Financial Management Graduate Course FGCU: Chapter 2

If a firms current assets = $200 and a firms current liabilities = $150, its NWC =

$50

If a firms NWC is $120 in 2014 and $100 in 2013, then the change in NWC is

+$20

If a firm acquires $100 in fixed assets and sells $80 of fixed assets, the cashflow from investing activities is

-$20 -$100 (acquiring means spending money) +$80 (selling means making money) = -$20

A firm has a debt-equity ratio of .36. What is the total debt ratio?

0.26 0.36/1.36

Jake owns The Corner Market which he is trying to sell so that he can retire and travel. The Corner Market owns the building in which it is located. This building was built at a cost of $1,200,000 and is currently appraised at $1,490,000. The counters and fixtures originally cost $679,000 and are currently valued at $415,000. The inventory is valued on the balance sheet at $347,000 and has a retail market value equal to 1.2 times its cost. Jake expects the store to collect 94 percent of the $189,100 in accounts receivable. The firm has $9,200 in cash and has total debt of $1,430,000. What is the market value of the firm's equity?

1,078,354

A firm has net working capital of $361, net fixed assets of $2,375, sales of $6,000, and current liabilities of $800. How many dollars worth of sales are generated from every $1 in total assets?

1.7 Current Assets= NWC + Current Liabilities Current Assets= 361+800= 1161 Total Assets= 1161+2375= 3536 Asset Turnover = Sales/Total Assets = 6000/3536 =$1.7

If your tax bill is $200 and your taxable income is $2,000, then your average tax rate is _____ percent.

10

Nielsen Auto Parts had beginning net fixed assets of 486 and ending net fixed assets of 554. Assets valued at 322 were sold. Depreciation for the year was 36. What is the amount of net capital spending?

104 Net Capital Spending= Ending Net Fixed Assets-Beginning Net Fixed Assets+Depreciation 554-486+36= 104

Crandall Oil has total sales of $1,160 and costs of $745. Depreciation is $135 and the tax rate is 34 percent. The firm does not have any interest expense. What is the operating cash flow?

320 OCF= EBIT+Depreciation-Taxes EBIT=280 (1160-745-135) Depreciation=135 Taxes=95.2 (0.34x280) 280+135-95.2= 319.80

If you earn an extra $100 of taxable income this year and owe taxes of $34 on that income, then your marginal tax rate is _______ percent

34

The Purple Martin has annual sales of $4,600, total debt of $1,380, total equity of $2,400, and a profit margin of 5 percent. What is the return on assets?

6.08% Return on Assets= Net Income/Total Assets =(4600 x 0.05)/(1380+2400) =230/3780 =0.0608 =6.8%

A firm has common stock of 110, paid-in surplus of 220, total liabilities of 380, current assets of 450, and fixed assets of 600. What is the amount of the shareholders' equity?

670 Total Assets-Total Liabilities=Shareholders Equity (600+450)-380= 670

Al's Sport Store has sales of $2,910, costs of goods sold of $2,020, inventory of $549, and accounts receivable of $439. How many days, on average, does it take the firm to sell its inventory assuming that all sales are on credit?

99.2 Days Sales in Inventory= 365/Inventory Turnover Inventory Turnover= COGS/Inventory =2,020/549 I.T.= 3.68 365/3.68= 99.18 Days Sales in Inventory= 99.2 days

Cashflow paid to stockholders =

= Dividends paid - net new equity raised =Dividends paid - (stock sold - stock repurchased)

The balance sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date. Snapshot of the firms accounting value at a certain date 2 Sides: Left is Assets; Right is Liabilities/Owners Equity

A conflict of interest between the stockholders and management of a firm is referred to as the:

Agency problem

Non-Operating Section of Income Statement

All financing costs such as interest expense (EBIT)

Accounts Receivable

Amounts not yet collected from customers or goods or services sold to them (after adjustment for potential bad debt) 2nd most liquid asset

Stockholders Equity =

Assets - Liabilities

Under GAAP

Audited financial statements of firms in the United States carry the assets at cost. Thus, the terms market value and book value are unfortunate. They specifically say value when in fact the numbers are based on cost. This misleads many readers of financial statements to think that firms assets are recorded at true market value.

cash flow from financing activities

Cash flows to and from creditors and owners include changes in equity and debt

The total outgoing cashflow of the firm can be separated into:

Cashflow paid to creditors and cashflow paid to stockholders

Inventory

Composed of raw materials to be used in production, work in progress, and finished goods. 3rd most liquid asset

Which form of business structure faces the greatest agency problems?

