Business Finance
3.8 According to the Cash Flow Statement for Allied Food Products, how much net cash flow was produced from its financing activities in 2021?
$133.8 million (see CF Statement for details).
2.6 What is the difference between a "private market" and a "public market"?
*"Private" means a financing transaction (i.e., sale of financial instruments) is "small enough" to be exempt from registration/permission with the U.S. Securities and Exchange Commission. *"Public" means a financing transaction (i.e., a sale of financial instruments) is "large enough" to require registration/permission with the U.S. Securities and Exchange Commission.
2.4 What is the difference between a "money market" versus a "capital market"?
*A "money" market is places of exchange for debt instruments with an original maturity of less than one year. *A "capital" market is places of exchange for debt instruments with an original maturity of more than one year and also the market for equity securities (common stocks and preferred stocks).
2.5 What is the difference between a "primary market" versus a "secondary market"?
*A "primary" market is the market where securities are sold by the issuing Productive Project Investor and the P.P.I receives cash. *A "secondary" market is the market for securities which have been previously sold in the Primary Market can be bought and sold multiple times.
2.8 What is the difference between a Commercial Bank and an Investment Bank? Examples?
*A Commercial Bank essentially makes loans to businesses and owns a portfolio of government securities financed with deposit liabilities and other capital. *An Investment Bank essentially advises corporations and governments about what kind of securities to sell; acts as an underwriter to purchase and re-sell the offerings of securities by corporations and governments; and operates wholesale and/or retail brokerage operations. [Bank of Oklahoma and Goldman Sachs].
2.13 What is the difference between a stock exchange (with a physical location) and the Over-The-Counter Market?
*A stock exchange with a physical location is essentially a wholesale market for large value blocks of securities transactions by the members-only. The members are investment companies and investment banks trading large blocks of securities. *"Over-The Counter" Market is places of exchange where security brokers and dealers (brokers which carry inventories of securities) trade securities in large or small blocks on both a wholesale and retail basis, and usually are transacting business over telephone lines (i.e., by phone) or the internet.
1.3 How is "Finance" different from "Accounting"?
*Accounting is about recording and reporting accurately according to Generally Accepted Accounting Principles the financial impact of an entity's historical business transactions. *Finance is about investing in an asset(s) with a reasonable expectation of receiving at least a fair return (in cash value terms) in the future (plus the original cash value of the amount invested).
1.13 What are the advantages and disadvantages to a business of being unincorporated? What two forms of unincorporated businesses were described in the text?
*Advantages: simple to form; subject to only the Individual Income Tax Code *Disadvantages: Personal Assets at risk; harder to finance and to sell (must sell assets separately). *Forms: Sole Proprietorships and Partnerships
1.10 What is the Agency Problem in Business Finance, and What are Agency Costs?
*Agency Problem: When Management fails to achieve the Primary Goal; Conflicts between the Business Owner's goals and Management's Goals. *Agency Costs: The various costs of the Agency Problem.
1.11 How can Stockholders manage/minimize the Agency problem?
*Aligning Management compensation to the Primary Goal *Sell the company to another company (so Management may lose their jobs) *Incurring monitoring and bonding costs *Have more independent (outside) directors on the board *Separate the role of Chairman of the BOD from the CEO position *Require Management (i.e., corporate officers and BOD members) to purchase a substantial amount of the company's common stock.
2.14 What is the difference between a common stock traded in the secondary market versus the IPO market?
*An "IPO" is an "initial public offering" of securities by a corporation (usually common stock) wherein it is the first time the corporation is selling its stock on a "public" versus "private" basis, in the Primary Market. *A "secondary" market is the market for securities which have been previously sold in the Primary Market can be bought and sold multiple times.
1.7 Why is "profit maximization" not strong enough to be the primary goal of business financial management?
*Because it only addresses Accounting Net Income (and not Free Cash Flow) *Because Accounting Net Income ignores managing a company's level of riskiness *Because Accounting Net Income ignores the company's Weighted Average Cost of Capital ("WACC") *Because focusing only on Free Cash Flow would also ignore risk and WACC.
2.9 What is the difference between a Commercial Bank and a Financial Service Corporation? Examples?
*Commercial Banks (see above) *Financial Service Corporation is a holding corporation which owns several different types of financial intermediaries (commercial bank, mutual funds, investment bank, insurance+).
1.4 How can "Finance" be defined by the kinds of professions it equips?
*Corporate Finance (Treasury: Cash Management, Treasury: Finance, Financial Planning) *Commercial Banking *Money Management (i.e., Professional Investing) *Investment Banking *Consulting
2.1 What are the three basic ways financial capital is channeled from "Net Savers" to "Productive Project Investors"?
*Direct Transfers: Net Savers purchase financial securities (aka financial instruments) directly from Productive Project Investors. *Indirectly through Financial Intermediary: Net Savers purchase securities issued by F.I.s, and F.I.s purchase securities issued by Productive Project Investors. *Investment Banks purchase/underwrite securities issued by Productive Project Investors, then sell those securities to F.I.s and/or Net Savers.
