Principles of finance Exam 1

pg28 Q1) Name Three ways capital is transferred between savers and borrowers.

-Direct Transfers: of money and securities, occur when a business sells its stocks or bonds directly to savers, without going through any type of financial institution. -Indirect Transfers: (primary market transaction) through an INVESTMENT BANK such as Morgan Stanley, which underwrites the issue. the securities and the savers money passes through the investment bank. -Indirect Transfers: Through FINANCIAL INTERMEDIARY such as a bank, insurance company, or a mutual fund. the intermediary obtains funds from savers in exchange for its securities. Then the intermediary uses this money to buy and hold businesses' securities, while the savers hold the intermediary's securities. example: saver deposits dollar in a bank, receives a CD, then bank lends the money to a business the form of a mortgage loan.

PG 44 Q3) what is an IPO?

-Initial public offering occurs when a company issues stock in the public market for the first time in order to raise capital. Once stocks are issued they are traded in the secondary market.

PG 38 Q1) What's the difference between a commercial bank and an investment bank?

-Investment bank: are organizations that underwrite and distribute new investment securities and help businesses obtain financing -Commercial banks: are like a department store for finance, they handle checking services among other services.

PG 33 Q3) Distinguish between money markets and capital markets.

-Money: less than one year, funds are borrowed or loaned for short periods. -Capital: financial markets for stock and long term debt.(more than a year)

PG 38 Q3) What are some important differences between mutual funds, Exchange Traded Funds, and hedge Funds? how are they similar?

-Mutual Fund are corporations that accept money from savers and then uses these funds to buy stocks, long-term bonds, or short-term debt instruments issued by businesses or governments. -Exchange Traded Fund: buy a portfolio of stocks of a certain type like the S&P 500 and then sell their own shares to the public. -Hedge Funds: are similar to mutual funds but are unregulated by the SEC and target investors that make large minimum investments.

PG 33 Q4) What's the Difference between primary markets and secondary markets?

-Primary: Markets in which corporations raise capital by issuing new securities. -Secondary: Markets in which securities and other financial assets are traded among investors after they have been issued by corporations.

PG 44 Q2) Differentiate between primary and secondary markets.

-Primary: Primary markets are markets in which corporations raise capital by issuing new securities. -Secondary: secondary markets are markets in which securities and other financial assets are traded among investors after they have been issued by corporations.

PG33 Q2) What's the difference between spot markets and future markets?

-Spot: the markets in which assets are bought and sold for "on the spot" delivery. -Future: The markets in which participants agree today to buy and sell an asset at some future date. ex- turkey in 2 weeks for $1/LB

Name three characteristics of liquid assets? Examples:

1. Money to cover unexpected expenses 2. You can turn it into cash without loss. 3. Stored in low risk low return account An asset that can be converted to cash quickly without having to reduce the asset's price very much.

Name two ratios that are used to measure financial leverage and write their equations

1. broader debt ratio total liabilities (including acct payable and accruals/ total assets 2. debt-to-equity total debt/ total equity

Why does the use of debt lower the profit margin and the ROA?

A firm who uses more debt has higher interest charges. The interest charges pull down its net income; and bc sales are identical from the other company, the result is a relatively low profit margin for the firm with more debt. A low ROA can result from a conscious decision to use a great deal of debt, in which case high interest expenses will cause net income to be relatively low.

Identify six profitability ratios and their equations

A group of rations that show the combined effects of liquidity, asset management, and debt on operating results. 1. Operating margin OM= EBIT/ Sales 2. Profit margin PM= Net income/sales 3. Return on Total Assets (ROA) ROA= net income/total assets 4. Return on Common Equity (ROE) ROE= Net income/ common equity 5. Return on Invested Capital (ROIC) ROIC=(EBIT(1-T)) / Total invested capital 6. Basic Earning Power (BEP) Ratio BEP= EBIT/Total Assets

PG33 Q6) Why are financial markets essential for a healthy economy and economic growth

A healthy economy is dependent on efficient funds transfers from people who are net savers to firms and individuals who need capital. Without efficient transfers, the economy simply could not function. Obviously, the level of employment and productivity, hence our standard of living, would be much lower. Therefore, it is absolutely essential that our financial markets function efficiently—not only quickly, but also at a low cost.

