. C) Loosen the credit standards for its customers. D) pay suppliers more slowly.

B)Tighten the credit standards for its customers. Correct! The credit standards are too loose, so the customers are not paying Firm A as quickly as they are paying other competitors in the industry. Tightening the credit standards would shorten the average collection period.

What is the main objective of personal financial goals? A)To maximize owner wealth B)To maximize individual utility C)To maximize stock investments D)To maximize charity donations

B)To maximize individual utility Correct! You set goals and act to increase your satisfaction or happiness by taking care of necessities and achieving priorities.

The lowest rate of return is required by which type of investor or lender? Preferred stockholder Common stockholder Correct Bank Bondholder

Bank

A pharmaceutical company recently spent $2 million developing a new drug. The company then conducts capital budgeting analysis to determine if it should produce the newly developed drug. The net present value (NPV) of the project is $1.5 million. Why should this company produce the drug? Because the losses due to cannibalization are less than the value of the project Because the project will provide a total value of $3.5 million to the company Because the NPV is greater than zero Because the development costs are greater than the value of the project

Because the NPV is greater than zero

What is the process of analyzing financial data with ratios to compare a firm's performance to competitors? Evaluating Benchmarking Valuing Auditing

Benchmarking

How do bond payments to investors differ from stock payments to investors? Stock payments have a shorter duration than bond payments. Stock payments are fixed, and bond payments are variable. Bond payments are fixed, and stock payments are variable. Bond payments are larger than stock payments.

Bond payments are fixed, and stock payments are variable.

How does an investment institution, such as a mutual fund, facilitate the circulation of money in the economy? By raising capital on a contractual basis, such as an insurance contract By insuring deposits in investment accounts up to $250,000 to promote public confidence By accepting deposits of money, paying interest on deposits, and providing loans to individuals and organizations By providing individuals and firms access to financial markets to buy or sell financial securities

By providing individuals and firms access to financial markets to buy or sell financial securities

Beckingham Sports is an American sporting goods company. Based on a $400,000 market study and a $600,000 fee for consulting spent prior to the project, the firm can increase its annual operating cash flow by $3,000,000 by selling overseas. Because the firm was considering the expansion, it spent $2,000,000 to purchase a land for new factory and equipment. However, someone is making an offer to pay the company $3,000,000 for the land it purchased for the new factory. What is relevant to include in the company's capital budgeting decision? A) $2,000,000 spent to purchase the land B) $400,000 spent on the market study C) 3,000,000 for the offer price of the land D) $600,000 for the consulting

C) 3,000,000 for the offer price of the land Correct! If you do the project, you will miss the opportunity to sell the land for $3,000,000. This is an example of an opportunity cost.

The nominal interest rate of an investment is 8%, and the inflation rate is 3%. What is the real interest rate? A) 8% B) 3% C) 5%. D) 13%

C) 5% Correct. Real Rate = Nominal Rate - Inflation, so 8% - 3% = 5%.

You just purchased a bond for $1,000 that has a par value of $1,000. What type of bond is this? A) A premium bond B) A discount bond C) A par bond D) A preferred bond

C) A par bond Correct! The market price of a par bond is the same as the par value.

Which example below is considered a market risk factor? A) A company's top management personnel die in a plane crash. B) An oil tank bursts and floods a company's production area. D) A company's labor force goes on strike. Incorrect. This influences only a single company. Therefore, this is a firm-specific risk factor.

C) An unexpected change in interest rate occurs. Correct. This is a factor that affects everyone because it will cause the cost of borrowing and lending to increase. This is a market risk factor.

Which type of interest rate includes interest on interest in addition to interest on the principal? A) Simple interest B) Nominal interest rate C) Compound interest

C) Compound interest Correct. The compound interest is known as interests on interests and the principal instead of only on the principal. Yield to maturity

What is another name for the cost of capital? A) Real rate B) Inflation rate C) Discount rate D) Compound interest

C) Discount rate Correct. Cost of capital, discount rate, required rate, and interest rate are the same thing with different names based on different perspectives.

Why is it appropriate to calculate the value of a preferred stock in the same way that you would find the present value of a perpetuity? A) Even though a preferred stock has a fixed length, the cash flows differ each year. B) Preferred stocks pay a coupon every six months, the coupon amount is constant, and the stock has a maturity date. C) For a preferred stock, a fixed amount is paid forever to compensate the investors. D) The cash flows that come from owning a preferred stock grow at a constant rate every year and continue forever.

