Corp Finance midterm
Working capital decision
"How much cash should be kept in the reserve?"
General Partnership
Any one of the partners can be held solely liable for all of the partnership's debt.
Present value formula
FV / ( 1 + r )^t
Which one of the following is the correct formula for the future value of $500 invested today at 7 percent interest for 8 years?
FV = $500 (1 + 0.07)^8
Accounts payable period
Length of time between the day a firm purchases an item from supplier, is paid for that purchase is called
Operating cycle
Length of time between the purchase of inventory and the receipt of cash from the sale of that inventory inventory + receivables period
Depreciation
Lowers taxes
EBIT
Sales - costs - expenses - depreciation
A firm has total debt of $1,410 and a debt-equity ratio of 0.26. What is the value of the total assets?
$1,410 / Total equity = 0.26; Total equity = $5,423.08 Total assets = $1,410 + $5,423.08 = $6,833.08
inventory period
365 / inventory turnover
Secondary Market
All stock trades between existing shareholders. NYSE: New York Stock Exchange
Average Tax Rate
Total Tax / Total Taxable Income
You are comparing the current financial statements of a firm to the pro forma statement for next year. The pro forma is based on a four percent increase in sales. The firm is currently operating at 85 percent of capacity. Net working capital and all costs vary directly with sales. The tax rate and the dividend payout ratio are fixed. Given this information, which one of the following statements must be true?
Total assets will increase by less than four percent.
Owners Equity
Total liabilities and owners equity - current lab - long term debt
Marginal tax rate
What tax bracket the income falls under
Cash flow from assets
cash flow to creditors + cash flow to stock holders Op cash flow - Change in NWC - net capital spending
receivables turnover
credit sales / average receivables
Days sales in inventory
365 / inventory turnover 365 / (cogs/inventory)
Jenny needs to borrow $16,000 for 3 years. The loan will be repaid in one lump sum at the end of the loan term. Which one of the following interest rates is best for Jenny?
8 percent simple interest
Which one of the following statements is true concerning annuities?
All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity. Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years.
Samuelson's has a debt-equity ratio of 31 percent, sales of $12,500, net income of $1,000, and total debt of $5,200. What is the return on equity?
Debt-equity ratio = 0.31 = $5,200 / Total equity; Total equity = $16,774.19 Return on equity = $1,000 / $16,774.19 = 5.96 percent
Capital Management
Decides which customers will be granted credit
Decrease present value of annuity
Decrease in the annuity payment
Common size balance sheet
Determines if changes are occurring in a firms mix of assets
Discounting
Determining how much that bonus is worth today
Cash flow to stock holders
Dividends Paid - net new equity Div - [ (com stk end + add pay in sur end) - (com stk beg + add pay in sur beg) ] net new equity = firm issued in new equity
EAR
EAR = [1 + (APR / m)]^m - 1 m= months
Times interest earned ratio
EBIT / Interest
Capital Structure Decision
Has to do with DEBT & EQUITY
Corporate Shareholders
Have the ability to change the corporation's bylaws.
Market value of assets
If current assets were liquidated today + Can be sold for Tends to provide a better guide to the actual worth of an asset than does the book value
Draiman, Inc., has sales of $596,000, costs of $262,000, depreciation expense of $65,500, interest expense of $32,500, and a tax rate of 40 percent. (Enter your answer as directed, but do not round intermediate calculations.) Required: What is the net income for this firm?
Income statement Sales $ 596,000 Costs 262,000 Depreciation 65,500 EBIT $ 268,500 Interest 32,500 Taxable income $236,000 Taxes (40%) 94,400 Net income $ 141,600
Goal of financial management
Increase current market value per share.
Sarbanes Oxley Act
Increase protection against corporate fraud. Made officers of publicly traded firms personally responsible for the firm's financial statements.
Increase future value of lump sum investment
Increasing interest rate, increasing time period
Cash flow to creditors
Interest Paid - Net New Borrowing Interest Paid - (long term debt end - LTDbeg) Net new borrowing = redeemed in outstanding long term debt
Current assets
Inventory , cash , accounts receivables
Interest on interest
Jamie earned $180 in interest on her savings account last year. She has decided to leave the $180 in her account so that she can earn interest on the $180 this year. The interest Jamie earns this year on this $180 is referred to as:
Annuity Due
Janis just won a scholarship that will pay her $500 a month, starting today, and continuing for the next 48 months. Which one of the following terms best describes these scholarship payments?
Time formula
LN(fv/pv) / LN(1+r)
Negative cash flow from assets for several years
May be continually increasing in size
Income Statement
Measures revenues, expenses, and net income of a firm over a period of time
Concept of marginal taxation
Mitchell's Grocer increased its sales by $52,000 last year and had to pay an additional $16,000 in taxes.
