Finance Exam 1

o Depreciation -

an annual charge against income that reflects the estimated dollar cost of the capital equipment and other tangible assets that were depleted in the production process (not a cash expenses)

o Operating activities -

deals with items that occur as part of normal ongoing operations

· The stock market -

where the prices of firms stocks are established

· Finance -

"the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities."

· Free Cash Flow = [EBIT (1 - t) + Depreciation and amortization] - [ capital expenditures + change in net operating working capital] o NOPAT or net operating profit after taxes - EBIT (1-t) o depreciation and amortization are added back because these are noncash expenses that reduce EBIT but do not reduce the amount of cash the company has available to pay its investors o second bracketed term indicates amount of cash company investing in fixed assets (capital expenditures); cash used to purchase new fixed assets; under Cash flow o and operating working capital in order to sustain ongoing operations o negative FCF means the company does not have sufficient internal funds to finance investments in fixed asssets and working capital and that it will have to raise new money in the capital markets to pay for the investments o change in net operating working capital o most rapid growing companies have negative FCFs —the fixed assets and working capital needed to support a firm's rapid growth generally exceed cash flows from its existing operations. This is not bad, provided a firm's new investments are eventually profitable and contribute to its FCF.

******= [_________ (_________) + _________ and _________] - [ _________ + _________ ] § Def - the amount of cash that could be withdrawn without harming a firm's ability to operate and to produce future cash flows o NOPAT or net operating profit after taxes - EBIT (1-t) o _________ and _________ are added back because these are noncash expenses that reduce EBIT but do not reduce the amount of cash the company has available to pay its investors o second bracketed term indicates amount of cash company investing in _________ assets (capital _________); cash used to purchase new fixed assets; under Cash flow o and operating working capital in order to sustain ongoing operations o negative FCF means the company does not have sufficient internal funds to finance investments in fixed asssets and working capital and that it will have to raise new money in the capital markets to pay for the investments o change in net operating working capital o most rapid growing companies have negative FCFs —the fixed assets and working capital needed to support a firm's rapid growth generally exceed cash flows from its existing operations. This is not bad, provided a firm's new investments are eventually profitable and contribute to its FCF.

10. Private equity companies are organizations that operate much like hedge funds, but rather than purchasing some of the stock of a firm, private equity players buy and then manage entire firms. Most of the money used to buy the target companies is borrowed. While private equity activity slowed around the financial crisis, over the past decade a number of high-profile companies (including H.J. Heinz, Dell Computer, Harrah's Entertainment, Albertson's, Neiman Marcus, Clear Channel, and Keurig Green Mountain) have been acquired by private equity firms. o With exception of hedge funds and private equity companies, financial institutions are regulated to ensure the safety of these institutions and to protect investors

10. ________ are organizations that operate much like hedge funds, but rather than purchasing some of the stock of a firm, these players buy and then manage entire firms. Most of the money used to buy the target companies is borrowed. While ________ activity slowed around the financial crisis, over the past decade a number of high-profile companies (including H.J. Heinz, Dell Computer, Harrah's Entertainment, Albertson's, Neiman Marcus, Clear Channel, and Keurig Green Mountain) have been acquired by these firms. o With exception of hedge funds and these companies, financial institutions are regulated to ensure the safety of these institutions and to protect investors

§ Financial services corporations -

A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking; are large conglomerates that combine many different financial institutions within a single corporation. Most financial services corporations started in one area but have now diversified to cover most of the financial spectrum.

§ Over-the-Counter (OTC) Market

A large collection of brokers and dealers, connected electronically by telephones and computers, that provides for trading in unlisted securities.

· Marginal Investor-

An investor whose views determine the actual stock price. ; not all investors agree so its these who determine the actual price

§ Investment banks - (1) help corporations design securities with features that are currently attractive to investors, (2) buy these securities from the corporation, and (3) resell them to savers. Because they generally guarantees that the firm will raise the needed capital, these bankers are also called underwriters. The credit crisis has had a dramatic effect on the investment banking industry. Bear Stearns collapsed and was later acquired by JPMorgan, Lehman Brothers went bankrupt, and Merrill Lynch was forced to sell out to Bank of America. The two "surviving" major investment banks (Morgan Stanley and Goldman Sachs) received Federal Reserve approval to become commercial bank holding companies.

An organization that underwrites and distributes new investment securities and helps businesses obtain financing; traditionally help companies raise capital. They (1) help corporations design ________ with features that are currently attractive to ________, (2) ________ these ________ from the corporation, and (3) ________ them to ________. Because they generally guarantees that the firm will raise the needed capital, these bankers are also called ________. The credit crisis has had a dramatic effect on the investment banking industry. Bear Stearns collapsed and was later acquired by JPMorgan, Lehman Brothers went bankrupt, and Merrill Lynch was forced to sell out to Bank of America. The two "surviving" major investment banks (Morgan Stanley and Goldman Sachs) received Federal Reserve approval to become commercial bank holding companies.

§ (2) partnerships, are similar to proprietorships in that they can be established relatively easily and inexpensively. Moreover, the firm's income is allocated on a pro rata basis to the partners and is taxed on an individual basis. This allows the firm to avoid the corporate income tax. However, all of the partners are generally subject to unlimited personal liability, which means that if it goes bankrupt and any partner is unable to meet his or her pro rata share of the firm's liabilities, the remaining partners will be responsible for making good on the unsatisfied claims. Thus, the actions of a Texas partner can bring ruin to a millionaire New York partner who had nothing to do with the actions that led to the downfall of the company. Unlimited liability makes it difficult for these to raise large amounts of capital.

An unincorporated business owned by two or more persons. ; is a legal arrangement between two or more people who decide to do business together. are similar to proprietorships in that they can be established relatively ________ and ________. Moreover, the firm's income is allocated on a ________ basis to the partners and is taxed on an ________ basis. This allows the firm to avoid the ________ income tax. However, all of the partners are generally subject to ________ personal liability, which means that if it goes bankrupt and any partner is unable to meet his or her pro rata share of the firm's liabilities, the ________ will be responsible for making good on the ________ claims. Unlimited liability makes it difficult for these to raise ________ amounts of capital.

· public markets,

By contrast, securities that are traded in _______ markets (for example, common stock and corporate bonds) are held by a large number of individuals. These securities must have fairly standardized contractual features because _______ investors do not generally have the time and expertise to negotiate unique, nonstandardized contracts. Broad ownership and standardization result in _______ traded securities being more liquid than tailor-made, uniquely negotiated securities.

notes payable, bonds, dividends to stockholders

Financing activities include

o Physical location stock exchages -

Formal organizations having tangible physical locations that conduct auction markets in designated ("listed") securities. ; are tangible entities. Each of the larger exchanges occupies its own building, allows a limited number of people to trade on its floor, and has an elected governing body—its board of governors.; security exchanges facilitate communication between buyers and sellers

· Forms of business organization o There are four main forms of business organizations: § (1) proprietorships, § (2) partnerships, § (3) corporations : § (4) limited liability companies (LLCs) - § (4 pt 2)and limited liability partnerships (LLPs):

Forms of business organization o There are four main forms of business organizations:

§ Corporate raider -

If a firms stock is undervalued, this will see it as a bargain and will attempt to capture the firm in a hostile takeover ; Individuals who target corporations for takeover because they are undervalued.

(1) proprietorships 3 main advantages: (1) They are easy and inexpensive to form. (2) They are subject to few government regulations. (3) They are subject to lower income taxes than are corporations. · They also have 3 main limitations: (1) have unlimited personal liability for the business' debts, so they can lose more than the amount of money they invested in the company. (2) The life of the business is limited to the life of the individual who created it, and to bring in new equity, investors require a change in the structure of the business. (3) Because of the first two points, they have difficulty obtaining large sums of capital; hence, they are used primarily for small businesses. However, businesses are frequently started as these and then converted to corporations when their growth results in the disadvantages outweighing the advantages.

In terms of numbers, most businesses are this; is an unincorporated business owned by an individual; going into business as a sole this is easy, 3 main advantages: (1) They are ________ and ________ to form. (2) They are subject to ________ government ________. (3) They are subject to ________ income ________ than are ________. · They also have 3 main limitations: (1) have ________ personal liability for the business' ________, so they can ________ more than the amount of money they ________ in the company. (2) The life of the business is ________ to the life of the individual who ________ it, and to bring in new equity, investors require a ________ in the structure of the business. (3) Because of the first two points, they have difficulty obtaining ________ sums of ________; hence, they are used primarily for ________ businesses. However, businesses are frequently ________ as these and then ________ to corporations when their growth results in the disadvantages outweighing the advantages.

o Individuals Taxes - wages, salaries, investment income (dividends, interest, and profits from the sale of securities) and on the profits of proprietorships and partnerships

Individuals Taxes - _________, _________, _________ income (_________, _________, and _________ from the sale of securities) and on the profits of _________ and _________

Investing Activities · Additions to property, plant and equipment - this is an outflow (decrease) · Net cash used in investing activities - depends o. ^^

Investing Activities · Additions to _________, _________ and _________ - this is an _________ (_________) · Net cash used in investing activities - depends

Operating activities · Net income - the first operating activity, first source of cash, not equal to cash from operations · Depreciation and amortization - first adjustment ; must be added to net income when determining cash flow · Increase in inventories - to make or buy these, firm must use cash; (increase leads to decrease in cash, and vice versa) · Increase in accounts receivable - amount to a use of cash ; vice versa decrease · Increase in accounts payable - increase in cash · Increase in accrued wages and taxes - increase in cash · Net cash provided by operating activities - all of these combined!

Operating activities · _________ - the first operating activity, first source of cash, not equal to cash from operations · _________ and _________ - first _________ ; must be added to _________ when determining cash flow · Increase in _________ - to make or buy these, firm must use _________; (increase in this leads to _________ in _________, and vice versa) · Increase in _________ - amount to a _________ of _________ ; vice versa · Increase in _________ - _________ in cash · Increase in _________ wages and _________ - _________ in cash · Net cash provided by operating activities - _________ of these _________!

· Other sources of funds - most companies finance assets with combo of short term and long term debt, and common equity; some also use hybrid securities such as preferred stock, convertible bonds, and long term leases o Preferred stock - hybrid between common stock and debt o Convertible bonds - debt securities that give the bondholder an option to exchange their bonds for shares of common stock o Common stock - receiving a payment only when something remains after the debt and preferred stock are paid off

Other sources of funds - most companies finance assets with combo of short term and long term _______, and common _______; some also use hybrid securities such as preferred _______, _______ bonds, and long term _______ o _______ - hybrid between common stock and debt o _______ - debt securities that give the bondholder an option to exchange their bonds for shares of common stock o _______ - receiving a payment only when something remains after the debt and preferred stock are paid off

§ Hostile Takeover -

The acquisition of a company over the opposition of its management. If the raid is successful, the target's executives will almost certainly be fired. This situation gives managers a strong incentive to take actions to maximize their stock's price. In the words of one executive, "If you want to keep your job, never let your stock become a bargain."

o Dodd-Frank Act -

The legislation's main goals were to create a new agency for consumer protection, work to increase the transparency of derivative transactions, and force financial institutions to take steps to limit excessive risk taking and to hold more capital.

