Corporate Finance: Chapter 1-5

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? A. offer price reduction with generous credit terms that would 1. enable the firm to sell some of its excess inventory, and 2. lead to an increased in accounts receivable B. issue new common stock and use proceeds to increase inventory C. Speed up collection of receivables and use cash generated to increase inventories D. Use some cash to purchase additional inventory E. Issue new common stock and use proceeds to acquire additional fixed assets.

A. Offer price reduction with generous credit terms that would 1. enable firm to sell excess inventory and 2. lead to increase in AR would increase Quick ratio. -Quick ratio = current asset - inventory / current liability, so anything that decreases inventory and increases profit would benefit, but anything that increases inventory, decreases profit, or increases liability would decrease quick ratio

Which Statement is CORRECT? a. one advantage of forming a corporation is that equity investors are usually exposed to less liability than they would in a partnership b. Corporations face fewer regulations than proprietorships c. one disadvantage of operating a business as a proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level d. it is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required; e. if a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the firm

A: One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership.

Perpetuity:

Annuity that continues forever.

which of the following items is not normally considered a current asset? A. Accounts Receivable B. Inventory C. Bonds D. Cash

C. Bonds is the only item not normally considered a current asset, because a company will have to pay the bond back, making it a liability

Which of the following statements is correct? A. The NYSE does not exist as a physical location. Rather it represents as loose collection of dealers who trade stock electronically. B. An example of a primary market transaction would be your uncle transferring 100 shares of walmart stock to you as a gift C. Capital market instruments include both long-term debt and common stock D. If your uncle in NY sold 100 shares of Microsoft through his broker to an investor in LA, this would be a primary market transaction E. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors

C: The Capital market instruments include both long-term debt and common stock

What is a Primary Market?

Company sells stocks or bonds to the public: Company receives money. -IPO (Initial public offering) -SeO: Seasonal equity offering

Annuity:

Equal payments at regular intervals of time: Ex: car payment or mortgage. In excel: Annuity: Finance formula --> PMT

Song Corp's stock price at end of last year = $23.50 and earnings per share = $1.30. What is P/E ratio?

PE= Market share/ EPS: 23.50/1.30= 18.08.

20 questions: 1st 10: multiple choice like quizzes last 10, excel: some are short answer, some are mult. choice. know how to calculate accounts receivable from -who has tax advantage: sole proprietorship and partnership = tax advantage -corperation: double taxed -Primary and secondary market -Function of finance market: Main goal of Finance management -income statement and blanace sheet: Video is income stmt, snapshot is balance sheet. -Chapter five: Future v., PV, npR, -Make something negative if investing money; PV or FV -Interest rate: if monthly: iR/12 -NPR: multiplied by 12 months if monthly -NysE and NAsdAQ are both secondary -Initial public offering: buy first round -Money market and financial market: money is short term, financial is long term -**know formulas** -if you buy something on credit, will quick test ratio increase -Quiz 2: 10 -easiest to transfer ownership in cooperation

Test Structure.

Ajax Corp slaes last year were $435,000, and its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times-interest-earned ratio?

Times interest earned ratio = EBIT/I: Sales: 435,000 - 362,500 (COGS (with D)) = 72,500 (EBIT). Interest = 12,500. 72,500/12,500 = 5.8.

What is Future Market?

Transactions take place on a pre-determined future date at a pre-determined price.

What is Spot Market?

Transactions take place on the spot

What is a Secondary Market?

Transfer of securities takes place.

What is a Capital Structure?

-How the company raises long-term finances by selling stock and raising bonds.

TF: The NYSE is defined as a "spot" market purely and sim;ply because it has a physical location. The NASDAQ, on the other hand, is not a spot market because it has no one central location.

False: The NYSE is a 'spot' market because the transactions take place on the spot, not because its location.

TF: The NYSE is defined as primary market because it is one of the largest and most important stock markets in the world.

