FINA ch 2 & 3

costs that do not change in the short run arise because of ....

fixed commitments

true:

free cash flow is very similar to cash flow from assets.

book

on the balance sheet, assets are listed at their _____ value

marginal tax rate

the extra tax you would pay if you earned one more dollar

noncash items

expenses charged against revenues that do not directly affect cash flows, such as depreciation.

the following would help a company take action to improve its ratios:

1. comparing to its own historical ratios 2. comparing to aspirant companies 3. comparing to peer companies 4. comparing to major competitors

long-term solvency ratios are also known as:

financial leverage ratios

Wes Motors has total assets of $98,300, net working capital of $11,300, owners' equity of $41,600, and long-term debt of $38,600. What is the value of the current assets?

$29,400

marginal tax rate

% tax paid on the next dollar earned

noncash items

- expenses charged against revenue that do not affect cash flow - Depreciation = the most important

for a mature firm, operating cash flow:

- is a sign of trouble if negative over a long period of time - is usually positive

components of cash flow from assets:

1. capital spending 2. operating cash flow 3. change in net working captial

based on the DuPont identity, an increase in sales, all else held equal, _______ ROE

a) may not change b) may increase or decrease

explaining the upward trend in the inventory turnover ratio requires:

1. examination of whether the increase is due to declining inventory or increasing sales 2. further investigation

marginal tax rates are the most important tax rates because:

1. financial decisions are usually based on new cash flows 2. incremental cash flows are taxed at marginal tax rates

these questions can be answered by reviewing a firm's balance sheet:

1. how much debt is used to finance the firm? 2. what is the total amount of assets the firm owns?

the 4 factors that affect a firm's sustainable growth rate are:

1. profit margin 2. dividend policy 3. financial policy 4. total asset turnover

the following create problems with financial statement analysis:

1. the firm and its competitors operate under different regulatory environments 2. the firm or its competitors are global companies 3. the firm or its competitors are conglomerates

true of financial ratios:

1. they are developed from a firm's financial information 2. they are used for comparison purposes

common-size statements are best used for comparing:

1. year-to-year for your firm 2. competitors 3. firms of different sizes

Motor Works has total assets of $919,200, long-term debt of $264,500, total equity of $466,900, net fixed assets of $682,800, and sales of $1,021,500. The profit margin is 6.2 percent. What is the current ratio?

1.26

PE ratio

Because the PE ratio measures how much investors are willing to pay per dollar of current earnings, higher PEs are often taken to mean that the firm has significant prospects for future growth. Of course, if a firm had no or almost no earnings, its PE would probably be quite large; so, as always, care is needed in interpreting this ratio.

product costs are usually shown on the income statement under the heading of ...

COGS

cash flow from assets

Cash flow from assets involves three components: operating cash flow, capital spending, and change in net working capital. Operating cash flow refers to the cash flow that results from the firm's day-to-day activities of producing and selling. Expenses associated with the firm's financing of its assets are not included because they are not operating expenses.

Which one of these transactions will increase the liquidity of a firm?

Credit sale of inventory at cost

equity

Equity holders are only entitled to the residual value, the portion left after creditors are paid. The value of this residual portion is the shareholders' equity in the firm, which is just the value of the firm's assets less the value of the firm's liabilities

financial ratio categories

Financial ratios are traditionally grouped into the following categories: Short-term solvency, or liquidity, ratios. Long-term solvency, or financial leverage, ratios. Asset management, or turnover, ratios. Profitability ratios. Market value ratios.

recognition principle

The general rule (the recognition principle) is to recognize revenue when the earnings process is virtually complete and the value of an exchange of goods or services is known or can be reliably determined. In practice, this principle usually means that revenue is recognized at the time of sale, which need not be the same as the time of collection.

market value VS book value

The true value of any asset is its market value, which is simply the amount of cash we would get if we actually sold it. In contrast, the values shown on the balance sheet for the firm's assets are book values and generally are not what the assets are actually worth.

you should keep in mind when examining an income statement :

cash vs noncash items time and costs GAAP

financial leverage

The use of debt in a firm's capital structure is called financial leverage. The more debt a firm has (as a percentage of assets), the greater is its degree of financial leverage.

average tax rate vs marginal tax rate

Your average tax rate is your tax bill divided by your taxable income, in other words, the percentage of your income that goes to pay taxes. Your marginal tax rate is the extra tax you would pay if you earned one more dollar. The percentage tax rates shown in Table 2.3 are all marginal rates. Put another way, the tax rates in Table 2.3 apply to the part of income in the indicated range only, not all income.

