FIRE-311 Chapter 1 - 4 Notes
You are a shareholder in a C corporation. The corporation earns $1.84 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. Assume the corporate tax rate is 25% and the personal tax rate on all income is 20%. How much is left for you after all taxes are paid?
$1.10
You are a shareholder in a corporation which has elected subchapter S tax treatment. The corporation announces a profit of $5 per share, of which it retains $1 for reinvestment and distributes the rest as dividend payments. Given that the personal tax rate is 35%, how much tax must you pay per share?
$1.75
What is the most important difference between a corporation and all other organizational forms?
-A corporation is a legal entity separate from its owners. This means ownership shares in the corporation can be freely traded. -None of the other organizational forms share this characteristic.
How do financial institutions help with risk-bearing?
-Insurance companies spread out risk by pooling premiums together from policy holders and pay the claims of those who have an accident, fire, medical need or die. This process spreads the financial risk of these events out across a large pool of policyholders and the investors in the insurance company. -Mutual funds and pension funds take your savings and spread them out among the stocks and bonds of many different companies, limiting your exposure to any one company. -Financial institutions not only assist with the risk-bearing of savers and investors, but must also be concerned about their own risk, spreading their loans out among a variety of clientele.
What role do investment banks play in the economy?
-Investment banks advise companies in major financial transactions such as buying or selling companies or divisions. -Investment banks assist companies in raising capital by issue of stocks and bonds on behalf of corporate clients.
Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than in their own interests. What strategies are available to shareholders to help ensure that managers are motivated to act this way?
-Mount hostile takeovers. -Write contracts that ensure that the interests of the managers and shareholders are closely aligned. -Ensure that employees are paid with company stock and/or stock options. -Ensure that underperforming managers are fired.
What are the three main roles financial institutions? SELECT ALL THAT APPLY.
-moving funds from savers to borrowers -moving funds through time -spreading out risk-bearing
1) Assume Global could increase it's annual depreciation in 2019 by $1 million. If Global's tax rate is 26%, what would be the effect of this depreciation increase on Global's cash at the end of the year? 2) Same except tax rate is 30%.
1) $1 million * 26% = $200,000 It would increase by $ 260 thousand because of the tax savings on extra depreciation. 2) $1 million * 30% = $300,000 It would increase by $ 300 thousand because of the tax savings on extra depreciation.
1) In a trade with the government of an oil producing nation, a manufacturer will deliver 10 Caterpillar D9 tractors, with a value of $350,000 per tractor, and receive 60,000 barrels of oil, valued at $70 per barrel. What is the net value of this trade to the manufacturer? 2) In a trade with the government of an oil producing nation, a manufacturer will deliver 13 Caterpillar D9 tractors, with a value of $320,000 per tractor, and receive 45,000 barrels of oil, valued at $120 per barrel. What is the net value of this trade to the manufacturer?
1) 10 tractors * $350,000 per tractor = $3,500,000 60,000 barrels * $70 per barrel = $4,200,000 NV = benefit - cost Manufacturer benefit = barrels of oil Manufacturer cost = tractors NV = 4,200,000 - 3,500,000 NV = $700,000 2) manu benefits = 45,000 barrels * $120 = $5.4 mil manu costs = 13 tractors * $320,000 = $4.16 mil net value = 5.4 - 4.16 = $1.24 million
1) Consider the above Income Statement for Corvex Corporation. Calculate the gross margin for 2015 and 2016. What does the change in the gross margin between these two years imply about the company? 2) Consider the above Income Statement for Xenon Manufacturing. All values are in millions of dollars. Calculate the gross margin for 2008 and 2009. What does the change in the gross margin between these two years imply about the company?
1) 2016 = 18.01%, 2015 = 36.18% The ability of Corvex Corporation to sell its goods and services for more than the costs of producing them fell between 2015 and 2016. 2) Gross margin = gross profit / sales 2008: 54 / 202 = 0.267 2009: 40 / 212 = 0.188 The ability of Xenon Manufacturing to sell its goods and services for more than the costs of producing them fell between 2008 and 2009.
1) Refer to the balance sheet and the income statement of a specific company above. All numbers are shown in millions of dollars. Given the accounts receivable days, which of the following is the most accurate statement about the company? 2) The balance sheet and income statement of a particular firm are shown above. What does the account receivable days ratio tell you about this company?
1) 22 / (312/365) = 25.73 It takes on average about 26 days to collect payment from its customers. 2) *wrong answer here* updates: Acc receivable days = acc receivable / average daily sales 22 / (sales/365) = not 5 weeks.
1) The cost of new machinery is estimated at $450 mil today. This cost is expected to increase by 3% in one year. If the competitive interest rate is set at 1.5%, what is the net value of delaying the purchase of machinery for a year? The net value in terms of dollars today is: 2) The cost of new machinery is estimated at $200 mil today. This cost is expected to increase by 5% in one year. If the competitive interest rate is set at 3.5%, what is the net value of delaying the purchase of machinery for a year? The net value in terms of dollars today is:
1) 450 * 3% = $463,500,000 463.5 mil / 1.015 = $456,650,246 Cost of delay: 450 mil - 456,650,246 = -$6,650,246 Answer: - $ 6.65 million 2) PV * (1 + r) = increased PV --> increased PV / original r = delay --> PV - delay = cost of delay 200 mil * 1.05 = $210 mil $210 mil / 1.035 = $202,898,551 200 mil - 202,898,551 = -$2.9 million
1) Manufacturer A has a profit margin of 2.2%, an asset turnover of 1.7 and an equity multiplier of 6.0. Manufacturer B has a profit margin of 2.5%, an asset turnover of 1.2 and an equity multiplier of 4.9. How much asset turnover should manufacturer B have to match manufacturer A's ROE, all else equal? 2) Manufacturer A has a profit margin of 2.2%, an asset turnover of 1.7 and an equity multiplier of 5.0. Manufacturer B has a profit margin of 2.5%, an asset turnover of 1.2 and an equity multiplier of 4.7. How much asset turnover should manufacturer B have to match manufacturer A's ROE?
