What is capital budgeting?
1. What are the 3 questions financial managers need to typically ask and make decisions on?
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10. Know the difference between a primary and secondary market.
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28. Tell me what you mean by sustainable growth rate and know the formula for it.
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29. Know that capital intensity ratio = 1/TAT
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31. What is net working capital?
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What are the major determinants of growth?
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You want to have $1 million to use for retirement in 35 years. If you can earn 1% per month, how much do you need to deposit on a monthly basis if the first payment is made in one month?
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Unlimited liability is faced by the owners of:
Both sole proprietorships and general partnerships.
Asset Management or Turnover Ratios Days Sales in Inventory
Days Sales in Inventory = 365 days / Inventory Turnover
Asset Management or Turnover Ratios Days Sales in Receivables
Days Sales in Receivables = 365 days / Receivables Turnover
11. Know the difference between an auction and a dealer market.
Dealer vs. Auction Market The fundamental difference between the NYSE and Nasdaq is in the way securities on the exchanges are transacted between buyers and sellers. The Nasdaq is a dealer's market, wherein market participants are not buying from and selling to one another directly but through a dealer, which, in the case of the Nasdaq, is a market maker. The NYSE is an auction market, wherein individuals are typically buying and selling between one another and there is an auction occurring; that is, the highest bidding price will be matched with the lowest asking price.
Long Term Solvency or Financial Leverage Ratios Debt Equity Ratio
Debt Equity Ratio = Total Debt / Total Equity DER = TD / TE
Suppose you have $500 to invest and you believe that you can earn 8% per year over the next 15 years. How much would you have at the end of 15 years using compound interest? How much would you have using simple interest?
N = 15; I/Y = 8; PV = 500; CPT FV = -1,586.08 Formula: 500(1.08)15 = 500(3.172169) = 1,586.08 500 + 15(500)(.08) = 1,100 Lecture Tip: You may wish to take this opportunity to remind students that, since compound growth rates are found using only the beginning and ending values of a series, they convey nothing about the values in between. For example, a firm may state that "EPS has grown at a 10% annually compounded rate over the last decade" in an attempt to impress investors of the quality of earnings. However, this just depends on EPS in year 1 and year 11. For example, if EPS in year 1 = $1, then a "10% annually compounded rate" implies that EPS in year 11 is (1.10)10 = 2.5937. So, the firm could have earned $1 per share 10 years ago, suffered a string of losses, and then earned $2.59 per share this year. Clearly, this is not what is implied by management's statement above.
Asset Management or Turnover Ratios NWC Turnover
NWC Turnover = Sales / NWC
Short term solvency of Liquidity ratios Net Working Capital To Total Assets
Net Working Capital To Total Assets = Net Working Capital /Total Assets Net Working Capital To Total Assets = NWC / TA
What is the Statement of Cash Flows and how do you determine sources and uses of cash?
Statement that summarizes the sources and uses of cash Changes divided into three major categories Operating Activity - includes net income and changes in most current accounts Investment Activity - includes changes in fixed assets Financing Activity - includes changes in notes payable, long-term debt, and equity accounts, as well as dividends
Partnership Advantages
Two or more owners More capital available Relatively easy to start Income taxed once as personal income
The mixture of debt and equity used by a firm to finance its operations is called:
capital structure.
The primary goal of a publicly-owned firm interested in serving its stockholders should be to
maximize share price.
12. What are some of the reasons why a manager should be ethical?
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13. Be able to determines sources and uses of cash
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14. Be able to construct a statement of cash flows
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15. Be able to construct common size, common base year and combined common size and base year statements and be able to give reasons why we would use these statements.
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16. What is the purpose of using ratios?
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17. Know what the solvency, leverage, turnover, profitability and market value ratios are.
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18. Know all the ratios presented in class. Table 3.8 page 65 of the text book and compute them. I will not test you on the interval measure, cash coverage ratio, PEG ratio, and Tobins Q ratio.
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19. Know the balance sheet identity and be able to use it to solve some of the leverage ratios.