§ Commercial banks -

The traditional department store of finance serving a variety of savers and borrowers; such as Bank of America, Citibank, Wells Fargo, and JPMorgan Chase, are the traditional "department stores of finance" because they serve a variety of savers and borrowers. Historically, were the major institutions that handled checking accounts and through which the Federal Reserve System expanded or contracted the money supply. Today, however, several other institutions also provide checking services and significantly influence the money supply. Note too that the larger banks are generally part of financial services corporations

· Depreciation - o 2 sets of financial statements - one based on Internal revenue service (IRS) and used to calculate taxes; other is based on GAAP and is used for reporting to investors o Firms often use straight line this for stockholder reportingl use IRS this for texes o Prior to tax legislations, firms used MACRS depreciation, an accelerated depreciation which lowered taxable income, lowered taxes, and increased cash flows

_______ - o 2 sets of financial statements - one based on _______ (_______) and used to calculate taxes; other is based on _______ and is used for reporting to investors o Firms often use _______ line this for stockholder reporting l use IRS this for texes o Prior to tax legislations, firms used _______ depreciation, an accelerated depreciation which lowered taxable income, lowered taxes, and increased cash flows

· Debt management ratios = A set of ratios that measure how effectively a firm manages its debt. -leverage up = increase -debt exposes the firm to more risk than if financed only with equity ; 2 firms the exact same can differ if one used debt and the other didn't -> having the debt can benefit you if the market is good, but if it's bad it can cause many issues for a company o Firsm with relatively high debt ratios typically have higher expected returns when the economy is normal, but experience lower returns and possibly face bankruptcy if the economy goes into a recession ; use of debt requires firms to balance higher expected returns against increased risk t : (1) They check the balance sheet to determine the proportion of total funds represented by debt. (2) They review the income statement to see the extent to which interest is covered by operating profits. o Total debt to capital ratio or debt ratio: The ratio of total debt to total capital; it measures the percentage of the firm's capital provided by debtholders.; creditors prefer low, stockholders opposite b § Total debt / total capital = total debt / (total debt + equity) · Total debt = all short and long term interest bearing debt , does not include acc pay and accruals o Times interest earned ratio TIE : The ratio of earnings before interest and taxes (EBIT) to interest charges; a measure of the firm's ability to meet its annual interest payments; determined by dividing EBIT by interest changes; measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs § = earnings before interest and taxes (EBIT) / interest changes

_________ = A set of ratios that measure how effectively a firm manages its debt. -leverage up = _________ -debt exposes the firm to more _________ than if financed only with equity ; 2 firms the exact same can differ if one used _________ and the other _________ -> having the debt can _________ you if the market is good, but if it's bad it can cause many _________ for a company o Firsm with relatively high debt ratios typically have _________ expected returns when the economy is normal, but experience _________ returns and possibly face _________ if the economy goes into a recession ; use of debt requires firms to balance _________ expected returns against _________ risk o two procedures that analysts use to examine the firm's debt: (1) They check the _________ to determine the proportion of total funds represented by debt. (2) They review the _________ to see the extent to which interest is covered by operating profits. o _________: The ratio of total debt to total capital; it measures the percentage of the firm's capital provided by debtholders. § _________ / _________ = _________ / (_________ + _________) · _________= all short and long term interest bearing debt , does not include acc pay and accruals o _________ : The ratio of earnings before interest and taxes (EBIT) to interest charges; a measure of the firm's ability to meet its annual interest payments; determined by dividing EBIT by interest changes; measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs § = _________ / _________

Asset Management Ratios: A set of ratios that measure how effectively a firm is managing its assets; o Inventory turnover ratios - divide sales by some assets : sales / various assets; shos how many times the particular asset is turned over during the year ; ratio is calculated by dividing sales by inventories. It indicates how many times inventory is turned over during the year.this figure is for one point in time § = sales / inventories § Turnover - term that originated many years ago; working capital because it was what he actually sold or turned over to produce the profits o Days sales outstanding ratio - also called the average collection period how accounts receivable are evaluated; calculated by dividing accounts receivable by average sales per day. It indicates the average length of time the firm must wait after making a sale before it receives cash. § = receivables / average sales per day = receivables / (annual sales/365) o Fixed assets turnover ratio - The ratio of sales to net fixed assets. It measures how effectively the firm uses its plant and equipment. § = sales / net fixed assets · Fixed assets - shown on balance sheet at historical costs - depreciation ---inflation has caused the value of many assets that were purchased in the past to be seriously understated ; if we compare an old firm whose fixed assets have been depreciated with a new company with similar operations that acquired fixed assets only recently, the old firm will probably have the higher fixed assets turnover ratio; this is more reflective of the age of the assets than of inefficiency on the part of the new firm o Total assets turnover ratio - measures the turnover or how effective a firm uses of all/the total of the firms assets, calculated by dividing sales by total assets § =sales / total assets should be able to answer : does the amount of each type of asset seem reasonable, too high, or too low in view of current and projected sales -important because when companies acquire assets, they must obtain capital from banks or other sources and capital is expensive, therefore, if have too many assets, costs of capital will be too high, which will depress profits, or if too low, profitable sales will be lost

_________: A set of ratios that measure how effectively a firm is managing its assets; these ratios include : o_________ - divide sales by some assets : sales / various assets (particular asset is in the name); shos how many times the particular asset is turned over during the year ; ratio is calculated by dividing sales by inventories. It indicates how many times inventory is turned over during the year.; § = _________ / _________ § _________ - term that originated many years ago; working capital because it was what he actually sold or _________ to produce the profits o _________ - also called the average collection period how accounts receivable are evaluated; calculated by dividing accounts receivable by average sales per day. It indicates the average length of time the firm must wait after making a sale before it receives cash. § = _________ / average _________ per day = _________ / (_________ /_________) o _________- The ratio of sales to net fixed assets. It measures how effectively the firm uses its plant and equipment. § = sales / net fixed assets · Fixed assets - shown on balance sheet at _________ costs - _________ ---_________ has caused the value of many assets that were purchased in the past to be seriously _________ ; if we compare an old firm whose fixed assets have been depreciated with a new company with similar operations that acquired fixed assets only recently, the old firm will probably have the _________ fixed assets turnover ratio; this is more reflective of the _________ of the assets than of _________ on the part of the new firm o _________ - measures the turnover or how effective a firm uses of all/the total of the firms assets, calculated by dividing sales by total assets § =_________ / _________ should be able to answer : does the amount of each type of asset seem _________, too _________, or too _________ in view of current and projected _________ -important because when companies acquire assets, they must obtain _________ from _________ or other _________ and capital is _________, therefore, if have too many _________, costs of capital will be too _________, which will _________ profits, or if too low, profitable sales will be _________

· Balance sheet - o Left side shows the assets that company owns o Right side shows firms liabilities and stockholders equity (claims against the firms assets) § Assets are divided into two major categories (current assets and fixed or long term assets Current assets Long term assets

a snapshot of a firms position at a specific point in time ; A statement of a firm's financial position at a specific point in time. o Left side shows the _______ that company owns o Right side shows firms _______ and _______ _______ (claims against the firms assets) § Assets are divided into two major categories (_______ assets and _______ or _______ assets

· Statement of Stockholders Equity -

a statement that shows by how much a firms equity changed during the year and why this change occurred

§ Investing Activities -

all activities involving long term assets; also includes purchase and sale of short term investments other than trading securities and lending and collecting on notes receivables

o Authorization -

amounts to the same thing as depreciation except that it represents the decline in value of intangible assets such as patents, copyrights, trademarks, and goodwill (not a cash expenses)

9. Hedge funds

are also similar to mutual funds because they accept money from savers and use the funds to buy various securities, but there are some important differences. While mutual funds (and ETFs) are registered and regulated by the Securities and Exchange Commission (SEC), ________ are largely unregulated. This difference in regulation stems from the fact that mutual funds typically target small investors, whereas ________ typically have large minimum investments (often exceeding $1 million) and are marketed primarily to institutions and individuals with high net worths. ________ received their name because they traditionally were used when an individual was trying to hedge risks. However, some take on risks that are considerably higher than that of an average individual stock or mutual fund. While ________ have grown tremendously over the past two decades, the road has been a bit bumpy in recent years. ________ assets under management fell sharply after the financial crisis, and it wasn't until 2013 that they once again reached their pre-crisis levels. At the same time, many have come under fire for their high fees and suboptimal performance. They have also faced increased competition from other products and investment advisors. In the midst of this challenging environment, some funds have reduced their minimum investment requirements and fees.

§ 4. Credit unions Credit unions are often the cheapest source of funds available to individual borrowers.

are cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm. Members' savings are loaned only to other members, generally for auto purchases, home improvement loans, and home mortgages. _________ are often the cheapest source of funds available to individual borrowers.

7. Mutual funds Hence, there are bond funds for those who prefer safety, stock funds for savers who are willing to accept significant risks in the hope of higher returns, and money market funds that are used as interest-bearing checking accounts.

are corporations that accept money from savers and then use these funds to buy stocks, long-term bonds, or short-term debt instruments issued by businesses or government units. These organizations pool funds and thus reduce risks by diversification. They also achieve economies of scale in analyzing securities, managing portfolios, and buying and selling securities. Different funds are designed to meet the objectives of different types of savers. Hence, there are ________ funds for those who prefer safety, ________ funds for savers who are willing to accept significant risks in the hope of higher returns, and ________ funds that are used as interest-bearing checking accounts. Another important distinction exists between actively managed funds and indexed funds. Actively managed funds try to outperform the overall markets, whereas indexed funds are designed to simply replicate the performance of a specific market index. There are literally thousands of different ________ funds with dozens of different goals and purposes. Excellent information on the objectives and past performances of the various funds are provided in publications such as Value Line Investment Survey and Morningstar Mutual Funds, which are available in most libraries and on the Internet.

· Physical asset markets (also called "tangible" or "real" asset markets)

are for products such as wheat, autos, real estate, computers, and machinery.

· Spot markets

are markets in which assets are bought or sold for "on-the-spot" delivery (literally, within a few days).

· Secondary markets The New York Stock Exchange is a secondary market because it deals in outstanding, as opposed to newly issued, stocks and bonds. Secondary markets also exist for mortgages, other types of loans, and other financial assets. The corporation whose securities are being traded is not involved in a secondary market transaction and thus does not receive funds from such a sale.

are markets in which existing, already outstanding securities are traded among investors. Thus, if Jane Doe decided to buy 1,000 shares of GE stock, the purchase would occur in the _________ market. The __________________ is a _________ market because it deals in outstanding, as opposed to newly issued, stocks and bonds. _________ markets also exist for _________, other types of _________, and other financial assets. The corporation whose securities are being traded is not involved in a secondary market transaction and thus does not receive funds from such a sale.

· Futures markets

are markets in which participants agree today to buy or sell an asset at some future date. For example, a farmer may enter into a futures contract in which he agrees today to sell 5,000 bushels of soybeans 6 months from now at a price of $10.275 a bushel. To continue that example, a food processor that needs soybeans in the future may enter into a futures contract in which it agrees to buy soybeans 6 months from now. Such a transaction can reduce, or hedge, the risks faced by both the farmer and the food processor.

5. Pension funds

are retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks or by life insurance companies. invest primarily in bonds, stocks, mortgages, and real estate.

8. Exchange Traded Funds (ETFs)

are similar to regular mutual funds and are often operated by mutual fund companies. they buy a portfolio of stocks of a certain type; these shares are generally traded in the public markets, so an investor who wants to invest in the Chinese market, for example, can buy shares in an _____ that holds stocks in that particular market. Table 2.2 provides a list of the top this in early March 2018 ranked according to the ETF's assets under management (AUM).

· Capital markets are the markets for intermediate- or long-term debt and corporate stocks. The New York Stock Exchange, where the stocks of the largest U.S. corporations are traded, is a prime example of a capital market. There is no hard-and-fast rule, but in a description of debt markets, short-term generally means less than 1 year, intermediate-term means 1 to 10 years, and long-term means more than 10 years.

are the markets for intermediate- or long-term debt and corporate stocks. The __________________, where the stocks of the largest U.S. corporations are traded, is a prime example of a _________ market. There is no hard-and-fast rule, but in a description of debt markets, short-term generally means less than 1 year, intermediate-term means 1 to 10 years, and long-term means more than 10 years.