False: that is not the definition of primary market. A primary market is a company that sells stock or bonds directly to the public.

What is Capital Budgeting?

How the company decides to invest money for the long-term

What is a Capital market?

Long term debt and stock (more than 1 year)

What is a Financial Asset Market?

Nonphysical assets such as stocks, bonds, and money markets.

What is a Money market?

Short term debt (less than 1 year)

Equivalent Annual Rate (or Effective Annual Rate)

(1 + i/m)^m -1 -excel --> Finance --> effect

What is a partnership? What are the advantages/disadvantages?

-2 or more owners. Needs at least 1 general partner. -Advantage: More capital -Disadvantage: Owner has unlimited personal liability. --> Limited partners = limited liability -->General partner = unlimited liability (income tax)

What is a corporation? What are advantage/disadvantage?

-A separate legal entity. It perpetually exists, even if owner is gone -Advantage: the owners all have limited liability -Disadvantage: Double taxation

Assets on a Balance Sheet

-Assets belong to the company. Company uses it to try and make a profit. -Current (short term) assets -Cash -Accounts Receivable -Inventory -Fixed (long term) assets: Land, buildings, factory, machinery, equipments all = Total Assets

What is the NYSE?

-Big companies -Physical (online) market created in 1817. -Brokers bring buyers and sellers together and earns commission

What are Commercial Banks?

-Collect money from depositors -Lend money to borrowers: Earn interest -FDIC: protects our money to up to $250,000

What is true about Corporations?

-Corporations experience double taxation -It is easier to transfer one's ownership interest in a corporation than in a partnership -Corporations have more regulations than proprietorships. -More expensive to form corporation than proprietorship and it requires more legal documentation. -shareholders are not exposed to unlimited liability.

What are Investment Banks?

-Help companies raise money -Underwright: Promis saying if they can't sell the shares the Investment Bank will buy it. -Best effort.

What are Mutual Funds?

-Investment companies. -Pool resources from large number of investors -Professionally managed: to invest funds -Diversified to reduce risk -Fees and expenses because a professional is working to invest the money (about 2%) -There are thousands of mutual funds with different goals and objectives

What is a limited liability company? Advantage? Disadvantage?

-LLC: Adv: all owners have limited liability, and it is taxed as partnership. Disadv: ownership is not easily transferred.

What is true about a proprietorship?

-Less regulation than a Corporation -Only taxed once. -cheaper to form proprietorship than Corporation. -Exposed to unlimited liability

Goals of Financial Management:

-Maximize profits -Increase sales -Minimize costs -Grow bigger -invest for future -society, environment -maximize shareholder wealth or maximize the share price of the company.

How can you reduce the agency problem?

-Offer: bonuses, incentives, promotions, stock options, and profit-sharing.

What are Credit Unions?

-Owned by close-knit members -Need to earn money but don't really make large profit -Theoretically, members get better rates, but in reality, it is not as large as bigger banks, it might not be the case -NCUA: National Credit Union Association.

What is a sole proprietorship? What are the advantages/disadvantages?

-Sole proprietorship has only one owner. -Advantage: Get to make and keep all money -Disadvantage: Lack of capital, owner has unlimited personal liability, and owner pays income tax: business tax is viewed as personal tax. Owner is not double taxed

Liability on Balance Sheet

-Things the company owes -Current (short term) liabilities: Notes, bills, A/P -Long term: loans, mortgage, bonds -Shareholders equity, retained earnings.

What are Hedge Funds?

-Unregulated -High net worth individuals: need at leas $1,000,000. -Much higher potential to increase profits.

What is NASDAQ?

-formed in 1971 for smaller companies -Over the counter market -Dealers bought and sold on their own account -Spread; how dealers make money: They always sell higher than they buy.

What are some examples of secondary stock?

1. Your uncle transferring 100 shares of Walmart stock to you as a gift. 2. Your uncle in NY sold 100 shares of Microsoft through his broker to an investor in LA. 3. You sell 200 shares of IBM stock on the NYSE to your broker 4. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.