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2. What are capital budgeting decisions, capital structure decisions, and working capital management decisions?
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20. Be able to use the Du Pont Identity.
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21. Be able to discuss some of the problems in using ratios.
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22. Why make a long term financial plan?
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23. Name the four elements of Financial Planning.
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24. Be able to tell what you mean by Planning horizon and Aggregation.
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25. Create pro forma income statements and pro forma balance sheets using the percentage of sales approach. Also be able to create these statements when the firm is not operating at full capacity.
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26. Be able to give me the plug variable (External funding needed)
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27. Tell me what internal growth rate is and the formula for it.
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3. Difference between and advantages and disadvantages of the 3 forms of organizations
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30. Know what retention ratio is. Know NI = Div. + RE and therefore 1 = Dividend payout ratio + Retention (plowback) ratio
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32. Know Future Value and Compounding, Present Value and Discounting.
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33. Be able to use the Time value of money registers in the financial calculator.
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34. Be able to use the Time value of money registers and the Cash flows registers in your financial calculator.
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35. Know what annuities and perpetuities are and be able to calculate uneven cash flows.
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36. Be able to differentiate between Annual Percentage Rate, Effective Annual Rate and Period Rate and be able to compute each other if one of them is given.
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37. What is continuous compounding?
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38. Different types of loans. Interest only loans, pure discount loans and amortized loans.
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4. What do you mean by the term limited liability?
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5. What is the goal of financial management?
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6. What is the agency problem? Be able to differentiate decisions management make if they meet the goal of financial management or not.
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7. What are some of the agency costs (Direct and Indirect costs)?
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8. Who are some of the stakeholders of a corporation?
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9. In what ways can a firm raise money in financial markets?
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How do you adjust the model when operating at less than full capacity?
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If you could invest the money at 8%, would you have to invest more or less than at 6%? How much?
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Suppose you are looking at the following possible cash flows: Year 1 CF = $100; Years 2 and 3 CFs = $200; Years 4 and 5 CFs = $300. The required discount rate is 7%. What is the value of the cash flows at year 5? What is the value of the cash flows today? What is the value of the cash flows at year 3?
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Suppose you have $200,000 to deposit and can earn 0.75% per month. How many months could you receive the $5,000 payment? How much could you receive every month for 5 years?
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Suppose you need $15,000 in 3 years. If you can earn 6% annually, how much do you need to invest today?
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Suppose you want to buy some new furniture for your family room. You currently have $500, and the furniture you want costs $600. If you can earn 6%, how long will you have to wait if you don't add any additional money?
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What are some situations in which you might want to know the implied interest rate?
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What are the major decision areas involved in developing a plan?
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What if the first payment is made today?
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What is the difference between simple interest and compound interest?
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What is the internal growth rate?
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What is the percentage of sales approach?
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What is the purpose of long-range planning?
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What is the relationship between present value and future value?
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What is the sustainable growth rate?
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What monthly rate would you need to earn if you only have $200,000 to deposit?
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When might you want to compute the number of periods?
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You are considering preferred stock that pays a quarterly dividend of $1.50. If your desired return is 3% per quarter, how much would you be willing to pay?
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You are offered the following investments: You can invest $500 today and receive $600 in 5 years. The investment is low risk. You can invest the $500 in a bank account paying 4%. What is the implied interest rate for the first choice, and which investment should you choose?
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You know the payment amount for a loan, and you want to know how much was borrowed. Do you compute a present value or a future value?
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You want to receive $5,000 per month for the next 5 years. How much would you need to deposit today if you can earn 0.75% per month?
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You want to receive 5,000 per month in retirement. If you can earn 0.75% per month and you expect to need the income for 25 years, how much do you need to have in your account at retirement?
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Why is having a positive net income generally considered a source of cash?
Because sales minus costs equals net income
What are the three types of financial management decisions and what questions are they designed to answer?
Capital budgeting -What long-term investments or projects should the business take on? Capital structure -How should we pay for our assets? Should we use debt or equity? Working capital management -How do we manage the day-to-day finances of the firm?
