Corporate Finance Exam 2
similar
Accounting breakeven and payback period are (similar/different) measures.
increases, decreases
As the number of units sold (increases/decreases), the degree of operating leverage (increases/decreases).
c.
Assume that the current exchange rate for Japanese Yen and U.S. Dollar is 140 JPY per USD. According to the International Fisher Effect (IFE), if interest rates are higher in the United States than in Japan, what should we expect what for that exchange rate? a. IFE does not apply to this situation. b. We would expect the exchange rate to move above 140 JPY per USD. c. We would expect the exchange rate to move below 140 JPY per USD. d. We should expect no change in the exchange rate.
d.
Assume that the current exchange rate for Japanese Yen and U.S. Dollar is 140 JPY per USD. Considering Interest Rate Parity (IRP), if interest rates are higher in the United States than in Japan, what should we expect what for the forward exchange rate? a. We should expect no change in the forward exchange rate. b. We would expect the forward exchange rate to move above 140 JPY per USD. c. IRP does not apply to this situation. d. We would expect the forward exchange rate to move below 140 JPY per USD.
+$14,536
Bob's Your Uncle Corporation is considering a project and has developed the following estimates: unit sales = 9,200, price per unit = $71, variable cost per unit = $44, annual fixed costs = $15,200. The depreciation is $18,800 per year and the tax rate is 21 percent. What effect would an increase of $2 in the selling price have on the operating cash flow?
Cannot. Earnings per share is reported instead.
Cash flow (can/cannot) be reported as alternative to accounting income.
1
Value of market-to-book ratio less than ____ could mean that the firm has not been successful overall in creating value for its stockholders.
best case, base case, worst case
What alternative assumptions should we consider when doing a scenario analysis?
The firm's needed investment in new assets. The degree of financial leverage the firm chooses to employ. The amount of cash the firm thinks is necessary and appropriate to pay shareholders. The amount of liquidity and working capital the firm needs on an ongoing basis.
What are the basic elements of a firm's financial policy needed to develop an explicit financial plan?
short-term solvency/liquidity, long-term solvency/financial leverage, asset management/turnover, profitability, and market value
What are the financial ratios traditionally grouped as?
operating, investing, financing
What are the three categories in a statement of cash flows?
those that vary directly with sales and those that do not
What are the two groups that the extended version of simple models can separate the income statement and balance sheet into?
debt-equity ratio, equity multiplier
What are the two useful variations of the total debt ratio?
at least 1
What current ratio should you normally expect to see?
high fixed costs
What does a high operating leverage mean?
low fixed costs
What does a low operating leverage mean?
Take a closer look at the project. Do not automatically accept.
What does a positive NPV on a base case mean?
decrease in asset account (on a net basis), or a sale of assets
What is an example of a source of cash?
increasing assets or decreasing liabilities
What is an example of use of cash?
short-term liquidity
What is the current ratio used for?
inventory is omitted from the quick ratio as it is the least liquid current asset
What is the difference between the quick (or acid-test) ratio and the current ratio?
internal and external
What kinds of comparison are ratios used for?
an inefficient use of cash and other short-term assets
What would a high current ratio indicate to a firm?
translation exposure
When a U.S. company calculates its accounting net income and E P S for some period, it must "translate" everything into dollars.
duponte identity
breaks roe into operating efficiency (profit margin), asset use efficiency (total asset turnover), and financial leverage (equity multiplier)
cash breakeven
the sales level that results in a zero operating cash flow. covers operating expenses
accounting breakeven
the sales level when net income is 0. covers capital costs
profit margin
there is a significant variation in ______ ________ across industries
all, all
total debt ratio considers _____ debts of _____ creditors and has two useful variations.
the same
In the simple financial planning model, every item increases at (the same/a different) rate as sales.
accounting breakeven
In which breakeven analysis is operating cash flow equal to depreciation?
