FINANCE QUIZ #1
is a legal entity separate from its owners.
A corporation:
dividends
A firm can increase its sustainable rate of growth by decreasing its:
has positive net working capital.
A firm has a current ratio of 1.4 and a quick ratio of .9. Given this, you know for certain that the firm:
has its profits taxed as personal income.
A sole proprietorship:
Price-earnings ratio
All else held constant, which one of the following will decrease if a firm increases its net income?
the relationships between a firm's sales and certain key economic indicators such as GDP and consumer confidence
An external sales forecast is based on ________.
depreciation
An increase in which one of the following will increase operating cash flow for a profitable, tax-paying firm?
Factors affecting value of company & stock price
size of cash flows, timing of cash flows, and risk of cash flows
percent-of-sales method
starts with the sales forecast and then expresses the cost of goods sold, operating expenses, interest expense, and other accounts as a percentage of projected sales.
Marginal tax rate
the extra taxes paid on an additional dollar of income
Corporate governance
the rules, processes, and laws by which companies are operated, controlled, and regulated.
Business ethics
the standards of conduct or moral judgment that apply to persons engaged in commerce
Performance plans
tie management compensation to measures such as EPS or growth in EPS. Performance shares and/or cash bonuses are used as compensation under these plans.
Average tax rate
total taxes paid divided by total income
The DuPont system
used to dissect the firm's financial statements and to assess its financial condition.
Forms of Business Organizations
•Sole proprietorship •Partnership •Corporation •LLC
Liquidity
− Speed and ease of conversion to cash without significant loss of value − Valuable in avoiding financial distress
Size, timing, and risk of future cash flows
Capital budgeting includes the evaluation of which of the following?
Rate of Return/Discount Rate
Cash flows occur over time and have an opportunity cost; the potential return earned elsewhere. Time and risk must be incorporated into the value of future cash flows.
total assets
Common-size financial statements present all balance sheet account values as a percentage of:
increases the potential return to the stockholders.
Financial leverage:
can still manipulate their earnings to some degree.
Firms that compile financial statements according to GAAP:
lowers taxes.
Given a profitable firm, depreciation:
Compare over time (Time Series Analysis)
Has a ratio changed over time? Why has it changed? Is it moving in a preferred direction? (e.g. are profit margins increasing?)
can be sold quickly at close to full value.
Highly liquid assets:
short-term investments
If a firm expects short-term cash surpluses, it can plan ________.
zero percent.
If a firm has a 100 percent dividend payout ratio, then the internal growth rate of the firm is:
It can meet the short-term obligations without any difficulty.
If the only information you are given about Ryan Corporation, a large public company in business for many years, is that it has a current ratio of 2.9, what could you infer from this?
the total debts of the partnership, even if he or she was unaware of those debts.
In a general partnership, each partner is personally liable for:
understate retained earnings and overstate the financing needed
In a period of rising sales utilizing past cost and expense ratios (percent-of-sales method), when preparing pro forma financial statements and planning financing, will tend to ________.
Which of the following represents a source of cash?
Increase in accounts payable
provide limited liability while avoiding double taxation.
Limited liability companies are primarily designed to:
involves tasks such as budgeting, financial forecasting, cash management, and funds procurement
Managerial finance ________.
Sole Proprietorship
Margie opened a used bookstore and is both the 100 percent owner and the store's manager. Which type of business entity does Margie own if she is personally liable for all the store's debts?
1. Sell the inventory and apply the proceeds to the debt 2. Withdraw funds from Maria's personal account at the bank to pay the store's debt 3. Sell any assets Maria personally owns and apply the proceeds to the store's debt
Maria is the sole proprietor of an antique store that is located in a rented warehouse. The store has an outstanding loan with the local bank but no other debt obligations. There are no specific assets pledged as security for the loan. Due to a sudden and unexpected downturn in the economy, the store is unable to generate sufficient funds to pay the loan payments due to the bank. Which of the following options does the bank have to collect the money it is owed?
corporation
Matt and Alicia created a firm that is a separate legal entity and will share ownership of that firm on a 75/25 basis. Which type of entity did they create if they have no personal liability for the firm's debts?
Finance
Measurement and study of an organization's cash flows in order to make business decisions related to its: • Investments • Financing• Operations
inventory is sold at a profit.
Net working capital increases when:
ability to raise larger sums of equity capital than other organizational forms.