· Money markets

are the markets for short-term, highly liquid debt securities. The New York, London, and Tokyo money markets are among the world's largest.

· Primary markets

are the markets in which corporations raise new capital. If GE were to sell a new issue of common stock to raise capital, a _________ market transaction would take place. The corporation selling the newly created stock, GE, receives the proceeds from the sale in a _________ market transaction.

§ Working capital -

assets are often referred to as this; because these assets "turn over" , they are used and then replaced throughout the year

§ Long term or fixed assets -

assets expected to be used for more than one year; they include plant and equipment in addition to intellectual property such as patents and copyrights · Plant and equipment is generally reported net of accumulated depreciation

§ Current assets - include cash, cash equivalents, accounts receivable, and inventory

assets that should be converted to cash within 1 year - include _______, _______ equivalents, _______ , and _______

§ (3) corporations : A legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability. It is this separation that limits stockholders' losses to the amount they invested in the firm—they can lose all of its money, but its owners can lose only the funds that they invested in the company. they also have unlimited lives, and it is easier to transfer shares of stock in these than one's interest in an unincorporated business. These factors make it much easier for them to raise the capital necessary to operate large businesses. · Major drawback is taxes; most earnings subject to double taxation · S-corporatsions: which are taxed as if they were proprietorships or partnerships; thus, they are exempt from the corporate income tax.3 To qualify for S corporation status, a firm can have no more than 100 stockholders, which limits their use to relatively small, privately owned firms. · C corporations - larger corporations

based on the dollar value of sales, more than 80% of all business is done by these ;is a legal entity created by a state, and it is separate and distinct from its owners and managers. A legal entity created by a state, _________ and _________ from its owners and managers, having _________ life, easy _________ of ownership, and limited _________. It is this separation that limits stockholders' losses to the amount they _________ in the firm—they can lose _________ of its money, but its owners can lose only the _________ that they _________ in the company. they also have _________ lives, and it is easier to _________ shares of stock in these than one's interest in an _________ business. These factors make it much easier for them to raise the _________ necessary to operate _________ businesses. · Major drawback is _________; most earnings subject to _________ _________ _________: which are taxed as if they were proprietorships or partnerships; thus, they are exempt from the corporate income tax.3 To qualify for this status, a firm can have no more than 100 stockholders, which limits their use to relatively small, privately owned firms. · _________ - larger corporations

COO - chief operating officer ;

below the CEO, who is often also designated as a firm's president. directs the firm's operations, which include marketing, manufacturing, sales, and other operating departments

o Business ethics -

can be thought of as a company's attitude and conduct toward its employees, customers, community, and stockholders. A firm's commitment to this can be measured by the tendency of its employees, from the top down, to adhere to laws, regulations, and moral standards relating to product safety and quality, fair employment practices, fair marketing and selling practices, the use of confidential information for personal gain, community involvement, and the use of illegal payments to obtain business.

o B or benefit corporations-

company must subject self to annual audit where practices regarding social responsibility, corporate governance, and transparency are reviewed

· Statement of Cash Flows - § Net income is not cash

managers strive to miximize this that's available to investors; it's the accounting report that shows how much cash the firm is generating; divided into 4 sections (operating activities, net income, ) § ________ is not cash

o Marginal tax rate -

defined as the tax rate on the last dollar of income - begin at 10% and rise to 37% (to determine look at page 87)

§ Operating income - · = sales revenue - operating costs Different firms have different amounts of debt, taxy carryforwards and dif amounts of non operating assets such as marketable securities which can cause identical companies to have sig different net incomes

derived from the firms regular core business; calculated before deducting interest expenses and taxes; which are considered to be non-operating costs; also called EBIT or earnings before interest and taxes · = _________ - _________ Different firms have different amounts of _________, _________ carryforwards and dif amounts of non _________ assets such as marketable _________ which can cause identical companies to have sig _________ net incomes

· Net fixed assets =

entirely net plant and equipment assets

· Intrinsic value - estimate of the stocks true value as calculated by a competent analyst who has the best available data; estimates, and different analysts with different data and different views about the future form different estimates of this; estimating this is what security analysis is all about and is what distinguishes successful from unsuccessful investors ; value is a long-run ; Note, though, that maximizing this will maximize the average price over the long run, but not necessarily the current price at each point in time. o Determinants of intrinsic values and stock prices § Managerial actions, the economic environment, taxes, and the political climate· these go to the To true investor cash flows and true risk, which leads to the sticks intrinsic value, leading to market equilibrium § Market equilibrium ; intrinsic value = stock price · The Perceived investor cash flows and the Perceived risk lead to the Stocks market price which leads to the Market equilibrium ; intrinsic value = stock price

estimate of the stocks true value as calculated by a competent analyst who has the best available data; estimates, and different analysts with different data and different views about the future form different estimates of this; estimating this is what _________ is all about and is what distinguishes successful from unsuccessful _________ ; value is a _________-run ; Note, though, that maximizing this will maximize the average _________ over the long run, but not necessarily the _________ price at each point in time. o Determinants of this and stock prices figure 1.2 page 10 § _________ actions, the _________ environment, _________, and the political _________ · these go to the To _________ investor cash flows and _________ risk, which leads to the sticks _________, leading to market _________ § Market equilibrium ; intrinsic value = _________ · The _________ investor cash flows and the _________ risk lead to the Stocks _________ which leads to the Market _________ ; _________ = stock price

o Taxable income -

gross income less a set of exemptions and deductions

· Arbitrage -

in an inefficient market, it might be possible to purchase the company's stock at a low price and then be able to turn around and sell it at a higher price making a profit

o Total debt - (accruals and accounts payable does not fall under short term because interest free)

includes both its short and long term interest bearing liabilities ( = short term + long term debt) (________ and ________ does not fall under short term because interest free)

o Total liabilities -

includes total debt plus the companys free (non interest bearing) liabilities (= total debt + [accounts payable + accruals])

§ (4) limited liability companies (LLCs) -

is a popular type of org that is a hybrid between a partnership and a corporation

o Ethics -

is defined in Webster's Dictionary as "standards of conduct or moral behavior."

§ (4 pt 2)and limited liability partnerships (LLPs): provide protection, but they are taxed as partnerships. Further, unlike limited partnerships, where the general partner has full control of the business, the investors in an LLC or this have votes in proportion to their ownership interest. LLCs and this have been gaining in popularity in recent years, but large companies still find it advantageous to be C corporations because of the advantages in raising capital to support growth. LLCs/this were dreamed up by lawyers; they are often structured in very complicated ways, and their legal protections often vary by state. So, it is necessary to hire a good lawyer when establishing one.

is similar to an LLC; used for professional firms in the fields of accounting, law, and architecture, whole LLCs are used by other businesses · provide _________, but they are taxed as _________. Further, unlike limited partnerships, where the general partner has _________ control of the business, the investors in an LLC or this have _________ in proportion to their ownership _________. LLCs and this have been gaining in popularity in recent years, but large companies still find it advantageous to be C corporations because of the advantages in raising _________ to support growth. LLCs/this were dreamed up by _________; they are often structured in very complicated ways, and their legal protections often _________ by state. So, it is necessary to hire a good _________ when establishing one.

§ Board of Directors -

is the top governing body, and the chairperson of this is generally the highest-ranking individual.

§ Brokerage departments -

most of larger banks operate these; they purchase on excahnges and designate one or more of their officers as members

o Accounting numbers or book values - are different from what the assets would sell for if they were offered for sale (or market values)

o Accounting numbers or _______ values - are different from what the assets would sell for if they were offered for sale (or _______)

amount of Taxes paid divided by the overall taxable income.

o Average tax rate -

o Behavioral finance theory § efficient markets hypothesis (EMH) remains one of the cornerstones of modern finance theory. It implies that, on average, asset prices are about equal to their intrinsic values. The logic behind the EMH is straightforward. If a stock's price is "too low," rational traders will quickly take advantage of this opportunity and buy the stock, pushing prices up to the proper level. Likewise, if prices are "too high," rational traders will sell the stock, pushing the price down to its equilibrium level. Proponents of the EMH argue that these forces keep prices from being systematically wrong. § Although the logic behind the EMH is compelling, many events in the real world seem inconsistent with the hypothesis, which has spurred a growing field called behavioral finance. Rather than assuming that investors are rational, behavioral finance theorists borrow insights from psychology to better understand how irrational behavior can be sustained over time. · Barberis argue that behavioral finance's criticism of the EMH rests on two key points. o First, it is often difficult or risky for traders to take advantage of mispriced assets. o The second point deals with why mispricings can occur in the first place. Here insights from psychology come into play. § These experiments suggest that investors and managers behave differently in down markets than they do in up markets, which might explain why those who made money early in the stock market bubble continued to invest their money in the market even as prices went ever higher. Other evidence suggests that individuals tend to overestimate their true abilities.

o Behavioral finance theory ________ ________ ________ (________) remains one of the cornerstones of modern finance theory. It implies that, on average, asset prices are about equal to their intrinsic values. The logic behind the EMH is straightforward. If a stock's price is "too low," rational traders will quickly take advantage of this opportunity and ________ the stock, pushing prices ________ to the ________ level. Likewise, if prices are "too high," rational traders will ________ the stock, pushing the price ________ to its equilibrium level. Proponents of the EMH argue that these forces keep prices from being systematically ________. § Although the logic behind the EMH is compelling, many events in the real world seem ________ with the hypothesis, which has spurred a growing field called ________ finance. Rather than assuming that investors are rational, ________ finance theorists borrow insights from psychology to better understand how ________ behavior can be ________ over time. · Barberis argue that behavioral finance's criticism of the EMH rests on two key points. o First, it is often difficult or risky for traders to take ________ of ________ assets. o The second point deals with why ________ can occur in the first place. Here insights from psychology come into play. § These experiments suggest that investors and managers behave ________ in down markets than they do in up markets, which might explain why those who made money ________ in the stock market bubble continued to invest their money in the market even as prices went ever ________. Other evidence suggests that individuals tend to ________ their true abilities.

