Finance Midterm #1

What are the major categories of financial ratios?

1) profitability or return on investment; 2) liquidity; 3) leverage, and 4) operating or efficiency—with several specific ratio calculations prescribed within each.

What is the difference between average and marginal tax rates?

A taxpayers average tax rate is the share of income that they pay in taxes where as the taxpayers marginal tax rate is the tax rate imposed on their last dollar of income

Corporate Control

The threat of a takeover that may result in better management

A firm has total debt of $4,620 and a debt-equity ratio of 0.57. What is the value of the total assets?

Total equity = $4,620/0.57 = $8,105.26 Total assets = $4,620 + $8,105.26 = $12,725.26

Partnership Advantages

Two or more owners, more capital available, relatively easy to start, and income taxed once as personal income

Time-Trend Analysis

Used to see how the firm's performance is changing through time. Internal and external uses

Capital Budgeting Questions

What long-term investments or projects should businesses take on?

Which of the following accounts are included in working capital management?

accounts payable, accounts receivable, and inventory

S Corporation

corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.

Current Ratio =

current assets - current liabilities

Profit Margin =

net income/net sales

Assets are listed in

order of decreasing liquidity; ease of conversion to cash and without significant loss of value

Which of the following should a financial manager consider when analyzing a capital budgeting project?

project start up costs, timing of all projected cash flows, dependability of future cash flows, and dollar amount of each projected cash flow

Market value is the price at which

the assets, liabilities, or equity can actually be bought or sold

Debt/Equity =

total liabilities/total equity

Ratio Analysis

the assessment of a firm's financial condition using calculations and interpretations of financial ratios developed from the firm's financial statements

Economic Value Added

is an estimate of a business's true economic profit for the year (different from accounting profit) - EVA = EBIT (1-T) - (Total Capital) (After-tax cost of capital)

Agency Relationship

is when a principal hires an agent to represent his/her interests. Stockholders (principals) hire managers (agents) to run the company

The cash coverage ratio directly measures the ability of a firm's revenues to meet which one of its following obligations?

payment of interest to a lender

What is the net working capital for 2009

$1,945 Net Working Capital = cash + accounts receivables +inventory - current liabilities = $313 + $1,162 + $1,521 - $1,051 = $1,945

What is the net capital spending for 2009?

$239 Net Capital Spending = 2009 Net Fixed Assets - 2008 Net Fixed Assets + 2009 Depreciation $4,123 - $4,006 + $122 = $239

A firm has $520 in inventory, $1,860 in fixed assets, $190 in accounts receivables, $210 in accounts payable, and $70 in cash. What is the amount of the current assets?

$780 Current Assets = 520 + 190 + 70 = 780

Quick Ratio =

(Current Assets - Inventory) / Current Liabilities

Cash Coverage =

(EBIT + Depreciation) / Interest

What is the change in net working capital from 2008 to 2009?

-175 Change in net working capital = (2009 cash + accounts receivables + inventory - current liabilities) - (2008 cash + accounts receivables + inventory - current liabilities) ($313 + $1,162 + $1,521 - $1,051) - ($250 + $1,092 + $1,495 - $717) = -175

The Du Pont identity can be used to help managers answer which of the following questions related to a firm's operations?

1. How many sales dollars has the firm generated per each dollar of assets? 2. How many dollars of assets has a firm acquired per each dollar in shareholders' equity? 3. How much net profit is a firm generating per dollar of sales?

Which of the following questions are addressed by financial managers?

1. How should a product be marketed? 2. Should the firm borrow more money? 3. Should the firm acquire new equipment?

Capital Structure Questions

1. How should we pay for our assets? 2. Should we use debt or equity?

Cash Flow to Assets =

1. Operating Cash Flow - Change in Working Capital - Change in Capital Spending 2. Or Cash Flow to Creditors - Changes in NWC 3. Or Cash Flow to Creditors + Cash Flow to Stockholders

3 Major Forms In the U.S.

1. Sole Proprietorship 2. Partnership (General and Limited) 3. Corporation (C-Corp, S-Corp (*taxed once in personal income with at most 100 workers*), and Limited Liability Company)

Some Important Questions That Are Answered Using Finance

1. What long-term investments should the firm take on? 2. How can cash be raised for the required investments? 3. How will we manage the everyday financial activities of the firm?