1) A=2.2*1.7*6=22.44 B=2.5*1.2*4.9=14.7 22.44=2.5*4.9*x = 1.83 2) ROE = asset turnover * net profit margin * equity multiplier A ROE = 2.2 * 1.7 * 5.0 = 18.7 B ROE = 2.5 * 1.2 * 4.7 = 14.1 New B ROE = 2.5 * x * 4.7 = 18.7 --> 2.5 * x = 3.978 --> x = 1.59
1) Company A has current assets of $4.2 billion and current liabilities of $4.3 billion. Company B has current assets of $3.7 billion and current liabilities of $2.8 billion. Which of the following statements is correct, based on this information? 2) Company A has current assets of $42 billion and current liabilities of $41 billion. Company B has current assets of $2.7 billion and current liabilities of $1.8 billion. Which of the following statements is correct, based on this information?
1) Company A is less likely than Company B to have sufficient working capital to meet its short-term needs. 2) Current ratio = current assets / current liabilities A = 42 bil / 41 bil = 1.02 billion B = 2.7 / 1.8 = 1.5 billion Since B has a higher current ratio, Company A is less likely than Company B to have sufficient working capital to meet its short-term needs.
1) Assume that at the end of 2018, Global Corporation had 3.6 million shares outstanding which traded at $8 per share on a stock exchange. Given the financial statements for Global Corporation that were used in the videos and lecture notes, what was the enterprise value of Global at that time? 2) 2019, $10 per share
1) Enterprise value = MV of equity + net debt (where net debt = short & long term debt - cash) Net debt = (78+3.2) - 20.5 = $60.7 million Enterprise value = 28.8 + 60.7 = $89.5 million 2) Net debt = (5.5 + 113.2) - 23.2 = $95.5 million Enterprise value = 36 + 95.5 = $131.5 million
1) What is the future value (FV) of $30,000 in thirty years, assuming the interest rate is 10% per year? What is the amount of interest on interest? 2) What is the future value (FV) of $50,000 in thirty years, assuming the interest rate is 12% per year? What is the amount of interest on interest?
1) FV = 30,000 * (1.1)^30 FV = $523,482.07 Simple interest = 30000 * 10% = 3,000 30 year SI = 3000 * 30 = $90,000 Compound interest = 523,482.07 - 30,000 - 90,000 CI = $403,482.07 Answer: FV = $ 523,482 and interest on interest is $ 403,482 2) N=30, I/Y=12, PV=50,000, PMT=0, so FV = $1,497,996.11 SI = 50,000 * 12% = 6,000 * 30 years = $180,000 CI = 1,497,996.11 - 180,000 - 50,000 = $1,267,996.11
1) Timeline: year 0=$1,000 / year 1=$2,000 / year 2 = $3,000 / year 3 = ? If the current market rate of interest is 8% per year, then the future value (FV) of this stream of cash flows in year 3 is closest to ________. 2) Timeline: 0=$1,000 / 1=$2,000 / 2=$3,000 / 3=$4,000 / 4 = ? If the current market rate of interest is 8%, then the future value (FV) of this stream of cash flows is closest to ________.
1) FV of payments in 3 periods. 1,000(1.08)^3 + 2,000(1.08)^2 + 3,000(1.08)^1 1,259.71 + 2,332.8 + 3,240 = 6,832.51 FV of year 3 = $6,832.51 2) Find the FV of payments in 4 periods. FV = C0*(1+r)^4 + C1*(1+r)^3 + C2*(1+r)^2 + C3*(1+r)^1 FV = 1,000(1.08)^4 + 2,000(1.08)^3 + 3,000(1.08)^2 + 4,000*(1.08)^1 FV = 1360.48896 + 2519.424 + 3499.2 + 4320 = 11699.11296 FV of year 4 is $11,699
1) You decided to start saving for your son's education and opened a college investment account. Assume that the account earns an 7% interest rate annually. You are planning on making $4,000 annual deposits to the account at the beginning of each of the next 10 years, with the first deposit to the account today. What will be the value of the savings account 10 years from today? 2) You decided to start saving for your son's education and opened a college investment account. Assume that the account earns an 8% interest rate annually. You are planning on making $4,000 annual deposits to the account at the beginning of each of the next 10 years, with the first deposit to the account today. What will be the value of the savings account 10 years from today?
1) Find future value in calculator N=10, I/Y=7, PMT=-4000, PV=0 So, FV = $59,134 2) *set financial calculator settings to PMT at beginning of year* N=10, I/Y=8, PV=0, PMT=-4,000 FV = $62,581.95
1) A perpetuity will pay $800 per year, starting five years after the perpetuity is purchased. What is the present value (PV) of this perpetuity on the date that it is purchased, given that the interest rate is 10% per year? 2) A perpetuity will pay $900 per year, starting five years after the perpetuity is purchased. What is the present value (PV) of this perpetuity on the date that it is purchased, given that the interest rate is 11%?