o Capital gains and losses - Capital assets treated differently than interest income; § Capital assets - assets such as stocs, bonds, and real estate ; when you buy this and later sell it for more than you paid, you earn a profit called a capital gain; when suffering a loss its called capital loss; if held for more than a year its long term capital g/l; shorter than a year short term g/l · Short term capital gain taxed at same rate as ordinary income · Long term taxed differently; only taxed at 15% · Double taxation of corporate income - income taxed first at corporate rate, then whats left is paid out as dividends is taxed again

o Capital gains and losses - _________ assets treated differently than interest income; § Capital assets - assets such as _________, _________, and _________ ; when you buy this and later sell it for more than you paid, you earn a profit called a _________; when suffering a loss its called _________; if held for more than a year its _________ term _________ g/l; shorter than a year _________ term g/l · Short term capital gain taxed at _________ rate as ordinary _________ · _________ term taxed differently; only taxed at _________% · because corporations pay dividends, there is a _________ taxation of corporate income - income taxed first at _________ rate, then whats left is paid out as _________ is taxed again

o Corporate Taxes - 25 % single flat rate? § Interest and dividends received by a corporation · Corporations earn most of their income from operations, but also securities (bonds and stocks) and receive interest and dividend income ; interest income received by corp is taxed as ordinary income at lower corp flat rate; 50% dividends received is excluded from taxable income, other 50% taxed at flat corporate rate o After tax income = pretax income (1-t) · Interest and dividends paid by a corporation o Can finance operations with either debt or stock ; if debt must pay interest, if stock expect to pay dividends § Interest paid can be deducted from operating income to obtain taxable income but the deduction is limited to 30% of earnings before interest, taxes and depreciation EBITDA § Pretax income needed to pay $1 dividends = $1 / (1 - tax rate) · Corporate capital gains - currently taxed at same flat rate at operating income · Corporate loss carryforward - ordinary corporate operating losses can be this indefinitely; this deduction is limited to lessor of total available net operating loss NOL or 80% of taxable income for the year to which the carryforward will be applied · Consolidated corporate tax returns - if a corporation owns 80% or more of another corporations stock it can aggregate income and file one consolidation tax return · Taxation of small businesses : S corporations - o S Corporation - A small corporation that, under Subchapter S of the Internal Revenue Code, elects to be taxed as a proprietorship or a partnership yet retains limited liability and other benefits of the corporate form of organization. · Depreciation - the larger this, the lower the taxable income, the lower the tax bill and thus the higher the operating cash flow

o Corporate Taxes - one single flat rate of _________ % § _________ and _________ received by a corporation · Corporations earn most of their income from _________, but also _________ (_________ and _________) and receive _________ and _________ income ; interest income received by corp is taxed as _________ income at lower corp _________ rate; 50% dividends received is _________ from taxable income, other 50% taxed at _________ corporate rate o After tax income = _________ income (1-t) · Interest and dividends paid by a corporation o Can finance operations with either _________ or _________ ; if debt must pay _________, if stock expect to pay _________ § Interest paid can be deducted from _________ income to obtain _________ income but the deduction is limited to _________% of earnings before interest, taxes and depreciation EBITDA § Pretax income needed to pay $1 _________ = $1 / (1 - tax rate) · Corporate capital gains - currently taxed at same _________ rate as operating income · Corporate loss carryforward - ordinary corporate operating losses can be this _________; this deduction is limited to lessor of total available net operating loss NOL or _________% of taxable income for the year to which the carryforward will be applied · Consolidated corporate tax returns - if a corporation owns 80% or more of another corporations stock it can _________ income and file _________ consolidation tax return · Taxation of small businesses : S corporations - o_________- A small corporation that, under Subchapter S of the Internal Revenue Code, elects to be taxed as a proprietorship or a partnership yet retains limited liability and other benefits of the corporate form of organization. · depreciation - the larger this, the _________ the taxable income, the _________ the tax bill and thus the _________ the operating cash flow

o Direct stockholder intervention - today majority of stock owned by institutional investors (insurance companies, pension funds, hedge funds, mutual funds, and private equity groups are ready and able to step in and take over underperforming firms); these inst money managers have clout to exercise considerable influence over firms operations , make suggestions about business being run; there has been ongoing debate on how much influence shareholders have

o Direct stockholder intervention - today majority of stock owned by institutional ________ (________ companies, ________ funds, ________ funds, ________ funds, and private ________ groups are ready and able to step in and take over underperforming firms); these inst money managers have clout to exercise considerable ________ over firms operations , make ________ about business being run; there has been ongoing debate on how much influence ________ should have

acronym for earnings before interest, taxes, depreciation, and amortization

o EBITDA -

o If firm is publicly owned: CEO and CFO both certify to SEC that reports released to stockholders and and especially the annual report, are accurate.; if innacurate could be fined or jailed

o If firm is _________ owned: CEO and CFO both certify to _________ that reports released to stockholders and and especially the annual report, are _________.; if innacurate could be _________ or _________

o Managers response § Corporate raider - § Hostile Takeover - § Managers should try to maximize their stock's intrinsic value and then communicate effectively with stockholders. That will cause the intrinsic value to be high and the actual stock price to remain close to the intrinsic value over time.

o Managers response § ____________ - § ____________ - § Managers should try to maximize their stock's ____________ value and then communicate effectively with stockholders. That will cause the ____________ value to be high and the actual stock price to remain ____________ to the ____________ value over time.

o Recent Trends § Technological advances in computers and telecommunicatios § Globalization of banking and commerce have led to deregulation - increasing competition around world · Exposed need for greater cooperation among regulators at international level · Factors that complicate coordination: 1. The different structures in nations banking and securities industries (2) the trend toward financial services conglomerates, which obscures developments in various market segments, and (3) the reluctance of individual countries to give up control over their national monetary policies. Still, regulators are unanimous about the need to close the gaps in the supervision of worldwide markets. § Derivatives - another important long standing trend over the past few decades, increasing the use of this; is any security whose value is taken from the price of some other "underlying" asset; can be used to reduce risks or speculate · Credit default swaps - are contracts that offer protection against the default of a particular security.

o Recent Trends § ________ ________ in computers and telecommunicatios § ________ of banking and commerce have led to ________ - ________ competition around world · Exposed need for greater ________ among regulators at international level · Factors that complicate coordination: 1. The different structures in nations ________ and ________ industries (2) the trend toward financial services ________, which obscures developments in various market segments, and (3) the reluctance of individual countries to give up control over their national ________ ________. Still, regulators are unanimous about the need to ________ the gaps in the supervision of worldwide markets. § ________ - another important long standing trend over the past few decades, increasing the use of this; is any security whose value is taken from the price of some other "underlying" asset; can be used to reduce risks or speculate · ________ - are contracts that offer protection against the default of a particular security.

o Stock market efficiency § ● Market price: The current price of a stock. For example, the Internet showed that on one day, Twitter's stock traded at $29.01. The market price had varied from $27.90 to $29.33 during that same day as buy and sell orders came in. § ● Intrinsic value: The price at which the stock would sell if all investors had all knowable information about a stock. This concept was discussed in Chapter 1, where we saw that a stock's intrinsic value is based on its expected future cash flows and its risk. Moreover, the market price tends to fluctuate around the intrinsic value, and the intrinsic value changes over time as the company succeeds or fails with new projects, competitors enter or exit the market, and so forth. We can guess (or estimate) Twitter's intrinsic value, but different analysts will reach somewhat different conclusions. § ● Equilibrium price: The price that balances buy and sell orders at any given time. When a stock is in equilibrium, the price remains relatively stable until new information becomes available and causes the price to change. § ● Efficient market: A market in which prices are close to intrinsic values and stocks seem to be in equilibrium. - when markets are these, investors can buy and slell stocks and be confident that they are getting good prices · Those who believe efficient - highly trained professional analysts and traders (fulltime), PhD's, etc. ; large companies followed by many analysts. Good communications with investors. · Not efficient - question analyst prediction ability , etc; Small companies not followed by many analysts. Not much contact with investors. ________

o Stock market efficiency § ● ________: The current price of a stock. § ● ________: The price at which the stock would sell if all investors had all knowable information about a stock. This concept was discussed in Chapter 1, where we saw that a stock's this is based on its expected future cash flows and its risk. Moreover, the market price tends to fluctuate around this , and it changes over time as the company succeeds or fails with new projects, competitors enter or exit the market, and so forth. We can guess (or estimate) this, but different analysts will reach somewhat different conclusions. § ● ________: The price that balances buy and sell orders at any given time. When a stock is in equilibrium, the price remains relatively stable until new information becomes available and causes the price to change. § ● ________: A market in which prices are close to intrinsic values and stocks seem to be in equilibrium. - when markets are these, investors can buy and slell stocks and be confident that they are getting good prices · Those who believe efficient - highly ________ ________ ________ and ________ (________), ________, etc. ; ________ companies followed by many ________. Good ________ with investors. · Not efficient - question analyst ________ ability , etc; ________ companies not followed by many ________. Not much contact with ________.

o Stock market reporting - used to be best info from Wall Street Journal § Two lines above daily and yearly price range give bid (buy) and the ask (sell) price range for the stock ; difference represents dealers spread or profit o Stock market returns - increase over years since 1968

o Stock market reporting - used to be best info from ________ ________ Journal § Two lines above daily and yearly price range give ________ (buy) and the ________ (sell) price range for the stock ; difference represents dealers spread or profit o Stock market returns - ________ over years since 1968

o Stocks are traded using a variety of market procedures, but there are two basic types: § (1) physical location exchanges, which include the NYSE and several regional stock exchanges, and ( § 2) electronic dealer-based markets, which include the NASDAQ, the less formal over-the-counter market, and the recently developed electronic communications networks (ECNs).

o Stocks are traded using a variety of market procedures, but there are two basic types: § (1) ________, which include the NYSE and several regional stock exchanges, and ( § 2) ________, which include the NASDAQ, the less formal over-the-counter market, and the recently developed electronic communications networks (ECNs).

o Types of Stock market transactions (3 categories) § Outstanding shares of established publicly owned companies that are traded: the secondary market. Allied Food Products, the company we study in Chapters 3 and 4, has 75 million shares of stock outstanding. If the owner of 100 shares sells his or her stock, the trade is said to have occurred in the secondary market. Thus, the market for outstanding shares, or used shares, is the secondary market. The company receives no new money when sales occur in this market. § 2. Additional shares sold by established publicly owned companies: the primary market. If Allied Food decides to sell (or issue) an additional 1 million shares to raise new equity capital, this transaction is said to occur in the primary market.14 § 3. Initial public offerings made by privately held firms: the IPO market. Whenever stock in a closely held corporation is offered to the public for the first time, the company is said to be going public. The market for stock that is just being offered to the public is called the initial public offering (IPO) market. In the summer of 2004, Google sold shares to the public for the first time at $85 per share. By March 2018, its parent company's stock (Alphabet Inc.) was selling for more than $1,030. Another noteworthy deal was when General Motors (GM) went public as part of its reorganization following its government bailout. Other high-profile recent IPOs include LinkedIn Corp, Alibaba, Facebook, Twitter, Snap (the parent company of Snapchat), and Dropbox. · Going Public The act of selling stock to the public at large by a closely held corporation or its principal stockholders. · Initial Public Offering (IPO) Market The market for stocks of companies that are in the process of going public. § Oversubscribed - difficult to identifiy a hot issue, then difficult to purchase shares in the initial offering because these deals are often this, which means the demand for shares at the offering price exceeds the number of shares issued; In such instances, investment bankers favor large institutional investors (who are their best customers), and small investors find it hard, if not impossible, to get in on the ground floor. ________

o Types of Stock market transactions (3 categories) § Outstanding shares of established publicly owned companies that are traded: the ________ market. If the owner of 100 shares sells his or her stock, the trade is said to have occurred in this market. Thus, the market for outstanding shares, or used shares, is this market. The company receives no new money when sales occur in this market. § 2. Additional shares sold by established publicly owned companies: the ________ market. If Allied Food decides to sell (or issue) an additional 1 million shares to raise new equity capital, this transaction is said to occur in the _______ § 3. ________________________________ Whenever stock in a closely held corporation is offered to the public for the first time, the company is said to be going public. The market for stock that is just being offered to the public is called the _______ (_______) market. Google General Motors (GM) Other high-profile recent IPOs include LinkedIn Corp, Alibaba, Facebook, Twitter, Snap (the parent company of Snapchat), and Dropbox. · ________________ The act of selling stock to the public at large by a closely held corporation or its principal stockholders. · ________________________ The market for stocks of companies that are in the process of going public. § ________ - difficult to identifiy a hot issue, then difficult to purchase shares in the initial offering because these deals are often this, which means the demand for shares at the offering price exceeds the number of shares issued; In such instances, investment bankers favor large institutional investors (who are their best customers), and small investors find it hard, if not impossible, to get in on the ground floor.