C) For a preferred stock, a fixed amount is paid forever to compensate the investors. Correct! This is the case for preferred stocks, which are a type of perpetuity.

How do you factor sunk costs into capital investment analysis? Sunk costs are subtracted from the opportunity cost and attributed to net cash flow. A) They can be added to our analysis, depending on management's decision. B) They are inputted as negative cash inflows along with the initial outlay. C) For the purposes of analysis, sunk costs are irrelevant.

C) For the purposes of analysis, sunk costs are irrelevant. Correct! Sunk costs are costs that have already been incurred whether you choose to do a project or not.

What is the term for the return over the entire period that an investor owns a financial security? A)Required rate of return. B)Expected return C) Holding period return

C) Holding period return Correct. This is the definition of holding period return. Real return

What are the three things one must determine before making a personal budget? A)Tax liabilities, expenses, and income B)Expenses, interest payments, and savings C)Income, expenses, and savings D)Liabilities, income, and expenses

C) Income, expenses, and savings Correct! Knowing these things allows you to create a statement that accurately reflects your cash flows from month to month.

What is the term for the risk that changes in interest rates will impact the value of a bond? A) Systematic risk B) Firm-specific risk C) Interest rate risk D) Default risk

C) Interest rate risk Correct. This is the risk that changes in interest rates will impact the value of a bond.

Which type of financial institution is a mutual fund? A) Contractual institution B) Federal institution C) Investment institution D) Depository institution

C) Investment institution Correct! Investment institutions provide individuals and firms access to financial markets.

Which task does the financial manager of a firm perform that involves the issuance of new stocks and bonds? A) Making investing decisions B) Deciding on accounting standards C) Making financing decisions

C) Making Financing decisions. Correct! Once investment decisions are made, a financial manager considers different possibilities of financing sources for the investments. This may include issuing new stocks and bonds.

Which financial institution specializes in managing and administering retirement funds? A) Mutual funds B) Private equity C) Pension funds

C) Pension funds Correct! Pension funds specialize in retirement funds. Investment banks

What would an analyst predict for a potential investment with an NPV of zero? A) The profitability index would also be equal to zero. B) The project would add value to the firm. C) The project would earn exactly the rate of return required by the firm. D) The project would take away value from the firm, but only a small amount.

C) The project would earn exactly the rate of return required by the firm. Correct! An NPV of zero indicates that a project will neither add nor take away value from a firm.

What three things should an individual or company be doing so that their budget is effective and so that they are on track to meet their financial goals? A) Reduce variable costs, account for income, and monitor outstanding loans B) Revise the budget, categorize investments, and track income Monitor cash flows, reduce variable costs, and track expenses C) Track cash flows, monitor cash flows, and revise the budget

C) Track cash flows, monitor cash flows, and revise the budget Correct! Doing these things helps you to use your money in the most efficient and effective way possible.

What type of ratio is used to consider how a firm is financed and to assess a firm's ability to pay interest and payback long-term obligations? A)Profitability ratios B)Activity ratios C)Financing ratios D)Market ratios

C)Financing ratios Correct! Financing ratios consider how a firm is financed.

You are comparing the return on equity of Firm 1 and Firm 2. Both firms have an identical profit margin and asset turnover, but Firm 1 has an overall higher return on equity. What must be true? A)Firm 2 is not using its assets as efficiently as Firm 1 to generate sales. B)Firm 2 has a higher cost of sales relative to Firm 1. C)Firm 1 is using a higher proportion of debt to finance its operations. D)Firm 1 has a lower times interest earned because its return on equity is higher.

C)Firm 1 is using a higher proportion of debt to finance its operations. Correct! The third component of return on equity is the leverage multiplier. Since the firms' profit margins and asset turnovers are the same, it must be the leverage multiplier that is different. Using a higher amount of debt would result in a larger leverage multiplier and an overall higher return on equity.

Jerry wants to begin budgeting his money. What are three principles that he should know before beginning the budgeting process? A)Track expenses categorically, use the most updated method of budgeting and eliminate consumer debt. B)Make eliminating consumer debt a priority, only use the budgeting strategies that are approved by GAAP, and track expenses categorically. C)Keep records; understand the key areas of savings, expenses, and income; and eliminate consumer debt. D)Know yourself; transfer long-term debt to short-term debt; and develop savings, expense, and income strategies.