Sis is thinking about starting business. Company would require 375,000 of assets and it would bed financed with common stock (entirely). She will only do it if she thinks firm can provide 13.5% Return on invested capital, so company must have ROE of 13.5%. How much NI must be expected to warrant starting business?

Asset: 375,000/ .135 (ROE) = $50,625.

Which of the following statements is correct? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. d. Limited liability is an advantage of the corporate form of organization to is owners (stockholders) but corporations have more trouble raising money in financial markets because the complexity of this form of organization.

B. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.

Which Statement is true? A. One of the advantages of the corporate form of organizations is that it avoids double taxation. B. It is easier to transfer one's ownership interest in a partnership than in a corporation. C. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability D. Corporations are subject to the corporate income statement

C and D: Sole proprietorship exposes the proprietor to unlimited liability. - Corporations are subject to the corporate income statement.

Which of the following is a primary market transaction? A. You sell 200 shares of IBM stock ,on the NYSE through your broker B. You buy 200 shares of IBM stock, from your brother. The trade is not made through a broker, you just give him cash and he gives you the stock. C. IBM issues 2,000,000 shares of new stock, and sells them to the public through an investment banker D. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.

C. IBM issuing 2,000,000 shares of new stock, and selling them to the public through an investment banker is an example of a primary market transaction.

You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of: A. A money market transaction B. A primary market transaction C. A secondary market transaction D. A future market transaction E. An over-the-counter market transaction

C. You recently selling 200 shares of Disney stock, and the transfer was made through a broker is an example of a secondary market transaction.

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? A. The company repurchases common stock. B. The company pays dividends C. Company issues new common stock D. Company gives customers more time to pay bills E. Company purchases new piece of equipment

C: Company issuing new common stock is the only option that would bring in money and increase cash.

Considered alone, which of the following would increase a company's current ratio? A. an increase in net fixed assets B. an increase in accrued liabilities C. An increase in notes payable D. An increase in accounts receivable E. An increase in accounts payable

D. An increase in accounts receivable would increase a company's current ratio. Current Ratio= Current asset/ current liability, so anything that increases current asset, in turn increases company's current ratio.

Which of the following statements is correct? A. If you purchase 100 shares of Disney stock from your brother-in-law, this is an example of a primary market transaction B. If disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction C. The NYSE is an example of an over-the-counter Market D. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

D. As they are generally defined, money market transactions involve debt securities with maturities of less than one year. -Money markets are short term.

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to: a. maximize expected total corporate income b. maximize its expected EPS c. Minimize the chances of losses d. maximize the stock price per share over the long run, which is the stock's intrinsic value

D: the primary operating goal of a publicly owned firm interested in serving its stockholders should be to maximize the stock price per share over the long run, which is the stock's intrinsic value.

Money Markets are markets for: A. Foreign Currencies B. Consumer Automobile Loans C. Common Stock D. Long-Term Bonds E. Short-Term debt securities such as treasury bills and commercial paper.

E. Money markets are for short-term debt securities such as treasury bills and commercial paper.

TF: A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liability in the event of bankruptcy than are investors in a typical partnership.

False. Corporate stockholders do not have unlimited liabilities.

TF: An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships.

False. Corporations are more highly regulated than proprietorships and partnerships.

TF: One advantage of the corporate form of organization is that it avoids double taxation.

False: Corporations have double taxation. Proprietorships and partnerships do not have double taxation.

TF: One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm's investors to transfer their ownership interests.

False: Forming a corporation rather than a partnership makes it easier for a firm's investors to transfer their ownership interests.

TF: IF Games inc has $800,000 of retained earnings, and $50,000 in cash, would they be able to pay cash to buy an asset with a cost of $200,000.

False: they would not be able to because they only have $50,000 in cash

What is Working Capital Management?

How the company manages its day-to-day finances.

Zero Corp's total common equity at end of last year was $405,000 and NI = $70,000. What was RoE?

