Finance Exam 1

If a firm has a negative cash flow from assets every year for several years, the firm

May be continually increasing in size

An Income statement prepared according to GAAP

Records expenses based on matching principle

A firm earns $0.18 in profit for every $1 of equity in the firm. The company borrows $0.60 for every $1 of equity. What is the firm's return on assets?

11.25 percent ROA= NI/TA TA= 1.00 + .60 TA=1.60 NI= .18/1.00 TD=.60/1 ROA= .18/1.60 =11.25 %

Non Cash Items

Expenses charged against revenues that do not directly affect cash flow such as depreciation

Maria is the sole proprietor of an antique store that she has operated at the same location for the past 16 years. The store rents the space in which it is located but does own all of the inventory and fixtures. The store has an outstanding loan with the local bank but no other debt obligations. There are no specific loan covenants or assets pledged as security for the loan. Due to a sudden and unexpected downturn in the economy, the store is unable to generate sufficient funds to pay the loan payments due to the bank. Which of the following options does the bank have to collect the money it is owed?

I. Sell the inventory and use the cash raised to apply the debt II. Sell the store fixtures and use the cash raised to apply to the debt III. Take funds from Maria's personal account at the bank to pay the stores debt IV. Sell any asserts Maria personally owns and apply the proceed to the stores debt ( I, II, III, IV )

Income statement

Measures performance over some period of time. Usually a quarter or a year. Revenues - expenses = income

The concept of marginal taxation is best exemplified by which one of the following?

Mitchels Grocer increased its sales by 52,000 Last year and had to pay an additional 16,000 in taxes

The goal of financial management in a corporation

To maximize the market value go the existing owners equity

ROE

often used as a measure of how well management is attaining the goal of owner wealth maximization

CFFA example

operating cash flow - net capital spending - change in NWC = CFFA

Standardized industrial classification code.

U.S. government code used to classify a firm by its type of business operations.

The daily financial operations of a firm are primarily controlled by managing the

Working capital

Working Capital

a firms short term assets and liabilities

Networking Capital

current assets less current liabilities Networking capital Is positive when current assets exceeds current liabilities.

Stakeholder

someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm

Able Co. has $218,000 in taxable income and Bravo Co. has $5,600,000 in taxable income. Suppose both firms have identified a new project that will increase taxable income by $12,000. The additional project will increase Able Co.'s taxes by _____ and Bravo Co.'s taxes by ____.

$4,680 ; $4,080 Able: $218,000 Bravo: $5,600,000 Able = 12,000 x .39 = 4,680 Bravo = 12,000 x .34= 4,080

Home supply, Inc. has compiled the following information: For 2014 the cash flow from assets is _____ and the cash flow to shareholders is _____

$49,100 ; $62,500 2014 operating cash flow = $511,500 - $61,100 - $289,300 - $39,400 = $121,700; Change in net working capital = ($34,900 + $56,800 - $32,900 + $36,700) - ($38,200 + $58,800 - $36,800 + $41,500) = -$6,200; Net capital spending = $392,200 - $336,900 + $23,500 = $78,800; Cash flow from assets = $121,700 - (-$6,200) - $78,800 = $49,100; Cash flow to creditors = $21,600 - ($295,000 - $260,000) = -$13,400; Addition to retained earnings = $32,700 - $28,600 = $4,100; Net income = $511,500 - $289,300 - $61,100 - $23,500 - $21,600 - $39,400 = $76,600; Dividends paid = $76,600 - $4,100 = $72,500; Cash flow to stockholders = $72,500 - ($160,000 - $150,000) = $62,500; Cash flow from assets = -$13,400 + $62,500 = $49,100

Martha's fabric house has sales of $137,200, total equity of $74,400, and a debt-equity ratio of 0.45. What is the capital intensity ratio?