1) First, find value of perpetuity at year 5 PV at year 5 = C/r = 800 / 0.10 = $8,000 Next, calculate PV using TVM keys: FV=8,000, N=4, I/Y=10, PMT=0 So, PV = $5,464 2) PV at 5 years = C/r = 900 / 11% = $8,181.82 PV on date purchased: N=4, I/Y=11, PMT=0, FV=8181.82 PV on date purchased = $5,389.62
1) An investment will pay $20,900 at the end of next year for an investment of $20,000 at the start of the year. If the bank offers an interest rate interest rate of 2.5% over the same period, should this investment be made? 2) An investment will pay $289,940 at the end of next year for an investment of $190,000 at the start of the year. If the market interest rate is 9% over the same period, should this investment be made?
1) Investment: 20,000 --> 20,900 Bank (FV equation): 20,000 * 1.025 = 20,500 Value: 20900 - 20500 = 400 Answer: Yes, because in one year the investment will yield $400 more than putting the money in a bank. 2) Find FV of $190,000 investment in the bank FV = C * (1 + r) --> 190,000 * 1.09 = $207,100 Value = 289,940 - 207,100 = $82,840 Yes, because in one year the investment will yield $82,840 more than putting the money in a bank.
1) Assume that at the end of 2018, Global Corporation had 3.6 million shares outstanding which traded at $8 per share on a stock exchange. Given the financial statements for Global Corporation that were used in the videos and lecture notes, what was the market-to-book of Global at that time? 2) Assume that at the end of 2019, Global Corporation had 3.6 million shares outstanding which traded at $10 per share on a stock exchange. Given the financial statements for Global Corporation that were used in the videos and lecture notes for Chapter 2, part 2.1-2.5, what was the market-to-book of Global at that time?
1) Market capitalization = price per share * # of shares MV of equity = $8 * 3.6 mil shares = $28.8 million Market-to-book ratio = MV of equity / BV of equity Global's 2018 BV of equity = 21.2 M-to-B ratio = 28.8 / 21.2 = 1.36 2) MV of equity = $10 * 3.6 mil shares = $36 million Global's 2019 BV of equity = 22.2 M-to-B ratio = 36 mil / 22.2 = 1.62
1) Since your first birthday, your grandparents have been depositing $1500 into a savings account on every one of your birthdays. The account pays 7% interest annually. Immediately after your grandparents make the deposit on your 18th birthday, the amount of money in your savings account will be closest to ________. 2) Since your first birthday, your grandparents have been depositing $1200 into a savings account on every one of your birthdays. The account pays 6% interest annually. Immediately after your grandparents make the deposit on your 18th birthday, the amount of money in your savings account will be closest to ________.
1) N=17, I/Y=7, PMT=-1500, PV=-1500 FV = $ 50,999 2) 18th birthday - 1st birthday = 17 years N=17, I/Y=6, PV=-1200, PMT=-1200 FV = $37,086.78
1) A close relative offers to sell you their 1967 Chevrolet Corvette for $56,000. You note that very similar classic cars are selling on the open market for $81,000. You don't care for classic cars and would rather buy a new Ford Escape for $25,000. What is the net value of buying the Chevrolet Corvette? 2) An elderly relative offers to sell you their used 1958 Cadillac Eldorado for $52,000. You note that very similar cars are selling on the open market for $87,000. You don't care for classic cars and would rather buy a new Ford Explorer for $35,000. What is the net value of buying the Cadillac?
1) Net value = difference between cost and benefit in one year. Chevrolet cost = $56,000 Similar car value = $81,000 Ford cost = $25,000 To find NV, subtract the similar car value to the Chevrolet. 81,000 - 56,000 = $25,000 Answer: $25,000, since this is the difference between purchase and resale price of the Chevrolet. 2) Net value = difference between cost/benefit 1 year Cadillac = 52,000 Similar = 87,000 Ford = 35,000 benefit of similar (87,000) - cost of Cadillac (52,000) = net value ($35,000) Answer: $35,000, since this is the difference between purchase and resale price of the Cadillac.
1) Your sibling wants to borrow money from you that she can repay in four equal annual payments of $1,500 at the end of each of the next four years. If you charge 4% interest rate on the loan to your sibling, and that is the competitive interest rate, what would be the amount that you can lend to her today? 2) Your sibling asks you to borrow money from you that she can repay in four equal annual payments of $1,000 at the end of each of the next four years. If you charge 3% interest rate on the loan to your sibling, and that is the competitive interest rate, what would be the amount that you can lend to her today?
1) PMT=1,500, I/Y=4, N=4, FV=0 Find PV in financial calculator. PV = $5,444.84 2) N=4, I/Y=3, PMT=1,000, FV=0 PV = $3,717.10
1) Jacob wants to provide money in his will for an annual bequest to his favorite relative. That bequest will provide $4000 in the first year (end-of-year), and will grow by 2% per year thereafter, forever. If the interest rate is 5% per year, how much must Jacob provide to fund this bequest? 2) Martin wants to provide money in his will for an annual bequest to whichever of his living relatives is oldest. That bequest will provide $4000 in the first year (end-of-year), and will grow by 7% per year thereafter, forever. If the interest rate is 9%, how much must Martin provide to fund this bequest?
1) PV = C / (r - g) PV = 4,000 / (0.05 - 0.02) PV = $133,333 2) PV = C / (r - g) PV = 4,000 / (0.09 - 0.07) = 4,000 / 0.02 PV = $200,000
1) An investment will pay you $150 in one year and $220 in two years. If the interest rate is 5% compounded annually, what is the present value of these cash flows? 2) An investment will pay you $120 in one year and $200 in two years. If the interest rate is 4%, what is the present value of these cash flows?