Corporation

Period costs

Costs that are allocated to a time period. They are called selling, general, and administrative expenses. One example would be the company's presidents salary

variable costs

Costs that change as output of the firm changes. i.e. raw materials and wages for workers on the production line.

fixed costs

Costs that will not change because of fixed commitments. (i.e. overhead, property taxes, bond interest).

2 examples of non cash items on an income statement are

Deferred tax and depreciation

Deferred Taxes

Difference between accounting income (reported on the income statement) and true, taxable income. I.e.- The accounting tax on the income statement states $84 million, however that can be broken down into current taxes and deferred taxes. The current taxes portion is the amount sent to the IRS while deferred tax is not. Deferred taxes have to be paid later on and represent a liability to the firm until they are. This will show up on the income statement as deferred tax liability.

Operating cash flow

Earnings before interest + depreciation - taxes This measures the cash generated from operations not counting capital spending or working capital requirements. It is usually positive.

EBIT

Earnings before interest and taxes

Change in Net Working Capital

Ending NWC - Beginning NWC in addition to investing in fixed assets (capital spending), a firm can also invest in net working capital.

Non-cash items

Expenses charged against revenue that do not affect cash flow Depreciation = most important

Statement of Cash Flows

Financial statement that reports cash receipts and disbursements related to a firm's three major activities: operations, investments, and financing. Helps explain the change in accounting cash and equivalents

What is/are the least liquid asset(s)?

Fixed assets

When analyzing an income statement, the financial manager should keep in mind...

GAAP, non-cash items, costs, and time

GAAP means

Generally Accepted Accounting Principles

Total cash flows of the firm

Includes adjustments for capital spending and additions to NWC. It is usually negative. Includes operating, capital spending, and NWC cash flows

revenue - expenses =

Income

What is the primary difference between the accounting cash flow and the financial cash flow of a firm?

Interest expense In accounting, interest expense is deducted as an expense when income is computed, therefore it is not place under the financing activities section of cash flows.

Debt service

Interest payments plus repayments of principle (i.e. retirement of debt)

In principle, equity

Is what the stockholders would have available after the firm discharged its obligations

cash flow analysis is popular because

It is harder to "spin" and is difficult to manipulate.

Assets =

Liabilities + Owner's Equity

Fixed Assets

Long-term assets that are relatively permanent such as land, buildings, or equipment. These assets are not easily converted into cash and are not commonly used to pay expenses such as payroll Least liquid asset

These are generally considered to be short run fixed costs

Management salaries, property taxes, overhead expenses

Are deferred taxes a cash outflow?

No

Do financial accountants distinguish between fixed costs and variable costs?

No

Does cash flow appear on an income statement?

No

Is net income equal to cash flow?

No

Net income is frequently expressed...

Per share of stock, or EPS

Operations section of income statement

Reports the firms revenues and expenses from principle operations

What are the cash flows that appear in the financing activities section of the accounting statement of cash flows?

Retirement of long term debt, repurchase of stock, payment of dividends

The ultimate control of a corporation lies in the hands of the corporate:

Stockholders

What equation is an accurate expression of the balance sheet?

Stockholders' equity ≡ Assets −Liabilities

Sole proprietorships and partnerships are

Taxed in a similar fashion

Depreciation

The accountants estimate of the cost of equipment used up in the production process. i.e. An asset with a 5-year life span is purchased for $1,000. Over the next 5 years, the accountant will expense the asset over its useful life, at $200 per year. That $200 er year is the depreciation expense. However from a finance perspective, that $1000 is incurred as a one time negative cash flow.