T. low values indicate low liquidity
T or F: Net working capital to total assets can indicate levels of liquidity.
higher
(higher/lower) operating leverage makes a company more susceptible to forecasting risk.
higher
(lower/higher) P/E ratios often mean the firm has significant prospects for future growth, but it could also mean a firm had no (or almost no) earnings.
fixed
(variable/fixed) costs are like a lever that magnify profits or losses
PM: .1185 (11.85%) X TAT: 2 X EM 1.5
A firm has Sales of $3,000,000, Earnings Before Taxes (EBT) of 15% of revenues, taxes of 21%, total assets of $1,500,000, and a debt-to-equity ratio of 0.5. What is the DuPont Identity (Profit Margin * Total Asset Turnover * Equity Multiplier)?
.237
A firm has Sales of $3,000,000, Earnings Before Taxes (EBT) of 15% of revenues, taxes of 21%, total assets of $1,500,000, and a debt-to-equity ratio of 0.5. What is the return on assets?
.3555
A firm has Sales of $3,000,000, Earnings Before Taxes (EBT) of 15% of revenues, taxes of 21%, total assets of $1,500,000, and a debt-to-equity ratio of 0.5. What is the return on equity?
4.667
A firm has cash of $120 million, fixed assets worth $450 million, inventory worth $180 million, accounts receivable of $100 million, accounts payable and notes payable of $300 million, and long-term debt of $400 million. What is the firm's debt-to-equity ratio?
.733
A firm has cash of $120 million, fixed assets worth $450 million, inventory worth $180 million, accounts receivable of $100 million, accounts payable and notes payable of $300 million, and long-term debt of $400 million. What is the firm's quick ratio?
Enterprise value
EBITDA multiple relates the value of all the operating assets (enterprise value) to a measure of the operating cash flow generated by those assets (EBITDA).
Can. (however, many firms are conglomerates or operate very differently, even in the same sector.)
Financial statements (can/cannot) be compared on a common-size basis/common base year
selling off equipment and outsourcing part of the production.
Firms can decrease operating leverage by
buying more equipment
Firms can increase operating leverage by
NPV
Firms may not be able to take on every positive ______ opportunity.
overall positions
Firms must be conscious of their______ ______ in a foreign currency and make coordinated decisions regarding any hedging strategies
Variable costs
Given Year One Projections Base Case: 20,000 units, $50 price, $30 cost, $125,000 fixed cost Lower Bound: 18,000 units, $40 price, $25 cost, 100,000 fixed costs Upper Bound: 22,000 units, $60 price, $35 cost, $150,000 fixed costs is the company exposed to more risk due to changes in fixed costs or variable costs?
is
Growing intentionally at the right rate (is/is not) important.
increase profit margin, increase asset turnover, use debt optimally
How can you increase ROE?
b.
If inflation is higher in the United Kingdom than in the United States, what would we expect in terms of exchange rates according to Purchasing Power Parity? a. We would expect no change in the exchange rate. b. We would expect the U.S. Dollar to appreciate as compared to the Pound Sterling. c. PPP does not apply in this situation. d. We would expect the Pound Sterling to appreciate as compared to the U.S. Dollar.
Covered Interest Arbitrage
If the change in the forward exchange rate of the JPY and USD in the previous question does not fully account for the difference in interest rates between the two countries, there may be an opportunity for what?
Sensitivity Analysis
If we consider a range of possible values for only one variable in our Net Present Value (NPV) projections, what is that called?
-$474,000
In The Ballpark (ITB) Corporation is considering a project and has developed the following estimates: unit sales = 120,000, price per unit = $220, variable cost per unit = $170, annual fixed costs = $38,000. The depreciation is $25,000 per year and the tax rate is 21 percent. What effect would a decrease of 10% in the unit sales have on the operating cash flow?
cash be < accounting be < financial be
List the types of breakeven analysis from least to greatest.
contribution
Managers are often concerned with the _______ a project will make to the firm's total accounting earnings.
low operating leverage
Many managers prefer ______ ______ ______ to keep the breakeven point lower.
440 hoodies
Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. What is the quantity needed to reach accounting break-even?