1) PV for year 2 = $199.55 PV for year 1 = $142.86 (add together) $342.40 2) PV year 1 = $115.38 PV year 2 = $184.91 Add together = $300.29
1) Ouranos Airlines has a contract that gives them the opportunity to purchase up to 12,000,000 gallons of jet fuel at $1.50 per gallon. The current market price of jet fuel is $1.80 per gallon. Ouranos believes they will only need 5,000,000 gallons of jet fuel. What is the value of this opportunity? 2) Cronus Airlines has a contract that gives them the opportunity to purchase up to 13,000,000 gallons of jet fuel at $2.00 per gallon. The current market price of jet fuel is $2.3 per gallon. Cronus believes they will only need 4,000,000 gallons of jet fuel. What is the value of this opportunity?
1) Purchase: 12,000,000 * $1.50 = $18,000,000 Market price: 12,000,000 * $1.80 = $21,600,000 Value: 21,600,000 - 18,000,000 = $3.6 mil 2) Purchase: 13 mil gallons * $2 = $26 million Market price: 13 mil * $2.3 = $29.9 million Value: 29.9 - 26 = $3.9 million
1) Convex Industries has inventories of $238 million, current assets of $1.62 billion, and current liabilities of $492 million. What is its quick ratio? 2) Convex Industries has inventories of $218 million, current assets of $1.4 billion, and current liabilities of $504 million. What is its quick ratio?
1) Quick ratio = (current assets - inventory) / current liabilities (1.62 bil - 238 mil) / 492 mil convert --> (1620 - 238) / 492 = 2.81 2) (1.4 bil - 218 mil) / 504 mil convert --> (1400 - 218) / 504 = 2.345
1) Refer to the income statement and select balance sheet data above. Corvex Corporation's return on assets (ROA) for the year ending December 31, 2016 is closest to ________. 2) Refer to the income statement above. Luther's return on assets (ROA) for the year ending December 31, 2005 is closest to ________.
1) Return on assets = (net income + interest expense) / total assets (10.6+25.1)/433.1 = 8.24% 2) (79.755 + 14.3) / 386.7 = 24.32%
1) An investment will pay $24,000 in 10 years for an investment of $20,000 today. Given this information, what is the expected annual interest rate earned on the investment? 2) An investment will pay $290,021 in 10 years for an investment of $190,000 today. Given this information, what is the expected interest rate earned on the investment?
1) Use finance calculator. 1.84% 2) N=10, PV=190,000, PMT=0, FV=290,021, so I/Y = 4.32%
1) If $17,000 is invested at 8.5% per year, in how many years will the investment triple in value? 2) If $17,000 is invested at 10% per year, in how many years will the investment double?
1) Use finance calculator. 13.467 years 13.5 years 2) I/Y=10, PV=17,000, PMT=0, FV=34,000 N = 7.273 = 7.3 years
1) Advanced Micro Devices, Inc. (NASDAQ: AMD) is currently trading at $91.75. Assume AMD is also listed on NYSE and assume it is currently trading on NYSE at $91.50. Does an arbitrage opportunity exist and, if so, how would you exploit it and how much would you make on a block trade of 100 shares? 2) Walgreens Company (NYSE: WAG) is currently trading at $48.75 on the NYSE. Walgreens Company is also listed on NASDAQ and assume it is currently trading on NASDAQ at $48.50. Does an arbitrage opportunity exist and, if so, how would you exploit it and how much would you make on a block trade of 100 shares?
1) a. Does an arbitrage opportunity exist? -Arbitrage opportunity = any situation in which it is possible to make a profit without taking any risk or making any investment. - Yes, it exists. b. How would you exploit it? - Buy on NYSE and sell on NASDAQ c. How much would you make on a block trade of 100 shares? - 91.75 * 100 = $9,175 - 91.50 * 100 = $9,150 - 9175 - 9150 = $25 Whole answer: Yes, buy on NYSE and sell on NASDAQ, make $25. 2) buy on nasdaq, sell on nyse 48.75 * 100 = 4875 48.50 * 100 = 4850 4875 - 4850 = make $25
1) Refer to the income statement of Corvex Corporation above. Calculate times-interest-earned (TIE) in 2016 using EBITDA as a measure of earnings. The TIE is closest to: 2) Refer to the income statement above. Calculate times-interest-earned (TIE) in 2006 using EBITDA as a measure of earnings. The TIE is closest to:
1) ebitda = 41.2 + 3.6 = 44.8 TIE w/ ebitda = 44.8 / 25.1 = 1.78 2) TIE = earnings / interest ebitda = ebit + dep = 41.2 + 3.6 = 44.8 TIE = 44.8 / 25.1 = 1.784
1) Refer to the income statement and the balance sheet above. Assume all data is in $ million. If the company has 5 million shares outstanding trading at $23.60 each on stock exchange, what is your estimate of EV-to-EBITDA (Enterprise Value / EBITDA)? 2) Refer to the income statement and the balance sheet above. Assume all data is in $ million. If the company has 5 million shares outstanding trading at $20 each on stock exchange, what is your estimate of EV-to-EBITDA (Enterprise Value / EBITDA)?
1) mv of equity = 23.60 * 5 = 118 total debt = 7 + 128 = 135 net debt = 135 - 50 = 85 enterprise value = 118 + 85 = 203 ebitda = 53 + 5 = 58 ev-ebitda = 203 / 58 = 3.5 2) ev-ebitda = enterprise value / ebitda mv of equity = price per share * # of shares mv of equity = 5 mil * $20 = $100 million net debt = (short + long term debt) - cash net debt = 128 + 7 - 50 = $85 enterprise value = mv of equity + net debt enterprise value = 100 mil + 85 = 185 mill ebitda = ebit + da ebitda = 53 + 5 = 58 ev-ebitda = 185 / 58 = 3.2
For each of the following cash transactions, identify whether it is better described as an operating, financing, or investing activity.