The assets in the balance sheet are listed in order by

The amount of time it would take to be converted into cash i.e. Liquidity

The last item on the income statement is

The bottom line, or net income.

Liquidity

The ease and quickness with which assets can be converted into cash (without significant loss in value)

Current assets

The most liquid asset as they include cash and assets that will likely be converted into cash within a year from the date of the balance sheet

The liabilities and stockholders equity are listed by

The order in which they would normally be paid by the firm

The short run

The period in which certain equipment, resources and commitments of the firm are fixed, but the time is long enough for the firm to vary its output by using more labor or raw materials. The short run is not a precise period that will be the same across industries, however all firms making decisions in the short run will have some fixed costs and some variable costs.

Market Value

The price at which buyers and sellers would be willing to trade assets. It would only be a coincidence if accounting value and market value were the same.

The liabilities and stockholders equity side reflects

The types and proportions of financing, which depend on managements choice of capital structure, as between debt and equity and between current debt and long term debt

Company write-off

The value the companies ASSETS have declined

If a firm defaults on its bond contracts, what can bondholders do to get their money back?

They can sue the firm, often leading the firm to declare bankruptcy

What is managements overall goal?

To create value for the firm that exceeds costs This means the market value, not necessarily the book value

Product costs

Total production costs incurred during a period- raw materials, direct labor, overhead- and are reported on the income statement as COGS.

In the long run, all costs are...

Variable, there are no fixed costs.

Do financial accountants distinguish between product costs and period costs?

Yes

Is cash flow more revealing than income in determining economic and financial conditions of a firm?

Yes

Is corporate taxation in the United States based on a modified flat rate tax?

Yes

The income statement

a financial statement that gives operating results for a specific period i.e. one year Video recording of what the company did between 2 periods

The first step in calculating cash flow from operating activities is to

adjust net income for not cash items and NWC changes

In the long run, ________ costs are variable

all

Net working capital plus current liabilities equal

current assets

Net Working Capital

current assets - current liabilities i.e. Current Assets = $10, Current liabilities =$6, NWC= $4

The economic value of an asset varies ___________ with the assets future cash flows.

directly

Dividends per share =

dividends / total shares outstanding

Capital Spending =

ending net fixed assets - beginning net fixed assets + depreciation

Non-cash items are ______ that _____ cash flow.

expenses; do not directly affect

The first step in determining cash flows of the firm is

figuring out cash flow from operations

cash flow to creditors=

interest - net new borrowing

Which one of these accounts is included in net working capital?

inventory, as it is a current asset

Cash flow from investing activities

involves changes in capital assets: acquisition of fixed assets and sales of fixed assets

The sustainable growth rate:

is normally higher than the internal growth rate.

An asset that can be quickly converted into cash without significant loss in value is referred to as being:

liquid.

Ratios that measure a firm's ability to pay its bills over the short run without undue stress are known as:

liquidity measures

Financial managers should primarily strive to:

maximize the current value per share of existing stock.

Earnings Per Share (EPS) =

net income/total shares outstanding

Projected future financial statements are called:

pro forma statements

The most important item that can be extracted from financial statements is

the actual cash flow of the firm

The cash flows received from a firms assets such as operating activities (CF(A)) must equal...

the cashflows to the firms creditors (CF(B)) and equity investors(CF(S)) CF(A) = CF(B)+CF(S)

Marginal tax rate

the extra taxes paid on an additional dollar of income i.e. $0-$50,000 =15% tax rate $50,001-$75,000 = 20% tax rate $75,001-$100,000= 25% tax rate ... and so on

Financing activities are

the net payments to creditors and owners (excluding interest expense) made during the year

Average tax rate

the tax bill / taxable income the percentage of your income that goes to pay taxes

Flat rate tax

there is only one tax rate, so the rate is the same for all income levels

The first step in determining the change in cash is

to figure out cashflow from operating activities

The third step in determining the change in cash is

to make an adjustment for cash flow from financial activities.

The second step in determining the change in cash is

to make an adjustment for cash flow from investing activities.

The balance sheet states

what the firm owns and how it is financed