o What companies are doing § Most firms have strong written codes of ethical behavior and training programs (some scenarios are questionable) o Consequences of unethical behavior § Ethical lapses over the years have led to a number of bankruptcies § Unethical behavior can lead to a firms rapid decline · Some lead to bankruptcy, some avoid but face a damaging blow to their reputation ; CEO face of corporation, can face the repercussions § Unethical actions can have adverse consequences far beyond the companies that peretrate them o How should employees deal with unethical behavior? § Too often stock options, bonuses, and promotions drve managersto take unethical actions § Employees risk their job if come forward over bosses objections

o What companies are doing § Most firms have strong ________ codes of ________ ________ and ________ programs (some scenarios are questionable) o Consequences of unethical behavior § Ethical lapses over the years have led to a number of ________ § Unethical behavior can lead to a firms rapid ________ · Some lead to ________, some avoid but face a damaging blow to their ________ ; ________, face of corporation, can face the repercussions § Unethical actions can have ________ consequences far beyond the ________ that peretrate them o How should employees deal with unethical behavior? § Too often ________ options, ________, and ________ drve managersto take unethical actions § ________ risk their job if come forward over bosses objections

o When deciding on its form of organization, a firm must trade off the advantages of incorporation against double taxation. However, for the following reasons, the value of any business other than a relatively small one will probably be maximized if it is organized as a corporation: § 1. Limited liability reduces the risks borne by investors, and, other things held constant, the lower the firm's risk, the higher its value. § 2. A firm's value is dependent on its growth opportunities, which are dependent on its ability to attract capital. Because corporations can attract capital more easily than other types of businesses, they are better able to take advantage of growth opportunities. § 3. The value of an asset also depends on its liquidity, which means the time and effort it takes to sell the asset for cash at a fair market value. Because the stock of a corporation is easier to transfer to a potential buyer than is an interest in a proprietorship or partnership, and because more investors are willing to invest in stocks than in partnerships (with their potential unlimited liability), a corporate investment is relatively liquid. This too enhances the value of a corporation. ________

o When deciding on its form of organization, a firm must trade off the advantages of ________ against double ________. However, for the following reasons, the value of any business other than a relatively small one will probably be maximized if it is organized as a ________: § 1. Limited ________ reduces the risks borne by investors, and, other things held constant, the lower the firm's ________, the higher its ________. § 2. A firm's value is dependent on its ________ opportunities, which are dependent on its ability to attract ________. Because ________ can attract capital more easily than other types of businesses, they are better able to take advantage of growth opportunities. § 3. The value of an asset also depends on its ________, which means the time and effort it takes to sell the asset for cash at a fair market value. Because the ________ of a corporation is easier to transfer to a potential buyer than is an interest in a ________ or ________, and because more investors are willing to invest in stocks than in partnerships (with their potential unlimited liability), a corporate investment is relatively liquid. This too enhances the value of a corporation.

o Interest income received by individuals from corp securities is added to other income and thus is taxed at federal rates going up to 37% plus state taxes

o _________ income received by individuals from corp securities is added to other _________ and thus is taxed at _________ rates going up to 37% plus state taxes

o Individual Retirement Accounts IRA's - encouraged individuals to save more for retirement § Traditional IRA's - Individual retirement arrangements in which qualified contributions are tax deductible and income and capital gains on investments within the account are not taxed until the money is withdrawn after age 59½. § Roth IRA's - Individual retirement arrangements in which contributions are not tax deductible but the future income and capital gains within these accounts are not taxed if the money is withdrawn after age 59½ § Alternative Minimum Tax AMT - 1969 because millionaires with high incomes paid no taxes because theyhad so many tax shelters from items such as depreciation on real estate and municipal bond interest; under this law, people must calculate their tax under the regular system and then under the system, where many deductions added back to income and then taxed at special this rate ; Created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.

o_________ _________ - encouraged individuals to save more for retirement § _________ - Individual retirement arrangements in which qualified contributions are tax deductible and income and capital gains on investments within the account are not taxed until the money is withdrawn after age 59½. § _________ - Individual retirement arrangements in which contributions are not tax deductible but the future income and capital gains within these accounts are not taxed if the money is withdrawn after age 59½ § _________- 1969 because millionaires with high incomes paid no taxes because theyhad so many tax shelters from items such as depreciation on real estate and municipal bond interest; under this law, people must calculate their tax under the regular system and then under the system, where many deductions added back to income and then taxed at special this rate ; Created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.

o EPS - earnings per share;

often called the bottom line, denoting that of all items on the income statement; it's one that is most important to stockholders; net income divided by number of shares

· Financial asset markets,

on the other hand, deal with stocks, bonds, notes, and mortgages; also deal with derivative securities whose values are derived from changes in the prices of other assets. A share of Ford stock is a "pure financial asset," while an option to buy Ford shares is a derivative security whose value depends on the price of Ford stock.

o Sarbanes Oxley Act -

passed by congress in the wake of a series of corporate scandals involving now-defunct companies such as Enron and WorldCom, where investors, workers, and suppliers lost billions of dollars due to false information released by those companies. A law passed by Congress that requires the CEO and CFO to certify that their firm's financial statements are accurate.

ratios help us evaluate financial statements - firm borrowed too much in past and debt threatens bankruptcy ? debt ratios important - firm expands too quickly , excess inventory and manufacturing capacity - asset management ratios - ROE always important; high ROE depends on maintaining liquidity, efficient asset management, and on proper use of debt; managers concerned with stock price, but have little control over stock market performance; however, have control over ROE, so it tends to be their main focal point --

ratios help us evaluate _______ statements - firm borrowed too much in past and debt threatens bankruptcy ? _______ ratios important - firm expands too quickly , excess inventory and manufacturing capacity - _______ ratios - _______ always important; high _______ depends on maintaining _______, efficient _______ , and on proper use of _______; managers concerned with _______ price, but have little control over stock market _______; however, have control over _______, so it tends to be their main focal point

o Retained earnings - represents a claim against assets, not assets per se ; stockholders allow this to happen and reinvest them in the business, using for additions to plant and equipment, add to inventories, etc. § Companies do not let cash pile up in bank § Do not represent cash and are not available for dividends or etc.

represents a claim against assets, not assets per se ; stockholders allow this to happen and reinvest them in the business, using for additions to plant and equipment, add to inventories, etc. § Companies do not let _________ pile up in _________ § Do not represent _________ and are not available for _________ or etc.

o Compensation packages -

should be sufficient to attract and retain able managers, but they should not go beyold what is needed; these policies need to be consistent over time; also this djould be structured so that managers are rewarded on the basis of the stocks performance over the long run not the stocks price on an option exercise date; this means that options or direct stock awards should be phased in over a number of years so that managers have an incentive to keep the stock price high over time

§ NASDAQ - National Association of Securities Dealers Automated Quotations."

started as a quotation system, but it has grown to become an organized securities market with its own listing requirements.

6. Life insurance companies

take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties. In recent years, have also offered a variety of tax-deferred savings plans designed to provide benefits to participants when they retire.

· Market price -

the actual price based on perceived but possibly incorrect information as seen by the marginal investor

§ CEO - Chief executive officer

this comes next, but note that the chairperson of the board often also serves as this

· Equilibrium -

when a stocks actual market price is equal to its intrinsic value, the stock is this; when this exists there is no pressure for a change in the stock's price;

o Progressive -

when tax rates are this, the higher ones income, the larger the percentage paid in taxes; A tax system where the tax rate is higher on higher incomes. The personal income tax in the United States, which ranges from 0% on the lowest incomes to 37% on the highest incomes, is progressive.

· Private markets,

where transactions are negotiated directly between two or more parties, are differentiated from; where standardized contracts are traded on organized exchanges. Bank loans and private debt placements with insurance companies are examples of private market transactions. Because these transactions are private, they may be structured in any manner to which the relevant parties agree.

CFO- chief financial officer

who is generally a senior vice president and the third-ranking officer, is in charge of accounting, finance, credit policy, decisions regarding asset acquisitions, and investor relations, which involves communications with stockholders and the press.

working capital: · Notes payable - borrowing/bank loans on short term basis ; do not bear interest · Current liabilities - total of accounts payable, accruals, and notes payable represent this on the balance sheet; · Net working capital = current assets - current liabilities · Net operating working capital NOWC - makes distinction between cash that is used for operating purposes and excess cash that is being held for other purposes; distinguishes between free liabililities (accruals and accounts payable) and its interest bearing notes payable ; operating current assets (where operating current assets equal current assets minus excess cash) minus operating current liabilities ( where operating current liabilities are calculated as current liabilities minus notes payable) o = operating current assets - operating current liabilities or (current assets - excess cash) - (current liabilities - notes payable)

working capital: · ______________ - borrowing/bank loans on short term basis ; do not bear interest · ______________ - total of accounts payable, accruals, and notes payable represent this on the balance sheet; · Net working capital =______________ - ______________ · ______________ - makes distinction between cash that is used for operating purposes and excess cash that is being held for other purposes; distinguishes between free liabililities (accruals and accounts payable) and its interest bearing notes payable ; operating current assets (where operating current assets equal current assets minus excess cash) minus operating current liabilities ( where operating current liabilities are calculated as current liabilities minus notes payable) o net operating working capital = ______________ - ______________ or (______________ - ______________ ) - ( ______________ - ______________)

§ Assets must equal liabilities and eqity otherwise the balance sheet does not balance · Cash and equivalents represent actual spending money (other assets don't);non cash assets should generate cash over time but they do not represent cash in hand · Accounts receivable- represents credit saes that have not yet been collected · Inventories - show the cost of raw materials, work in process, and finished goods · Net fixed assets - represent the cost of the buildings and equipment used in operations minus the depreciation that has been taken on these assets

§ Assets must equal _______ and _______ otherwise the balance sheet does not balance · Cash and equivalents represent actual _______ _______ (other assets don't); non cash assets should generate _______ over time but they do not represent _______ in hand · _______- represents credit saes that have not yet been collected · _______ - show the cost of raw materials, work in process, and finished goods · _______ - represent the cost of the buildings and equipment used in operations minus the depreciation that has been taken on these assets

§ Brokers and dealers who participate in the OTC market are members of a self-regulatory body known as the Financial Industry Regulatory Authority (FINRA), which licenses brokers and oversees trading practices. The computerized network used by FINRA is known as NASDAQ, which originally stood for "National Association of Securities Dealers Automated Quotations."

§ Brokers and dealers who participate in the OTC market are members of a ________ body known as the ________ ________ ________ ________ (FINRA), which licenses brokers and oversees trading practices. The computerized network used by FINRA is known as ________, which originally stood for "National Association of Securities Dealers Automated Quotations."