1. An entrepreneur contributes his own money to start a new business. -Financing 2. The business buys a machine. -Investing 3. The business purchases inventory. -Operating 4. The business sells inventory to customers. -Operating 5. The business repays a loan. -Financing
U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form?
10-K
GenCorp. has a total debt of $115 million and stockholders' equity of $50 million. It also has 26 million shares outstanding, with a market price of $4.00 per share. What is GenCorp's market debt-equity ratio?
115 / 104 = 1.11
What was the change in Global's book value of equity from 2018 to 2019 according to Table 2.1? Does this imply that the market price of Global's shares increased in 2019? Explain.
2019 equity = 22.9 2018 equity = 21.2 Change in equity = 22.9 - 21.2 = $1.7 million Explain: -The market value of a stock does not depend on the historical cost of the firm's assets, but on investors' expectation of the firm's future performance. -There are many events that may affect Global's future profitability, and hence its share price, that do not show up on the balance sheet. -An increase in book value does not necessarily indicate an increase in Global's share price.
Which of the statements below is TRUE?
Accounting Identity is: Assets = Liabilities + Stockholders' Equity.
What are the main advantages and disadvantages of organizing a firm as a corporation?
Advantages: -There is no limit on the number of owners a corporation may have, thus allowing the corporation to raise substantial amounts of capital. -The life of the business can continue beyond the death of any of the owners. -The liability of the owners is limited to the amount of their investment in the firm. Disadvantages: -Income to a corporation is subject to double taxation, once at the corporate level and again when received by the owners in the form of a dividend. -The corporation is more complicated and more expensive to set up than other business entities.
Brett has almond orchards, but he is sick of almonds and prefers to eat walnuts instead. The owner of the walnut orchard next door has offered to swap this year's crop with him. Assume he produces 1,040 tons of almonds and his neighbor produces 780 tons of walnuts. If the market price of almonds is $106 per ton and the market price of walnuts is $112 per ton: a. Should he make the exchange? b. Does it matter whether he prefers almonds or walnuts? Why or why not?
Almonds = 1040 * 106 = $110,240 Walnuts = 780 * 112 = $87,360 a. No b. No. His preference is irrelevant to the value of the crops.
Fossil is famous for fashion wristwatches and leather goods. At the end of a recent year, Fossil's total assets added up to $397 million, and stockholders' equity was $201 million. How much were Fossil's liabilities?
Assets = Liabilities + Stockholders' Equity 397 = liabilities + 201 397 - 201 = liabilities Liabilities = $196 million
The third party who checks annual financial statements to ensure that they are prepared according to Generally Accepted Accounting Principles (GAAP) and verifies that the information reported is reliable is the ________.
Auditor
How do the shareholders of most corporations exercise their control of that corporation?
By electing members of a board of directors.
Over four-fifths of all U.S. business revenue is generated by which type of firm?
Corporations
You are an international shrimp trader. A food producer in the Czech Republic offers to pay you 2.1 million Czech koruna today in exchange for a year's supply of frozen shrimp. Your Thai supplier will provide you with the same supply for 2.8 million Thai baht today. If the current competitive market exchange rates are 25.27 koruna per dollar and 41.21 baht per dollar, what is the value of this exchange to you?
Cost of shrimp from Thai supplier: 2.8 mil Thai baht for year of shrimp 41.21 baht per dollar 2.8 mil / 41.21 = $67,944.67 Czech producer: 2.1 mil Czech koruna for year of shrimp 25.27 koruna per dollar 2.1 mil / 25.27 = $83,102.49 Profit you'd make from the trade: 83,102.49 - 67,944.67 = $15,157.82
Which of the following statements is FALSE?
Depreciation is a current expense of a cash outflow in the current period.
Use the income statement for Global Corporation from the videos or chapter notes. Given the results for the year 2018, the EBITDA for the company in 2018 would be closest to:
EBITDA = EBIT but with depreciation & amortization Global's 2018 EBIT = 7.1 Global's 2018 depreciation & amortization = -1.1 EBITDA = 7.1 + 1.1 = $8.2 million
An S corporation earns $9.10 per share before taxes. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the total amount of taxes paid per share if the company pays a $5.00 dividend per share?
EPS / income 9.10 x Income tax rate 36% = Personal tax 3.276 Answer: $3.28
A C corporation earns $8.30 per share before taxes and the company pays a dividend of $4.00 per share. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the after-tax amount an individual would receive from the dividend?
Earnings before tax 8.30 x Corporate tax rate 39% = Corporate tax 3.237 EPS/dividend 4.00 x Dividend tax rate 15% = Personal tax 0.60 After tax income = EPS - personal tax After tax income = 4.00 - 0.60 = 3.40 Answer: $3.40
What four financial statements can be found in a firm's 10-K filing? What checks are there on the accuracy of these statements?
Every public company is required to produce quarterly and annual financial statements. Those statements are: -The statement of financial position. -The income statement. -The statement of cash flows. -The statement of stockholders' equity. What checks are there on the accuracy of these statements? -Public companies must use a common set of rules and standard format when they prepare their reports. -Corporations are required to hire a neutral party, known as an auditor, to check the annual financial statements, ensure that the statements are prepared according to GAAP and provide evidence to support the reliability of the information. -In addition to the auditor's role in reviewing the financial statements, the Sarbanes-Oxley Act requires both the CEO and the CFO to personally attest to the accuracy of the financial statements presented to shareholders and to sign a statement to that effect.
The management of public companies is not legally required to disclose any off−balance sheet transactions.
False
Put the following steps of the financial cycle in the correct order. I. Money flows to companies who use it to fund growth through new products. II. People invest and save their money. III. Money flows back to savers and investors.