0.79 Capital Intensity= (TA/sales) Total assets =( 0.45 x 74,400) +74,400 = 107,880 107,880/137,200= .79

Cash flows to and from the firm

1. Cash flows to the firm from the financial markets 2. The firm invests the cash in current and fixed or long term assets 3. These assets generate some cash 4. Some of which goes to pay corporate taxes 5. After taxes are paid, some of this cash flow is reinvested in the firm 6. The rest goes back to the financial markets as cash paid to creditors and shareholders

Managerial compensation

1. Managerial compensation is usually tied to financial performance in general and often times to share value in particular. 2. Better performs with in the firm will tend to get promoted

Primary Disadvantages of sole proprietorships and partnerships as forms of business organizations are..

1. Unlimited liability for business debts on the part of the owners 2. Limited life of the business 3. Difficulty of transferring ownership The ability of such businesses to grow can be seriously limited by an inability to raise cash for investment.

Travis invests $10,000 today into a retirement account. He expects to earn 8 percent, compounded annually, on his money for the next 26 years. After that, he wants to be more conservative, so only expects to earn 5 percent, compounded annually. How much money will he have in his account when he retires 38 years from now, assuming this is the only deposit he makes into the account?

132,827.88 10,000 (1+.08)^26 x 10,000 ( 1+.05)^38x26 73,963.53 x 17,958.56= 132,827.88

Four corporate Tax Rates

15%,25%,34%,35% 38 and 39% brackets arise because of surcharges applied on top of the 34 and 35 %.

Precision Engineering invested $110,000 at 6.5 percent interest, compounded annually for 4 years. How much interest on interest did the company earn over this period of time?

2,911.30 FV= PV (1+r)^t 110,000 (1+6.5)^4- 110,000 + ( 110,000 x 0.65 x 4) FV= 141,511.29-138,600=2,911.30

Jim just deposited $13,000 into his account at Traditions Bank. The bank will pay 1.3 percent interest, compounded annually, on this account. How much interest on interest will he earn over the next 15 years?

244.20 FV=13,000(1+.013)^15 - 13,000+ (13,000 x 0.13 x15) 15,779.20-15,535= 244.2

Baugh & Essary has net income of $149,200, sales of $936,800, a capital intensity ratio of 0.74, and an equity multiplier of 1.5. What is the Return on equity?

32.25 percent ROE= Net income/Total equity 149,200/662,154.67 ROE= 32.3 % Capital intensity ratio= TA/sales .74= x/936,800 TA= 693,232 EM=TA/TE 1.5= 693,232/x TE= 462,154.67

The paint ball range, Inc. paid $30,500 in dividends and $7,600 in interest over the past year. Sales totaled $211,800 with cost of $167,900. The depreciation expense was $16,500. The applicable tax rate is 34 percent. What is the amount of the operating cash flow

37,168 Sales 211,800 Cost 167,900 Depreciation 16,500 ----------------------- EBIT 27,400 Interest paid 7600 ------------------------ Tax 19,800 x .34= 6,732 27,400+16,500-6,732 = 37,168

Goshen Industrial Sales has sales of 828,900, and total equity of 539,200, a profit margin of 4.6 percent, and a debt to equity ratio of 0.55. What is the return on assets?

4.56 ROA= (NI/TA) Profit Margin= (NI/Sales) 4.6= x/828,900 NI= 3,812,940 DE ratio= TD/TE .55= x/539,200 TD= 296,560 TA= TE+TD x=539,200+296,560 TA= 835,760 ROA= 3,812,840/835,760=4.56

The Brown Jug has compiled the following information: What is the operating cash flow for 2014?

42,100 OCF= EBIT + depreciation - Taxes sales 198,500 cost of goods sold 128,300 Other 27,100 ------------------------------ EBIT 43,100 Taxes 1,000 ------------------------ OCF 42,100

Bridgewater Furniture has sales of $811,000, costs of $658,000, and interest paid of $21,800. The depreciation expense is $56,100 and the tax rate is 34 percent. At the beginning of the year, the firm had retained earnings of $318,300 and common stock of $250,000. At the end of the year, the firm has retained earnings of $322,500 and common stock of $280,000. What is the amount of the dividends paid for the year?

