FIN 221 Quiz 2

Beckham Broadcasting Company (BBC) has operating income (EBIT) of $2,500,000. The company's depreciation expense is $500,000 and it has no amortization expense. The company is 100% equity financed. The company has a 40% tax rate, and its net investment in operating capital is $1,000,000.

$ 500,000

Garfield Inc. is expanding throughout the Southeast United States, and it expects sales to increase by $1 million and operating costs (excluding depreciation and amortization) by $700,000. Depreciation and amortization expenses will rise by $50,000 and interest expense by $150,000, while the company's tax rate will remain at 40%. If the company's forecast is correct, how much will net income change, as a result of the expansion?

$ 60,000 increase

Johnson Battery Systems recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $800 of capital expenditures on new fixed assets and to invest $500 in net operating working capital. What was its free cash flow?

$1,100

Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $38.50 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA?

$18,500,000

Marcus Nurseries Inc.'s 2005 balance sheet showed total common equity of $2,050,000, which included $1,750,000 of retained earnings. The company had 100,000 shares of stock outstanding which sold at a price of $57.25 per share. If the firm had net income of $250,000 in 2006 and paid out $100,000 as dividends, what would its book value per share be at the end of 2006, assuming that it neither issued nor retired any common stock?

$22.00

Miles Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was the firm's net income after taxes? The company uses the same depreciation for tax and stockholder reporting.

$732

Net Working Operating Capital =

(Cash + Accounts receivable + Inventories) - (Accounts Payable - accrued expenses)

Quick Ratio

(Current Assets - Inventory) / Current Liabilities Want between 1.2 and 2

EBITDA coverage ratio

(EBITDA + lease payments) / (interest + principal payments + lease payments)

Traditional IRA

(Individual Retirement Arrangement) contributions are tax deductible, income and capital gains taxes when you withdraw money

Market Value Added (MVA)

(stock price * shares outstanding) - book value Want to be high

Byrd Lumber has 2 million shares of common stock outstanding that sell for $15 a share. If the company has $40 million of common equity, what is the company's Market Value Added (MVA)?

-$10,000,000

Outflows

-increases in assets (buying more stuff) -decreases in liabilities and stock (paying off loans and debts, buying back stock) -dividends (not tax deductible, company pays dividends to stockholders)

Inflows

-net income -depreciation -decrease in assets (because you are selling stuff) -increase in liabilities and stock (borrows more money, raises cash, sells more stock to public)

Moss Motors has $8 billion in assets, and its tax rate is 40%. The company's basic earning power (BEP) ratio is 12%, and its return on assets (ROA) is 3%. What is Moss' times interest earned (TIE) ratio?

1.17 TIE = EBIT / INT charges BEP = EBIT / assets --> 0.12 = EBIT / 8 bil EBIT = 960 million ROA = NI/assets --> 0.03 = NI / 8 bil NI = 240 million interest charge = (.4 x 240) + (960-240) = 816 TIE = 960 / 816 = 1.17

Beckham Broadcasting Company (BBC) has operating income (EBIT) of $2,500,000. The company's depreciation expense is $500,000 and it has no amortization expense. The company is 100% equity financed. The company has a 40% tax rate, and its net investment in operating capital is $1,000,000. What is BBC's net income?

1.5 million

Ramala Corp's sales last year were $48,000, and its total assets were $25,500. What was its total assets turnover ratio (TATO)?

1.88

Rutland Corp's stock price at the end of last year was $30.25 and its earnings per share for the year were $2.45. What was its P/E ratio?

12.35 price per share/EPS = 30.25 / 2.45 = 12.35

Rangoon Corp's sales last year were $400,000, and its year-end total assets were $300,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.5. The new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average?

140,000

The Wilson Corporation has the following results: Sales/Total assets 2.0x Return on assets (ROA) 4.0% Return on equity (ROE) 6.0% What is Wilson's profit margin and debt ratio?

