Finance Ch. 2 Test

What is the different between a marginal and average tax rate?

- Average Tax Rate: Total taxes paid divided by total taxable income - Marginal Tax Rate: Amount of tax payable on the next dollar earned

Explain the difference between accounting value and market value. Which is more important to the financial manager? Why?

- Managers and investors will frequently be interested in knowing the market value of the firm. - Investors are concerned with a company's assets as they compare to its liabilities or book value, but also to the company's stock price or market value. Book value is the value of a company according to its balance sheet, or "books." Market value is the value of the company in the eyes of the stock market.

What is the balance sheet identity?

Assets = Liabilities + Stockholders' Equity

What is the cash flow identity? Explain what it says.

Cash Flow from assets = Cash Flow to Creditor + Cash Flow to Stockholders This is the cash flow identity. What it reflects is the fact that a firm generates cash through its various activities, and that cash either is used to pay creditors or else is paid out to the owners of the firm.

What are the three things to keep in mind when looking at an income statement?

Financial managers needs to keep three things in mind: GAAP, cash versus non-cash items, and time and costs.

Why is interest paid not a component of operating cash flow?

Interest is not a component of operating cash flow because it is considered a financing expense, not an operating expense

What is liquidity? Why is it important?

Liquidity refers to the speed and ease with witch an asset can be converted to cash. Liquidity is valuable because the more liquid a business is, the less likely it is to experience financial distress.

Why is accounting income not the same as cash flow?

Primary reason that accounting income differs from cash flow is that an income statement contains noncash items. Non cash Items (Expenses charged against revenues that do not directly affect cash flow, such as depreciation.

What is the income statement equation?

Revenues - Expenses = Income

What do we mean by financial leverage?

The use of debt in a firm's capital structure, the more debt a firm has (as a percentage of assets), the greater is its degree of financial leverage.

What are the component of operating cash flow?

Want to calculate revenues minus costs, but we don' t want to include depreciation because it's not a cash outflow, and we don't want to include interest because it's a financial expense. We do want to include taxes because taxes are, unfortunately, paid in cash.

Do the wealthiest corporations receive a tax break in terms of a lower tax rate? Explain

flat-rate tax = only one tax rate, so rate is same for all income levels. wealthiest corporations do not receive a tax break with lower rates because at a certain point, average tax rate doesn't change