Corp Finance midterm

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Working capital decision

"How much cash should be kept in the reserve?"

General Partnership

Any one of the partners can be held solely liable for all of the partnership's debt.

Present value formula

FV / ( 1 + r )^t

Which one of the following is the correct formula for the future value of $500 invested today at 7 percent interest for 8 years?

FV = $500 (1 + 0.07)^8

Accounts payable period

Length of time between the day a firm purchases an item from supplier, is paid for that purchase is called

Operating cycle

Length of time between the purchase of inventory and the receipt of cash from the sale of that inventory inventory + receivables period

Depreciation

Lowers taxes

EBIT

Sales - costs - expenses - depreciation

A firm has total debt of $1,410 and a debt-equity ratio of 0.26. What is the value of the total assets?

$1,410 / Total equity = 0.26; Total equity = $5,423.08 Total assets = $1,410 + $5,423.08 = $6,833.08

inventory period

365 / inventory turnover

Secondary Market

All stock trades between existing shareholders. NYSE: New York Stock Exchange

Average Tax Rate

Total Tax / Total Taxable Income

You are comparing the current financial statements of a firm to the pro forma statement for next year. The pro forma is based on a four percent increase in sales. The firm is currently operating at 85 percent of capacity. Net working capital and all costs vary directly with sales. The tax rate and the dividend payout ratio are fixed. Given this information, which one of the following statements must be true?

Total assets will increase by less than four percent.

Owners Equity

Total liabilities and owners equity - current lab - long term debt

Marginal tax rate

What tax bracket the income falls under

Cash flow from assets

cash flow to creditors + cash flow to stock holders Op cash flow - Change in NWC - net capital spending

receivables turnover

credit sales / average receivables

Days sales in inventory

365 / inventory turnover 365 / (cogs/inventory)

Jenny needs to borrow $16,000 for 3 years. The loan will be repaid in one lump sum at the end of the loan term. Which one of the following interest rates is best for Jenny?

8 percent simple interest

Which one of the following statements is true concerning annuities?

All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity. Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years.

Samuelson's has a debt-equity ratio of 31 percent, sales of $12,500, net income of $1,000, and total debt of $5,200. What is the return on equity?

Debt-equity ratio = 0.31 = $5,200 / Total equity; Total equity = $16,774.19 Return on equity = $1,000 / $16,774.19 = 5.96 percent

Capital Management

Decides which customers will be granted credit

Decrease present value of annuity

Decrease in the annuity payment

Common size balance sheet

Determines if changes are occurring in a firms mix of assets

Discounting

Determining how much that bonus is worth today

Cash flow to stock holders

Dividends Paid - net new equity Div - [ (com stk end + add pay in sur end) - (com stk beg + add pay in sur beg) ] net new equity = firm issued in new equity

EAR

EAR = [1 + (APR / m)]^m - 1 m= months

Times interest earned ratio

EBIT / Interest

Capital Structure Decision

Has to do with DEBT & EQUITY

Corporate Shareholders

Have the ability to change the corporation's bylaws.

Market value of assets

If current assets were liquidated today + Can be sold for Tends to provide a better guide to the actual worth of an asset than does the book value

Draiman, Inc., has sales of $596,000, costs of $262,000, depreciation expense of $65,500, interest expense of $32,500, and a tax rate of 40 percent. (Enter your answer as directed, but do not round intermediate calculations.) Required: What is the net income for this firm?

Income statement Sales $ 596,000 Costs 262,000 Depreciation 65,500 EBIT $ 268,500 Interest 32,500 Taxable income $236,000 Taxes (40%) 94,400 Net income $ 141,600

Goal of financial management

Increase current market value per share.

Sarbanes Oxley Act

Increase protection against corporate fraud. Made officers of publicly traded firms personally responsible for the firm's financial statements.

Increase future value of lump sum investment

Increasing interest rate, increasing time period

Cash flow to creditors

Interest Paid - Net New Borrowing Interest Paid - (long term debt end - LTDbeg) Net new borrowing = redeemed in outstanding long term debt

Current assets

Inventory , cash , accounts receivables

Interest on interest

Jamie earned $180 in interest on her savings account last year. She has decided to leave the $180 in her account so that she can earn interest on the $180 this year. The interest Jamie earns this year on this $180 is referred to as:

Annuity Due

Janis just won a scholarship that will pay her $500 a month, starting today, and continuing for the next 48 months. Which one of the following terms best describes these scholarship payments?

Time formula

LN(fv/pv) / LN(1+r)

Negative cash flow from assets for several years

May be continually increasing in size

Income Statement

Measures revenues, expenses, and net income of a firm over a period of time

Concept of marginal taxation

Mitchell's Grocer increased its sales by $52,000 last year and had to pay an additional $16,000 in taxes.