Annual percentage rate
Monthly interest percentage * 12
Book Value of assets
NWC + Current Liabilities
Net Capital Spending
Net fixed assets end - net fixed assets beginning + depreciation
Earnings per share EPS
Net income / Shares
Profit margin
Net income / sales
Lee Sun's has sales of $3,800, total assets of $3,500, and a profit margin of 6 percent. The firm has a total debt ratio of 42 percent. What is the return on equity?
Net income = $3,800 × 0.06 = $228.00 Total debt ratio = 0.42 = ($3,500 - Total equity) / $3,500; Total equity = $2,030.00 Return on equity = $228.00 / $2,030.00 = 11.23 percent
Addition to retained earnings
Net income = Dividends + Addition to retained earnings
Sole Proprietorship
Obtaining additional equity is dependent on the owner's personal finances. Owner is liable for debts. Has profits taxed as personal income.
Limited Partnership
Offers liability protection to some of its owners but not to all of its owners. Loss is limited to capital investment. There must be AT LEAST ONE general partner
Future value formula
PV(1+r) ^t
PVA
PVA = C({1 - [1 / (1 + r)t]} / r ) Use this for finding the length of an annuity, then solve for t by using ln's Use this for finding the amount needed
Common size financial statements
Present all balance sheet account values as a percentage of SALES
Price Earnings Ratio
Price / Earnings per share Price / (net income/shares)
To reduce general costs, increase which ratios?
Profit margin, return on assets, return on equity
Total asset turnover
Sales / total assets
Stakeholder
Someone who buys from your company
Operating Cash Flow
The cash that a firm generates from its normal business activities. EBIT + Depreciation - taxes
Matching Principle
The costs of producing an item should be recorded when the sale of that item is recorded as revenue
Current ratio of 1.4 and quick ratio of .9 Given this, you know
The firm has positive net working capital
Compounding
The process of earning interest on prior interest earnings is called
Price sales ratio OR Sales per share
Sales / shares
Market to book ratio
Market value per share / book value per share
Book value per share
value of equity / shares
High Tower Pharmacy pays out a fixed percentage of its net income to its shareholders in the form of annual dividends. Given this, the percentage shown on a common-size income statement for the dividend account will:
vary in direct relation to the net profit percentage.
Teddy's Pillows has beginning net fixed assets of $472 and ending net fixed assets of $552. Assets valued at $320 were sold during the year. Depreciation was $44. What is the amount of net capital spending?
$552 + $44 - $472 = $124
Quick ratio
( current assets - inventory ) / current liabilities
Cash coverage ratio
(EBIT + depreciation) / interest
Rate formula
(FV / PV) ^ 1/t -1
Total debt ratio
(current liabilities + long term debt) / total assets
Return on Equity
(profit margin)(total asset turnover)(equity multiplier) (ROA)(equity multiplier) Net income / (common stock + ret earnings)
Highly liquid assets
Can be sold quickly at close to full value
Decrease or increase liquidity of a firm
Cash purchase of inventory will decrease liquidity of a firm Credit sale of inventory at cost will increase liquidity of a firm
Primary Market
Company sells 1000 newly issued stocks to Mike
Common size income statement
Compare firms sales and costs over period of time to determine any trends
Discounted cash flow valuation
Computing the present value of a future cash flow to determine what that cash flow is worth today is called
Treasurer
Controls the cash management
Net Working Capital
Current Assets - Current Liabilities
Shareholder Equity
Current assets + net fixed assets - total liabilities
Current ratio
Current assets / Current liabilities To increase. cash payment of account payable
Your firm has net income of $260 on total sales of $1,160. Costs are $650 and depreciation is $110. The tax rate is 35 percent. The firm does not have interest expenses. What is the operating cash flow?
EBIT = $1,160 - $650 - $110 = $400 (Sales - Costs - Depreciation) Taxes = 0.35 × $400 = $140 (Tax rate × EBIT) OCF = $400 + $110 - $140 = $370 (EBIT + Depreciation - Taxes)
A firm has sales of $4,790, costs of $2,590, interest paid of $174, and depreciation of $483. The tax rate is 30 percent. What is the value of the cash coverage ratio?
EBIT = $4,790 - $2,590 - $483 = $1,717 Cash coverage ratio = ($1,717 + $483) / $174 = 12.64
Jupiter Explorers has $10,600 in sales. The profit margin is 5 percent. There are 5,600 shares of stock outstanding. The market price per share is $2.00. What is the price-earnings ratio?
Earnings per share = ($10,600 × 0.05) / 5,600 = $0.09464 Price-earnings ratio = $2.00 / $0.09464 = 21.13
Annuity
Equal annual payments for life All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity. Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years.