45,366 Sales 811,000 Cost 658,000 Dep 56,100 Interest paid 21,800 ---------------------- EBIT 75,100 Taxable income 75,100 x (1-.34) 75,100x .66= 49,566 Dividends 318,300-322,500 = -4,200 49,566-4,200 = 45,366

A firm has $42,900 in receivables and $211,800 in total assets. The total asset turnover rate is 1.40 and the profit margin is 5.2 percent. How long on average does it take the firm to collect its receivables?

52.1 days TATO = (sales/ TA) Profit Margin = (NI/Sales) 1.40= (x/211,800) Sales= 296,520 Receivable Turnover= (sales/accounts receivable) 296,520/42,900= 6.91 days 365/6.91= 52.81

Last year, The Pizza Joint added $4,100 to retained earnings from sales of $93,600. The company had costs of $74,400, dividends of $2,500, and interest paid of $1,400. The tax rate was 34 percent. What was the amount of the depreciation expense?

7,800 Earnings before interest and taxes = [($4,100 + $2,500)/(1 - 0.34)] + $1,400 = $11,400; Depreciation = $93,600 - $74,400 - $11,400 = $7,800

Joshua's Antiques has a total asset turnover rate of 1.2, an equity multiplier of 1.4, a profit margin of 5 percent, a retention ratio of 0.8, and total assets of $120,000. What is the sustainable growth rate?

7.20 percent Sustainable growth rate= (ROE x b/ 1-ROE x b) = ROE x .8 / 1-ROE x .8 Sustainable growth rate = [(0.05 × 1.2 × 1.4) × 0.8]/{1 - [(0.05 × 1.2 × 1.4) × 0.8]} = 7.20 percent

A fire has destroyed a large percentage of the financial records of the Strongwell Co. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 13.8 percent. Sales were $979,000, the total debt ratio was 0.42, and total debt was $548,000. What is the return on assets?

8% ROE= 13.8 % Sales 979,000 TD ratio = 0.42 TD = 548,000 ROA= net income/total assets .42=548,000/TA TA= 1,304,761 TA=TD + TE 1,304,761= 548,000 + x TE= 756,761 13.8= NI/ 1,304,761 NI= 104,433 ROA = 104,433/1,304,761= 8 %

Waldale Pools has total equity of $289,100 and net income of $64,500. The Debt-equity ration is 0.55 and total asset turnover is 1.6. What is the profit Margin?

9.00 percent PM= NI/sales DE ratio= TD/TE TATO= Sales/TA 0.55=x/289,100 TD=159,005 TA= TE+TD TA= 289,100+159,005= 448,105 1.6=x/448,105 sales= 716,968 PM= 64,500/716,968 =8.99 = 9

The pretzel factory has net sales of $821,300 and cost of $698,500. The depreciation expense is $28,400 and the interest paid is $8,400. What is the amount of the firms operating cash flow if the tax rate is 34 percent?

93,560 Operating cash flow= EBIT + depreciation - Tax Sales 821,300 Cost 698,500 Depreciation 28,400 ------------------------ EBIT 94,400 Interest paid 8,400 ------------------------ 86,000 x .34= 29,240 94,400+28400-29240= 93,560

Current Ratio

= current assets/ current liabilities Current ratio is a measure of Short term liquidity. To a creditor the higher the current ratio the better. A current ratio of less than one would mean that the NEW is negative and is unusual in a healthy firm.

Partnership

A business formed by two or more individuals or entities. General partnership: all share in gain or losses. all have unlimited liability for all partnership debt, not just some particular share. Limited partnership: one or more general partners will run the business and have unlimited liability but there will be one or more limited partners who don't actively participate in the business.

Sole proprietorship

A business owned by a single individual

Corporation

A legal "person" separate and distinct from its owners and it has many of the rights, duties, and privileges of an actual person. Involves preparing articles of incorporation or set of bylaws Advantages: ownership can be readily transferred, the life of the corporation is not limited, and borrows money its its own name. Disadvantages: Double taxation on corporate and personal level

Common-size Statements

A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statement items as a percentage of sales.