One advantage of the corporate form of organization is the:
Compare against industry (Cross-sectional Analysis)
Our competitors face similar economic circumstances. Are their ratios different? If so, why? (e.g. what are our competitors doing to achieve higher profit margins?)
1. Profit margin 2. Return on assets 3. Return on equity
Outdoor Gear reduced its general and administrative costs this year. This cost improvement will increase which of the following ratios?
had to decrease.
Over the past year, a firm decreased its current assets and increased its current liabilities. As a result, the firm's net working capital:
Present Value
Present value is the mathematical method of creating equivalence across time and risk for cash flows.
profit maximization does not consider risk
Profit maximization as the goal of the firm is not ideal because ________.
Timing is important—the receipt of funds sooner rather than later is preferred Profits do not necessarily result in cash flows available to stockholders Profit maximization fails to account for risk
Profit maximization may not lead to the highest possible share price for at least three reasons:
Your firm's banker insists that you increase the firm's current ratio, which is less than 1.0. Which change will successfully increase your firm's current ratio?
Purchasing additional inventory on credit.
the residual value of a firm.
Shareholders' equity is best defined as:
net fixed assets minus long-term debt plus net working capital.
Shareholders' equity is equal to:
intrinsic value
The "value" of any security is the market value - the price that a buyer and seller agree to exchange. To be willing to make a transaction the buyer and seller decide the appropriate price. This is the theoretical value.
Equity multiplier × Return on assets.
The DuPont identity can be accurately defined as:
I. degree of financial leverage used by a firm. II. operating efficiency of a firm. III. utilization rate of a firm's assets. IV. rate of return on a firm's assets.
The DuPont identity can be used to help a financial manager determine the:
inventory turnover ratio
The ________ measures the activity, or liquidity, of a firm's stock of goods.
total asset turnover
The ________ ratio indicates the efficiency with which a firm uses its assets to generate sales.
profitability
The ________ ratios are primarily used as measures of return.
job security
The agency problem may result from a manager's concerns about ________.
approving strategic goals and plans
The board of directors is typically responsible for ________.
Working capital
The daily financial operations of a firm are primarily controlled by managing the:
Expected future cash flows
The future is unknown. Forecasting is a "best guess." Understanding the drivers of cash flows, primarily risk, helps us forecast.
current market value per share.
The goal of financial management is to increase the:
a positive corporate image and increased respect, a reduction in risk, and enhanced cash flow resulting in an increase in share price
The implementation of a pro-active ethics program is expected to result in ________.
the sales forecast
The key input to any cash budget is ________.
the sales forecast
The key input to the short-term financial planning process is ________.
sales forecast for the coming year and financial statements for the preceding year
The key inputs for preparing pro forma income statements using the simplified approaches are the ________.
all costs are variable
The percentage-of-sales method of preparing pro forma income statements assumes that ________.
Agency
The potential conflict of interest between a firm's owners and its managers is referred to as which type of conflict?
for profit planning
The primary purpose in preparing pro forma financial statements is ________.
No new external equity and a constant debt-equity ratio
The sustainable growth rate is defined as the maximum rate at which a firm can grow given which of the following conditions?
Working capital management
Theo's BBQ has $48,000 in current assets and $39,000 in current liabilities. Decisions related to these accounts are referred to as:
Capital Structure
Uptown Markets is financed with 45 percent debt and 55 percent equity. This mixture of debt and equity is referred to as the firm's:
1. Decreasing accounts receivable 2. Increasing accounts payable 3. Increasing common stock
Which of the following are sources of cash?
a decrease in accounts receivable
Which of the following is a cash inflow?
Minimizing the cash balances held by the firm
Which of these actions is indicative of a restrictive short-term financial policy?
Decreasing accounts payable
Which of these is a use of cash?
High ratio of current assets to sales
Which of these is the most indicative of a flexible short-term financial policy?
Cash payment of an account payable
Which one of the following actions will increase the current ratio, all else constant? Assume the current ratio is greater than 1.0.
Limited partnership
Which one of the following forms of business organization offers liability protection to some of its owners but not to all of its owners?
Establishing the preferred debt-equity level
Which one of the following is a capital structure decision?
Paying a supplier for inventory you purchased last month
Which one of the following is a use of cash?
How much cash should the firm keep in reserve?
Which one of the following is a working capital decision?
Losses limited to capital invested
Which one of the following is an advantage of being a limited partner?
Compensating managers with shares of stock that must be held for a minimum of three years
Which one of the following is most apt to align management's priorities with shareholders' interests?