C)Keep records; understand the key areas of savings, expenses, and income; and eliminate consumer debt. Correct! These are three of the six principles of budgeting. The other three are know yourself; develop savings, income, and expense

How does management choose between two projects that are seemingly the same? A) As stated in the reinvestment assumption, there cannot be two projects that are the same. B) Management can analyze the effect each project will have on the firm's overall capital structure. C) Management can analyze the different inherent risks that change the cost of capital to the firm. D) If two projects are seemingly the same, it does not matter what choice management makes.

C)Management can analyze the different inherent risks that change the cost of capital to the firm. Correct! Each project will have its own inherent risks.

Which action reduces the future value of cash flows? A) Increase the discount rate. B)Receive all cash flows earlier than expected. C)Receive all cash flows later than expected. D)Increase the inflation rate.

C)Receive all cash flows later than expected. Correct. The later the cash flows are received, the lower the future value is.

Which term refers to the metrics and calculations that use tools such as net present value (NPV), internal rate of return (IRR), and profitability index (PI) to evaluate investments? Projected financing criteria Accounting investment criteria Security analysis criteria Capital budgeting criteria

Capital budgeting criteria

An investor really cares about having voting rights in a firm. Which type of financial security should this investor purchase? Secured bonds Common stock Zero-coupon bonds Preferred stock

Common stock

An investor is reviewing the bonds of four different companies: Company A issues AA-rated bonds. Company B issues A-rated bonds. Company C issues BB-rated bonds. Company D issues C-rated bonds. Which company is likely to provide the lowest rate of return to the investor? Company A Company B Company C Company D

Company A AA-rated bonds have lower interest rates.

Based on the information in the chart below, what can you conclude about Company A's ability to collect its accounts receivable (AR)? Entity: Percentage of Sales on Credit: AR Turnover: Industry 30% 12 Company A 30% 7 Entity: AR Collection Period: Industry 30.42 Company A 52.14 Company A is more efficient at collecting its accounts receivable than the industry. Company A collects its accounts receivable in a highly variable pattern compared to the industry. Company A is less efficient at collecting its accounts receivable than the industry. Company A collects its accounts receivable just as quickly as the average of other firms in the industry.

Company A is less efficient at collecting its accounts receivable than the industry.

Which item is considered a sunk cost? A) The required training in order to operate new equipment B) The shipping cost of a new machine for a project C) The price of selling old equipment that will be replaced by new equipment D) The consulting cost spent three months prior to the start of a project

D) The consulting cost spent three months prior to the start of a project Correct! Since the cost was incurred before the start of the project, this is a sunk cost.

Why can compounding interest be a good tool but also a significant detriment? Compounding interest can be a good tool because it allows a lender to gain interest on interest, but it is a detriment because it causes a borrower to pay interest on interest. Compounding interest can be a good tool to understand opportunity cost, but it is a detriment because it does not take risk into account. Compounding interest can be a good tool because it summarizes the required return, but it is a detriment because it requires a larger cost of capital. Compounding interest can be a good tool to understand the time value of money, but it is a detriment because it does not take inflation into account.

Compounding interest can be a good tool because it allows a lender to gain interest on interest, but it is a detriment because it causes a borrower to pay interest on interest.

Maya is considering purchasing stock in a certain company. Her financial advisor suggests that she purchase stocks in multiple companies instead of just one. Which risk management technique is this financial advisor suggesting? Risk avoidance Risk diversification Risk transfer Risk separation

Correct Risk diversification

Which ratio helps an analyst evaluate whether a company can cover its short-term obligations? Current ratio Net margin Return on equity Market-to-book ratio

Current ratio

Tyles of liquidity ratios

Current ratios & quick ratios

A firm had sales of $100,000 this month. However, the firm received only $90,000 in cash from sales. Why would the firm receive $10,000 less cash than its monthly sales? A) Because the firm paid cash for inventory purchased B) Because the firm purchased inventory on credit this month C) Because the firm paid down $10,000 on a loan D) Because the firm did not make all sales on cash

D) Because the firm did not make all sales on cash Correct! Some sales are made on credit rather than cash, and a portion of credit sales are collected in the following months after the sales.