Q4.1 What are a few of the benefits of computing financial ratios? (Select all that apply)
*Financial ratios help us to better understand a company's different kinds of financial performances (such as liquidity, asset productivity, use of debt, profitability, or whatever particular kind of Performance is being measured). *Financial ratios computed for different time periods and different companies permit a comparison analysis to be done irrespective of the different sizes of the company over time or the different sizes of companies being compared.
4.3 What are some of the limitations of financial ratios?
*First, they use only historical figures from the standard financial statements (book values), and not assets or liabilities based on their market/cash values. *Second, larger, more complicated companies have consolidated financial statements which means complete financial statements may not be available for different businesses/business segments. *Third, seasonality can distort ratios.
1.8 What is the difference between "intrinsic value" and "market price" with respect to the valuation of common stocks?
*Intrinsic value is an estimate of a stock's theoretical "true" value based on accurate risk and return data. *Market price is the current price being paid in the market for a stock based on perceived but possible incorrect information
1.14 What are the basic forms of being incorporated?
*Limited Partnerships *Corporations ("Inc." or "Corp.") *"S" Corporations (Income Tax Code designation), *Limited Liability Companies ("LLCs")
2.10 What are the major kinds of Investment Companies?
*Mutual Funds *Private Equity Funds *Hedge Funds *Exchange Traded Funds.
Q4.2 What are some of the limitations of financial ratios? (Select all that apply)
*Ratios use only historical figures from the standard financial statements (book values), and not assets or liabilities based on their market/cash values. *Larger, more complicated companies have consolidated financial statements which means complete financial statements may not be available for different businesses/business segments. *Seasonality of financial results reported can distort ratios.
2.7 How did the instructor categorize the six (6) largest kinds of financial institutions?
1.) Depository Institutions (e.g., Commercial Banks, Credit Unions, S&Ls) 2.) Contractual Savings Institutions (e.g., Insurance Companies, Pension Funds) 3.) Investment Intermediaries (e.g., Mutual Funds, private equity funds, finance companies) 4.) Investment Banks (as advisors, underwriters and brokers) 5.) Financial Service Corporations (combinations of all of the above under one holding corporation, like JP Morgan Chase; Bank of America, Wells Fargo Corp.) 6.) Central Banks (e.g., Federal Reserve System)
3.12 Obviously, the $(71.5) million of Free Cash Flow for this company was not enough to cover its Weighted Average Cost of Capital. What changes could Management make to improves its Free Cash Flow performance?
1.) Increase EBIT (by increasing sales and improving operating profitability) 2.) Reduce effective income tax rate (by making investments which reduce taxes) 3.) Reduce capital expenditures 4.) Reduce investment in Net Operating Working Capital.
2.2 What are the four (4) basic markets for financial assets (securities)?
1.) Spot Markets and Futures Markets 2.) Money Markets and Capital Markets 3.) Primary Markets and Secondary Markets 4.) Private Markets and Public Markets
Q4.5 Calculate Allied Food Product's ("AFP's") Total Assets Turnover Ratio 12/31/21. If the industry average ratio is 1.3x, how could AFP's performance be interpreted?
1.5x, which is superior to the industry average of 1.3x
Q4.8 Calculate Allied Food Product's ("AFP's") AFP's Market to Book Ratio for 12/31/21. Assume the market price of AFP is $23.06 per share, and that AFP has 75 million shares outstanding. If the industry average ratio is 1.18x, how could AFP's performance be interpreted?
1.84x (AFP has a superior performance).
Q4.7 Calculate Allied Food Product's ("AFP's") AFP's Profit Margin for 2021 compared to 2020 and comment on what happened in 2021.
4.88% (2021 has inferior performance).
Q4.4 Calculate AFP's Days Sales Outstanding Ratio for 12/31/21. Assume there are 365 days in AFP's fiscal year. If the industry average ratio is 36 days, how could AFP's performance be interpreted?
46 days = average amount of time it takes AFP to collect its receivables, which is more than the industry average of 36 days (AFP has inferior performance).
Q4.6 Calculate AFP's Total Debt to Total Capital Ratio for 12/31/21. If the industry average ratio is 36%, how could AFP's performance be interpreted?
47.8% (AFP has inferior performance).
2.3 What is the difference between a "spot" market versus a "futures" market?
A "spot" market is for current "on-the-spot" transactions (i.e., "today"); a "futures" market is for transactions to occur in the future.