Long Term Solvency or Financial Leverage Ratios Cash Coverage Ratio
Cash Coverage Ratio = EBIT + Depreciation / Interest
Short term solvency of Liquidity ratios Cash Ratio
Cash ratio = Cash / Current Liability CASH RATIO = CASH / CL
Standardized Financial Statements
Common-Size Balance Sheets Compute all accounts as a percent of total assets Common-Size Income Statements Compute all line items as a percent of sales Common-Base year Statements Combined Common-Size and Base year Standardized statements make it easier to compare financial information, particularly as the company grows They are also useful for comparing companies of different sizes, particularly within the same industry
How do you standardize balance sheets and income statements and why is standardization useful?
Common-Size Balance Sheets: Compute all accounts as a percent of total assets. Common-Size Income Statements: Compute all line items as a percent of sales.
Which of the following measures would help reduce the agency problem?
Compensate management according to their pursuance of stock holders goals
Which one of the following is an agency cost?
Cost of an internal audit required by bondholders
Short term solvency of Liquidity ratios Current Ratio
Current Ratio = Current Assets / Current Liability CR = CA / CL
Which of the following is a function of a financial manager?
Managing the firms capital expenditures
Market Value Ratios Market to Book Ratios
Market to Book Ratios = Market Value Per Share / Book Value Per Share
What is the goal of financial management?
Maximize profit? Minimize costs? Maximize market share? Maximize the current value of the company's stock?
Which one of the following actions is the best example of an agency problem?
Paying management bonuses based on the number of store locations opened during the year.
Market Value Ratios Price Earnings Ratio
Price Earnings Ratio = Price Per Share / Earning Per Share or Market value / Net Income
Market Value Ratios Price Sales Ratio
Price Sales Ratio = Price Per Share / Sales Per Share
What is the difference between a primary market and a secondary market?
Primary vs. secondary markets Dealer vs. auction markets Listed vs. over-the-counter securities NYSE NASDAQ
Profitability Ratios Profit Margin
Profit Margin = Net Income / Sales
Short term solvency of Liquidity ratios Quick Ratio
Quick Ratio = Current Asset - Inventory / Current Liability
Profitability Ratios ROE
ROE = Net Income / Sales * Sales / Assets * Assets / Equity
Ratio Analysis
Ratios allow for better comparison through time or between companies As we look at each ratio, ask yourself what the ratio is trying to measure and why that information is important Ratios are used both internally and externally
Asset Management or Turnover Ratios Receivables Turnover
Receivables Turnover = Sales / Account Receivables
Profitability Ratios Return on Asset
Return on Asset = Net Income / Total Asset
Profitability Ratios Return on Equity
Return on Equity = Net Income / Total Equity
Corporation Disadvantages
Separation of ownership and management Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)
Categories of Financial Ratios
Short-term solvency or liquidity ratios Long-term solvency or financial leverage ratios Asset management or turnover ratios Profitability ratios Market value ratios
What are the major categories of ratios and how do you compute specific ratios within each category?
Short-term solvency or liquidity ratios Long-term solvency or financial leverage ratios Asset management or turnover ratios Profitability ratios Market value ratios
Three major forms in the United States
Sole Proprietorship Partnership Corporation
What are the three major forms of business organization?
Sole Proprietorship Partnership Corporation
The top financial manager within a firm is usually the
The Chief Financial Officer (CFO) or Vice-President of Finance coordinates the activities of the treasurer and the controller. Treasurer - oversees cash management, credit management, capital expenditures, and financial planning. Controller - oversees taxes, cost accounting, financial accounting and data processing
Which one of the following is true about the Sarbanes Oxley Act of 2002?
The main goal of the law is to protect investors from corporate abuses.
What is capital budgeting?
The process of managing a firm's long-term investments
Long Term Solvency or Financial Leverage Ratios Time Interest Earned Ratio
Time Interest Earned Ratio = EBIT / Interest
What is the purpose of a primary market?