What is the disadvantage of debt financing? A) A company with high amounts of debt will have a shorter YTM for its bonds. B) Debt financing creates a tax shield disadvantage. C) The more debt a company takes on, the less equity it can raise. D) Debt financing does not actually achieve an optimal capital structure for a company.

D) Debt financing does not actually achieve an optimal capital structure for a company. Correct! Debt creates a tax shield, but there should be a mixture of debt and equity in an optimal capital structure.

What is the difference between the current ratio and the quick ratio? A)Cash is excluded in the calculation of a quick ratio. B) Notes payable are excluded in the calculation of a quick ratio. C) Accounts payable are excluded in the calculation of a quick ratio. D) Inventory is excluded in the calculation of the quick ratio.

D) Inventory is excluded in the calculation of the quick ratio. Correct! Since inventory is the least liquid current asset, inventory is not included in the calculation.

How can the DuPont framework help a company assess its return on equity? A) It compares alternative ways of financing the firm with debt so the company can determine which will provide the highest return on equity. B) It breaks the cash flow of a company into the operating, investing, and financing aspects of the firm to help identify how each contribute to the firm's profitability. C) It provides a cross-sectional analysis of the industry for the firm to be able to compare its return on equity to that of its competitors. D) It allows the company to determine how its abilities to generate profits, manage assets, and use financing contribute to the return on equity.

D) It allows the company to determine how its abilities to generate profits, manage assets, and use financing contribute to the return on equity. Correct! The DuPont framework breaks the return on equity into each of these components using the profit margin, total asset turnover, and leverage ratio.

Why is NPV the most reliable method for evaluating investments? A) It is capable of considering cash flows without taking into account the time value of money, it is useful for comparing two projects of different sizes, and it is an infallible rule for accepting or rejecting capital projects. B) It makes it easy to estimate the cost of capital, it ignores risk, and it is better for tax purposes. C) It does not require you to estimate the cost of capital. D) It considers the time value of money, it tells you the dollar value that the investment will add to the firm, and it takes risk into account.

D) It considers the time value of money, it tells you the dollar value that the investment will add to the firm, and it takes risk into account. Correct! These are the main advantages of the NPV, some of which are not included in other methods of valuation, which makes NPV the most reliable.

What must be determined in order to compare the values of two projects with differently timed cash flows that does not need to be determined for projects with similarly timed cash flows? A) Positive cash inflows and negative cash outflows B) Present value of the benefits C) Future value of the benefits and future value of the costs D) Opportunity cost

D) Opportunity cost Correct! Opportunity cost must be determined to analyze two such projects.

In which type of market would a company issue bonds or stocks for the first time? A) Money market B) Dealer market C) Secondary market D) Primary market

D) Primary market Correct! This is the purpose of a primary market.

Suppose you are a manager at a firm. One of your financial analysts places a report on your desk of valuation calculations for some potential investment projects. When you look at the calculations later, you notice that the analyst did not indicate if she used the NPV or IRR method. However, you do notice that the results of the calculations are all percentages. What can you conclude? A) The calculations are incomplete. B) The analyst used the NPV method. C) The calculations are all wrong. D) The analyst used the IRR method.

D) The analyst used the IRR method. Correct! IRR calculations are represented as percentages because they are rates of return.

How is risk defined in finance? A) The probability that firm-specific factors will affect an investment B) The probability that systematic factors in the market will affect an investment C) The probability that a recession occurs D) The possibility that the realized or actual return will differ from what we expect

D) The possibility that the realized or actual return will differ from what we expect Correct. Risk is defined as the possibility that the realized or actual return will differ from our expected return.

Which account is a discretionary account? A) Fixed assets B) Accounts receivable C) Cash D)Notes payable

D)Notes payable Correct! Notes payable does not vary with sales, and it is based on management discretion.

What is the effect of debt financing on a firm's income? Income is taxed at a lower rate when a firm has no debt. Debt interest payments have no effect on taxable income. Debt interest payments reduce taxable income. Income is taxed at a lower rate when a firm has more debt.

Debt interest payments reduce taxable income.