2%; 0.33

Fama's French Bakery has a return on assets (ROA) of 10% and a return on equity (ROE) of 14%. Fama's total assets equal total debt plus common equity (that is, there is no preferred stock). Furthermore, we know that the firm's total assets turnover is 5. What is Fama's profit margin?

2.00%

Suppose the rate of return on a 10-year T-bond is currently 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average

2.00%

Long term capital gains are taxed at

20%

Dividend Income tax

20% or less

Aaron Aviation recently reported the following information: Net income $500,000 ROA 10% Interest expense $200,000 The company's average tax rate is 40%. What is the company's basic earning power (BEP)?

20.67%

Rollins Corp's total assets at the end of last year were $300,000 and its EBIT was $75,000. What was its basic earning power (BEP)?

25% EBIT / total assets = 75000/300000 = 0.25

Fama's French Bakery has a return on assets (ROA) of 10% and a return on equity (ROE) of 14%. Fama's total assets equal total debt plus common equity (that is, there is no preferred stock). Furthermore, we know that the firm's total assets turnover is 5. What is Fama's debt ratio?

28.57%

The Merriam Company has determined that its return on equity (ROE) is 15%. If its debt ratio is 0.35 and its total assets turnover is 2.8, what is the profit margin?

3.48% ROE = profit margin x total asset turnover. x equity mult equity multiplier = 1 / (1-0.35) = 1.54 .15 = PM x 2.8 x 1.54 --> PM = .15/4.3 = 3.48%

How much of Corporate Dividend Income is taxable? (income received from other corporations)

30% (in general) of Corporate Dividend income is taxable -exclude 70% to avoid triple taxation

The industry average inventory turnover is 5. You think you can change your inventory control system and steer your turnover to the industry average. This change will have no effect on either sales or cost of goods sold. The cash generated from reducing inventories will be invested in tax-exempt securities that yield 7%. What will your profit margin be after the change in inventories is reflected in the income statement?

4.5%

Last year Bell Corp had $200,000 of assets, $300,000 of sales, $20,000 of net income, and a debt-to-total-assets ratio of 40%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets to $150,000. Sales, costs, and net income would not be affected, and the firm would maintain the 40% debt ratio. By how much would the reduction in assets improve the ROE?

5.56%

Company A has sales of $1,000, assets of $500, a debt ratio of 30%, and an ROE of 15%. Company B has the same sales, assets, and net income as Company A, but its ROE is 30%. What is B's debt ratio? (Hint: Begin by looking at the Du Pont equation.)

65.0%

One-year Treasury bills yield 6%, while 2-year Treasury notes yield 6.7%. If the expectations theory holds, what is the market's forecast of what 1-year T-bills will be yielding one year from now?

7.4%

Miller Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was its net cash flow?

732 NCF = NI + Depreciation sales (9000) - op costs (6000) = EBITDA (3000) EBITDA (3000) - Depreiation (1500) = EBIT (1500) EBIT (1500) - Interest Expense (4000 x .07 =280) = EBT (1220) EBT (1220) - Taxes (.4 x 1220 =488) = 732 (NI) NCF = 732 + 1500 = 2,232

At the end of 2004, Lehnhoff Inc. had $75 million in cash. During 2005, the following events occurred: * Cash flow from Lehnhoff's operating activities totaled $325 million. * Lehnhoff issued $500 million in common stock. * Lehnhoff's notes payable decreased by $100 million. * Lehnhoff purchased fixed assets totaling $600 million. How much cash did Lehnhoff Inc. have at the end of 2005?

75+325+500-100-600 = 200 million

Assume that the real risk-free rate, r*, equals 3%, and it is expected to be constant over time. Expected inflation is expected to be 3% in Year 1, 4% in Year 2, and 5% in Year 3. Assume that the maturity risk premium (MRP) = 0. The interest rate on Treasury securities that mature in four years is 8%. What is expected inflation in Year 4?

8.0%

Reynolds Corp's total assets at the end of last year were $300,000 and its net income after taxes was $25,000. What was its return on total assets?