To allow a company to raise money
Asset Management or Turnover Ratios Total Asset Turnover
Total Asset Turnover = Sales / Total Assets
Long Term Solvency or Financial Leverage Ratios Total Debt Ratio
Total Debt Ratio = Total Assets - Total Equity / Total Assets
What kind of liability regarding the owners' assets is faced by the owners in a general partnership?
Unlimited liability
Partnership Disadvantages
Unlimited liability General partnership Limited partnership Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership
Which rate do you need to use in the time value of money calculations?
We need the period rate, and we have to use the APR to get it
Which rate should you use to compare alternative investments or loans?
We should use the EAR to compare alternatives
A(n) ________ transaction occurs when a firm first sells its shares to the investing public.
primary market
IBM has decided to issue stock to fund a new project. When the stock is issued it will be sold on the:
primary market.
Agency costs refer to:
the cost of the conflict between stockholders and management.
The Board of Directors of Mild Chili Peppers, Inc. have decided to base the salary of its CEO entirely on the market share of the firm. Accordingly,
the manager may not act to maximize the current value of the firm's stock, resulting in agency costs for the firm's shareholders.
What is the definition of an APR?
APR = period rate * # of compounding periods per year
What are agency problems and why do they exist within a corporation?
Agency relationship -Principal hires an agent to represent his/her interests -Stockholders (principals) hire managers (agents) to run the company Agency problem -Conflict of interest between principal and agent Management goals and agency costs
Ann is interested in purchasing Ted's factory. Since Ann is a poor negotiator, she hires Mary to negotiate a purchase price. Identify the parties to this transaction.
Ann is the principal and Mary is the agent
What is the effective annual rate?
EAR is the rate we earn (or pay) after we account for compounding
Sole Proprietorship Advantages
Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income
Long Term Solvency or Financial Leverage Ratios Equity Multiplier
Equity Multiplier = Total Asset / Total Equity EM = TA / TE or 1 + Debt Equity Ratio
Asset Management or Turnover Ratios Fixed Asset Turnover
Fixed Asset Turnover = Sales ? Net Fixed Assets
Short term solvency of Liquidity ratios Interval Measure
Interval Measure Current Asset / Average Daily Operating Cost IM = CA / ADOC
Asset Management or Turnover Ratios Inventory Turnover
Inventory Turnover = Cost of Goods Sold / Inventory IT = COGS / Inventory
In what ways can a corporation raise financing for its assets externally?
Issuing debt and equity
Corporation Advantages
Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital
Sole Proprietorship Disadvantages
Limited to life of owner Equity capital limited to owner's personal wealth Unlimited liability Difficult to sell ownership interest
Long Term Solvency or Financial Leverage Ratios Long Term Debt Ratio
Long Term Debt Ratio = Long Term Debt / Long Term Debt - Total Equity
Goal of Financial Management
What should be the goal of a corporation? Maximize profit? Minimize costs? Maximize market share? Maximize the current value of the company's stock?
What are some of the problems associated with financial statement analysis?
_____________?
What are capital budgeting decisions, capital structure decisions, and working capital management decisions?
a. Capital budgeting: What long-term investments or projects should the business take on? b. Capital structure: How should we pay for our assets? Should we use debt or equity? c. Working capital management: How do we manage the day-to-day finances of the firm?
What are the 3 questions financial managers need to typically ask and make decisions on?
a. What long-term investments should the firm take on? b. Where will we get the long-term financing to pay for the investment? c. How will we manage the everyday financial activities of the firm?
S-Corps
are corporations that pass through the earnings to their investors. The investor must then pay the tax. This gets around double taxation while maintaining the limited liability benefits of a corporation. Only firms with fewer than 100 shareholders as of (2008) can qualify under the IRS's rulings as an S-Corp. (Note that as a result of S-Corps, many now use C-Corp to distinguish a normal corporation that does not pass through its earnings.)
Limited Liability Companies (LLC)
are in some ways the best of both worlds. They allow for limited liability but also allow the tax benefits of the S-Corp without the restrictive qualifications of the S-Corp. These companies are beneficial to small and medium sized businesses such as law firms and medical practices.
Limited liability is faced by the owners of:
corporations.