Types of Leverage ratios

Debt ratio Debt-to-equity ratio Times interest earned

What would profitability index (PI) be useful for? Deciding between projects that are mutually exclusive Determining whether a firm should invest in projects with different initial outlays Computing the future value of a project in the future rather than the present value Calculating returns for a project that does not have a definite return rate for IRR or NPV

Determining whether a firm should invest in projects with different initial outlays

IRR

Discount rate that make NPV=0 We want a high IRR It's the rate of return that a firm earns on projects. IRR is easier to interpret TVM Doesn't require use of required rate of return

Current ratios

Does company has enough current assets to cover current liabilities? Current assets are assets that can be converted into cash within year. Current liabilities are financial obligations < 1 not enough assets >1 More than enough assets to cover liabilities

Fixed assets turnover

Efficiency in turnover of sales. Property, plant and equipment. If we get 4 we say, we're generating $4 for every $1 of fixed assets.

Net Margin

Example; Net margin of 7% = for every dollar of revenue, 7 cents remain for the equity holders after all costs are covered.

How can yo finance a project?

Issuing: Bonds (debt financing) or Stocks (equity financing)

Which tool is forward-looking and thus helps decision-makers understand how actions taken today can affect their firm's future performance? Accounting Ratio analysis Financial forecasting Financial statements

Financial forecasting

A company is developing a financial forecast for the next year. The company plans to implement a new factory that will increase production and resulting sales by 20%. Since the company's assets are increasing significantly, what else must increase? Profit turnover Financing You Selected Gross margin Accounts receivable turnover

Financing

Which principle of ratio analysis means that ratios are open for analyst interpretation, are not governed by rules, and allow creativity to work according to a particular company or asset? Focus Evaluation Flexibility Standardization

Flexibility

You are the financial manager of a firm. The firm is small and is struggling to collect cash from accounts receivable. Also, due to the nature of industry, inventories are illiquid. To make sure that the firm has enough cash holdings for short-term obligations, you decide to create a new ratio of cash to short-term obligations. What is this scenario an example of? A)Standardization B)Cross-sectional analysis C)Flexibility D)Trend analysis

Flexibility Correct! Ratio analysis is flexible, so you can create a new ratio given the need of the firm.

Gross Margin

For every product/service is offered what % of profit is being earned.

Market Ratios

Helps evaluate the current share price of a public firms stock. Helps us determine if a stock is undervalued or overvalued.

Total asset turn over (part of dupont)

How efficiently a company uses assets to generate sales. The higher the number the more efficient the company is at turning over assets to generate sales.

Market-to-book ratio

How firm is performing in market. Book value is found on balance sheet ( how much was invested and how much was retained) Market value is how firm is being treated/invested in Market value/book value <1 =value stock >1 = earning more

Average Collection period

How many days to receive payment on a receivable

Times-interest- earned

How many times over can a company pay interest over. EBIT/interest expense if 10, we earn 10x more profit than needed to cover interest expenses. If less than 1= Not enough profit.

Inventory Turnover

How many times per year a business is selling inventory. Higher demand, higher turn over. Helps us see inventory management of a firm.

Operating income return on investment

How much profit we're generating in terms of the assets we're using. Evaluates just the operations of the firm and how efficient the firm is generating profits for the total assets owned. The higher the ration, the better.

Accounts Receivable Turnover

How often receivables turn over in a year. Net credit sales/average net accounts receivable

Which factor contributes to the inflation of the prices of goods and services over time? Decrease in employee demand for higher wages Decrease in costs of production Increase in demand for goods and services Increase in purchasing power of goods and services

Increase in demand for goods and services

Which action will increase the return on equity of a firm? Increasing the asset usage efficiency of the firm Decreasing the debt financing of the firm Decreasing the profitability of the firm Increasing the liquidity of the firm

Increasing the asset usage efficiency of the firm

How is inflation calculated?

Inflation is calculated by determining the rate at which the average price level of particular goods and services increases over a period of time in an economy.

Profitability ratios

Investors are interested in returns in sales or asset investments. This ratio will help investors see how profitable a company is. Gross Margin = Gross profit/sales The higher the gross margin the lower the costs to make the sale and produce a product. This helps us determine if production costs are low.

What are the benefits of using the traditional envelope method to track cash flows? It enables users to connect bank and credit card accounts to automatically update income and expenses. It automatically separates expenses into categories so users can quickly assess their purchases during the month. It is simple and helps ensure that users do not spend more than the cash that they have available. It requires users to carefully track specific expenses and write down their income and spending for the month.

It is simple and helps ensure that users do not spend more than the cash that they have available.