Which one of the following indicates that a firm has generated sufficient internal cash flow to finance its entire operations for the period?

A. positive cash flow from assets

Shareholders Equity

Assets - Liabilities = the residual portion

Which one of the following is a capital budgeting decision?

B. Deciding whether or not to open a new store.

What is the change in the net working capital from 2005 to 2006?

C. $1,335 Change in net working capital = ($7,310 - $2,570) - ($6,225 - $2,820) = $1,335

For the past year, LP gas, Inc. had cash flow from assets of 38,100 of which $21,500 flowed to the firm's stockholders. The interest paid was $2,300. What is the amount of the net new borrowing?

CF to creditors = interest paid - net new borrowing CFFA = CF to creditors + CF to stockholders 38,100 = x + 21,500 CF to creditors = 16,600 16,600- 21,300= x x = -14,300

Cash flow to creditors Cash flow to stockholders

CF to creditors= interest paid-net new borrowing CF to stockholders= dividend paid-net new equity raised

The Underground Cafe has an operating cash flow of $187,000 and a cash flow to creditors of $71,400 for the past year. During that time, the firm invested $28,000 in net working capital and incurred net capital spending of $47,900. What is the amount of the cash flow to stockholders for the last year?

CFFA= operating cash flow - networking capital - net capital spending x= 187,000-28,000-47,900 CFFA = 111,100 CFFA= CF creditors + CF Stockholders 111,100 = 71,400 + x x=39,700

Discount

Calculate the present value of some future amount

Operating cash flow

Cash generated from a firms normal business activities -Negative OCF shows trouble OCF= EBIT+depreciation-taxes

Which one of the following is most apt to align management priorities with shareholders' interest?

Compensating managers with shares of stock that must be held for three years before shared can be sold

Current or long term Liabilities

Current Liabilities: have a life less than one year meaning they must be paid within a year. (examples: accounts payable). Listed before Long term liabilities A debt thats not due in the coming year is a long term liability. A long that the firm will pay off in 5 years is one such long term debt.

What is the amount of the non-cash expenses for 2006?

D. $1,370 The non-cash expense is depreciation in the amount of $1,370.

Free cash flow is

D. cash that the firm is free to distribute to creditors and stockholders.

Working capital management includes which one of the following?

Determining which customers will be granted credit

Which one of the following is a capital structure decision?

Establishing the preferred debt-equity ratio

What is the amount of net new borrowing for 2006?

E. $225 Net new borrowing = $8,100 - $7,875 = $225

A _____ standardizes items on the income statement and balance sheet as a percentage of total sales and total assets, respectively.

E. common-size statement

Change in networking capital

Ending NWC- Beginning NWC = change in NWC

Balance Sheet

Financial statement showing a firms accounting value on a particular date. Convenient means of organizing and summarizing what a firm owns (its assets) and what a firm owes ( its liabilities). The difference between the two ( is the firms equity) at a given point in time.

Fixed Asset Versus Current Asset

Fixed Asset: has a relatively long life, can be tangible like a (truck or computer), or intangible like a (trademark or patent). current asset: has a life of less than one year. This means that the asset will normally convert to cash within 12 months. (examples: inventory, accounts receivable)

Which one of the following is a working capital decision?

How much cash should the firm keep in reserve

Which of the following are effective means of aligning management goals with shareholder interest?

I. Employee stock options II. Threat of a takeover III. Management bonuses tied to performance goals IV. Threat of a proxy fight ( I, II, III, IV )

Which of the following are advantages of the corporate form of organization?

I. Ability to raise large sums of equity capital II. Ease of ownership transfer III. Profits taxed at the corporate level IV. Limited liability for all owners ( I, II, IV )

Simple interest

Interest earned only on the original principal amount invested

Martha's Sweet Shop reduced its fixed assets this year without affecting the shop's operations, sales, or equity. This reduction will increase which of the following ratios?

I. capital intensity ratio II. Return on assets III. Total asset turnover IV. Return on equity Return on assets and total asset turnover (II and III only)

The T-shirt Hut successfully managed to reduce its general and administrative costs this year. This cost improvement will increase which of the following ratios?