Annual percentage rate

Monthly interest percentage * 12

Book Value of assets

NWC + Current Liabilities

Net Capital Spending

Net fixed assets end - net fixed assets beginning + depreciation

Earnings per share EPS

Net income / Shares

Profit margin

Net income / sales

Lee Sun's has sales of $3,800, total assets of $3,500, and a profit margin of 6 percent. The firm has a total debt ratio of 42 percent. What is the return on equity?

Net income = $3,800 × 0.06 = $228.00 Total debt ratio = 0.42 = ($3,500 - Total equity) / $3,500; Total equity = $2,030.00 Return on equity = $228.00 / $2,030.00 = 11.23 percent

Addition to retained earnings

Net income = Dividends + Addition to retained earnings

Sole Proprietorship

Obtaining additional equity is dependent on the owner's personal finances. Owner is liable for debts. Has profits taxed as personal income.

Limited Partnership

Offers liability protection to some of its owners but not to all of its owners. Loss is limited to capital investment. There must be AT LEAST ONE general partner

Future value formula

PV(1+r) ^t

PVA

PVA = C({1 - [1 / (1 + r)t]} / r ) Use this for finding the length of an annuity, then solve for t by using ln's Use this for finding the amount needed

Common size financial statements

Present all balance sheet account values as a percentage of SALES

Price Earnings Ratio

Price / Earnings per share Price / (net income/shares)

To reduce general costs, increase which ratios?

Profit margin, return on assets, return on equity

Total asset turnover

Sales / total assets

Stakeholder

Someone who buys from your company

Operating Cash Flow

The cash that a firm generates from its normal business activities. EBIT + Depreciation - taxes

Matching Principle

The costs of producing an item should be recorded when the sale of that item is recorded as revenue

Current ratio of 1.4 and quick ratio of .9 Given this, you know

The firm has positive net working capital

Compounding

The process of earning interest on prior interest earnings is called

Price sales ratio OR Sales per share

Sales / shares

Market to book ratio

Market value per share / book value per share

Book value per share

value of equity / shares

High Tower Pharmacy pays out a fixed percentage of its net income to its shareholders in the form of annual dividends. Given this, the percentage shown on a common-size income statement for the dividend account will:

vary in direct relation to the net profit percentage.

Teddy's Pillows has beginning net fixed assets of $472 and ending net fixed assets of $552. Assets valued at $320 were sold during the year. Depreciation was $44. What is the amount of net capital spending?

$552 + $44 - $472 = $124

Quick ratio

( current assets - inventory ) / current liabilities

Cash coverage ratio

(EBIT + depreciation) / interest

Rate formula

(FV / PV) ^ 1/t -1

Total debt ratio

(current liabilities + long term debt) / total assets

Return on Equity

(profit margin)(total asset turnover)(equity multiplier) (ROA)(equity multiplier) Net income / (common stock + ret earnings)

Highly liquid assets

Can be sold quickly at close to full value

Decrease or increase liquidity of a firm

Cash purchase of inventory will decrease liquidity of a firm Credit sale of inventory at cost will increase liquidity of a firm

Primary Market

Company sells 1000 newly issued stocks to Mike

Common size income statement

Compare firms sales and costs over period of time to determine any trends

Discounted cash flow valuation

Computing the present value of a future cash flow to determine what that cash flow is worth today is called

Treasurer

Controls the cash management

Net Working Capital

Current Assets - Current Liabilities

Shareholder Equity

Current assets + net fixed assets - total liabilities

Current ratio

Current assets / Current liabilities To increase. cash payment of account payable

Your firm has net income of $260 on total sales of $1,160. Costs are $650 and depreciation is $110. The tax rate is 35 percent. The firm does not have interest expenses. What is the operating cash flow?

EBIT = $1,160 - $650 - $110 = $400 (Sales - Costs - Depreciation) Taxes = 0.35 × $400 = $140 (Tax rate × EBIT) OCF = $400 + $110 - $140 = $370 (EBIT + Depreciation - Taxes)

A firm has sales of $4,790, costs of $2,590, interest paid of $174, and depreciation of $483. The tax rate is 30 percent. What is the value of the cash coverage ratio?

EBIT = $4,790 - $2,590 - $483 = $1,717 Cash coverage ratio = ($1,717 + $483) / $174 = 12.64

Jupiter Explorers has $10,600 in sales. The profit margin is 5 percent. There are 5,600 shares of stock outstanding. The market price per share is $2.00. What is the price-earnings ratio?

Earnings per share = ($10,600 × 0.05) / 5,600 = $0.09464 Price-earnings ratio = $2.00 / $0.09464 = 21.13

Annuity

Equal annual payments for life All else equal, an increase in the discount rate decreases the present value and increases the future value of an annuity. Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years.

