Exam 1 Study Guide FINC 3331

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Brown Office Supplies recently reported $13,000 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 25%. How much was the firm's earnings before taxes (EBT)?

2,370 Bonds $9,000 Interest rate 7.0% Sales $13,000 Operating costs excluding depr'n -$8,250 Depreciation -$1,750 Operating income (EBIT) $3,000 Interest charges -$630 EBT = Taxable income$2,370

Brown Fashions Inc.'s December 31, 2020 balance sheet showed total common equity of $4,050,000 and 140,000 shares of stock outstanding. During 2021, the firm had $450,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/21, assuming no common stock was either issued or retired during 2021? (Round your final answer to two decimal places.)

$31.43 12/31/20 common equity $4,050,000 2021 net income $450,000 2021 dividends $100,000 2021 addition to retained earnings $350,000 12/31/21 common equity $4,400,000 Shares outstanding 140,000 12/31/21 BVPS$31.43 ​

Companies E and P each reported the same earnings per share (EPS), but Company E's stock trades at a higher price. Which of the following statements is CORRECT?

Company E trades at a higher P/E ratio.

You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:

A secondary market transaction

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ ​ ​ ​ ​ Refer to Exhibit 4.1. What is the firm's BEP? Do not round your intermediate calculations.

BEP = EBIT/Total assets = 5.50%

provides a snapshot of a firm's financial position at one point in time

Balance sheet

Which of the following statements is CORRECT? Answers: a. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. b. Capital market instruments include both long-term debt and common stocks. c. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. d. An example of a primary market transaction would be your uncle transferring 100 shares of Walmart stock to you as a birthday gift. e. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically.

Capital market instruments include both long-term debt and common stocks.

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ ​ ​ ​ ​ Refer to Exhibit 4.1. What is the firm's current ratio? Do not round your intermediate calculations.

Current ratio = Current assets/Current liabilities = 1.11

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ ​ ​ ​ ​ Refer to Exhibit 4.1. What is the firm's dividends per share? Do not round your intermediate calculations.

DPS = Common dividends paid/Shares outstanding = $1.17

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ ​ ​ ​ ​ Refer to Exhibit 4.1. What is the firm's total debt to total capital ratio? Do not round your intermediate calculations.

Debt to capital ratio = (ST Debt + LT Debt)/(ST Debt + LT Debt + Common Equity) = 53.57%

Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes.

False

Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement.

False

The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world.

False

The amount shown on the December 31, 2019 balance sheet as "retained earnings" is equal to the firm's net income for 2019 minus any dividends it paid

False

The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock.

False

Trades on the NYSE are generally completed by having a brokerage firm acting as a "dealer" buy securities and adding them to its inventory or selling from its inventory. The NASDAQ, on the other hand, operates as an auction market, where buyers offer to buy, and sellers to sell, and the price is negotiated on the floor of the exchange.

False

Consider the following balance sheet for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000. Cash $50,000 Accounts payable $100,000 Inventory $200,000 Accruals $100,000 Accounts receivable $250,000 Total CL $200,000 Total CA $500,000 Long-term debt $200,000 Net fixed assets $900,000 Common stock $200,000 Retained earnings $800,000 Total assets $1,400,000 Total L & E $1,400,000 ​

False Note that the firm has only $50,000 of cash. It would have to either sell assets or borrow $150,000 to pay cash for the new asset. That might not be possible.

If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.

False - There is no reason to think that net income would be equal to FCF. For example, a company that is not growing might report zero net income yet have high FCF because of depreciation.

summarizes a firm's revenues and expenses over a given period of time

IncomeStatement

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ ​ ​ ​ ​ Refer to Exhibit 4.1. What is the firm's inventory turnover ratio? Assume that the firm's cost of goods sold is 65% of sales. Do not round your intermediate calculations.

Inventory turnover ratio =Cost of Goods Sold/Inventory = 2.38

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?

Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

Moose Industries has a corporate tax rate of 25%. Last year the company realized $14,000,000 in operating income (EBIT). Its annual interest expense is $1,500,000. What was the company's net income for the year?

Operating income $14,000,000 Interest expense $1,500,000 Taxable income = Operating income - Interest expense Taxable income = $14,000,000 - $1,500,000 Taxable income = $12,500,000 Tax liability = Taxable income x Tax Rate $3,125,000 Net income = Taxable income - Taxes Net income = $9,375,000

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ Refer to Exhibit 4.1. What is the firm's P/E ratio? Do not round your intermediate calculations

P/E ratio = Price per share/Earnings per share = 12.0 We actually fixed the P/E ratio at 12 in order to get a stock price. Either the price or the P/E ratio must be fixed or the model becomes very complicated and a stock pricing equation is required.

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 ​ What is the firm's ROA? Do not round your intermediate calculations.

ROA = Net income/Total assets = 2.78%

The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $)Assets 2021 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity Accounts payable $17,160 Accruals 9,240 Notes payable 6,000 Total current liabilities $32,400 Long-term bonds $12,000 Total liabilities $44,400 Common stock $3,900 Retained earnings 11,700 Total common equity $15,600 Total liabilities and equity $60,000 Income Statement (Millions of $)2021Net sales $66,000 Operating costs except depreciation 61,380 Depreciation 1,320 Earnings before interest and taxes (EBIT) $3,300 Less interest 1,080 Earnings before taxes (EBT) $2,220 Taxes (25%) 555 Net income $1,665 Other data: Shares outstanding (millions) 500.00 Common dividends (millions of $) $582.75 Int. rate on notes payable & L-T bonds 6% Federal plus state income tax rate 25% Year-end stock price $39.96 What is the firm's EPS? Do not round your intermediate calculations.

Rationale: EPS = Net income/Common shares outstanding = $3.33

reports the impact of a firm's activities on cash flows over a given period of time

Statement of cash flow

shows how much of the firm's earnings were retained, rather than paid out as dividends

Statement of stockholders equity

A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary.

True

Which of the following statements is CORRECT? Answers: a. Home mortgage loans are traded in the money market. b. The New York Stock Exchange is an auction market, and it has a physical location. c. While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. d. Capital markets deal only with common stocks and other equity securities. e. If an investor sells shares of stock through a broker, then it would be a primary market transaction.

The New York Stock Exchange is an auction market, and it has a physical location.

You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction?

This is an example of a direct transfer of capital.

Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $46.00 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA?

Total book value of equity $20,000,000 Stock price per share $46.00 Shares outstanding 1,000,000 Market value of equity Stock price Number of shares $46,000,000 MVA Market value of equity Book value of equity $26,000,000

Each stock's rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A weighted average of those returns, using each stock's total market value, is then calculated, and that average return is often used as an indicator of the "return on the market."

True

Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.

True

​If you decide to buy 100 shares of Google, you would probably do so by calling your broker and asking him or her to execute the trade for you. This would be defined as a secondary market transaction, not a primary market transaction.

True


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