How is the cost of capital used in the decision-making process for a capital investment project? It is used as the discount rate of cash flows. It is compared to the NPV. It is input into cash flow calculations. It is part of the initial investment.

It is used as the discount rate of cash flows.

How does an analyst use the hurdle rate? It is used to calculate the IRR for a project and determine its value. It is used to determine the time frame of a project. It is used with the IRR as a method to find the required payment amount for a project. It is used to compare with the IRR to determine whether a project should be accepted.

It is used to compare with the IRR to determine whether a project should be accepted.

How can investing help a person reach personal financial goals? A)It provides access to potential revenue or increases in value to help meet goals faster. B)It ensures money is placed in a safe, risk-free, and easily accessible financial asset. C)It provides a guaranteed future outcome in order to predictably meet financial goals. D)It helps a person understand how money was spent previously in order to reliably predict future expenses.

It provides access to potential revenue or increases in value to help meet goals faster.

Which type of economic indicator changes after the economy changes and helps identify trends in the long term? Leading indicator Lagging indicator Yield curve indicator Coincident indicator

Lagging indicator

Which type of economic indicator is used by governments and policymakers to implement or alter policies in an effort to avoid or minimize the effects of an economic downturn? Coincident indicator Correct Leading indicator Lagging indicator Correlated indicator

Leading indicator

Which type of ratios are banks and lenders most concerned about? Profitability Correct Liquidity Activity Efficiency

Liquidity

Jack works for a company that manufactures televisions and must obtain financing to increase the company's inventory levels. Jack's manager knows that current investment markets are tight, and it may be difficult for the company to obtain additional financing for the next year. The manager asks Jack to propose a way for the firm to reduce its discretionary financing needed (DFN). What should Jack suggest to reduce next year's DFN? Increase the amount spent on fixed assets to increase production capacity Lower the amount of dividends that are paid out to shareholders next year Increase sales growth, resulting in a larger amount of revenue coming into the firm Lower the net margin by decreasing the sales prices and maintaining current costs

Lower the amount of dividends that are paid out to shareholders next year

A financial manager at a company is trying to determine whether to issue new stocks or new bonds to cover the costs of a project the company is doing the next year. Which main task in business finance is this situation an example of? Managing working capital Managing interdepartmental loans Making investment decisions Making financing decisions

Making financing decisions

Types of Market Ratios

Market to book ratio Price to earnings ratio

Why are financial models helpful in financial forecasting? Models are required by the SEC when a firm plans to issue additional stock on the public market. Models provide credibility to a firm's financial statements for government agencies to review. Models show the future supply schedule for a firm, which allows for negotiation with suppliers. Models allow users to see the complex relationships between sales and other aspects of the business.

Models allow users to see the complex relationships between sales and other aspects of the business.

Suppose an individual does not eat chocolate because eating chocolate goes against his personal beliefs. Which type of standard is this? Moral Financial Legal Ethical

Moral

What is the term for an individual's beliefs concerning what is and is not acceptable to personally do? Laws Morals Ethics Honesty

Morals

A firm is currently operating at 75% capacity with current sales of $34 million. Will the firm need to acquire additional fixed assets if its sales are predicted to increase by $6 million next year? No, because the increase in sales will exceed the firm's sales capacity. Correct No, because the increase in sales will not exceed the firm's sales capacity. Yes, because the increase in sales will not exceed the firm's sales capacity. You Selected Yes, because the increase in sales will exceed the firm's sales capacity.

No, because the increase in sales will not exceed the firm's sales capacity.

Disadvantages of IRR

Not an indicator of amount of value added to firm Ignores mutually exclusive projects Assumes reinvestment at IRR rate Cannot be used to compare projects w/ different durations requires conventional cash flow.