total assets

a common-size balance sheet expresses accounts as a percentage of _____

26 cents

a firm with a 26% return on equity earned ______ cents in profit for every one dollar in shareholder's equity

created

a firm with a market-to-book value that is greater than 1 is said to have ____ value for shareholders

balance sheet

a snapshot of the firm. a convenient means of organizing and summarizing what a firm owns (its assets), what a firm owes (its liabilities), and the difference between the two (the firm's equity) at a given point in time

cash ratio

a very short-term creditor might be interested in the ___

true:

a way to establish a benchmark for ratio analysis is to identify a peer group

exception

financial statement analysis is primarily "management by _____"

a balance sheet reflects a firms

accounting value on a specific date

current ratio

accounts payable and cash are used to compute the current ratio

net earnings refers to income earned ____

after interest and taxes

increase

an increase in a firm's total asset turnover will _____ the sustainable growth rate

financial ratios

another way of avoiding the problems involved in comparing companies of different sizes is to calculate and compare financial ratios . such ratios are ways of comparing and investigating the relationships between different pieces of financial information

liabilities

appear on the RIGHT side of the balance sheet

financial ratios

are NOT computed in the same manner by all firms

shareholders

are entitled to the residual value of a firm's cash flows

under GAAP :`

audited financial statements in the USA generally show assets at historical cost. so assets are "carried on the books" at what the firm paid for them, (minus accumulated depreciation)... no matter how long ago they were purchased or how much they are worth today

the DuPont Identity

can help to explain why 2 firms with the same return on equity may not be operating in the same way

in finance, the value of a firm depends on its ability to generate

cash flows

net working capital =

current assets - current liabilities

liquidity

current assets on the common-size balance sheet over the past 3 years have increased from 32 to 35% while the current liabilities have decreased from 29 to 25%. this indicates that the firm has increased its ______

fixed assets / equipment

depreciation is the accountant's estimate of the cost of __________ used in the production process matched with the benefits produced from owning it

Donovan's would like to increase its internal rate of growth. Decreasing which one of the following will help the firm achieve its goal?

dividend payout ratio

using cash to buy inventory

does not affect the current ratio, but it reduces the quick ratio

less than

if a company has inventory, the quick ratio will always be _____ the current ratio

A common-size balance sheet helps financial managers determine:

if changes are occurring in a firm's mix of assets.

increase

if sales increase while there is no change in AR, the receivables turnover ratio will _____

net earnings

income earned after interest and taxes

According to GAAP

income is reported when it is earned or accrued

Which one of the following is the maximum growth rate that a firm can achieve without any additional external financing?

internal growth rate

time-trend analysis

is an example of management by exception

for financial decision-making purposes, the most important tax rate is the ____ tax rate

marginal

production efficiency

must take into account the fixed assets

what is the main difference between the cash coverage ratio and the times interest earned ratio

non-cash expenses

true ...

operating cash flow does not include depreciation or interest. depreciation is a non-cash expense and interest is a financing expense. we ass depreciation BACK to EBIT in order to reflect the fact that we didnt pay it out in cash

tangible

physical assets are termed ____ assets

if a company has had negative earnings for several periods they might choose to use a ______

price-sales ratio

Leon is the owner of a corner store. Which ratio should he compute if he wants to know how long the store can pay its bills given its current level of cash and accounts receivable? Assume all receivables are collectible when due.

quick ratio

liquidity

refers to the speed and ease with which an asset can be converted to cash

If a firm has an inventory turnover of 15, the firm:

sells its entire inventory an average of 15 times each year.

net capital spending is equal to

the change in net fixed assets plus depreciation

the major downside of using financial statements for analysis is that....

the data contained in them is based on historical values and book values.

net working capital

the difference between a firm's current assets and its current liabilities is called net working capital. Net working capital is positive when current assets exceed current liabilities. Based on the definitions of current assets and current liabilities, this means that the cash that will become available over the next 12 months exceeds the cash that must be paid over that same period. For this reason, net working capital is usually positive in a healthy firm.

net working capital

the difference between a firm's current assets and its current liabilities. it is positive when current assets exceed current liabilities.

owner's equity

the difference between the total value of the assets (current and fixed) and the total value of the liabilities (current and long-term) is the shareholders' equity, also called common equity or owners' equity

income statement

the information needed to compute the profit margin can be found on the ____

leverage

the long-term debt on the common-size balance sheet of firm over the past 3 years is 30%, 34%, and 40%. This indicates that the firm has increased its ______

market

the price at which willing buyers and sellers would trade is called ____ value

a long time

the quick ratio provides a more reliable measure of liquidity than the current ratio especially when the company's inventory takes _____ to sell

financial leverage

the use of debt in a firm's capital structure is called financial leverage. the more debt a firm has (as a percentage of assets), the greater is its degree of financial leverage

when a firm has a days' sales in receivables of 45,

this means the firm collects its credit sales in 45 days on average

The Wood Shop generates $.97 in sales for every $1 invested in total assets. Which one of the following ratios would reflect this relationship?

total asset turnover

Common-size financial statements present all balance sheet account values as a percentage of:

total assets

average tax rate

total tax bill / taxable income

financial leverage refers to a firm's

use of debt in its capital structure

it will increase

what will happen to the current ratio if current assets increase, while everything else remains unchanged?

average tax rate

your tax bill divided by your taxable income. the percentage of your income that goes to pay taxes