§ Brokers communicate with own exchange members · Sell orders - offer the shares for sale, · Buy orders - bid for by the members with this · Auction markets - how the exchanges operate

§ Brokers communicate with own exchange members · ________ - offer the shares for sale, · ________ - bid for by the members with this · ________- how the exchanges operate

§ Claims against assets are two basic types · Liabilities/money the company owes to others) - current liabilities consist of claims that must be paid off within one year, including accounts payable, accruals (total of accrued wages and accrued taxes), and notes payable to banks and other short term lenders due within one year · Stockholders equity - the amount that stockholders paid to the company when they bought shares the company sold to raise capital, in addition to all of the earnings the company has retained over the years § SE = paid in capital + retained earnings § SE = Total assets - total liabilities o Retained earnings - are not just the earnings retained in the last year, they are the cumulative total of all of the earnings the company has earned and retained during its life o Assets on the balance sheet are listed by the length of time before they will be converted to cash (inventories and accounts receivable) or used by the firm (fixed assets) o Claims are listed in the order in which they must be paid w/in one year

§ Claims against assets are two basic types · _______ - money the company owes to others) - current _______ consist of claims that must be paid off within one year, including _______, _______ (total of accrued wages and accrued taxes), and _______ to banks and other short term lenders due within one year · _______- the amount that stockholders paid to the company when they bought shares the company sold to raise capital, in addition to all of the earnings the company has retained over the years § SE = paid in _______ + _______ § SE = Total _______ - total _______ o _______ - are not just the earnings retained in the last year, they are the cumulative total of all of the earnings the company has earned and retained during its life o Assets on the balance sheet are listed by the _______ of _______ before they will be converted to cash (_______ and accounts _______) or used by the firm (fixed _______) o Claims are listed in the order in which they must be paid w/in _______

§ Consequences of having a short run focus: · Ideally managers adhere to long run focus; many recently shifted to short; ex wall street massive gov bailout · Corporate governance - with concerns in mind, many academics and practitioners stress the need for boards and directors to establish effective procedures; this involved putting in place a set of rules and practices to ensure that managers act in shareholders' interests while also balancing the needs of other key constituencies such as customers, employees, and affected citizens; Establishment of rules and practices by Board of Directors to ensure that managers act in shareholders' interests while balancing the needs of other key constituencies. · Effective governance requires holding managers accountable for poor performance and understanding the important role that executive compensation plays in encouraging managers to focus on the proper objectives. · Despite the best of intentions, stock-based compensation does not always work as planned. To give managers an incentive to focus on stock prices, stockholders (acting through boards of directors) awarded executives stock options that could be exercised on a specified future date. An executive could exercise the option on that date, receive stock, immediately sell it, and earn a profit ________

§ Consequences of having a short run focus: · Ideally managers adhere to ________ run focus; many recently shifted to ________; ex wall street massive gov bailout · Corporate governance - with concerns in mind, many academics and practitioners stress the need for ________ and ________ to establish effective ________; this involved putting in place a set of rules and practices to ensure that managers act in ________' interests while also balancing the needs of other key ________ such as customers, employees, and affected citizens; Establishment of rules and practices by Board of Directors to ensure that managers act in shareholders' interests while balancing the needs of other key constituencies. · Effective governance requires holding managers ________ for ________ performance and understanding the important role that executive ________ plays in encouraging managers to focus on the ________ objectives. · Despite the best of intentions, ________-based compensation does not always work as planned. To give managers an incentive to focus on stock ________, stockholders (acting through boards of directors) awarded executives ________ options that could be exercised on a specified ________ date. An executive could exercise the option on that date, receive stock, immediately sell it, and earn a profit

§ Financing Activities - · Increase in notes payable - cash increase · Increase in bonds (long term debt) - inflow ; when paid off looks like outflow · Payment of dividends to stockholders - decrease in cash · Net cash provided by financial activities - sum of these

§ Financing Activities - · Increase in _________ - cash _________ · Increase in _________ (long term debt) - _________ ; when paid off looks like _________ · Payment of _________ to stockholders - _________ in cash · Net cash provided by financial activities - _________ of these

§ Market prices can and do differ from intrinsic values; eventually however as the future unfolds the two values tend to converge

§ Market prices can and do _________ from intrinsic values; eventually however as the future unfolds the two values tend to _________

§ Summary - summarizes change in cash and cash equivalents over year · Net decrease/increase in cash - net sum of operating, investing, and financing activities · Cash and equivalents at beginning of year - what began with · Cash and equivalents at the end of the year - what started with minus net decrease/increase occurred during year

§ Summary - summarizes _________ in cash and cash equivalents over _________ · Net decrease/increase in cash - net sum of _________, _________, and _________ activities · Cash and equivalents at beginning of year - what _________ with · Cash and equivalents at the end of the year - what started with _________ net _________ occurred during year

§ The dealers who make a market in a particular stock quote the price at which they will pay for the stock (the bid price) and the price at which they will sell shares (the ask price). Each dealer's prices, which are adjusted as supply and demand conditions change, can be seen on computer screens across the world. The bid-ask spread, which is the difference between bid and ask prices, represents the dealer's markup, or profit. The dealer's risk increases when the stock is more volatile or when the stock trades infrequently. ________

§ The dealers who make a market in a particular stock ________ the price at which they will pay for the stock (the ________) and the price at which they will sell shares (the ________). Each dealer's prices, which are adjusted as ________ and ________ conditions change, can be seen on computer screens across the world. The ________, which is the difference between bid and ask prices, represents the dealer's markup, or profit. The dealer's risk ________ when the stock is more volatile or when the stock trades infrequently.

§ Dealer Markets Include all facilities that are needed to conduct security transactions not conducted on the physical location exchanges; includes all facilities that are needed to conduct security transactions, but the transactions are not made on the physical location exchanges. The dealer market system consists of (1) the relatively few dealers who hold inventories of these securities and who are said to "make a market" in these securities, (2) the thousands of brokers who act as agents in bringing the dealers together with investors, and (3) the computers, terminals, and electronic networks that provide a communication link between dealers and brokers.

§ ________ ________ Include all facilities that are needed to conduct security transactions not conducted on the physical location exchanges; includes all facilities that are needed to conduct security transactions, but the transactions are not made on the physical location exchanges. The dealer market system consists of (1) the relatively few dealers who hold ________ of these securities and who are said to "make a ________" in these securities, (2) the thousands of ________ who act as agents in bringing the ________ together with ________, and (3) the computers, terminals, and electronic ________ that provide a ________ link between ________ and ________.

o Financial management

§ also called corporate finance, focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value. The same principles apply to both for-profit and not-for-profit organizations, and as the title suggests, much of this book is concerned with this

o Investments § (1) Security analysis deals with finding the proper values of individual securities (i.e., stocks and bonds). § (2) Portfolio theory deals with the best way to structure portfolios, or "baskets," of stocks and bonds. Rational investors want to hold diversified portfolios in order to limit risks, so choosing a properly balanced portfolio is an important issue for any investor. § (3) Market analysis deals with the issue of whether stock and bond markets at any given time are "too high," "too low," or "about right." Included in market analysis is behavioral finance, where investor psychology is examined in an effort to determine whether stock prices have been bid up to unreasonable heights in a speculative bubble or driven down to unreasonable lows in a fit of irrational pessimism. § All closely interconnected

§ relate to decisions concerning stocks and bonds and include a number of activities: § (1) __________ deals with finding the proper values of individual securities (i.e., stocks and bonds). § (2) __________ deals with the best way to structure portfolios, or "baskets," of stocks and bonds. Rational investors want to hold diversified portfolios in order to limit risks, so choosing a properly balanced portfolio is an important issue for any investor. § (3) __________ deals with the issue of whether stock and bond markets at any given time are "too high," "too low," or "about right." Included in this is behavioral finance, where investor psychology is examined in an effort to determine whether stock prices have been bid up to unreasonable heights in a speculative bubble or driven down to unreasonable lows in a fit of irrational pessimism. § All closely interconnected

o Capital markets :

§ relate to the markets where interest rates, along with stock and bond prices, are determined. Also studied here are the financial institutions that supply capital to businesses. Banks, investment banks, stockbrokers, mutual funds, insurance companies, and the like bring together "savers" who have money to invest and businesses, individuals, and other entities that need capital for various purposes. Governmental organizations such as the Federal Reserve System, which regulates banks and controls the supply of money, and the Securities and Exchange Commission (SEC), which regulates the trading of stocks and bonds in public markets, are also studied as part of this

· "efficiency continuum," o Highly efficient - large companies followed by many analysts. Good communications with investors. o Highly inefficient - Small companies not followed by many analysts. Not much contact with investors. o The key factor is the size of the company—the larger the firm, the more analysts tend to follow it and thus the faster new information is likely to be reflected in the stock's price. Also, different companies communicate better with analysts and investors, and the better the communications, the more efficient the market for the stock.

· "efficiency continuum," o Highly ________ - large companies followed by many analysts. Good communications with investors. o Highly ________ - Small companies not followed by many analysts. Not much contact with investors. o The key factor is the size of the company—the ________ the firm, the more analysts tend to follow it and thus the ________ new information is likely to be reflected in the stock's price. Also, different companies communicate ________ with analysts and investors, and the ________ the communications, the more ________ the market for the stock.

o Financial management o Capital markets : o Investments

· Areas of finance - 3 areas :

· Balancing shareholder interests and the interests of society o Shareholder wealth maximization - public owned companies operate on the assumption that managements primary financial goal is this; Maximization The primary financial goal for managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firm's common stock. Does not mean maximize shareholder value at all costs o Important to keep in mind when taking steps to maximize shareholder value to also keep in mind the society imposed constraints - broader consensus emphasizes that maximizing shareholder value doesn't mean that corporate managers should ignore other societal interests ____________

· Balancing shareholder interests and the interests of society o____________ - public owned companies operate on the assumption that managements primary financial goal is this; Maximization The primary financial goal for managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firm's common stock. -Does ________ mean maximize shareholder value at all ________ o Important to keep in mind when taking steps to maximize shareholder value to also keep in mind the ________ imposed constraints - ________ consensus emphasizes that maximizing shareholder value doesn't mean that corporate managers should ignore other ________ interests

· Business Ethics -o Congress's passing of the Sarbanes-Oxley Act of 2002 to impose sanctions on executives who sign financial statements later found to be false; o Congress's passing of the Dodd-Frank Act to implement an aggressive overhaul of the U.S. financial regulatory system aimed at preventing reckless actions that would cause another financial crisis; and business schools trying to inform students about proper versus improper business actions. ________

· Business Ethics - o Congress's passing of the ________ of 2002 to impose sanctions on executives who sign financial statements later found to be false; o Congress's passing of the ________ to implement an aggressive overhaul of the U.S. financial regulatory system aimed at preventing reckless actions that would cause another financial crisis; and business schools trying to inform students about proper versus improper business actions.

· Finance within an organization (fig 1.1) o Most businesses have an org chart similar to this: § Board of Directors - § CEO - § COO - § CFO- o Board of Directors -> CEO --- COO and CFO § COO - marketing, production, HR and other operating departments § CFO - accounting, treasury, credit, legal capital budgeting, and investor relations

· Finance within an organization (fig 1.1) o Most businesses have an org chart similar to this: § _________ - § _________ - § _________ -§ _________- or o _________ -> _________ --- _________ and _________§ _________ - marketing, production, HR and other operating departments§ _________ - accounting, treasury, credit, legal capital budgeting, and investor relations

· Financial Markets o Types of Markets = different financial markets serve different types of customers or different parts of country

· Financial Markets o Types of Markets = different financial markets serve different types of ________ or different ________ of country

· Financial institutions o Major categories: § Investment banks - § Commercial banks - § Financial services corporations - § 4. Credit unions are cooperative associations 5. Pension funds . 6. Life insurance companies 7. Mutual funds 8. Exchange Traded Funds (ETFs) 9. Hedge funds 10. Private equity companies

· Financial institutions o Major categories: (10)

· In a well-functioning economy, capital flows efficiently from those with surplus capital to those who need it. This transfer can take place in the three ways described in Figure 2.1. (diagram of the capital formation process for businesses o 1. Direct transfers of money and securities, as shown in the top section, occur when a business sells its stocks or bonds directly to savers, without going through any type of financial institution. The business delivers its securities to savers, who, in turn, give the firm the money it needs. This procedure is used mainly by small firms, and relatively little capital is raised by direct transfers. § Business to savers (securities (stocks or bonds); savers to business (dollars) o 2. As shown in the middle section, transfers may also go through an investment bank (IB) such as Morgan Stanley, which underwrites the issue. An underwriter facilitates the issuance of securities. The company sells its stocks or bonds to the investment bank, which then sells these same securities to savers. The businesses' securities and the savers' money merely "pass through" the investment bank. However, because the investment bank buys and holds the securities for a period of time, it is taking a risk—it may not be able to resell the securities to savers for as much as it paid. Because new securities are involved and the corporation receives the sale proceeds, this transaction is called a primary market transaction. § Business to investment banks to savers (securities to i.b. to securities) § Savers to investment banks to business (dollars to i.b. to dollars) o 3. Transfers can also be made through a financial intermediary such as a bank, an insurance company, or a mutual fund. Here the intermediary obtains funds from savers in exchange for its securities. The intermediary uses this money to buy and hold businesses' securities, and the savers hold the intermediary's securities. For example, a saver deposits dollars in a bank, receiving a certificate of deposit; then the bank lends the money to a business in the form of a mortgage loan. Thus, intermediaries literally create new forms of capital—in this case, certificates of deposit, which are safer and more liquid than mortgages and thus better for most savers to hold. The existence of intermediaries greatly increases the efficiency of money and capital markets. § Business to financial intermediary to savers (business securities to f.i. to intermediary's securities) § Savers to financial intermediary to business (dollars to f.i. to dollars)