The Lakeside Inn had operating cash flow of $48,450. Interest paid was $2,480. A net total of $2,620 was paid on reducing long-term debt. The firm spent $24,000 on capital spending and decreased net working capital by $1,330. What is the amount of cash flow to stockholders?

20,680. Cash Flow from Assets = $48,450 - (-$1,330) - $24,000 = $25,780 Cash Flow to Creditors = $2,480 - (-$2,620) = $5,100 Cash Flow From Assets = Cash flow to creditors + cash flow to stockholders Cash flow to stockholders = $25,780 - $5,100 = $20,680

What is the Average Tax Rate?

33.62% Tax Liability = .15($50,000) + .25($25,000) + .34 (25,000) + .39 ($211,360) = $104,680.40 Average Tax Rate = $104,680.40/311,360 = 33.62%

Days' Sales in Inventory =

365/inventory turnover

What is the Marginal Tax Rate?

39.00%

Liquidity

Ability to convert assets to cash quickly and meet short-term obligations without a significant loss in value. Liquid firms are less likely to experience financial distress, but liquid assets typically earn a lower return. Trade-off to find balance between liquid and illiquid assets

Which of the following accounts are included in working capital management?

Accounts payable, accounts receivable, and inventory

How many days of sales are in receivables? (Use 2009 values)

Accounts receivable turnover for 2009 = $627,800/$56,700 = 11.07 Days' sales in receivables for 2009 = 365/11.07 = 32.97 Accounts Receivables Turnover: Net Sales/Net Income Day's Sales in Receivables: 365/Accounts Receivables Turnover

Which one of the following terms is defined as a conflict of interest between the corporate shareholders and the corporate managers?

Agency problem

Balance Sheet Identity

Assets = Liabilities + Stockholders' Equity

Which one of the following terms is defined as the management of a firm's long-term investments?

Capital Budgeting

Which one of the following terms is defined as the mixture of a firm's debt and equity financing?

Capital Structure

Cash Ratio =

Cash / Current Liabilities

A firm has sales of $68,400, costs of $42,900, interest paid of $2,100, and depreciation of $6,500. The tax rate is 34 percent. What is the value of the cash coverage ratio?

Cash coverage ratio = ($68,400 - $42,900)/$2,100 = 12.14

What is the cash coverage ratio for 2009?

Cash coverage ratio = ($95,200 + $11,200)/$10,100 = 10.53 (EBIT + depreciation)/Interest Paid

Cash Flow

Cash flow is one of the most important pieces of info that a financial manager can take from financial statements. The statement of cash flows doesn't provide us with the same info that we are looking at here. Cash flow from assets (CFFA) = Cash Flow to Creditors + Cash Flow to Stockholders. CFFA = Operating Cash Flow - Net Capital Spending - Changes in NWC

Adelson's Electric had beginning long-term debt of $42,511 and ending long-term debt of $48,919. The beginning and ending total debt balances were $84,652 and $78,613, respectively. The interest paid was $4,767. What is the amount of the cash flow to creditors?

Cash flow to creditors = $4,767 - ($48,919 - $42,511) = -$1,641

At the beginning of the year, the long-term debt of a firm was $72,918 and total debt was $138,407. At the end of the year, long-term debt was $68,219 and total debt was $145,838. The interest paid was $6,430. What is the amount of the cash flow to creditors?

Cash flow to creditors = $6,430 - ($68,219 - $72,918) = $11,129

The Daily News had net income of $121,600 of which 40 percent was distributed to the shareholders as dividends. During the year, the company sold $75,000 worth of common stock. What is the cash flow to stockholders?

Cash flow to stockholders = .40($121,600) - $75,000 = -$26,360

The Top Financial Manager Within a Firm is

Chief Financial Officer (CFO)

Peer Group Analysis

Compare to similar companies or within industries. SIC and NAICS codes

Agency Problem

Conflict of interest between principal and agent, and Management goals and agency costs

Inventory Turnover =

Cost of Goods Sold / Inventory

The Flower Shoppe has accounts receivable of $3,709, inventory of $4,407, sales of $218,640, and cost of goods sold of $167,306. How many days does it take the firm to both sell its inventory and collect the payment on the sale assuming that all sales are on credit?