Q4.3 Calculate the Current Ratio for Allied Food Product's ("AFP") for 12/31/21. If the industry average ratio was 2.85x, how could AFP's performance be interpreted?
AFP's ratio is larger than the industry average, so AFP is more liquid than the industry average company, and this is generally good.
1.15 What are the advantages and disadvantages of Incorporation?
Advantages: *Lower risk to Owners, Management and Employees because an incorporated business (in all of its forms) is a legally separate Person *Easier to sell the company (i.e., just sell the stock to sell all assets) *Easier to obtain external financing Disadvantages: *More complicated to form and maintain subject to the Corporate Income Tax Code *"Double Taxation" = Business' Net Earnings are subject to Corporate Income Tax and any distributed Net Earnings to shareholders (dividends) are subject to either the Personal or Corporate Income Tax Code
2.15 How does an investor in a common stock receive a return on their equity investment?
An investor in common stock pays a price as agreed between that investor and whomever is selling the stock in hopes of receiving in the future (a) cash dividend payments per share (i.e., dividend income), plus (b) an increase in the market price of the common stock which the investor can realize in cash in the future by selling the common stock (i.e., capital gains income).
4.5 Review all of the Activity Ratios for AFP and comment on its Activity profile.
Asset Management Ratios: these ratios measure how effectively a company is managing its investment in its assets, how productive the assets are, whether or not the company has excess assets or a deficiency of assets. *Inventory Turnover Ratio = 3.4x (industry average = 7.6x; poor comparison) *Days Sales Outstanding = 46 days (industry average = 36 days; poor comparison) *Fixed Assets Turnover = 3.0x (industry average = 2.8x; okay comparison) *Total Assets Turnover = 1.5x (industry average = 1.8x; a little lower than average)
1.2 How can "Business Finance" be defined generally?
Business Finance is the management of money invested in business assets/projects that are expected to produce at least a fair return for the Owner by the appreciation of the asset's market value and/or future cash flows to be received.
4.6 Review all of the Debt Ratios for AFP and comment on its Debt profile.
Debt ratios measure a company's use of Debt, whether it may have too much or too little indebtedness. *Total Debt to Total Capital = 47.8% (industry average = 36.4%; higher, riskier than average) *Times Interest Earned = 3.3x (industry average = 6.0x; low coverage is a poor comparison)
1.1 How can "Finance" be defined" generally?
Finance is the management of money invested in assets that are expected to produce at least a fair return for the Owner by the appreciation of the asset's market value and/or future cash flows to be received.
4.1 What are a few of the benefits of computing financial ratios?
Financial ratios help us to better understand a company's different kinds of financial performances (such as liquidity, asset productivity, use of debt, profitability, or whatever particular kind of performance). Financial ratios computed for different time periods and different companies permit a comparison analysis to be done irrespective of the different sizes of the company over time or the different sizes of companies being compared.
3.11 Explain how Free Cash Flow was computed for Allied Food Products for 2021.
Free Cash Flow = [ (EBIT x (1 less inc.tax rate)) plus Depreciation/Amort.] less [Capital Expenditures] less [Change in Net Operating Working Capital] Free Cash Flow = [ ($278.0 x (1 - 0.25)) + $100 = $308.5 ] less [ $230 ] less [ ($1,000 - ($60+$140)) less ($810 - ($30 + $130)) = $150 ] = $(71.5)
1.6 What "formula" summarizes what management needs to do in order to achieve the primary goal?
Free Cash Flow > Weighted Average Cost of Capital
3.10 What is Free Cash Flow ("FCF"), and why is it important? What five things can be done with it?
Free Cash Flow represents the amount of after-tax operating cash flow (after subtracting capital expenditures and investment in net operating working capital). It represents the amount of net cash flow available to the business owners which they are "free" to distribute to lenders and to all stockholders. 1.) Debt service payments 2.) Dividends to stockholders 3.) Investments in business assets/projects to grow the company 4.) Extraordinary compensation to management/employees 5.) Charitable and other contributions.
3.6 What four things are communicated in the Cash Flow Statement?
Gross cash flow from operations; total investing expenditures; total net funds from financing activities; and the net change in the company's balance of cash.
1.9 What can be the relationship between ethical problems in business and shareholder value?
If a publicly-held corporation has management and employees who violate generally accepted standards of ethical behavior, then this could lead to common stockholders losing confidence in management's ability to serve their interests, and this could lead to a lower demand for the stock, and thereby, a lower value/price for the stock.
3.1 What does the Balance Sheet communicate?
It shows the historical cost of all assets purchased on a cumulative basis and still in service less any applicable accumulated depreciation for long-term assets ("book value"), as well as a list of the major categories of liabilities and equity capital used to finance the purchase of those assets.