Which component of the required rate of return takes into account the loss of potential gain from other alternatives? Inflation Risk Opportunity cost Hurdle rate

Opportunity cost

What is the present value of the stream of cash flows in range C12:F12 at a discount rate of 4%? Year 1 Year 2 Year 3 Year 4 CFs $5,400.00 $3,510.00 $3,750.00 $4,275.00 Discount Rate 4.0% PV $15,425.52

PV $15,425.52 =NPV(C13,C12:F12)

What is the present value of the following ordinary annuity? rate 5.0% nper 2 pmt $300.00 fv $0.00 type 0 PV

PV ($557.82) =PV(F3,F4,F5,F6,F7)

PI (profitability index)

Pay off as a percentage of the initial investment. NPV does not consider the initial investment = 1 break-even-point =< 1 project will generate loss => 1 Project will generate profits Note: initial investments can vary

Which method is most commonly used for determining a company's DFN? Sustainable growth rate Historical regression Company multiples Percent of sales

Percent of sales

A company calculated variances of a budget and actual cash flows that indicate the firm's strengths and weaknesses in cash flows and its budgeting process. Which major use of cash budgeting is this an example of? Standardization Performance evaluation Assessment of future needs Corrective action

Performance evaluation

NPV

Present value of future cash flows minus the initial cost. >0 =accept project

A sign company is planning to have an initial public offering (IPO). In which type of market will its stock first be sold to the public? Efficient market Money market Primary market Secondary market

Primary market

Which type of ratio should be used to examine the cost efficiency of a firm's production? Market Profitability Efficiency Liquidity

Profitability

Company ABC is considering several projects for the next year as outlined in the chart below. Project 1 NVP: $5,600 IRR: 15% PI: 2.5 Project 2 NVP $2,700 IRR18% PI: 1.7 Project 3 NVP: $8,300 IRR: 17% PI: 2.0 If the company has a limited amount of capital to spend on projects, in which order should Company ABC do the projects to create the greatest value? Project 2, Project 3, Project 1 Project 1, Project 3, Project 2 Project 3, Project 1, Project 2 Project 3, Project 2, Project 1

Project 1, Project 3, Project 2

An employee was recently hired as a financial analyst and asked to create a cash budget for the employee's division for the next year. Which component should the employee exclude from the budget? Payment toward the line of credit that is due next month Payments to suppliers that will be made over the next six months Purchase of inventory for sales that the employee will make this year Purchase of equipment that will be bought in three years

Purchase of equipment that will be bought in three years

An investment analyst is concerned about a construction company's ability to sell its inventory to meet current obligations, because much of the inventory (commercial buildings) it builds and sells takes longer than a year to construct. Which ratio should this analyst use to consider the effect of the firm's inventory on the firm's ability to meet current obligations? Current ratio Quick ratio Inventory ratio Leverage ratio

Quick ratio

What is the rate of return of an investment with the stream of cash flows in range C18:G18? Year 0 Year 1 Year 2 Year 3 Year 4 CFs ($2,500.00) $1,300.00 $2,000.00 $2,300.00 $1,800.00 Rate of Return 57.88%

Rate of Return 57.88% =IRR(C18:G18)

Disadvantages of NPV

Requires calculation of appropriate cost of capital. Not useful for comparing projects of varying sizes.

Disadvantages of PI

Requires calculation of cost of capital Not useful for mutually exclusive projects so you can choose more than 1 project of you have the budget for it

Types of profitability ratios

Return on assets Return on equity Gross Margin Operating Margin Met Margin

An energy company discovers that a new bill has been proposed to change the amount of fuel that can be exported outside the country. If passed, this could have a serious negative effect on the company's revenues. Some of the company's competitors are obtaining insurance policies to compensate for this risk, but since the energy company believes the likelihood of this bill passing is low, it chooses to do nothing—ultimately taking responsibility for this particular risk instead of trying to transfer the risk through an insurance policy. Which risk management technique is this choice an example of? Risk retention Diversification Risk separation Risk avoidance

Risk retention

Quick ratios

Same as current rations except we subtract inventories. Inventories cannot always be turned in cash quickly.

What should a potential bondholder (lender) do to prevent a company (borrower) from taking on risky projects? Separate owners from management so their interests do not conflict Encourage manipulation of accounting procedures to optimize the company's profit Release managers who do not attempt to maximize immediate shareholder value Set strict covenants that the company cannot uphold if it chooses a risky project

Set strict covenants that the company cannot uphold if it chooses a risky project

Liquidity Ratio

Short term obligations without raising external capital. Banks and suppliers are most interested in this type of ratio. It is the measure of cash you have now and how quickly you can turn short term assets into cash.