400 hoodies
Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. What is the quantity needed to reach cash break-even?
1,400
Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. What is the quantity needed to reach financial break-even?
$1,000
Mocktober Clothing is considering a new project to sell a unique annual hoodie for each of the next 5 years. All costs associated with annual changes are integrated into the variable and fixed costs. Moctober will sell hoodies for $50 each and estimate a variable cost of production per hoodie at $25 each. Fixed costs will be $10,000 annually. Cost of the machinery to produce the hoodies will be $5,000, depreciated straight-line over the course of 5 years ($1,000 per year). The operating cash flow necessary for the project to have an NPV of $0 would be $25,000. what OCF would be required in order to reach accounting break-even?
forecasting risk
NPV Calculations are estimates with _______ ______.
Triangular Arbitrage
The U.S. Dollar and Euro are exchanging at parity. Two other current observed exchange rates are $1.14 per GBP and 0.864 GBP per EUR. Given these exchange rates, there may be an opportunity for what?
15-20 range
Price to earnings ratios vary significantly across companies, but in 2020, a typical large company in the U.S. had a PE in the ______________.
P/E ratio is not meaningful due (for example: a firm has negative earnings for extended periods)
Price-sales ratio is useful if ___________
compare
Ratios can be used to _______ companies and firms over time.
international fisher effect
Real Interests Rates should be the same across countries. Over the long term, all else equal, we would expect the country with the higher interest rate to see its currency depreciate.
large
Relatively (small/large) inventories are often a sign of short-term trouble.
18,000 units, $40 price, $35 cost, $150,000 fixed costs
Suppose you are given the following information. What would be the assumptions for the worst case scenario? Year One Projections Base Case: 20,000 units, $50 price, $30 cost, $125,000 fixed cost Lower Bound: 18,000 units, $40 price, $25 cost, 100,000 fixed costs Upper Bound: 22,000 units, $60 price, $35 cost, $150,000 fixed costs
higher
To a creditor, is it better if the current ratio higher or lower?
to a very short term creditor
To whom would a cash ratio possibly be of interest?
difficult
Tobin's Q is (easy/difficult) to calculate with accuracy because estimating the replacement cost of a firm's assets is not an easy task and market values for a firm's debt are often unobservable.
superior
Tobin's Q ratio is (inferior/superior) to the market-to-book ratio because it focuses on what the firm is worth today relative to what it would cost to replace it today.
net importers
Who does a strong dollar favor?
net exporters
Who does a weak dollar favor?
-$79,000
You are analyzing a BLO Corporation project and have developed the following estimates. The depreciation is $15,000 a year and the tax rate is 21 percent. How would a 4% reduction in the price per unit impact the base case operating cash flow? Year One Projections Base Case: 50,000 units, $50 price, $30 cost, $150,000 fixed costs Lower Bound: 45,000 units, $40 price, $25 cost, $100,000 fixed costs Upper Bound: 55,000 units, $60 price, $35 cost, $200,000 fixed costs
$22,900
You are analyzing a BLO Corporation project and have developed the following estimates. The depreciation is $15,000 a year and the tax rate is 21 percent. What is the worst-case operating cash flow? Year One Projections Base Case: 50,000 units, $50 price, $30 cost, $150,000 fixed costs Lower Bound: 45,000 units, $40 price, $25 cost, $100,000 fixed costs Upper Bound: 55,000 units, $60 price, $35 cost, $200,000 fixed costs
financial managers
______ ______ have least control over sales volume, but it can be analyzed numerous ways.
interval measure
______ ______ indicates how long the business can continue.
Ratios
_______ aren't always computed the same way by everyone.
breakeven
_______ helps us to understand the relationship between sales volume and profitability.
Forecasting risk
________ ________ refers to the possibility that errors in projected cash flows will lead to incorrect decisions.
accounting
________ breakeven is often used as an early stage screening number.
cash coverage ratio
a basic measure of the firm's ability to generate cash from operations and is frequently used as a measure of cash flow available to meet financial obligations.