8.33%

Last year, Candle Corp had $200,000 of assets, $300,000 of sales, $20,000 of net income, and a debt-to-total-assets ratio of 40%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $30,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE?

8.33% ROE = NI/sales x sales/total assets x equity multiplier old = 20000/300000 x 300000/200000 x 1/(1-.4) = 0.1667 new = 30000/300000 x 300000/200000 x 1/(1-.4) = .25 .25 - .16667 = 0.0833 = 8.33%

Ruby Corp's sales last year were $435,500, its operating costs were $350,000, and its interest charges were $10,000. What was the firm's times interest earned (TIE) ratio?

8.55

The company's CFO, Fred Mertz, wants to see a 25% increase in net income over the next year. In other words, his target for next year's net income is $2,250,000. Mertz has made the following observations: - Ricardo's operating margin (EBIT/Sales) was 37.5% this past year. - Mertz expects that next year this margin will increase to 40%. - Ricardo's interest expense is expected to remain constant. - Ricardo's tax rate is expected to remain at 40%. On the basis of these numbers, what is the percentage increase in sales that Ricardo needs in order to meet Mertz's target for net income?

9.38%

The real risk-free rate is expected to remain constant at 3%. Inflation is expected to be 4% a year for the next four years, and then 3% a year thereafter. The maturity risk premium is 0.1(t - 1)%, where t equals the maturity of the bond. A 7-year corporate bond has a yield of 9.8%. What is the yield on a 10-year corporate bond that has the same default risk premium and liquidity premium as the 7-year corporate bond? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

9.93%

Private Equity Company

A business usually owned by private individuals backed by financial institutions

over the counter market

A collection of brokers and dealers, connected electronically by telephones and computers that provides for trading in securities not listed on the physical exchanges. NASDAQ

publicly owned corporation

A corporation that is owned by a relatively large number of individuals who are not actively involved in the firm's management.

financial service corporation

A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking.

Amortization

A non-cash charge similar to depreciation except that it represents a decline in value of intangible assets.

Liquidity Premium (LP)

A premium added to the equilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to its "fair market value" Corporate: how easily can you find a buyer if you want to sell debt

Inflation Premium (IP)

A premium equal to expected inflation that investors add to the real risk-free rate of return Treasury impacted by IP

Maturity Risk Premium (MRP)

A premium that reflects interest rate risk; bonds with longer maturities have greater interest rate risk. Treasury: investors enticed to lend money for long period of time 0.1(T-1)%

hedge fund

A private investment organization that employs risky strategies that often made huge profits for investors

You recently sold to your brother 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:

A secondary market transaction.

Statement of Stockholder Equity

A statement that shows by how much a firm's equity changed during the year and why this change occurred. amount stockholders paid company and how much earnings they have paid

progressive tax

A tax for which the percentage of income paid in taxes increases as income increases

Pure Expectations Theory

A theory that states that the shape of the yield curve depends on investors' expectations about future interest rates.

Humped Yield Curve

A yield curve where interest rates on intermediate-term maturities are higher than rates on both short- and long-term maturities.

Which of the following items is NOT included in current assets? a. Accounts receivable. b. Cash. c. Short-term, highly liquid, marketable securities. d. Inventory. e. Accounts payable.

Accounts payable.

Which of the following items can be found on a firm's balance sheet under current liabilities?

Accrued wages.

Which of the following statements is CORRECT?

An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin

Which of the following statements is CORRECT? a.The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio. b.An increase in the DSO, other things held constant, could be expected to increase the ROE. c.An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio. d.If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE. e.An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin.

An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin.

Considered alone, which of the following would increase a company's current ratio?

An increase in accounts receivable.

Companies generate income from their "regular" operations and from things like interest on securities they hold, which is called non-operating income. Mitel Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges and no non-operating income. It had issued $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was the firm's operating income, or EBIT?