II, I, and III
All of the following is a source of cash except: -decrease in inventory -increase in short-term debt -increase in accounts receivable -increase in common stock -increase in accounts payable
Increase in accounts receivable
Which of the following is a way that the operating activity section of the statement of cash flows adjusts Net Income from the balance sheet?
It adds all non−cash entries related to a firm's operating activities.
Why is it possible for a corporation to enter into contracts, acquire assets, incur obligations, and enjoy protection against the seizure of its property?
It is a legally defined, artificial entity that is separate from its owners.
What are the requirements of section 404 of SOX?
It requires that senior management and the boards of public companies attest to the effectiveness and validity of their financial control process.
Which of the following best describes why the Valuation Principle is a key concept in making financial decisions?
It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly.
Allen Company bought a new copy machine to be depreciated straight line for three years for use by sales personnel. Where would this purchase be reflected on the Statement of Cash Flows?
It would be an addition to property, plant and equipment so it would be an investing activity.
Whose cash flow is best described by the timeline shown below? Date (years) / Cash flows 0 / -3500 1 / 1000 2 / 1000 3 / 1000 4 / 1000
Joe, who loans a friend $3,500, and the friend then pays back the loan in four annual installments of $1,000
The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes. Next, interest expense is subtracted to find the taxable income for the period. Then the appropriate taxes are calculated and subtracted. We finally arrive at the ________ , the so called bottom line of the income statement.
Net income
Use the financial statements for Global Corporation from the videos or chapter notes. Given the data reported for 2018, the working capital for the company in 2018 would be closest to:
Networking capital = current assets - current liabilities Global's 2018 current assets = 48 Global's 2018 current liabilities = 29.7 Working capital = 48 - 29.7 = $18.3 million
What does the phrase limited liability mean in a corporate context?
Owners' liability (is) limited to the amount they invested in the firm. Stockholders (are not) responsible for any encumbrances of the firm; in particular, they (cannot) be required to pay back any debts incurred by the firm.
What is the present value (PV) of $100,000 received fifteen years from now, assuming the interest rate is 5% per year?
PV = 100,000 / (1.05)^15 PV = $48,101.71 Answer: $48,102
The local electronics store is offering a promotion "1-year: same as cash," meaning that you can buy a TV now, and wait a year to pay (with no interest). So, if you take home a $1,350 TV today, you will owe them $1,350 in one year. If your bank is offering 4.4% interest, what is the true cost of the TV to you today?
PV = 1350 / 1.044 = $1,293.10
Your brother has offered to give you either $35,000 today or $70,000 in 9 years. If the interest rate is 8% per year, which option is preferable?
PV of future amount in 9 years: PV = 70,000 / 1.08^9 = $35,017.43 Which is preferable? Take the future amount because it's greater than the amount offered today.
What is the most common type of firm in the United States?
Sole proprietorships
What is the difference between a primary and a secondary market?
The (primary market) refers to a corporation issuing new shares of stock and selling them to investors. After this initial transaction between the corporation and investors, the shares continue to trade in a (secondary market) between investors without the involvement of the corporation.
Which of the following is typically the major factor in limiting the growth of sole proprietorships?
The amount of money that can be raised by such firms is limited by the fact that the single owner must make good on all debts.
What is the process of double taxation for the stockholders in a C corporation?
The corporation is taxed on the profits it makes, and the owners are taxed when this profit is distributed to them.
What is the most important type of decision that the financial manager makes?
The financial manager's most important job is to make the firm's investment decisions.
Explain the difference between an S and a C corporation.
The profits and losses of the (S corporation) are passed directly to shareholders and are not subject to corporate taxes, while the (C corporation) must first pay taxes on any profits before passing the after-tax profits on to shareholders. In addition, the (S corporation) can have no more than 100 shareholders, all of whom must be U.S. citizens or residents. The (C corporation) does not have any such restrictions on its shareholders.
What is the difference between a public and private corporation?
The shares of a (public) corporation are traded on an exchange (or "over the counter" in an electronic trading system) while the shares of a (private) corporation are not traded on a public exchange.
Whose interests should a financial manager consider paramount when making a financial decision?
The stockholders who have risked their money to become owners of the company.
On August 19, 2004 Google IPO offered 19,605,052 shares at a price of U.S. $85 per share, which were sold in an online auction in a bid to make the shares more widely available. Which of the following statements best describes why these are considered a primary market transaction?
The transaction was between the corporation and investors.
Which of the following is NOT a reason why a firm's financial managers must take great care when making investment decisions?
These investment decisions determine the corporation's mix of debt and equity.
You plan to borrow $3,000 from a bank. In exchange for $3,000 today, you promise to pay $3,150 in one year. What does the cash flow timeline look like from your perspective? What does it look like from the bank's perspective?
Your perspective: 0 --> $3,000 1 --> -$3,150 Bank's perspective: 0 --> -$3,000 1 --> $3,150
What is a competitive market?
a market in which a good can be bought and sold at the same price
Local Co. has sales of $10.8 million and cost of sales of $5.9 million. Its selling, general and administrative expenses are $470,000 and its research and development is $1.3 million. It has annual depreciation charges of $1.1 million and a tax rate of 25%. a. What is Local's gross margin? b. What is Local's operating margin? c. What is Local's net profit margin?
a. 10.8-5.9=4.9, 4.9/10.8=0.4537, =45.4% b. 10.8-5.9-0.47-1.3-1.1=2.03, 2.03/10.8=0.1879, =18.8% c. 10.8-5.9-0.47-1.3-1.1=2.03, 2.03*25%=0.5075, 2.03-0.5075=1.5225, 1.5225/10.8=0.14097, =14.10%
In December 2018, Apple had cash of $86.27 billion, current assets of $140.98 billion, and current liabilities of $107.97 billion. It also had inventories of $4.99 billion. a. What was Apple's current ratio? b. What was Apple's quick ratio? c. In January 2019, Hewlett-Packard had a quick ratio of 0.55 and a current ratio of 0.78. What can you say about the asset liquidity of Apple relative to Hewlett-Packard?
a. 140.98/107.97=1.31 b. (140-4.99)/107.97=1.26 c. Apple's higher current and quick ratios demonstrate that it has much higher asset liquidity than does Hewlett-Packard. This means that in a pinch, Apple has more liquidity to draw on than does Hewlett-Packard.