DuPont Identity
Equity multiplier and return on equity
Capital Budgeting
Evaluation of size, timing, and risk of future cash flows. In charge of fixed asset purchasing.
Recently, the owner of Martha's Wares encountered severe legal problems and is trying to sell her business. The company built a building at a cost of $1,210,000 that is currently appraised at $1,410,000. The equipment originally cost $690,000 and is currently valued at $437,000. The inventory is valued on the balance sheet at $380,000 but has a market value of only one-half of that amount. The owner expects to collect 98 percent of the $210,200 in accounts receivable. The firm has $10,200 in cash and owes a total of $1,410,000. The legal problems are personal and unrelated to the actual business. What is the market value of this firm?
Market value = $1,410,000 (building) + $437,000 + (0.5 × $380,000) + (0.98 × $210,200) + $10,200 - $1,410,000 (amount owed) = $843,196
Simple interest
Savings account will pay interest only on the principal amount originially invested
Corporation
Separate legal entity, owners have no personal liability for the firms debts. Ability to raise large sums of equity capital Ease of ownership transfer Profits taxed at the corporate level
Agency Conflict
Separating management from ownership TO AVOID: Compensating managers with shares of stock that must be held for three years before the shares can be sold
Balance Sheet
Summarizes a firms accounting value as of a particular date Assets are listed in descending order of liquidity
The SGS Co. had $131,000 in taxable income. Use the rates from Table 2.3.
Taxes = 0.15($50,000) + 0.25($25,000) + 0.34($25,000) + 0.39($131,000 - 100,000) Taxes = $34,340
The tax rates are as shown. Taxable Income Tax Rate $0 - 50,000 15% 50,001 - 75,000 25% 75,001 - 100,000 34% 100,001 - 335,000 39% What is the average tax rate for a firm with taxable income of $129,513?
Taxes paid = 0.15($50,000) + 0.25($75,000 - 50,000) + 0.34($100,000 - 75,000) + 0.39($129,513 - 100,000) = $33,760.07 Average tax rate = $33,760.07 / $129,513 = 26.07%
If them firm has a positive external financing needed, that need will be met by
long term debt
Profit margin
net income / sales
Equity multiplier
1 + Debt equity ratio Total assets / total equity
Radio Shack offers credit to its customers and charges interest of 1.2 percent per month. What is the annual percentage rate?
APR = 1.2 percent × 12 = 14.40 percent
A firm has net working capital of $590, net fixed assets of $2,336, sales of $7,000, and current liabilities of $900. How many dollars worth of sales are generated from every $1 in total assets?
Current assets = $590 + $900 = $1,490 Total asset turnover = $7,000 / ($1,490 + $2,336) = 1.83 Sales generated by $1 in total assets = $1 x 1.83 = $1.83
Security Dealer
Dealers buy and sell from their own inventory.
Dimeback Co. has total assets of $9,000,000 and a total asset turnover of 2.40 times. Assume the return on assets is 10 percent. Required: What is its profit margin?
To find the profit margin, we need the net income and sales. We can use the total asset turnover to find the sales and the return on assets to find the net income. Beginning with the total asset turnover, we find sales are: Total asset turnover = Sales / Total assets 2.40 = Sales / $9,000,000 Sales = $21,600,000 And the net income is: ROA = Net income / Total assets 0.10 = Net income / $9,000,000 Net income = $900,000 Now we can find the profit margin which is: Profit margin = Net income / Sales Profit margin = $900,000 / $21,600,000 Profit margin = .0417, or 4.17%
Jiminy Cricket Removal has a profit margin of 10 percent, total asset turnover of 1.10, and ROE of 14.36 percent. Required: What is this firm's debt-equity ratio
We can use the Du Pont identity and solve for the equity multiplier. With the equity multiplier we can find the debt-equity ratio. Doing so we find: ROE = (Profit margin)(Total asset turnover)(Equity multiplier) .1436 = (0.10)(1.10)(Equity multiplier) Equity multiplier = 1.31 Now, using the equation for the equity multiplier, we get: Equity multiplier = 1 + Debt-equity ratio 1.31 = 1 + Debt-equity ratio Debt-equity ratio = .31
If the Baseball Shoppe has an 8 percent ROA and a 25 percent payout ratio, what is its internal growth rate?
We need to calculate the retention ratio to calculate the internal growth rate. The retention ratio is: b = 1 - 0.25 b = 0.75 Now we can use the internal growth rate equation to get: Internal growth rate = (ROA × b) / [1 - (ROA × b)] Internal growth rate = [0.08(0.75)] / [1 - 0.08(0.75)] Internal growth rate = 0.0638 or 6.38%