Answer: $1,500 Explanation: The computation of the firm operating income is shown below: = Sales - operating cost other than depreciation - depreciation expenses = $9,000 - $6,000 - $1,500 = $1,500 We simply deduct the operating cost and the depreciation expenses from the sales revenue amount to find out the earnings before income and taxes (EBIT) or firm operating income

Which of the following statements is CORRECT?

Both Nasdaq dealers and "specialists" on the NYSE hold inventories of stocks.

Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates are not affected.

Companies' cash positions would decline.

Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?

Company HD has a lower times interest earned (TIE) ratio.

Keys Corporation's 5-year bonds yield 6.50%, and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the default risk premium for Keys' bonds is DRP = 0.40%, the liquidity premium on Keys' bonds is LP = 1.7% versus zero on T-bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on a 5-year bond?

Corporate bond yield = r* + IP + MRP + DRP + LP 6.5 = 2.5 + 1.5 + MRP + 0.4 + 1.7 MRP = 0.4%

net working capital

Current Assets-Current Liabilities (Usually positive for a healthy firm)

total assets

Current assets + Net plant and equipment

total liabilities and equity

Current liabilities + Long-term debt + Total common equity

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were caused primarily by

Default risk differences.

interest expense

EBIT - EBT

Operating Cash Flow

EBIT(1-T) + Depreciation

Economic Value Added (EVA)

EBIT(1-T) - (total invested capital * aftertax percentage) =net income - (equity * cost of equity) =equity (net income/equity - cost of equity) =equity(ROE - cost of equity) Want to be positive

Times Interest Earned

EBIT/ interest expense How many times EBIT covers interest expense Want greater than 2.5

Operating Margin

EBIT/Sales Contribution of operations to profitability 10% is average and 20% is high

Basic Earning Power (BEP)

EBIT/Total Assets Operating Income compared to assets higher is better

EV/EBITDA

Enterprise Value / EBITDA (MV of equity + MV of total debt + MV of other financials - cash)/EBITDA below 10 is considered healthy/above average

Physical Location Exchanges

Formal organizations having tangible physical locations that conduct auction markets in designated ("listed") securities NYSE.

Which of the following statements is CORRECT? a. The income statement gives us a snapshot of what is happening at a point in time. b. The balance sheet gives us a picture of the firm's financial situation over a period of time. c. The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits. d. Four key financial statements are the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings.e.The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.

Four key financial statements are the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings.

Which of the following statements is CORRECT?

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

Which of the following statements is CORRECT?

If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.

Which of the following statements is CORRECT?

If two firms differ only in their use of debt-i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates-but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.

A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?

Increase EBIT while holding sales constant.

Most studies of stock market efficiency suggest that the stock market is highly efficient in the weak-form and reasonably efficient in the semistrong-form. Assuming these findings are correct, which of the following statements is CORRECT?

Information you read in The Wall Street Journal cannot be used to select stocks that are likely to produce above-average rates of return.

If the stock market is semistrong-form efficient, which of the following statements is CORRECT?

Investors can outperform the market if they have access to information that has not yet been publicly revealed.

Cash Flow from Financing

Issuances and payments of debt and stock: L-T Debt, Common and Preferred Stock, Notes Payable (short-term debt), Dividends paid -normally slightly positive, could be negative if company is doing well

Tax losses can be carried back and forward for how long?

Losses can be carried back 2 years (refund on past taxes) and carried forward up to 20 years

alternative minimum tax

More difficult for wealthy people to avoid paying taxes

Money Market Fund

Mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts

Return on Invested Capital (ROIC)

NOPAT / total invested capital (EBIT(1-T))/(debt + equity) accounting profit earned by all investors Want positive/high

Return on Equity (ROE)

Net Income/Common Equity want between 15% and 20% rate of return on common stockholder investment

profit margin

Net Income/Sales How much net income as a percentage to revenue 10% to 20%

Assume that Congress recently passed a provision that will enable Piazza Cola to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, Piazza's net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on Piazza's financial statements versus the statements without the provision? Assume that the company uses the same depreciation for tax and stockholder reporting purposes.