In December 2018, General Electric (GE) had a book value of equity of $51.2 billion, 8.8 billion shares outstanding, and a market price of $8.05 per share. GE also had cash of $71.6 billion, and total debt of $110.5 billion. a. What was GE's market capitalization? What was GE's market-to-book ratio? b. What was GE's book debt-equity ratio? What was GE's market debt-equity ratio? c. What was GE's enterprise value?
a. 8.05*8.8=70.8, 70.8/51.2=1.38 b. 110.5/51.2=2.16, 110.5/70.8=1.56 c. (net debt=110.5-71.6=38.9), 38.9+70.8=109.7
You are analyzing the leverage of two firms and you note the following (all values in millions of dollars): 1.Debt 2.Book Equity 3.Market Equity 4.Operating Income 5.Interest Expense Firm A: 497.9, 297.3, 400.3, 98.6, 49.9 Firm B: 79.8, 34.9, 41.8, 7.7, 6.9 a. What is the market debt-to-equity ratio of each firm? b. What is the book debt-to-equity ratio of each firm? c. What is the interest coverage ratio of each firm? d. Which firm will have more difficulty meeting its debt obligations?
a. A: 497.9/400.3=1.24, B: 79.8/41.8=1.91 b. A: 497.9/297.3=1.67, B: 79.8/34.9=2.29 c. A: 98.6/49.9=1.98, B: 7.7/6.9=1.12 d. firm B, because the most affective ratio is 0.
Suppose you invest $1,000 in an account paying 3% interest per year. a. What is the balance in the account after 2 years? How much of this balance corresponds to "interest on interest"? b. What is the balance in the account after 30 years? How much of this balance corresponds to "interest on interest"?
a. FV = 1000 * 1.03^2 = $1,060.90 simple interest = 0.03 * 1000 = 30 2 year simple = 30 * 2 = 60 compound = 1,060.90 - 1000 - 60 = $0.90 b. FV = 1000 * 1.03^30 = $2,427.26 30 year simple = 30 * 30 = 900 compound = 2,427.26 - 1000 - 900 = $527.26
Suppose the interest rate is 4.3%. a. Having $300 today is equivalent to having what amount in one year? b. Having $300 in one year is equivalent to having what amount today? c. Which would you prefer, $300 today or $300 in one year? Does your answer depend on when you need the money? Why or why not?
a. FV = 300 * 1.043 = $312.90 b. PV = 300 / 1.043 = $287.63 c. Because money today is worth more than money in the future, $300 today is preferred to $300 in one year. This answer is correct even if you don't need the money today, because by investing the $300 you receive today at the current interest rate, you will have more than $300 in one year.
A friend asks to borrow $46 from you and in return will pay you $49 in one year. If your bank is offering a 5.6% interest rate on deposits and loans: a. How much would you have in one year if you deposited the $46 instead? b. How much money could you borrow today if you pay the bank $49 in one year? c. Should you loan the money to your friend or deposit it in the bank?
a. FV = 46 * 1.056 = $48.58 b. PV = 49 / 1.056 = $46.40 c. From a financial perspective, you should lend the money to your friend, as it will result in more money for you at the end of the year.
Your grandfather put some money in an account for you on the day you were born. You are now 18 years old and are allowed to withdraw the money for the first time. The account currently has $5,334 in it and pays an 3% interest rate. a. How much money would be in the account if you left the money there until your 25th birthday? b. What if you left the money until your 65th birthday? c. How much money did your grandfather originally put in the account?
a. FV = 5334 * 1.03^7 = $6,560.15 b. FV = 5334 * 1.03^47 = $21,399.45 c. PV = 5334 / 1.03^18 = $3,133.16
Consider the following potential events that might have occurred to Global on December 30, 2019. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. a. Global used $20.9 million of its available cash to repay $20.9 million of its long-term debt. b. A warehouse fire destroyed $5.3 million worth of uninsured inventory. c. Global used $5.1 million in cash and $4.5 million in new long-term debt to purchase a $9.6 million building. d. A large customer owing $2.9 million for products it already received declared bankruptcy, leaving no possibility that Global would ever receive payment. e. Global's engineers discover a new manufacturing process that will cut the cost of its flagship product by more than 45%. f. A key competitor announces a radical new pricing policy that will drastically undercut Global's prices.
a. Long-term liabilities would decrease by $20.9 million, and cash would decrease by the same amount. The book value of equity would be unchanged. b. Inventory would decrease by $5.3 million, as would the book value of equity. c. Long-term assets would increase by $9.6 million, cash would decrease by $5.1 million, and long-term liabilities would increase by $4.5 million. There would be no change to the book value of equity. d. Accounts receivable would decrease by $2.9 million, as would the book value of equity. e. This event would not affect the balance sheet. f. This event would not affect the balance sheet.