· In a well-functioning economy, capital flows efficiently from those with ________ capital to those who ________ it. This transfer can take place in the three ways described in Figure 2.1. (diagram of the capital formation process for businesses o 1. ________ transfers of money and securities, as shown in the top section, occur when a business sells its stocks or bonds directly to savers, without going through any type of financial ________. The business delivers its ________ to savers, who, in turn, give the firm the ________ it needs. This procedure is used mainly by ________ firms, and relatively ________ capital is raised by direct transfers. § Business to savers (securities (stocks or bonds); savers to business (dollars) o 2. As shown in the middle section, transfers may also go through an _________ (_________) such as Morgan Stanley, which underwrites the issue. An _________ facilitates the issuance of securities. The company sells its stocks or bonds to the _________ , which then sells these same securities to _________. The businesses' securities and the savers' money merely "_________ through" the investment bank. However, because the investment bank buys and holds the securities for a period of time, it is taking a _________—it may not be able to _________ the securities to savers for as much as it paid. Because new securities are involved and the corporation receives the sale proceeds, this transaction is called a _________ transaction. § Business to investment banks to savers (_________ to i.b. to _________) § Savers to investment banks to business (_________ to i.b. to _________) o 3. Transfers can also be made through a financial intermediary such as a _________, an _________ company, or a mutual _________. Here the intermediary obtains funds from _________ in exchange for its _________. The intermediary uses this money to buy and hold businesses' _________, and the savers hold the _________ securities. For example, a saver deposits dollars in a bank, receiving a certificate of deposit; then the bank lends the money to a business in the form of a mortgage loan. Thus, intermediaries literally create new forms of capital—in this case, certificates of deposit, which are safer and more liquid than mortgages and thus better for most savers to hold. The existence of intermediaries greatly increases the efficiency of money and capital markets. § Business to financial intermediary to savers (_________ securities to f.i. to _________ securities) § Savers to financial intermediary to business (_________ to f.i. to _________)

· Jobs in Finance o Banking, investments, insurance, corporations, and government o Most jobs (marketing, management) need to understand basics of finance o Important to everyone - pensions, retirement, personal investments

· Jobs in Finance o Banking, investments, insurance, corporations, and government o Most jobs (marketing, management) need to understand basics of finance o Important to everyone - pensions, retirement, personal investments*******

· Liquidity Ratios o Liquid asset is one that trades in an active market and thus can be quickly converted to cash at the going market price o Current ratio - the primary liquidity ratio; This ratio is calculated by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. § = current assets / current liabilities · Current assets - include cash, marketable securities, accounts receivable, and inventories · Current liabilities - pay accounts payable and borrowing from bank increase this o Quick or acid test ratio - second liquidity ratio - is calculated by deducting inventories from current assets and then dividing the remainder by current liabilities; measures the firms ability to pay off short term obligations without relying on the sale of inventories § (Current assets - inventories) / current liabilities § Inventories typically least liquid of firms current assets; are also the assets on which losses are most likely to occur in the event of liquidation answer the question - will the firm be able to pay off its debts as they come due and thus remain a viable organization _______

· Liquidity Ratios o Liquid asset is one that trades in an _________ market and thus can be quickly converted to _________ at the going _________ price o _________ ratio - the primary liquidity ratio; This ratio is calculated by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. § = _________ / _________ · Current assets - include _________, _________, _________, and _________ · Current liabilities - pay _________ and _________ from _________ increase this o _________ - second liquidity ratio - is calculated by deducting inventories from current assets and then dividing the remainder by current liabilities; measures the firms ability to pay off short term obligations without relying on the sale of inventories § (_________ - _________) / _________ § Inventories typically _________ liquid of firms current assets; are also the assets on which _________ are most likely to occur in the event of liquidation should answer the question - will the firm be able to _________ its _________ as they come due and thus remain a _________ organization

· Potential Misuses of ROE o ROE does not consider risk , does not consider the amount of invested capital , a focus on ROE can cause managers to turn down profitable projects o ROE must be combined with its size and risk to determine its effect on shareholder value

· Potential Misuses of ROE o ROE does not consider _________ , does not consider the amount of invested _________ , a focus on ROE can cause managers to turn down _________ projects o ROE must be combined with its _________ and _________ to determine its effect on _________ value

o Liquidity ratios - which give an idea of the firms ability to pay off debts that are maturing within a year; Ratios that show the relationship of a firm's cash and other current assets to its current liabilities. § Satisfactory these are necessary if the firm is to continue operating o Asset Management Ratios - which give an idea of how efficiently the firm is using its assets § Good this re necessary for the firm to keep costs low and net income high o Debt management ratios - give an idea of how the firm has finances its assets as well as the firms ability to repay its long term debt § Indicate how risky the firm is and how much of its operating income must be paid to bondholders rather than stockholders o Profitability ratios - which give an idea of how profitably the firm is operating and utilizing its assets § Combine the asset and debt management categories and show their effects on ROE o Market value ratios - which give an idea of what investors think about the firm and its future prospects § Tells us what investors think about the company and its prospects

· Ratio Analysis (5 ratios into 5 categories) o _________ - which give an idea of the firms ability to pay off debts that are maturing within a year; _________ that show the relationship of a firm's cash and other current assets to its current liabilities. § Satisfactory these are necessary if the firm is to continue _________ o_________ - which give an idea of how efficiently the firm is using its assets § Good this re necessary for the firm to keep costs low and net income high o _________ - give an idea of how the firm has finances its assets as well as the firms ability to repay its long term debt § Indicate how risky the firm is and how much of its operating income must be paid to bondholders rather than stockholders o _________ - which give an idea of how profitably the firm is operating and utilizing its assets § Combine the asset and debt management categories and show their effects on ROE (return on equity) o_________- which give an idea of what investors think about the firm and its future prospects § Tells us what investors think about the company and its prospects

· Stock mArkets and Returns - anyone invested in stock market knows there can be arge differences between expected and realized prices and returns ________

· Stock mArkets and Returns - anyone invested in stock market knows there can be large differences between ________ and ________ prices and returns

· Stockholder - Manager Conflicts o Effective executive compensation plans motivate managers to act in their stockholders' best interests. Useful motivational tools include (1) reasonable compensation packages, (2) firing of managers who don't perform well, and (3) the threat of hostile takeovers. o Compensation packages § Intrinsic value can be measured - performance pay can be based on changes in it § If not observable - compensation must be based on the stocks market price but the price used should be an average over time rather than on a specific date ________

· Stockholder - Manager Conflicts o Effective executive ________ plans motivate managers to act in their stockholders' best interests. Useful motivational tools include (1) reasonable ________ packages, (2) ________ of managers who don't ________ well, and (3) the threat of ________ ________. o Compensation packages § ________ value can be measured - ________ pay can be based on changes in it § If not observable - compensation must be based on the stocks ________ price but the price used should be an ________ over time rather than on a ________ date

· Stockholder - debtholder conflicts: o Debtholders ( include the company's bankers and its bondholders, generally receive fixed payments regardless of how well the company does) o Stockholders (do better when the company does better) § These ( ) cause problems · Stockholders typically more willing to take on risky projects (stockholders are bearing more risk - their payoff depends on the market, but they are also earning higher expected return) · Additional debt (more debt, riskier firm becomes) · Covenants - bondholders attempt to protect themselves by including these in bond agreements that limit firms use of additional debt and constrain managers actions in other ways

· Stockholder - debtholder conflicts: o ____________ ( include the company's bankers and its bondholders, generally receive fixed payments regardless of how well the company does) o ____________ (do better when the company does better) § These ( ) cause problems between the two · Stockholders typically more willing to take on ____________ projects (stockholders are bearing more ____________ - their payoff depends on the ____________, but they are also earning ____________ expected return) · Additional debt (more debt, ____________ firm becomes) · ____________ - bondholders attempt to protect themselves by including these in bond agreements that limit firms use of additional debt and constrain managers actions in other ways

· The main financial goal: creating value for investors o Public corps work on behalf of stakeholders (which include individuals and orgs choosing to return investment) § Managerial actions combined with the economy, taxes and political conditions, influence the level and riskiness of the copany's future cash flows, which ultimately determine the company's stock price · Larger the expected cash flow, lower the perceived risk = higher stocks price § Each stock has an intrinsic value, market price, and marginal investor

· The main financial goal: creating value for ________ o Public corps work on behalf of ________ (which include individuals and orgs choosing to return investment) § Managerial actions combined with the ________, ________ and ________ conditions, influence the level and riskiness of the copany's future cash flows, which ultimately determine the company's stock ________ · Larger the expected cash flow, ________ the perceived ________ = ________ stocks price § Each stock has an ________ value, ________ price, and ________ investor

· The market for common stock o Closely Held Corporation A corporation that is owned by a few individuals who are typically associated with the firm's management. Publicly OwnedCorporationA corporation that is owned by a relatively large number of individuals who are not actively involved in the firm's management

· The market for common stock o ________________________ A corporation that is owned by a few individuals who are typically associated with the firm's management. _______________________________ A corporation that is owned by a relatively large number of individuals who are not actively involved in the firm's management

· Time dimension - o Balance sheet - snapshot of financial position at a point in time

· Time dimension - o _______ - snapshot of financial position at a point in time

· Tying the ratios together: The DuPont Equation o A formula that shows that the rate of return on equity can be found as the product of profit margin, total assets turnover, and the equity multiplier. It shows the relationships among asset management, debt management, and profitability ratios. § ROE = ROA x equity multiplier = profit margin x total assets turnover x equity multiplier = (net income / sales) x (sales / total assets) x (total assets / total common equity) · Profit margin - tells us how much the firm earns on its sales · Total assets turnover - multiplier that tells us how mnay times the profit margin is earned each year · Equity multiplier - the adjustment factor

· Tying the ratios together: DuPont Equation o A formula that shows that the rate of _________ on equity can be found as the product of _________, total _________ _________, and the _________ . It shows the relationships among _________ management, _________ management, and _________ ratios. § ROE = ROA x equity multiplier = profit margin x total assets turnover x equity multiplier = (net income / sales) x (sales / total assets) x (total assets / total common equity) · _________ - tells us how much the firm earns on its sales _________ - multiplier that tells us how mnay times the profit margin is earned each year · _________ - the adjustment factor

· Uses and limitations of financial statements - must follow GAAP ; Sarbanes oxley act came into play

· Uses and limitations of financial statements - must follow _________ ; _________ act came into play