Days in inventory = 365/($167,306/$4,407) = 9.614 days Days' sales in receivables = 365/($218,640/$3,709) = 6.192 days Total days in inventory and receivables = 9.614 + 6.192 = 15.81 days

What is debt-equity ratio? (Use 2009 values)

Debt-equity ratio = ($134,700 + $141,000)/($140,000 + $131,800) = 1.01 (Accounts payable + long-term debt)/common stock + retained earnings)

Operating Cash Flow (OCF) =

EBIT + Depreciation - Taxes (Income Statement)

A firm has 160,000 shares of stock outstanding, sales of $1.94 million, net income of $126,400, a price-earnings ratio of 18.7, and a book value per share of $9.12. What is the market-to-book ratio?

Earnings per share = $126,400/160,000 = $0.79 Price per share = $0.79 times 18.7 = $14.773 Market-to-book ratio = $14.773/$9.12 = 1.62

The Meat Market has $747,000 in sales. The profit margin is 4.1 percent and the firm has 7,500 shares of stock outstanding. The market price per share is $27. What is the price-earnings ratio?

Earnings per share = (.041 times $747,000)/7,500 = 4.0836 Price-earnings ratio = $27/4.0836 = 6.61

Sole Proprietorship Advantages

Easiest to start, least regulated, single owner keeps all the profits, and taxed once as personal income

Changes in NWC =

Ending NWC - Beginning NWC

A business formed by two or more individuals who each have unlimited liability for all of the firm's business debts is called a:

General Partnership

Working Capital Management Question

How do we manage the day-to-day finances of the firm?

Managerial Compensation

Incentives can be used to align management and stockholder interests. The incentives need to be structured carefully to make sure that they achieve their goal

Al's Sport Store has sales of $897,400, costs of goods sold of $628,300, inventory of $208,400, and accounts receivable of $74,100. How many days, on average, does it take the firm to sell its inventory assuming that all sales are on credit?

Inventory turnover = $628,300/$208,400 = 3.014875 Days in inventory = 365/3.014875 = 121.07 days

A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a:

Limited Partner

Corporation Advantages

Limited liability, Unlimited life, Separation of ownership and management, Transfer of ownership is easy, and it's Easier to raise capital

Sole Proprietorship Disadvantages

Limited to life of owner, equity capital limited to owner's personal wealth, unlimited liability

Long-term debt ratio

Long Term Debt/(Long Term Debt + Equity)

Market Value Added (MVA)

MV of equity - Equity capital supplied by shareholders. = (Shares outstanding)(stock price) - Total common equity

What should be the goal of a corporation?

Maximize the current value of the company's stock

Goal of a Corporation

Maximize the current value of the company's stock. Stockholders in a firm are residual owners meaning whatever is left after the employees, suppliers, and creditors are paid, thats what the stockholder gets. So if the stockholder is doing well, the company must be doing well too.

Return on Assets (ROA) =

Net Income/Total Equity

Return on Equity (ROE)

Net Income/Total Equity - ROE = PM * TAT * EM - Profit Margin is a measure of the firm's operating efficiency (how well it controls costs) - Total Asset turnover is a measure of the firm's asset use efficiency (how well does it manage its assets) - Equity multiplier is a measure of the firm's financial leverage

What is net new borrowing for 2009?

Net New Borrowing = 2009 Long-term debt - 2008 long-term debt $1,100 - $2,400 = -$1,300

Net Working Capital to Total Assets =

Net Working Capital / Total Assets

What is the cash flow to creditors for 2009?

Net new borrowing = $1,100 - $2,400 = $ -1,300 Cash Flow to Creditors = 280 - ($ -1,300) = $1,580

Uptown Men's Wear has accounts payable of $2,214, inventory of $7,950, cash of $1,263, fixed assets of $8,400, accounts receivable of $3,907, and long-term debt of $4,200. What is the value of the net working capital to total assets ratio?

Net working capital to total assets = ($1,263 + $3,907 + $7,950 - $2,214)/($1,263 + $3,907 + $7,950 + $8,400) = 0.51

What is the operating cash flow for 2009?

Operating Cash Flow = (2009 sales - COGS - 2009 Depreciation) + Depreciation - Taxes ($6,423 - $4,109 - $122) + $122 - $670 = $1,644

What is the cash flow from assets for 2009?

Operating cash flow = ($6,423 - $4,109 - $122) + $122 - $670 = $1,644 Net capital spending = $4,123 - $4,006 + $122 = $239 Change in net working capital = ($313 + $1,162 + $1,521 - $1,051) - ($250 + $1,092 + $1,495 - $717) = -$175 Cash flow from assets = $1,644 - $239 - (-$175) = $1,580

What is the cash flow to stockholders for 2009?