Net fixed assets on the balance sheet will decrease.

Are dividends paid tax deductible?

No. -The money used comes out of taxed income -It is taxed again once paid out to investors (investors pay tax) -double taxation

Tax Loss Carry-Back or Carry-Forward

Ordinary corporate operating losses can be carried backward for 2 years and carried forward for 20 years to offset taxable income in a given year.

A security analyst obtained the following information from Palmer Products' financial statements: * Retained earnings at the end of 2004 were $700,000, but retained earnings at the end of 2005 had declined to $320,000. * The company does not pay dividends. * The company's depreciation expense is its only non-cash expense; it has no amortization charges. * The company has no non-cash revenues. * The company's net cash flow (NCF) for 2005 was $150,000. On the basis of this information, which of the following statements is CORRECT?

Palmer had negative net income in 2005

A security analyst obtained the following information from Palmer Products' financial statements: * Retained earnings at the end of 2004 were $700,000, but retained earnings at the end of 2005 had declined to $320,000. * The company does not pay dividends. * The company's depreciation expense is its only non-cash expense; it has no amortization charges. * The company has no non-cash revenues. * The company's net cash flow (NCF) for 2005 was $150,000. On the basis of this information, which of the following statements is CORRECT?

Palmer had negative net income in 2005.

Which of the following is an example of a capital market instrument?

Preferred stock.

If the Federal Reserve sells $50 billion of short-term U.S. Treasury securities to the public, other things held constant, what would be the most likely effect on short-term securities prices and interest rates?

Prices will decline and interest rates will rise.

Cash Flow from Investing

Purchases and Sales of: long term real assets and investments (marketable securities) -normal for it to be negative

Day Sales Outstanding (DSO)

Receivables/(Annual Sales/365) average time firm waits after sale for cash Lower is better: less than 40

Inventory Turnover Ratio

Sales/Inventories average number of times inventory is turned over per year More is better: between 5-10

Fixed Asset Turnover

Sales/Net Fixed Assets (Net PPE) How effectively firm uses fixed assets Higher is better: greater than 2.5

"Window Dressing" Techniques

Techniques employed by firms to make their financial statements look better than they really are.

Which of the following would indicate an improvement in a company's financial position, holding other things constant?

The EBITDA coverage ratio increases.

going public

The act of selling stock to the public at large by a closely held corporation or its principal stockholders.

Inflation

The amount by which prices increase over time Expected interest means they want to be compensated for change in value of money, causes higher interest

Depreciation

The charge to reflect the cost of assets depleted in the production process. Depreciation is not a cash outlay. EBITDA - EBIT

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?

The company issues new common stock.

Last year, Owen Technologies reported (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?

The company sold a new issue of common stock.

Maple Furniture recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action?

The company's current ratio increased.

Holmes Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance?

The company's depreciation and amortization expenses declined.

Default Risk Premium (DRP)

The difference between the interest rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability Corporate: based on credit worthiness of borrower

Which of the following statements is CORRECT?

The income statement for a given year, say 2005, is designed to give us an idea of how much the firm earned during that year.

Production Opportunities

The investment opportunities in productive (cash-generating) assets. Affects demand: more opportunities, more demand for money, higher interest

spot market

The markets in which assets are bought or sold for "on-the-spot" delivery.

If the pure expectations theory holds, which of the following statements is CORRECT?

The maturity risk premium would be zero.

Capital Gain/Loss

The profit (loss) from the sale of a capital asset for more (less) than its purchase price.

NOPAT

The profit a company would generate if it had no debt and held only operating assets.

Foreign Trade Deficit

The situation that exists when a country imports more than it exports

Which of the following statements is CORRECT?

The statement of cash flows for 2005 shows how much the firm's cash (the total of currency, bank deposits, and short-term liquid securities, or cash equivalents) increased or decreased during 2005.