I. profit margin II. Return on assets III. Total asset turnover IV. Return on equity (I, II, and IV only )

Agency Cost

If management does not take the investment, then the stockholders may lose a valuable opportunity

Which one of the following relates to a negative change in net working capital?

Increase in current liabilities with no change in current assets for the period

Which one of the following best matches the primary goal of financial management?

Increasing the market value of the firm

Sarbanes-Oxley act (sarbox)

Intended to strengthen protection against corporate accounting fraud and financial malpractice

Compound interest

Interest earned on both the initial principal and the interest reinvested from prior periods

Interest on Interest

Interest earned on the reinvestment of precious interest payments

Assets =

Liabilities + shareholders equity also called common equity or shareholders equity

Which one of the following situations is most apt to create an agent conflict?

Rejecting a profitable project to protect employee jobs

Agency Relationship versus Agency Problem

Relationship between stockholders and management. when the principal hires another (the agent) to represent his or her interest. The possibility of conflict of interest between the owners and management of the firm

Financial Ratios

Relationships determined from a firms financial information and used for comparison purposes

The Embroidery Shoppe had beginning retained earnings of $18,670. During the year, the company reported sales of $83,490, costs of $68,407, depreciation of $8,200, dividends of $950, and interest paid of $478. The tax rate is 35 percent. What is the retained earnings balance at the end of the year?

Sales 83,490 Cost 68,407 Dep 8,200 Interest paid 478 ----------------------- EBIT= 6,405 ----------------------- Taxable Income = 6,405 x (1-.35) 6,405 x .65= 4,163.25 Beginning RE + NI - Dividends = Ending RE 18,670+4163.25-950= 21,883.25 (21,883.25)

Terry invested $2,000 today in an investment that pays 6.5 percent annual interest. Which one of the following statements is correct, assuming all interest is reinvested?

Terry could have the same future value and invest less than 2,000 initially if he could earn more than 6.5 percent interest.

Market Value

The values of any assets (the amount of cash we would get if we actually sold it)

Future value

The amount an investment is worth after one or more periods.

Sixty years ago, your grandparents opened two savings accounts and deposited $200 in each account. The first account was with City Bank at 3 percent, compounded annually. The second account was with Country Bank at 3.5 percent, compounded annually. Which one of the following statements is true concerning these accounts?

The country bank account has paid 397.30 more in interest than the city bank account

Present Value

The current value of future cash flows discounted at the appropriate discount rate

Inventory Turnover

The higher this ratio is the more efficiently we are managing inventory

Sustainable growth rate

The maximum possible growth rate for a firm that maintains a consistent debt ratio and doesn't sell new stock

Internal Growth Rate

The maximum possible growth rate for a firm that relies only on internal financing

Capital Structure (Financial Structure)

The mixture of debt and equity maintained by a firm

Capital Spending

The net spending on fixed assets (purchases of fixed assets less sales of fixed assets) Ending net fixed assets - beginning net fixed assets+ depreciation= net investment in fixed assets

Compounding

The process of accumulating interest in an investment over time to earn more interest

Capital Budgeting

The process of planning and managing a firms long term investments -the value of the cash flow generated by an asset exceeds the cost of that asset (evaluating size, timing, and risk)

Liquidity

The speed and ease with which an asset can be converted to cash. The most liquid assets are listed first on the balance sheet. It has 2 dimensions 1. ease of conversion 2. Loss of value Inventory = least liquid

Cash flow from Assets

The total of cash flow to creditors and cash flow to stockholders, consisting of the following: operating cash flow, capital spending, and change in networking capital. = cash flow to creditors + cash flow to stockholders

Financial leverage

The use of debt in a firms capital structure

Book Values

The value shown on the balance sheet for the firms assets and are generally not what the assets are actually worth

ROE>ROA

as long as there is debt

Cash flow to creditors is equal to

beginning long-term debt minus ending long-term debt plus interest paid