Why might different companies account for similar transactions in different ways?

Accounting practices differ. This is why you note in the comment section what practice you used and when you recorded such data, so others can understand the slight variation in numbers.

Qualitative Factors: Company's Future Financial Performance

Are the firm's revenues tied to one key customer, product, or supplier? What percentage of the firm's business is generated overseas? Firm's competitive environment Future prospects (innovation, pipeline) Legal and regulatory environment

How is the order in which items are shown on the balance sheet determined?

Assets are listed from most liquid to least liquid.

What four financial statements are typically included in the annual report?

Balance Sheet, Income Statement, Statement of Cash Flows, Statement of Stockholders Equity

Which is more like a snapshot of the firm's operations -- the balance sheet or the income statement? Explain your answer.

Balance Sheet. This provides a snapshot of the firms financial standing. Income Statement summarizes a firms revenues and expenses over a given period of time.

Explain why the following statement is true: The retained earnings account reported on the balance sheet does not represent cash and is not "available" for dividend payments of anything else.

Because, at this point you have already subtracted dividends and use this money to return to the firm for net profit.

Why do changes in retained earnings occur?

Both Net Income and cash dividends can effect retained earnings.

Potential Problems and Limitations of Financial Ratio Analysis

Comparison with industry averages is difficult for a conglomerate firm that operates in many different divisions. (GE) Different operating and accounting practices can distort comparisons.(LIFO/FIFO, Depreciation) Sometimes it is hard to tell if a ratio is "good" or "bad." (high current ratio) Difficult to tell whether a company is, on balance, in a strong or weak position. (Discriminant Analysis)

How does the use of financial leverage affect stockholders' control position?

Creditors prefer low debt ratios because the lower the ratio, the greater the cushion against creditors' losses in the event of liquidation. Stockholders, on the other hand, my want more leverage because they can magnify expected earnings.

A company has current liabilities of "$500" million, and its current ratio is 2.0. What is the total current assets? If the firms quick ratio is 1.6, how much inventory does it have?

Current assets: $1000 Million Current ratio= 2.0 = CA/CL=CA/$500,so CA= 2($500)=1000 Inventory: $200 Million Quick ratio= 1.6 =(CA-inventories)/CL=($1000-inventories)/$500, so $1000-inventories=1.6($500) and inventories = 1000-800=$200

Explain in words the difference between total debt and total liabilities?

Debt is always a liability, A liability is not always a debt(like accounts payable i.e. wages)

What is EBITA?

Earning Before Interest, Taxes, and Amortization

PG28 Q2) Why are efficient capital markets necessary for economic growth?

Economic development is highly correlated with the level and efficiency of financial markets and institutions.

What is the annual report, and what two types of information does it provide?

Formal, comprehensive financial reports that are published yearly. They give shareholders and other interested parties involved information regarding the companies activities and financial performance.

Can investors be confident that if the financial statements of different companies are accurate and are prepared in accordance with GAAP, that the data reported by one company will be compatible to the data provided by another?

GAAP has fuzzy lines, so even though each company has filled in the financial statements with accurate information in accordance to GAAP, does not mean that they will be identical in preparation.

In what sense do these market value ratios reflect investors' opinions about a stock's risk and expected future growth?

If investors think these ratios will continue to look good in the future, the market value ratios will be high, the stock price will be as high as can be expected, and management will be judged as having done a good job.

PG 51 Q3) Why is it good for the economy, in which markets be efficient?

If markets are inefficient, then investors will be afraid to invest, and this will lead to a poor allocation of capital and economic stagnation

Which is the least liquid of the firm's current assets?

Inventories, if sales slow down, they might not be converted to cash as quickly as expected. Also, inventories are the assets on which losses are most likely to occur in the vent of liquidation. Therefore, the quick ratio, which measure the firm's ability to pay off short-term obligations without relying on the sale of inventories, is important.

a firm has annual sales of 100 million, 20 million of inventory and 30 million of accounts receivables. What is its inventory turn over ratio? What is its DSO?