Nelson Automotive is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Nelson pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?

The tax bill will increase.

Which of the following statements is CORRECT?

The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

Debt to Equity Ratio

Total Debt / Equity

Total Debt to Total Capital

Total Debt/(Total Debt + Equity) How much debt a company is using Lower is better/less risky

Operating Cash Flow (OCF)

Total cash available for new asset investment, and for debt and equity investors. This measure is often used to value a firm (part of FCF) -OCF= EBIT(1-tax rate) + depreciation & amortization

yield curve

a graph showing the relationship between bond yields and maturities

benchmarking

a process by which a company compares its performance with that of high-performing organizations

Income Statement

a report of revenue, expenses, and net income or loss from operations for a specific period

Balance Sheet

a statement of the assets, liabilities, and capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period.

Annual Report

a yearly statement of the financial condition, progress, and expectations of an organization to stockholders

inverted yield curve

abnormal, a yield curve that is downward sloping

current liabilities

accounts payable + notes payable

S corporation

allows a small business to be taxed as a proprietorship or partnership

Retained Earnings

amount of capital raised beyond new common stock net income - dividends paid

Basis

amount of your investment in an asset

Roth IRA

an individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59½ are tax-free.

Interest income is taxed at....

an individuals marginal tax rate (unless it is a municipal bond)

Mutual Fund

an organization that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets

Normal Yield Curve

an upward-sloping yield curve

Derivatives

any financial asset whose value is derived from the value of some other "underlying" asset Credit Default Swaps, Hedging Operations

Liquid Asset

asset that can quickly be converted into cash with little risk of loss

Below are the 2004 and 2005 year-end balance sheets for Kewell Kewell Products has never paid a dividend on its common stock, and it issued $1,200,000 of 10-year non-callable, long-term debt in 2004. As of the end of 2005, none of the principal on this debt had been repaid. Assume that the company's sales in 2004 and 2005 were the same. Which of the following statements must be CORRECT?

b. Kewell issued new common stock in 2005.

after-tax return

before tax return * (1-T)

After tax return =

before tax return * (1-tax rate)

Madison Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges and no non-operating income. It had issued $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was the firm's taxable, or pre-tax, income?

c. $1,220

The real risk-free rate is 2%. The inflation rate is expected to be 3% a year for the next three years and then 4% a year thereafter. Assume that the default risk and liquidity premiums on all Treasury securities equal zero. You observe that 10-year Treasury bonds yield 1% more than the yield on 5-year Treasury bonds. What is the difference in the maturity risk premium on the two bonds? (That is, what is MRP10 - MRP5?) Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

c. 0.7%

Which of the following statements is CORRECT? a. One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital. b. If a firm reports positive net income, its EVA must also be positive. c. One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital. d. Actions that increase reported net income will always increase net cash flow. e. One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.

c. One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital.

Money markets are markets for

c. Short-term debt securities such a Treasury bills.

Total amount of money company has raised by selling stock to the public=

capital surplus + common stock account

Free Cash Flow (FCF)

cash available for debt & equity investors. This measure is often used to value a firm. -FCF= operating cash flow (OCF)- investment in operating capital

Risk

chance investment will provide low or negative return A riskier borrower, higher interest

Investment in Operating Capital

change in gross fixed assets + change in net operating working capital

Depreciation on a balance sheet

comes from fixed long term assets (that way the total expense of fixed assets isn't expensed all at once), periodic write off of some asset, NON CASH EXPENSE

Book Value

common equity/shares outstanding market cap/total equity

Nominal risk-free interest rate

contracted interest value

Corporate Bond Yield Spread

corporate bond yield - treasury bond yield DRP + LP

primary market

corporations raise capital by issuing new securities

Accounts Receivable

credit sales (cash has yet to be collected)

Working Capital

current assets

net operating working capital

current assets - (current liabilities - notes payable) operating current assets - operating current liabilities

Net working Capital =

current assets - current liabilities

Current Ratio

current assets/current liabilities want equal or greater than 1 extent to which current liabilities are covered by assets

Non-interest bearing liabilities

current liabilities - notes payable

Which of the following statements is CORRECT?

d. Borrowing on a long-term basis and using the proceeds to retire short-term debt could be an example of window dressing.