DuPont Identity

Equity multiplier and return on equity

Capital Budgeting

Evaluation of size, timing, and risk of future cash flows. In charge of fixed asset purchasing.

Recently, the owner of Martha's Wares encountered severe legal problems and is trying to sell her business. The company built a building at a cost of $1,210,000 that is currently appraised at $1,410,000. The equipment originally cost $690,000 and is currently valued at $437,000. The inventory is valued on the balance sheet at $380,000 but has a market value of only one-half of that amount. The owner expects to collect 98 percent of the $210,200 in accounts receivable. The firm has $10,200 in cash and owes a total of $1,410,000. The legal problems are personal and unrelated to the actual business. What is the market value of this firm?

Market value = $1,410,000 (building) + $437,000 + (0.5 × $380,000) + (0.98 × $210,200) + $10,200 - $1,410,000 (amount owed) = $843,196

Simple interest

Savings account will pay interest only on the principal amount originially invested

Corporation

Separate legal entity, owners have no personal liability for the firms debts. Ability to raise large sums of equity capital Ease of ownership transfer Profits taxed at the corporate level

Agency Conflict

Separating management from ownership TO AVOID: Compensating managers with shares of stock that must be held for three years before the shares can be sold

Balance Sheet

Summarizes a firms accounting value as of a particular date Assets are listed in descending order of liquidity

The SGS Co. had $131,000 in taxable income. Use the rates from Table 2.3.

Taxes = 0.15($50,000) + 0.25($25,000) + 0.34($25,000) + 0.39($131,000 - 100,000) Taxes = $34,340

The tax rates are as shown. Taxable Income Tax Rate $0 - 50,000 15% 50,001 - 75,000 25% 75,001 - 100,000 34% 100,001 - 335,000 39% What is the average tax rate for a firm with taxable income of $129,513?

Taxes paid = 0.15($50,000) + 0.25($75,000 - 50,000) + 0.34($100,000 - 75,000) + 0.39($129,513 - 100,000) = $33,760.07 Average tax rate = $33,760.07 / $129,513 = 26.07%

If them firm has a positive external financing needed, that need will be met by

long term debt

Profit margin

net income / sales

Equity multiplier

1 + Debt equity ratio Total assets / total equity

Radio Shack offers credit to its customers and charges interest of 1.2 percent per month. What is the annual percentage rate?

APR = 1.2 percent × 12 = 14.40 percent

A firm has net working capital of $590, net fixed assets of $2,336, sales of $7,000, and current liabilities of $900. How many dollars worth of sales are generated from every $1 in total assets?

Current assets = $590 + $900 = $1,490 Total asset turnover = $7,000 / ($1,490 + $2,336) = 1.83 Sales generated by $1 in total assets = $1 x 1.83 = $1.83

Security Dealer

Dealers buy and sell from their own inventory.

Dimeback Co. has total assets of $9,000,000 and a total asset turnover of 2.40 times. Assume the return on assets is 10 percent. Required: What is its profit margin?

To find the profit margin, we need the net income and sales. We can use the total asset turnover to find the sales and the return on assets to find the net income. Beginning with the total asset turnover, we find sales are: Total asset turnover = Sales / Total assets 2.40 = Sales / $9,000,000 Sales = $21,600,000 And the net income is: ROA = Net income / Total assets 0.10 = Net income / $9,000,000 Net income = $900,000 Now we can find the profit margin which is: Profit margin = Net income / Sales Profit margin = $900,000 / $21,600,000 Profit margin = .0417, or 4.17%

Jiminy Cricket Removal has a profit margin of 10 percent, total asset turnover of 1.10, and ROE of 14.36 percent. Required: What is this firm's debt-equity ratio

We can use the Du Pont identity and solve for the equity multiplier. With the equity multiplier we can find the debt-equity ratio. Doing so we find: ROE = (Profit margin)(Total asset turnover)(Equity multiplier) .1436 = (0.10)(1.10)(Equity multiplier) Equity multiplier = 1.31 Now, using the equation for the equity multiplier, we get: Equity multiplier = 1 + Debt-equity ratio 1.31 = 1 + Debt-equity ratio Debt-equity ratio = .31

If the Baseball Shoppe has an 8 percent ROA and a 25 percent payout ratio, what is its internal growth rate?

We need to calculate the retention ratio to calculate the internal growth rate. The retention ratio is: b = 1 - 0.25 b = 0.75 Now we can use the internal growth rate equation to get: Internal growth rate = (ROA × b) / [1 - (ROA × b)] Internal growth rate = [0.08(0.75)] / [1 - 0.08(0.75)] Internal growth rate = 0.0638 or 6.38%


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