RoE = NI/Equity: 70,000/405,000= 17.28%

River Corp total assets = $415,000 and NI = $32,750. What was return on total assets?

RoTA = NI/TA: 32,750/415,000 = 7.89%

What is an LLP

Limited liability partnership -Owners are of the same profession

What is an Agency Problem?

Problem between shareholders and managers; the more owners pay employees, the less they make, but employees wont be motivated if not payed enough.

Royce Corps sales last year = $280,000, and NI = $23,000. What is the profit margin?

Profit margin = NI/Sales 23,000/280,000 = 8.21%

In 2014, Inc reported RE: $525,000 and NI: $135,000. In 2013: RE: $445,000. How much in dividends were payed in 2014?

RE 2014 (525,000)- RE 2013 (445,000)= $80,000. 135,000 (NI 2014) - 80000 = $55,000 worth of dividends were payed. Why? Because on Inc Stmt: RE= Net Profit - Dividends.

Rao Construction recently reported $20.50 million of sales, $12.60 million of operating costs other than depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax was 40%. what was Rao's operating income, or EBIT in millions?

Sales: 2.5 million -COGS: 12.6 million = Gross profit: 7.9 million - Depreciation: 3.0 million = Operating profit: 4.9 million Answer: Operating income=4.9 mil

TF: If you decide to buy 100 shares of Google, you would probably do so by calling your broker and asking him/her to execute the trade for you. This would be defined as a secondary market transaction, not a primary market transaction.

True.

TF: If we were describing the income statement and the balance sheet, it would be correct to say the income statement is more like a video and the balance sheet is more like a snapshot.

True. An income statement breaks down into bi-yearly segments and is more like a video, while a balance sheet is just a year end snap shot.

T/F: Partnerships and proprietorships generally have a tax advantage over corporations.

True. Corporations have double taxation, while partnerships and proprietorships do not.

TF: If a firm sold some inventory on credit, its current ratio would probably not change much but its quick ratio would increase.

True. Current ratio = Current assets/ Current liabilities. -Quick ratio = Current Assets - Inventory/ Current liability

TF: The price/earning (PE) ratio tells us how much investors are willing to pay for a dollar of current earnings. IN general investors regard companies with higher PE ratios as being less risky and/or more likely to enjoy high growth in the future.

True. The PE ratio = Market price (Price per share) / EPS EPS= NI/# of shares. -Price earning ratio shows how much investors are willing to pay per dollar of reported profits.

TF: On the balance sheet, total assets must always equal the sum of total liabilities and equity.

True. Total Assets = Total Liabilities + Equity

TF: The time dimension is important in financial statement analysis. The Balance Sheet shows the firm's financial position at a given point in time, will the income statement shows results over a period of time

True: Balance sheets show financial position at a given point in time, while income statement sows results over a period of time.

TF: Hedge funds are somewhat similar to mutual funds. The primary differences are that hedge funds are less regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions.

True: Hedge funds are similar to mutual funds, but they are less regulated, and thus have more flexibility on what they can buy, and their investors have a minimum of 1,000,000 buy in.

RF: EBIT stands for earnings before interest and taxes, and is often called "Operating Income"

True: Revenue/Sales - COGS = EBDIT (Gross Profit) - D = EBIT: Operating Income. - I = EBT - T in percentage = Net profit - Dividends = Retained Earnings.

TF: It is generally harder to transfer one's ownership in a partnership than in a corporation.

True: it is harder to transfer ownership in a partnership than in a corporation.

What is a Physical Asset Market?

Whenever you go to the store and buy physical objects such as cars, clothes, shoes, etc.

Which of the following statements is CORRECT? a. Corporations usually face fewer regulations than proprietorships b. corporate shareholders are exposed to unlimited liability c. it is usually easier to transfer ownership in a corporation than in a partnership. d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.

c. It is usually easier to transfer ownership in a corporation than in a partnership.