Based on the following information about the stocks of several companies, which stock displays the greatest amount of risk? Stock A: Return = 22.22%, Standard Deviation = 9.99% Stock B: Return = 15.05%, Standard Deviation = 7.35% Stock C: Return = 38.83%, Standard Deviation = 4.54% Stock D: Return = 5.69%, Standard Deviation = 5.32% Stock A Stock B Stock C Stock D

Stock A

What is the term for the rate that allows a firm to maintain its present financial ratios without issuing new equity or increasing debt? Steady state growth rate Capital growth rate Sales growth rate Sustainable growth rate

Sustainable growth rate

Advantages of NPV

TVM Calculates added value to firm Considers risk and required return Note: mutually exclusive projects

Advantages of PI

TVM considers risk of future cash flows via cost of capital includes all cash flows indicates value for firm

Why might an investor be concerned by how Company A is achieving its higher-than-industry return on equity? Company A Net Profit Margin: 7% Total Asset Turnover: 1.25 Leverage Multiplier: 2.5 Return on Equity: 21.88% Company B Net Profit Margin: 15% Total Asset Turnover: 1.30 Leverage Multiplier: 1.3 Return on Equity :25.35% Industry Net Profit Margin: 8% Total Asset Turnover: 1.30 Leverage Multiplier: 1.5 Return on Equity: 15.6% The company has a higher amount of profit generated per sales earned when compared to the industry. The company's return on assets is significantly higher than the industry's. The company is more efficient than the industry at using its assets to generate sales, and this may be unsustainable. The company's significantly higher use of debt could present a financial risk.

The company's significantly higher use of debt could present a financial risk. Note:Look at leverage multiplier (debt)

What is the relationship between risk and return? The lower risk an investor takes, the higher return the investor expects to receive. The higher risk an investor takes, the slower the investor expects to receive a return. The higher risk an investor takes, the higher return the investor expects to receive. The lower risk an investor takes, the faster the investor expects to receive a return.

The higher risk an investor takes, the higher return the investor expects to receive.

Coupon rate

The interest amount received each year

Yield to Maturity

The rate of return earned by an investor is the bond is purchased at market rate today and help until it's maturity date.

Maria is planning to invest in some company stocks for retirement and is trying to figure out if the stocks are a good buy. She calculates the intrinsic value of one of the stocks, Quiet Flag Industries, to be $35. The stock is currently trading on the market for $30, so she decides to buy it. Why was it a good idea for Maria to buy this stock? The stock's intrinsic value is less than its actual value. The stock is overvalued. The stock is undervalued. The stock's intrinsic value is greater than 1.

The stock is undervalued.

Maturity

Time when bond expires

Which process is Li engaging in if he recently made a personal budget and is now keeping a record of his cash flows? Forecasting Tracking Revising Monitoring

Tracking

As an active investor, Maria is analyzing her portfolio to decide if there are any stocks she should remove from her pool of financial securities. A company she has invested in, Quiet Flag Industries, just released its annual report. Which kind of method should Maria use to see if the company has improved? Trend analysis Cross-sectional analysis Focus analysis Progress measurement

Trend analysis

Which term is used to describe the stock of a firm with a market-to-book ratio of less than 1? A)Growth stock B)Undervalued C)Value stock D)Overvalued

Value stock Correct! An M/B ratio of less than 1 is considered a value stock.

Which type of expense is a magazine subscription? Asset expense Fixed expense Correct Variable expense Monitored expense

Variable expense

Debt-to-equity ratio

What amount of debt a company has in proportion to equity. Total liabilities/total owners equity If =1, for every $1 of equity firm has $1 of debt.

What is the main question that both individuals and companies must consider when making financial decisions to reach a goal?

Will the benefits of the action outweigh the costs?

Quiet Flag Industries has a large piece of land worth $250,000 that it is considering using for a miniature golf business. When evaluating the cash flows that would result from doing this project, should Quiet Flag consider the land value? Why or why not? Yes, the land value represents an opportunity cost. Yes, the land value represents cannibalization. No, the land value represents a sunk cost. No, the land value represents an existing expense.

Yes, the land value represents an opportunity cost.

Price-to-earnings ratio

price per share/earnings per share How many times over a company is selling in the market.

Suppose you invested $3,500 today into an account that will pay 8% per year. What will the value of the account be in 35 years? rate- nper- pmt- pv- type- FV-

rate 8.0% nper 35 pmt $0.00 pv ($3,500.00) type 0 FV $51,748.71 =FV(C3,C4,C5,C6,C7)