Does the US favor debt financing or equity financing?

debt financing

Fine Breads Inc. paid out $26,000 common dividends during 2005, and it ended the year with $150,000 of retained earnings. The prior year's retained earnings were $145,000. What was the firm's 2005 net income?

dividend = NI - Change in retained earnings 26000 = NI - (150000-145000) = NI - 5000 NI = 31,000

Assume that r* = 2.0%; the maturity risk premium is found as MRP = 0.1%(t - 1), where t = years to maturity; the default risk premium for corporate bonds is found as DRP = 0.05%(t - 1); the liquidity premium is 1% for corporate bonds only; and inflation is expected to be 3%, 4%, and 5% during the next three years and then 6% thereafter. What is the difference in interest rates between 10-year corporate and Treasury bonds? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

doesn't include C-Bond DRP and LP 0.05%(t-1) + LP 0.45 + 1 = 1.45%

Other things held constant, which of the following alternatives would increase a company's cash flow for the current year?

e. Reduce the days' sales outstanding (DSO) without reducing sales

EBT

earnings before taxes income/(1-T)

trend analysis

estimate likelihood of improvement/deterioration in financial conditions

capital market

financial market for stock and intermediate/long term debt (greater than a year) US Treasury Bonds, mortgages, state bonds, corporate bonds, leases, preferred and common stock

Marriage Penalty

higher taxes when filing jointly or separately when married

Statement of Cash Flows

how balance sheet and income statement items affect cash flow

money markets

include short-term, highly liquid, and relatively low-risk debt instruments funds are borrowed/loaned for a short period of time (less than 1 year) US Treasury Bills, commercial paper, consumer credit, credit card debt

dealer market

includes all facilities that are needed to conduct security transactions not conducted on the physical location exchanges

Investment in Operating Capital =

increase in gross fixed assets (capital expenditures) + increase in net operating working capital

M/B Ratio

market price per share/book value per share low/undervalued: less than 3

DuPont Analysis

measures the rate of return on equity = ROA * equity multiplier = profit margin * total asset turnover * equity multiplier = net income/sales *sales/total assets * total assets/total common equity

Behavioral Finance

models of financial markets that emphasize potential implications of psychological factors affecting investor behavior

Liabilities

money borrowed from suppliers, investors, etc

Cash Flow from Operations

net cash income from income statement: Net Income, Depreciation, Change in A/R, Inv, Other CA, Accruals (taxes and wages) , A/P, other CL

dividend

net income - change in retained earnings

Change in retained earnings =

net income -dividends paid

Earnings Per Share (EPS)

net income/common shares outstanding

Return on Assets (ROA)

net income/total assets measure of profit per dollar of assets want greater than 5%

Are dividends on an income statement?

no

Do income statements reflect all cash collected and paid?

no

Efficient Market Hypothesis (EMH)

on average, asset prices are about equal to intrinsic values

Corporate tax deductions include...

operating expenses, depreciation, interest expense

Earnings Before Interest and Taxes (EBIT)

operating income -taxable income of company -EBIT= (sales-operating expense) - (depreciation & amortization)

Claims are listed by...

order which they should be paid (normally accounts payable then accruals)

closely held corporation

owned by a few individuals who are typically associated with the firm's management

Stockholder equity

paid in capital + retained earnings total assets - total liabilities amount stockholders paid the company and the earnings they have made since

Goodwill

purchasing other companies or assets for more than their accounting value

rRF with cross product term

r* + IP + (r* * IP)