Suppose Big Bank offers an interest rate of 6.0% on both savings and loans, and Bank Enn offers an interest rate of 6.5% on both savings and loans. a. What profit opportunity is available? b. Which bank would experience a surge in the demand for loans? Which bank would receive a surge in deposits? c. What would you expect to happen to the interest rates the two banks are offering?
a. Take a loan from Big Bank at 6.0% and save the money in Bank Enn at 6.5%. b. Big Bank would experience a surge in the demand for loans, while Bank Enn would receive a surge in deposits. c. Big Bank would increase its interest rate and Bank Enn would decrease its rate.
Bubba is a shrimp farmer. In an ironic twist, Bubba is allergic to shellfish, so he cannot eat any shrimp. Each day he has a one-ton supply of shrimp. The market price of shrimp is $10,200 per ton. a. What is the value of a ton of shrimp to him? b. Would this value change if he were not allergic to shrimp? Why or why not?
a. The value of a ton of shrimp to Bubba is $10,200 because that is the market price. b. No. As long as he can buy or sell shrimp at $10,200 per ton, his personal preference or use for shrimp is irrelevant to the value of the shrimp.
Suppose a firm's tax rate is 25%.
a. What effect would a $9.96 million operating expense have on this year's earnings? -operating expense: + 9.96 mil -earnings: - 9.96 mil -tax: (.25)*(9.96) = $2.49 mil -adjust: 9.96 - 2.49 = $7.47 -answer: $7.47 million decrease a2. What effect would it have on next year's earnings? -There would be no effect on next year's earnings. b. What effect would a $9.45 million capital expense have on this year's earnings if the capital is depreciated at a rate of $1.89 million per year for five years? What effect would it have on next year's earnings? -tax: 1.89 * 0.25 = $0.4725 mil -earnings: 1.89 - 0.4725 = $1.4175 mil -answer: decrease by $1.42 each year
Consider a retail firm with a net profit margin of 3.82%, a total asset turnover of 1.71, total assets of $42.4 million, and a book value of equity of $17.6 million. a. What is the firm's current ROE? b. If the firm increased its net profit margin to 4.66%, what would be its ROE?
a. equity multiplier = 42.4 / 17.6 = 2.409, ROE = 3.82 * 1.71 * 2.409 = 15.7 b. 4.66 * 1.71 * 2.409 = 19.2
Suppose your firm receives a $5.69 million order on the last day of the year. You fill the order with $2.13 million worth of inventory. The customer picks up the entire order the same day and pays $1.19 million up front in cash; you also issue a bill for the customer to pay the remaining balance of $4.50 million within 40 days. Suppose your firm's tax rate is 0% (i.e., ignore taxes). Determine the consequences of this transaction for each of the following: a. Revenues b. Earnings c. Receivables d. Inventory e. Cash
a. revenues increase by $5.69 b. earnings increase by $3.56 (5.69-2.13) c. receivable increase by $4.50 d. inventory decrease by $2.13 e. cash increase by $1.19 (3.56-4.50+2.13)
In fiscal year 2018, Wal-Mart Stores (WMT) had revenue of $514.41 billion, gross profit of $129.10 billion, and net income of $6.67 billion. Costco Wholesale Corporation (COST) had revenue of $141.6 billion, gross profit of $18.42 billion, and net income of $3.13 billion. a. Compare the gross margins for Walmart and Costco. b. Compare the net profit margins for Walmart and Costco. c. Which firm was more profitable in 2018?
a. walmart: 129.10/514.41=0.25096 =25.10%, costco: 18.42/141.6=0.13008 =13.01% b. walmart: 6.67/514.41=0.01296 =1.30%, costco: 3.13/141.6=0.02210 =2.21% c. Costco because we compare net profit margins.
JPJ Corp has sales of $1.19 million, accounts receivable of $51,000, total assets of $5.14 million (of which $2.96 million are fixed assets), inventory of $153,000, and cost of goods sold of $599,000. What is JPJ's accounts receivable days? Fixed asset turnover? Total asset turnover? Inventory turnover?
acc receivable days = 0.051 / (1.19/365) = 15.64 fixed asset turnover = 1.19 / 2.96 = 0.40 total asset turnover = 1.19 / 5.14 = 0.23 inventory turnover = 0.599 / 0.153 = 3.92
The major components of stockholders' equity on the balance sheet are ________.
common stock, paid-in surplus, and retained earnings
Above are portions of the balance sheet and income statement for two companies in 2018. Based upon this information, which of the following statements is most likely to be true?
fixed asset turnover A = 1.2 fixed asset turnover B = 1.7 so... Fixed asset turnover ratios indicate that firm A generating fewer sales for the assets it employs than firm B.
A 30-year mortgage loan taken on by a storage company to purchase a warehouse is a ________.
long-term liability
Investments by wealthy individuals and endowments is a major source of money for each of the following EXCEPT ________.
mutual funds. (Correct 3 choices: hedge funds, venture capital funds, and private equity funds)
Ladders, Inc. has a net profit margin of 5.2% on sales of $51.3 million. It has book value of equity of $39.8 million and total book liabilities of $31.8 million. What is Ladders' ROE? ROA? Note: Assume the value of Interest Expense is equal to zero.
net income = 51.3 * 0.052 = 2.6676 ROE = 2.6676 / 39.8 = 0.06702 = 6.70% assets = 31.8 + 39.8 = 71.6 ROA = (2.6676 + 0) / 71.6 = 0.03725 = 3.73%
Chutes & Co. has interest expense of $1.47 million and an operating margin of 10.6% on total sales of $30.1 million. What is Chutes' interest coverage ratio?
operating income = 30.1 * 0.106 = 3.1906 ratio = 3.1906 / 1.47 = 2.2