Basing management bonuses on the length of employment
Which one of the following situations is most apt to create an agency conflict?
Obtaining additional equity is dependent on the owner's personal finances.
Which one of the following statements correctly applies to a sole proprietorship?
average tax rate
Which one of the following terms is defined as the total tax paid divided by the total taxable income?
Decrease in the tax rate
Which one of the following will increase the profit margin of a firm, all else held constant?
Net income is distributed either to dividends or retained earnings.
Which one of these is correct?
general parnership
Will and Bill both enjoy sunshine, water, and surfboards. Thus, the two friends decided to create a business together renting surfboards, paddle boats, and inflatable devices in California. Will and Bill will equally share in the decision making and in the business profits or losses. Which type of business did they create if they both have full personal liability for the firm's debts?
secondary market
You contacted your stock broker this morning and placed an order to sell 300 shares of a stock that trades on the NYSE. This sale will occur in the:
Pro forma statements
________ are projected financial statements.
Financial services
________ is concerned with design and delivery of advice and financial products to individuals, businesses, and governments.
Inventory turnover ratio
________ may indicate a firm is experiencing stockouts and lost sales.
The implementation of a pro-active ethics program is expected to result in
a positive corporate image and increased respect, a reduction in risk, and enhanced cash flow resulting in an increase in share price
sales forecast
a prediction of the sales activity during a given period, based on external and/or internal data.
internal forecast
a sales forecast based on a buildup, or consensus, of sales forecasts through the firm's own sales channels.
external forecast
a sales forecast based on the relationships observed between the firm's sales and certain key external economic indicators.
The cash budget or cash forecast
a statement of the firm's planned inflows and outflows of cash that is used to estimate its short-term cash requirements.
principal-agent relationship
an arrangement in which an agent acts on the behalf of a principal. For example, shareholders of a company (principals) elect management (agents) to act on their behalf.
Incentive plans
are management compensation plans that tie management compensation to share price; one example involves the granting of stock options.
Agency costs
arise from agency problems that are borne by shareholders and represent a loss of shareholder wealth.
Agency problems
arise when managers place personal goals ahead of the goals of shareholders.
Goal of firm
maximize shareholder wealth
price/earnings (P/E) ratio
measures the amount that investors are willing to pay for each dollar of a firm's earnings.
times interest earned ratio
measures the firm's ability to make contractual interest payments; sometimes called the interest coverage ratio.
Operating profit margin
measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividends are deducted.
Net profit margin
measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted.
Gross profit margin
measures the percentage of each sales dollar remaining after the firm has paid for its goods.
Next year's Balance Sheet projections show Total Assets of $50,000, Liabilities of $30,000, and Owner's Equity of $10,000. What does this mean for the company?
$10,000 of external financing is needed
Limited Partnership (LP)
- Advantages of Limited Partnership • Limited liability - Disadvantages • not active in management • less favorable allocation of ownership/profit/losses
Sole Proprietorship
- Advantages• Easily Established• Minimal Organizational Costs • Keep all Generated Profits - Disadvantages• Unlimited Liability • Losses absorbed by owner • Limited Capital• Limited Life
Limited Liability Company (LLC)
- Advantages• Limited Liability• No Double Taxation - Disadvantages• Relatively New - Some Legal Issues Not Yet Defined
General Partnership
- Advantages• Minimal Organizational Requirements • Negligible Government Regulations - Disadvantages • Unlimited Liability • Must be Dissolved or Reorganized if a Partner Leaves or Dies
Net working capital
- Current Assets minus Current Liabilities - Usually positive for a healthy firm
Corporation
- In the eyes of the law, a corporation is a legal entity separate and distinct from its owners - Advantages• Limited Liability• Permanency• Transferability of Ownership • Better Access to Capital - Disadvantages• Double Taxation• Time and Cost of Incorporation• Separation of ownership and management (agency problem)
Ethics programs seek to:
- reduce litigation and judgment costs- maintain a positive corporate image- build shareholder confidence- gain the loyalty and respect of all stakeholders • The expected result of such programs is topositively affect the firm's share price.
The return received by shareholders is influenced by two major categories:
1) What a firm does operationally - ROA (Return on Assets) 2) How a firm finances itself, through borrowing or shareholder financing - FLM (Financial Leverage Multiplier)
Pro forma financial statements
projected, or forecast, income statements and balance sheets.