Inventory turnover: Sales/inventory= 5.0 Days Sales outstanding: Receivables/(Sales/365)= 109.5 Days

PG 41 Q2) What is the bid-ask spread?

Is the difference between bid and ask prices, represents the dealer's markup, or profit.

What is the annual report of great interest to investors?

It gives them a snapshot of the companies activities and financial standing

PG 51 Q1) What does it mean for a market to be "efficient"?

It means that investors can buy and sell stocks and be confident that they are getting good prices. inefficient means investors are afraid to invest,an this will lead to a poor allocation of capital and economic stagnation.

Whats the difference between marginal and average tax rates?

One depends on what tax bracket you fall in. The other is the taxes you have paid divided by your total income.

Explain in words the difference between net working capital and net operating working capital?

One is current assets minus current liabilities. One is the excess of working current assets over current liabilities

Identify and briefly explain the four sections shown in the Statement of Cash Flows.

Operating activities represents the companies core business, including sales and expenses. Investing activities include the cash flows that arise out of the purchase and sale of long-term assets such as plant and equipment. Financing activities represent changes in the firms use of debt and equity such as issue of new shares, the repurchase of outstanding shares, and the payment of dividends.

What is the balance Sheet and what information does it provide?

Provides a snapshot of a firms financial position at one point in time. Includes total liabilities, total shareholders equity, and total assets

What is the Statement of Cash Flows, and what are some questions it answers?

Reports the impact of a firms activities on cash flows over a given period of time and identifies all of the sources and uses of cash. Shows operating income, investing activities, and financing activities.

What information does the statement of stockholders equity provide?

Shows how much of the firms earning were retained, rather than paid out as dividends.

If you wanted to evaluate a firm's DSO, with what could you compare it?

The DSO can be compared with the industry average, but it is also evaluated by comparing it with Allied's credit terms.

What is Free Cash Flow (FCF)?

The amount of cash that could be withdrawn without harming a firms ability to operate and to produce future cash flows.

financial ratio analysis is conducted by three main groups of analysts: credit, stock, and managers, what is the primary emphasis of each group and how would that emphasis affect the ratios on which they focus?

The emphasis of the various types of analysts is by no means uniform nor should it be. Management is interested in all types of ratios for two reasons. First, the ratios point out weaknesses that should be strengthened; second, management recognizes that the other parties are interested in all the ratios and that financial appearances must be kept up if the firm is to be regarded highly by creditors and equity investors. Equity investors (stockholders) are interested primarily in profitability, but they examine the other ratios to obtain information on the riskiness of equity commitments. Credit analysts are more interested in the debt to capital, TIE, and EBITDA coverage ratios, as well as the profitability ratios. Short-term creditors emphasize liquidity and look most carefully at the current ratio.

PG 41 Q1) What are the differences between the physical location exchanges and the NASDAW stock market?

The physical location exchanges are formal organizations having tangible, physical locations and trading in designated securities. like the NYSE Nasdaq is a electronic dealer based market that facilitates trading of securities that are not listed on a physical location exchange.

Why is FCF an important determinate of a firms value?

This shows how profitable a firm is

If one firm is growing rapidly and another is not, how might this distort a comparison of their inventory turnover ratios?

Use year-end rather than average inventories or the opposite, idk

What question are the two liquidity ratios designed to answer?

Will the firm be able to pay off its debts as they come due and thus remain a viable organization?

If during the year a company has high cash flows from its operations, does this mean that cash on its balance sheet will be higher at the end of the year than it was at the beginning of the year? Explain.

Yes- depending on when the statement of cash flows is captured. It can reflect the higher cash flows during seasonal impacts.

a set of ratios that measure how effectively a firm is managing its assets 4?

asset management ratios

How does the U.S. tax structure influence a firm's willingness to finance with debt?

tax system favors debt financing over equity financing

Why is Earnings Per Share called "the bottom line"? What is EBIT, or operating income?

the bottom line refers to the last line on a firms income statement. This line shows net profit after all expenses, depreciation and taxes have been taken out. EBIT is Earnings before Interest and Taxes. This comes before the bottom line and is your operating income.