Operating cash flow = ($6,423 - $4,109 - $122) + $122 - $670 = $1,644 Net capital spending = $4,123 - $4,006 + $122 = $239 Change in net working capital = ($313 + $1,162 + $1,521 - $1,051) - ($250 + $1,092 + $1,495 - $717) = -$175 Cash flow from assets = $1,644 - $239 - (-$175) = $1,580 Net new borrowing = $1,100 - $2,400 = -$1,300 Cash flow to creditors = 280 - (-$1,300) = $1,580 Cash flow to stockholders = $1,580 - $1,580 = $0

Treasurer

Oversees cash management, credit management, capital expenditures, and financial planning

Controller

Oversees taxes, cost accounting, financial accounting, and data processing

What is the price-sales ratio for 2009 if the market price is $18.49 per share?

Price-sales ratio = $18.49/[$627,800/($140,000/$1)] = 4.12 18.49/[net sales/(common stock/$1)]

What is the quick ratio for 2009?

Quick ratio for 2009 = ($268,100 - $186,700)/$134,700 = 0.60 (Sub-total - Inventory)/ Accounts Payable

The Purple Martin has annual sales of $687,400, total debt of $210,000, total equity of $365,000, and a profit margin of 5.20 percent. What is the return on assets?

Return on assets = (.0520 times $687,400)/($210,000 + $365,000) = 6.22 percent

What is the return on equity? (Use 2009 values)

Return on equity = $56,200/($140,000 + $131,800) = 20.68 percent Net Income/(Common stock + Retained Earnings)

Reliable Cars has sales of $807,200, total assets of $1,105,100, and a profit margin of 9.68 percent. The firm has a total debt ratio of 78 percent. What is the return on equity?

Return on equity = (.0968 times $807,200)/[$1,105,100 divided (1 - .78)] = 32.14 percent

Oscar's Dog House has a profit margin of 5.6 percent, a return on assets of 12.5 percent, and an equity multiplier of 1.49. What is the return on equity?

Return on equity = 12.5 percent times 1.49 = 18.63 percent, using the Du Pont Identity

Receivables Turnover =

Sales / Accounts Receivable

Net Working Capital Turnover =

Sales/Net Fixed Assets

Total Asset Turnover =

Sales/Total Assets

Corporation Disadvantages

Separation of ownership and management, Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

Which one of the following is defined as a firm's short-term assets and its short-term liabilities?

Working Capital

Limited Liability Company (LLC)

a form of legal protection for shareholders and owners that prevents individuals from being held personally responsible for their company's debts or financial losses

C Corporation

a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity

Net Working Capital

current assets - current liabilities 1. It's positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out 2. Usually positive in a healthy firm 3. A positive NWC means that the available cash is greater than the cash to be paid out 4. Example: CA in 2008 = $1112, CL in 2008 = $428; NWC = CA - CL = $684 5. NWC is not the same as cash flow because using cash to buy inventory decreases cash flow but does not change NWC

Net Working Capital is Defined As:

current assets minus current liabilities

Which one of the following is a capital budgeting decision?

deciding whether or not to purchase a new machine for the production line

Which one of the following is a capital structure decision?

determining how much debt should be assumed to fund a project

Cash Flow to Stockholders =

dividends paid - net new equity raised

Net Capital Spending =

ending net fixed assets - beginning net fixed assets + depreciation

Cash Flow to Creditors =

interest paid - net new borrowing

The income statement is more like a

video of the firm's operations for a specified period of time. You generally report revenues first and then deduct any expenses for the period

Big Guy Subs has net income of $150,980, a price-earnings ratio of 12.8, and earnings per share of $0.87. How many shares of stock are outstanding?

Number of shares = $150,980/$0.87 = 173,540

A business owned by a solitary individual who has unlimited liability for its debt is called a:

Sole Proprietorship

Balance Sheet

The balance sheet is a snapshot of the firm's assets and liabilities at a given point in time

What is the difference between book value and market value

The balance sheet provides the book value of the assets, liabilities and equity while the market value is the price at which the assets, liabilities, or equity can actually be bought or sold

Partnership Disadvantages

Unlimited liability (general and limited partnership), Partnership dissolves when one partner dies or wishes to sell, and it's Difficult to transfer ownership

Managing partners

a partner in charge of running a partnership including managerial compensation, corporate control and other stakeholders

The decision to issue additional shares of stock is an example of which one of the following?

capital structure decision