return on equity
a measure of how the stockholders fared during the year, or how much money the company generated in profit for every dollar in equity.
return on assets
a measure of profit per dollar of assets
percentage of sales approach
a planning method in which accounts are varied depending on a firm's predicted sales levels.
aggregation
a process by which small investment proposals of each of a firm's operational units are added up and treated as one big project.
high
all other things equal, a relatively (low/high) profit margin is desireable.
sensitivity analysis
an investigation of what happens to NPV when only one variable is changed.
short-run exposure
characterized by day-to-day fluctuations in exchange rates creating short-run risks for international firms.
long-run exposure
characterized by fluctuations in the value of a foreign operation because of unanticipated changes in relative economic conditions.
simulation analysis
combination of scenario and sensitivity analysis, wherein we allow all items to vary at the same time.
market-to-book ratio
compares the market value of the firm's investments to their costs.
operating leverage
degree to which firm or project relies on fixed costs
relative purchasing power parity
does not tell us what determines the absolute level of the exchange rate, but rather what determines the change in the exchange rate over time.
Planning dimensions
examine interactions, explore options, avoid surprises, ensure feasibility, and foster internal consistency are all what?
pro forma statements
financial plan will have a forecast balance sheet, income statement, and statement of cash flows. These are called _____ ______ ___________
high
firms with ______ Q ratios tend to be those with attractive investment opportunities or significant competitive advantages (or both)
profit margin x total asset turnover x financial leverage
formula for ROE using the dupont identity
0, 1
if fixed costs equals ___, then the degree of operating leverage is equal to ____.
Enterprise value
is an estimate of the market value of the company's operating assets, which include all assets of the firm except cash.
long-term debt ratio
long-term debt/(long-term debt + total equity)
2-5
long-term planning is typically __________ years out
historical costs
market-to-book ratio focuses on ______ _____, which are less relevant.
NWC turnover
measures how much "work" we get out of our working capital
price to earnings ratio
measures how much investors are willing to pay per dollar of current earnings
times interest earned ratio (tie)
measures how well a company has its interests obligations covered, and is often called the interest coverage ratio
profit margin
measures how well a company makes money, aka how much money it generates in profit for every dollar in sales
sales forecast
nearly all financial plans require an externally supplied _______ ______. It will often be given as the growth rate in sales.
asset requirements
plan will describe projected capital spending and, at a minimum, the projected balance sheet will contain changes in total fixed assets and net working capital
economic assumptions
plan will explicitly state the economic environment in which the firm expects to reside over plan's life
financial requirements
plan will include a section about the necessary financing arrangements
breakeven analysis
popular and commonly used tool for analyzing the relationship between sales volume and profitability.
financial model
sales forecast, proforma statements, asset requirements, financial requirements, the plug, and economic assumptions are all elements of a ____________ ___________
financial breakeven
the sales level that results in a zero NPV. covers financial costs (required return)
days' sales in inventory
shows how many days inventory sits (on average) before it is sold.
receivables turnover
shows how many times a firm collects outstanding credit accounts and reloans the money
Inventory turnover
tells how many times the firm sold off/turned over the entire inventory
total assets turnover
tells how much the company generates in sales for every dollar in assets
fixed asset turnover
tells how much the company generates in sales for every dollar in fixed assets
the plug
the designated source of external financing needed to deal with any shortfall (or surplus) in financing and thereby bring the balance sheet into balance
scenario analysis
the determination of what happens to NPV estimates when we ask what-if questions.
absolute purchasing power parity
the idea that a commodity costs the same regardless of what currency is used to purchase it or where it is selling.
purchasing power parity (PPP)
the idea that the exchange rate adjusts to keep purchasing power constant among currencies
forecasting risk
the possibility that errors in projected cash flows will lead to incorrect decisions
straight line
the relationship between sales volume and operating cash flow is a _____ _____. If sales volume increases ocf increases.
political risk
the risk related to changes in value that arise because of political actions
exchange rate risk
the risk related to having international operations in a world where relative currency values vary.
