Finance Skills for Managers - D076

Which type of expense is a magazine subscription?

Variable expense

In which way is accounting different from finance?

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

The lowest rate of return is required by which type of investor or lender?

Bank

How do bond payments to investors differ from stock payments to investors?

Bond payments are fixed, and stock payments are variable.

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?

Capital budgeting criteria

An investor really cares about having voting rights in a firm. Which type of financial security should this investor purchase?

Common stock

Which action will increase the return on equity of a 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.

What are the benefits of using the traditional envelope method to track cash flows?

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

Which type of economic indicator changes after the economy changes and helps identify trends in the long term?

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?

Leading indicator

Which type of ratios are banks and lenders most concerned about?

Liquidity

Why are financial models helpful in financial forecasting?

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

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

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 not exceed the firm's sales capacity.

Which component of the required rate of return takes into account the loss of potential gain from other alternatives?

Opportunity cost

Which method is most commonly used for determining a company's DFN?

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?

Performance evaluation

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?

Primary market

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?

Quick ratio

What should a potential bondholder (lender) do to prevent a company (borrower) from taking on risky projects?

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

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

Sustainable growth rate

Given the table above, what does the DuPont framework indicate about return on assets?

The firm's market ratio helps determine the price of the stock.

What is the relationship between risk and return?

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

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

Which cash flow of a particular project would be a sunk cost?

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

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

Benchmarking

How does an investment institution, such as a mutual fund, facilitate the circulation of money in the economy?

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

Which factor contributes to the inflation of the prices of goods and services over time?

Increase in demand for goods and services

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.

How does an analyst use the hurdle rate?

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?

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

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?

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?

Making financing decisions

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

Profitability

Company ABC is considering several projects for the next year as outlined in the chart below. 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 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?

Purchase of equipment that will be bought in three years

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 diversification

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

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 is undervalued.

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.

Based on the information in the chart below, what can you conclude about Company A's ability to collect its accounts receivable (AR)?

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

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.

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 NPV is greater than zero

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

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.

Which ratio helps an analyst evaluate whether a company can cover its short-term obligations?

Current ratio

What is the effect of debt financing on a firm's income?

Debt interest payments reduce taxable income.

What would profitability index (PI) be useful for?

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

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

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?

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?

Flexibility

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 avoidance

Why might an investor be concerned by how Company A is achieving its higher-than-industry return on equity?

The company's significantly higher use of debt could present a financial risk.

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

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