4.4 Review all of the Liquidity Ratios. What are they attempting to measure, and how would you describe Allied Food Product's ("AFP") liquidity profile?
Liquidity Ratios: Whether or not a company had/will have enough Cash to meet short-term obligations. *Current Ratio for AFP = 3.2x which means it had more Current Assets than Current Liabilities *Quick Ratio = 1.2x; these numbers suggest AFP's liquidity is okay (but represent an unfavorable comparison to the industry average ratios of 4.2x and 2.2x, respectively.
2.12 What is the largest source of external funds for most U.S. companies?
Loans from Commercial Banks.
4.8 Review all of the Market Ratios for AFP and comment on its market value profile.
Market Ratios measure to what extent Management is increasing the company's market value. *Price to Earnings Ratio = 11.8x (industry average = 13.6x; lower than average) *Market to Book Ratio = 1.8x (industry average = 2.6x; lower than average)
3.9 What is the formula for Net Operating Profit After Tax ("NOPAT") and what does it measure?
NOPAT = EBIT x (1 less the income tax rate). The profit a company would generate if it had no debt (and therefore no interest expense) and only had operating assets (with no financial assets it would not have any interest income, either).
4.7 Review all of the Profitability Ratios for AFP and comment on its profitability profile.
Profitability Ratios measure a company's ability to control expenses relative to sales. *Operating Profit Margin = 9.3% (industry average = 10.0%; lower than average) *Profit Margin = 4.9% (industry average = 6.0%; lower than average) *Return on Total Assets = 7.3% (industry average = 10.8%; lower than average) *Return on Common Equity = 15.6% (industry average = 18.7%; lower than average) *Return on Invested Capital = 11.6% (industry average = 13.2%; lower than average)
3.4 Analyze the Income Statement for Allied Food Products. What happened to Sales in 2021 compared to 2020?
Sales increased from $2,850 million ($2.85 billion) to $3,000 million ($3.0 billion), an increase of $150 million or up 5.26%
3.3 What does the Income Statement communicate?
The Income Statement shows for a designated period of time (i.e., one month, one quarter, or one year) the total value of all products sold, the cost to the company of those goods/services sold, all other expenses incurred during the designated period, and whether or not the total value of sales was more than, equal to or less than the total amount of expenses (i.e., net earnings or net losses).
2.11 Which financial institution is owned by all U.S. national commercial banks but is controlled by a board that is appointed by the President of the United States?
The U.S. central bank the Federal Reserve System: its 12 Independent District Banks and their boards of directors (elected by district-based Commercial Banks as stockholders and by the Board of Governors), and its Board of Governors (comprised of 7 members appointed by the POTUS).
3.2 Review the Balance Sheet for Allied Food Products in the textbook. What does the 12/31/21 balance for Accounts Receivable mean, and what does the change in this balance for 2021 mean?
The balance of $375 million of Accounts Receivable means $375 million of the Company's sales made of credit had not yet been collected as of 12/31/2021.
4.2 The Instructor said the list of financial ratios in the textbook we are reviewing are not "exhaustive"? What does this mean?
The list of financial ratios in the textbook represent those that among the most reviewed ratios, and there are many other types of ratios which could be defined and computed. So, the list in the textbook is not an exhaustive list.
3.7 What is unusual about the Cash Flow Statement compared to the Income Statement and Balance Sheet (generally)?
There are no separate general ledger accounts for the CF Statement lines items like there are for the Income Statement and the Balance Sheet; the CF Statement is derived from the changes to the Balance Sheet account balances.
3.5 How many different levels of Profitability are displayed on this company's Income Statement? (See Income Statement in the textbook)
Three: EBIT, EBT and Net Income.
1.5 What is the primary goal of Business Finance?
To maximize the market value of the shareholders equity investment (by working to produce enough Free Cash Flow profitability to at least cover the company's Weighted Average Cost of Capital). The focus is on making the market value of the business' assets increase in value, and this will lead to an increase in the value of the Business Owner's equity investment.
1.12 What are the two basic legal categories of Business Organization?
Unincorporated and Incorporated.
2.18 NASDAQ Composite Index
a portfolio of approximately 3,300 technology-oriented corporations' common stocks.
2.17 Dow Jones Industrial Average
a small portfolio of 30 very large and very well-known corporations' common stock This Index reflects the average stock price performance for these very-large "blue chip" companies with the implication being their performance as a group is one kind of indicator as to how the stock market is doing in general (even though it is not a representative sample from a statistical perspective).
2.16 S&P 500 Index
an industry-broad portfolio of 500 of the largest, widely-held, U.S. corporations the common stock of which is publicly-traded. Managed by Standard & Poor's Corporation. This Index reflects the average stock price performance for all companies in the Index.