Quoted Interest Rate (r)

r* + IP + DRP + LP + MRP = rRF + DRP + LP + MRP

r T-bond

r* + IP + MRP

r C-bond

r* + IP + MRP + DRP + LP

r T-bill

rRF = r* + IP

Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, and a maturity premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

rate on return = real rate + inflation rate + (per year MRP x years to maturity) 3.5 + 2.25 + (0.1 x 5) = 6.25%

Statement of Cash Flows

reflects changes in balance sheet which reconciles for income statement

Stockholders equity =

retained earnings + amount paid in capital (initial investment)

Interest Rate Risk

risk of capital losses to investors because of a change in interest rates

operating income (EBIT)

sales revenue - operating costs

Total Asset Turnover

sales/total assets How productive total assets are in producing sales Higher is better, 2.5+

What has the highest marginal tax rate for an individual?

savings account

secondary market

securities and financials are traded among investors after being issued by corporations

ask price

selling price

Exchange Traded Fund (ETF)

shares traded on securities markets that represent the legal right of ownership over part of a basket of individual stock certificates or other securities

total debt

short-term debt + long term debt

Public Market

standardized contracts are traded on organized exchanges

Itemized Deductions

state and local taxes, charitable donations, mortgage interest, a portion of a student loan interest, personal exemptions, and medical expenses to an extent (>7.5% of gross income)

P/E Ratio

stock price/earnings per share high: expect higher future growth, willing to pay more (18+) low: cheap stock, a buying opportunity (less than 15)

marginal tax rate

tax rate that applies to the next dollar of taxable income

Free Cash Flow (FCF)

the amount of cash that could be withdrawn without harming a firm's ability to operate and to produce future cash flows. Positive: generates enough cash to finance investments in fixed assets/working capital Negative: insufficient internal funds to finance investments and must raise new money = Operating Cash Flow - Investment in Operating Capital OCF = EBIT(1-T) + depreciation & amortization Investment in Operating Capital = increase in gross fixed assets (capital expenditures) + increase in NOWC NOWC = increase in current assets + increase in non-interest bearing current liabilities (accounts payable and accruals)

Bid Price

the buy price

IPO market

the market for stocks of companies that are in the process of going public

future markets

the markets in which participants agree today to buy or sell an asset at some future date

Time Preferences for Consumption

the preferences of consumers for current consumption as opposed to saving for future consumption affects supply: more willing to save into future, greater supply for money, interest lower

term structure of interest rates

the relationship between bond yields and maturities

Reinvestment Rate Risk

the risk that a decline in interest rates will lead to lower income when bonds mature and funds are reinvested

real risk-free rate

the risk-free rate that would exist on a default-free security if no inflation were expected

Arbitrage

the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.

Short term assets (less than 12 months) sold for capital gains are taxed at...

the taxpayers marginal rate (ordinary income)

Commercial banks

the traditional department store of finance serving a variety of savers and borrowers

Assets on balance sheet are listed by....

time they will be converted to cash or used by the firm (fixed assets)

current assets

total assets - cash

total equity

total assets - total liabilities

total liabilities

total debt + (accounts payable + accruals)

yield (% return)

total dollar return/beginning value (dollar income + (ending value-beginning value)) / beginning value

Liabilities to Assets Ratio

total liabilities/total assets

average tax rate

total taxes paid divided by total income taxes paid divided by taxable income

Private Market

transactions are worked out directly between two or more parties

Investment Banks

underwrites and distributes new investment securities and helps businesses obtain financing

Ordinary taxable income

wages, tips, interest income

Lennox Furniture Company's 2005 balance sheet showed total current assets of $1,500,000. All of the current assets were required in operations, and its current liabilities consisted of $300,000 of accounts payable, $200,000 of 6% short-term notes payable to the bank, and $100,000 of accrued wages and taxes. What was the net operating working capital that was financed by investors at the end of 2005?

working capital by investors doesn't include interest bearing liabilities = current assets - accounts payable - wages = 1.5 - .3 -.1 = 1.1 million

Do book values (assets & equity) consider depreciation?

yes