· Uses and limitations of ratios o Some potential problems are listed: § Many firms have divisions that operate in different industries; for such companies, it is difficult to develop a meaningful set of industry averages. § Most firms want to be better than average, so merely attaining average performance is not necessarily good. As a target for high-level performance, it is best to focus on the industry leaders' ratios. Benchmarking helps in this regard. 3. Inflation has distorted many firms' balance sheets—book values are often different from market values. Market values would be more appropriate for most purposes, but we cannot generally get market value figures because assets such as used machinery are not traded in the marketplace. Further, inflation affects asset values, depreciation charges, inventory costs, and thus profits. Therefore, a ratio analysis for one firm over time or a comparative analysis of firms of different ages must be interpreted with care and judgment. 4. Seasonal factors can also distort a ratio analysis. For example, the inventory turnover ratio for a food processor will be radically different if the balance sheet figure used for inventory is the one just before, versus just after, the close of the canning season. This problem can be mitigated by using monthly averages for inventory (and receivables) when calculating turnover ratios. 5. Firms can employ "window dressing" techniques to improve their financial statements. To illustrate, people tend to think that larger hedge funds got large because their high returns attracted many investors. However, we learned in 2007 that some funds simply borrowed and invested money to increase their apparent size. One fund, Wharton Asset Management, reported $2 billion "under management," but it had actually attracted less than $100 million of investors' capital. 6. Different accounting practices can distort comparisons. As noted earlier, inventory valuation and depreciation methods can affect financial statements and thus distort comparisons among firms. 7. It is difficult to generalize about whether a particular ratio is "good" or "bad." 8. Firms often have some ratios that look "good" and others that look "bad," making it difficult to tell whether the company is, on balance, strong or weak. To deal with this problem, banks and other lending organizations often use statistical procedures to analyze the net effects of a set of ratios and to classify firms according to their probability of getting into financial trouble

· Uses and limitations of ratios o Some potential problems are listed: § Many firms have divisions that operate in different industries; for such companies, it is difficult to develop a meaningful set of industry _________. § Most firms want to be better than average, so merely attaining _________ performance is not necessarily good. As a target for high-level performance, it is best to focus on the industry leaders' _________. _________ helps in this regard. 3. _________ has distorted many firms' balance sheets—_________ values are often different from _________ values. _________ values would be more appropriate for most purposes, but we cannot generally get market value figures because assets such as used _________ are not traded in the marketplace. Further, _________ affects asset values, depreciation charges, inventory costs, and thus profits. Therefore, a _________ for one firm over time or a comparative analysis of firms of different ages must be interpreted with care and judgment. 4. _________ factors can also distort a ratio analysis. For example, the inventory turnover ratio for a food processor will be radically different if the balance sheet figure used for inventory is the one just before, versus just after, the close of the canning season. This problem can be mitigated by using monthly averages for inventory (and receivables) when calculating turnover ratios. 5. Firms can employ "_________ _________" techniques to improve their financial statements. To illustrate, people tend to think that larger hedge funds got large because their high returns attracted many investors. However, we learned in 2007 that some funds simply borrowed and invested money to increase their apparent size. One fund, Wharton Asset Management, reported $2 billion "under management," but it had actually attracted less than $100 million of investors' capital. 6. Different _________ practices can distort _________. As noted earlier, inventory valuation and depreciation methods can affect financial statements and thus distort comparisons among firms. 7. It is difficult to generalize about whether a particular ratio is "_________" or "_________." 8. Firms often have some ratios that look "good" and others that look "bad," making it difficult to tell whether the company is, on balance, _________ or _________. To deal with this problem, banks and other lending organizations often use _________ procedures to analyze the net effects of a set of ratios and to classify firms according to their probability of getting into financial trouble -- re read page 134

· Using Financial Ratios to assess performance o Comparison to industry averages - gives a good sense of a companies strengths and weaknesses relative to the average company in their district o Benchmarking - The process of comparing a particular company with a subset of top competitors in its industry.; allows to see where stand in relative to competition o Trend analysis - compares ratios to own past levels; important to analyze the trends and absolute levels to see whether a firms financial condition is likely to improve or deteriorate ; An analysis of a firm's financial ratios over time; used to estimate the likelihood of improvement or deterioration in its financial condition.

· Using Financial Ratios to assess performance o _________ to industry _________- gives a good sense of a companies strengths and weaknesses relative to the average company in their district o _________ - The process of comparing a particular company with a subset of top competitors in its industry.; allows to see where stand in relative to competition o _________ - compares ratios to own past levels; important to analyze the trends and absolute levels to see whether a firms financial condition is likely to improve or deteriorate ; An analysis of a firm's financial ratios over time; used to estimate the likelihood of improvement or deterioration in its financial condition.

· Profitability Ratios - A group of ratios that show the combined effects of liquidity, asset management, and debt on operating results. o Operating Margin : This ratio measures operating income, or EBIT, per dollar of sales; it is calculated by dividing operating income by sales. § = EBIT / sales o Profit margin or net profit margin: This ratio measures net income per dollar of sales and is calculated by dividing net income by sales.(net income is after interest) -- use more debt, you have more interest charges ; higher debt ratio, lower profit margin § = net income / sales o Return on total assets : The ratio of net income to total assets; it measures the rate of return on the firm's assets.; you want this higher § = net income / total assets o Return on common equity ROE : The ratio of net income to common equity; it measures the rate of return on common stockholders' investment.; ROE reflects the effects of all of the other ratios, and it is the single best accounting measure of performance. ; high ROE reflects high stock prices ; higher this normally the higher the risk § = net income / common equity o Return on invested capital ROIC : The ratio of after-tax operating income to total invested capital; it measures the total return that the company has provided for its investors.; differs from ROA in two ways - return based on total invested capital rather than total assets. Uses after tax operating income rather than net income § = [EBIT (1-t)] / total invested capital o Basic earning power BEP ratio : This ratio indicates the ability of the firm's assets to generate operating income; it is calculated by dividing EBIT by total assets. § = EBIT / total assets

· _________ - A group of ratios that show the combined effects of liquidity, asset management, and debt on operating results. These include: o _________ : This ratio measures operating income, or EBIT, per dollar of sales; it is calculated by dividing operating income by sales. § = _________ / _________ o _________: This ratio measures net income per dollar of sales and is calculated by dividing net income by sales. (_________ is after interest) -- use more debt, you have more _________ charges ; _________ debt ratio, _________ profit margin § = _________ / _________ o _________ : The ratio of net income to total assets; it measures the rate of return on the firm's assets. you want this higher § = _________ / _________ o _________ : The ratio of net income to common equity; it measures the rate of return on common stockholders' investment. reflects the effects of all of the other ratios, and it is the single best accounting measure of performance. high ROE reflects high stock prices ; higher this normally the higher the risk § = _________ / common equity o _________ : The ratio of after-tax operating income to total invested capital; it measures the total return that the company has provided for its investors.; differs from ROA in two ways - return based on total invested capital rather than total assets. Uses after tax operating income rather than net income § = [EBIT (1-t)] / total invested capital o_________ : This ratio indicates the ability of the firm's assets to generate operating income; it is calculated by dividing EBIT by total assets. § = EBIT / total assets

· Market Value Ratios - Ratios that relate the firm's stock price to its earnings and book value per share.; used in 3 ways - (1) by investors when they are deciding to buy or sell a stock, (2) by investment bankers when they are setting the share price for a new stock issue (an IPO), and (3) by firms when they are deciding how much to offer for another firm in a potential merger. o Price/earnings ratio P/E : The ratio of the price per share to earnings per share; shows the dollar amount investors will pay for $1 of current earnings.; if below the industry average, suggests company being risky, having poor growth prospects, or both § = price per share / earnings per share § Relatively high for firms with strong growth prospects and little risk, but low for slowly growing and risky firms o Market/book ratio : The ratio of a stock's market price to its book value. Well regarded companies have high m/b ratio; typically exceed 1, which means that investors are willing to pay more for stocks than the accounting book values of the stocks § = market price per share / book value per share · Book value per share = Common equity / shares outstanding o Enterprise value/ EBITDA ratio: The ratio of a firm's enterprise value relative to its EBITDA.; looks at the relative market value of all the company's key financial claims; not heavily influenced by the companys debt and tax situation § EV= market value of equity + market value of total debt + market value of other financial claims - (cash and equivalents) § = EV / EBITDA

· _________ - Ratios that relate the firm's stock price to its earnings and book value per share.; used in 3 ways - (1) by _________ when they are deciding to buy or sell a _________, (2) by _________ when they are setting the _________ price for a new stock issue (an IPO), and (3) by _________ when they are deciding how much to offer for another firm in a potential _________. Different types include: o _________ : The ratio of the price per share to earnings per share; shows the dollar amount investors will pay for $1 of current earnings. if below the industry average, suggests company being risky, having poor growth prospects, or both § = _________ / _________ § Relatively high for firms with strong growth prospects and little risk, but low for slowly growing and risky firms o _________ : The ratio of a stock's market price to its book value. Well regarded companies have high this ratio; typically exceed 1, which means that investors are willing to pay more for stocks than the accounting book values of the stocks § = _________ / _________ · Book value per share = Common equity / shares outstanding o_________: The ratio of a firm's enterprise value relative to its EBITDA.; looks at the relative market value of all the company's key financial claims; not heavily influenced by the companys debt and tax situation § EV= market value of equity + market value of total debt + market value of other financial claims - (cash and equivalents) § = _________ / _________

§ True expected cash flows, and true risk v. perceived cash flows and perceived risks · True - the cash flows and risk that investors would expect if they had all of the information that existed about a company · Perceived - means what investors expect, given the limited information they have

· _________ - the cash flows and risk that investors would expect if they had all of the information that existed about a company · ________ - means what investors expect, given the limited information they have

· Income Taxes - indivs and corps pay sig income to taxes

· _________ Taxes - indivs and corps pay sig _________ to taxes

· The Income Statement - net sales are shown at the top of the statement, then operating costs, interest, and taxes are subtracted to obtain the net income available to common shareholder; also show earnings and dividends per share, in addition to some other data; OVER A PERIOD OF TIME; tied to balance sheet through the retained earnings account on balance sheet

· ______________ - reports summarizing a firms revenues, expenses, and profits during a reporting period, generally a quarter or a year; OVER A PERIOD OF TIME _______ are shown at the top of the statement, then _______ , _______, and _______ are subtracted to obtain the net income available to common _______; also show _______ and _______ per share, in addition to some other data; tied to balance sheet through the _______ account on balance sheet

· MVA and EVA o Financial statements reflect historical, past values not current market values o Interest rates and inflation affect MV, but not the BV normally o Accounting statements do not reflect market values so they are not sufficient for managers performace o MVA or market value added - difference between the market vaue of a firms equity and the book value on balance sheet; higher the MVA, better job management is doing for firms shareholders; may not be entirely attributable to management performance o EVA or economic value added or economic profit -= net operating profit after taxes NOPAT - annual $ cost of capital OR EBIT (1-t) - total invested capital x after tax % cost of capital; an estimate of businesses true econ profit for given year and often differs sharply from accounting net income, b takes into account total dollar cost of all capital including both the ost of debt and equity capital NOPAT is the amount of money that investments generated for companys investors after paying operating costs and taxe

·****** MVA and EVA o Financial statements reflect historical, past values not current _________ values o Interest rates and inflation affect _________, but not the _________ normally o Accounting statements do not reflect _________ values so they are not sufficient for _________ performace o _________ or _________ _________ _________ - difference between the market vaue of a firms equity and the book value on balance sheet; higher the _________, better job management is doing for firms shareholders; may not be entirely attributable to _________ performance o _________ or _________ _________ _________ or _________ _________ -= net operating profit after taxes NOPAT - annual $ cost of capital OR EBIT (1-t) - total invested capital x after tax % cost of capital; an estimate of businesses true econ profit for given year and often differs sharply from accounting net income, b takes into account total dollar cost of all capital including both the ost of debt and equity capital NOPAT is the amount of money that investments generated for companys investors after paying operating costs and taxe