Exam #4

What is GAAP?

Generally Accepted Accounting Principles; financial statements have to be made in accordance with them

What is sunk cost?

a cost that has already been paid should not be considered in an investment decision

Which examples involve only implicit opportunity costs (not explicit costs)?

a firm withholding licensing rights from others to gain a competitive advantage; a rental estate company using a rental apartment as its own office; a company using a spare machine for a new project

What is cash flow to owners?

a firm's dividend payments less net new equity raised

What is financial leverage?

a ratio of debt to equity or debt to total assets

What are financial statements the language of?

accountants, auditors, analysts, examiners, creditors, investors

Total asset turnover is a measure of:

asset use efficiency

The balance sheet shows a company's:

assets and liabilities at one point in time

What is the stand-alone principle?

assumption that evaluating a project is as simple as considering the project's incremental cash flows

What are stock variables?

balance sheet and statement of changes in owners' equity

What value are financial statements stated at?

book

What are examples of current assets?

cash accounts receivable inventory

What is free cash flow?

cash flow available to pay creditors and owners

What is cash flow identity?

cash flow from assets equals cash flow to creditors plus cash flow to owners

According to the cash flow identity, cash flow from assets must equal:

cash flow to shareholders and creditors

Common-size statements are useful for comparing:

companies of different sizes a company's performance over time different companies in the same industry

What is net working capital (NWC)?

current assets - current liabilities

What are examples of current liabilities?

current portion of long-term debt accrued wages accounts payable

What is a current liability?

debt that needs to be paid in cash within a year

Which of these items does not add to or subtract from incremental cash flow by its full amount? taxes opportunity costs side effects depreciation

depreciation

What is cash flow?

difference between the amount of money that is collected and dispersed; inflows minus outflows

What is incremental cash flows?

difference between the firm's existing cash flows without the new project versus its cash flows with the new project

Cash flow to shareholders equals:

dividends paid minus net new equity issued

What are fixed assets and long-term liabilities?

everything else

What is liquidity?

how quickly/easily you can convert something to cash

Financial ratios are useful:

if they can be compared to historical ratios or other companies' ratios

When determining relevant cash flows for project evaluation, we should:

ignore interest and other financing expenses

What are flow variables?

income statement and cash flow

What are the 4 types of financial statements?

income statement, balance sheet, statement of cash flows, statement of owner's equity

Cash flow to creditors equals:

interest paid minus net new borrowing

What is common-sized financial statements?

listed in percentages instead of dollar values

What value does finance care about?

market

Which are components of cash flow to assets?

net capital spending change in net working capital operating cash flow

How is book value stated?

net of any charges or adjustments (depreciation, amortization, charge-offs, write-downs, etc.)

What is cash flow from assets?

operating cash flow + capital spending + change in net working capital

When calculating incremental cash flows, we should include:

opportunity costs

What are uses of the cash flow from assets generated by a company?

pay dividends to shareholders reinvest the money in the company pay interest and principal to creditors

What are statements of changes in owner's equity?

shows estimated changes in overall firm equity; shares and classes of stock, retained earnings and accumulated other comprehensive income

What is statement of cash flows?

standard financial accounting statement that discloses a firm's cash flows

What is project cash flows?

what cash flows should we include?; how we determine whether to undertake or not based on the cash flows the project will generate

What is market value?

whatever price it will bring in the market

What is cash flow erosion?

when cash flows are lost due to investing in a new project

What is a proforma financial statement?

"what might be"

What is relevant cash flows?

any change in the firm's overall future cash flows that come directly from a new project

What is a current asset?

anything that can be converted to cash in a year

What is cost?

anything you give up

What is operating cash flow?

cash generated from a firm's normal business activities; approximately equal to EBITDA; EBIT + depreciation - taxes

What is opportunity cost?

cost of the next best alternative that we give up

What is cash flow to creditors?

firm's interest payments to creditors less net new borrowing

Sunk costs are costs that:

have been incurred in the past and cannot be recouped fully

What is another name for book value of assets?

historical cost

What is another name for book value of debt and equity?

issue price

Even though depreciation is not a cash outflow, we should consider it in capital budgeting because:

it changes tax liabilities, which are a cash outflow

What are audited financial statements?

required to issue and trade most financial instruments

The income statement shows a company's:

revenue and expenses over a period of time