Managerial Finance - Exam 1

Using the description of each business, classify it as a sole proprietorship, a partnership, a corporation, or a limited liability company/limited liability partnership. Selena and Mario run a law firm in Chicago. The firm has debt of $100,000, but Selena and Mario will not be held personally liable for the law firm's debt.

LLC/LLP

Most firms borrow money to finance some of their assets, and most will choose to borrow some long-term funds and some short-term funds. Which group of lenders would put greater emphasis on a firm's liquidity ratio when evaluating a potential borrower? a) short-term lenders b) long-term lenders

a) short-term lenders

Can a company have negative free cash flow? a) yes b) no

a) yes

Can a company's shares exhibit a negative P/E ratio? a) yes b) no

a) yes

What is the most commonly used base item for a common size balance sheet? a) earnings before interest and taxes b) net sales c) total assets d) net income

c) total assets

An analyst with a leading investment bank tracks the stock of Mandalays Inc. According to her estimations, the value of Mandalays Inc.'s stock should be $45.69 per share, but Mandalays Inc.'s stock is trading at $40.12 per share on the New York Stock Exchange (NYSE). Considering the analyst's expectations, the stock is currently: a) overvalued b) in equilibrium c) undervalued

c) undervalued

Ratios that help determine whether a company can access its cash and pay its debts that mature in less than a year are called _____ ratios.

liquidity

What is reported in the financing section of the statement of cash flows?

shows cash flows generated or utilized from financing activities

Statement of Owner's Equity

shows changes to stockholder's or owner's equity during the period; shows the impact of net income (or loss) on equity, the impact of stock issuance or buy backs, and the impact of dividends paid

Using the description of each business, classify it as a sole proprietorship, a partnership, a corporation, or a limited liability company/limited liability partnership. Joshua started a tutoring website. After a few months, a publishing company filed a lawsuit against his company for copyright infringement. Joshua had to shut down his business and lost all his personal assets in the process.

sole proprietorship

The following table lists descriptions of the major financial statements and reports that a firm publishes. Identify the correct statement or report for each description. Gives details about the company's cash at the beginning of the year and what is left at the end of the year, including some details about where cash was generated and where it was used during the course of the year.

statement of cash flows

Indicate which financial statement you would refer to when answering the questions in the following table: How much of the firm's earnings are left as balance after the firm pays out dividends to its shareholders?

statement of stockholders' equity

Disadvantages of Sole Proprietorships

1. unlimited liability

Cute Camel Woodcraft Company just reported earnings after tax (also called net income) of $9,250,000 and a current stock price of $39.50 per share. The company is forecasting an increase of 25% for its after-tax income next year, but it also expects it will have to issue 3,000,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,500,000). 1. If Cute Camel's forecast turns out to be correct and its price/earnings (P/E) ratio does not change, what does the company's management expect its stock price to be one year from now? a) $31.98 per share b) $39.50 per share c) $23.99 per share d) $39.98 per share 2. One year later, Cute Camel's shares are trading at $55.80 per share, and the company reports the value of its total common equity as $54,366,000. Given this information, Cute Camel's market-to-book (M/B) ratio is _____.

1. a) $31.98 per share explanation: step 1: EPS = net income / shares outstanding EPS = $9,250,000 / 5,500,000 shares EPS = $1.68 step 2: P/E ratio = price per share / EPS P/E ratio = $39.50 / $1.68 P/E ratio = 23.5119x step 3: expected EPS = expected net income / outstanding shares next year expected EPS = $11,562,500 / 8,500,000 expected EPS = $1.36 step 4: expected stock price = expected EPS x P/E ratio expected stock price = $1.36 x 23.5229 expected stock price = $31.98 per share 2. 8.72x explanation: step 1: BVPS = common equity / shares outstanding BVPS = $54,366,000 / 8,500,000 shares BVPS = $6.40 step 2: M/B ratio = market price per share / BVPS M/B ratio = $55.80 per share / $6.40 M/B ratio = 8.72x

Krit Corp. is a U.S. manufacturing company based in the Midwest. As an investor, Wilson bought 175 shares of stock in Krit Corp. The stock price of Krit Corp. is currently trading at $25 per share. 1. Wilson's total wealth in Krit Corp. is: a) $8,775 b) $4,375 c) $175 d) $4,125 2. If the stock price of Krit Corp. decreases in the next two years, Wilson's wealth in Krit Corp. will _____.

1. b) $4,375 explanation: Wilson's wealth = number of shares that Wilson owns x market price per share Wilson's wealth = 175 shares x $25 Wilson's wealth = $4,375 2. decrease

Ways to Align Management's Interest with Shareholder's Interest

1. compensation packages should be geared towards long-term value maximization (intrinsic value) 2. threat of a takeover: impacts management's actions 3. direct intervention by shareholders: shareholders can vote on Board of Directors and can force changes to the Board and management 4. stockholder (owner) wealth maximization is the ultimate and long-run goal of finance

Adams Furniture has a quick ratio of 2.00x, $37,575 in cash, $20,875 in accounts receivable, some inventory, total current assets of $83,500, and total current liabilities of $29,225. The company reported annual sales of $100,000 in the most recent annual report. Additionally, the company's cost of goods sold is 75% of sales. 1. Over the past year, how often did Adams Furniture sell and replace its inventory? a) 2.86x b) 8.01x c) 3.29x d) 2.99x 2. The inventory turnover ratio across companies in the furniture industry is 3.289x. Based on this information, which of the following statements is true for Adams Furniture? a) Adams Furniture is holding more inventory per dollar of sales compared with the industry average b) Adams Furniture is holding less inventory per dollar of sales compared with the industry average

1. d) 2.99x explanation: inventories = current assets - (quick ratio x current liabilities) step 1: inventories = $83,500 - (2.00 x $29,225) inventories = $25,050 step 2: inventory turnover ratio = cost of goods sold / inventories inventory turnover ratio = (0.75 x $100,000) / $25,050 inventory turnover ratio = 2.99x 2. a) Adams Furniture is holding more inventory per dollar of sales compared with the industry average

Disadvantages of Corporations

1. double taxation

Advantages of Sole Proprietorships

1. easy to form 2. one tax layer

Advantages of Partnerships

1. easy to form 2. shared expertise

Disadvantages of LLCs/LLPs

1. files reports each year 2. pays fees

Advantages of Corporations

1. limited liability 2. ease of raising capital 3. pooling of resources

Advantages of LLCs/LLPs

1. limited liability protection 2. fairly easy to set up

What are the forms of business organizations?

1. sole proprietorship 2. partnership 3. LLC or LLP 4. corporation

Disadvantages of Partnerships

1. unlimited liability

Stock's Current Market Price

a stock's market value based on perceived information by the marginal (not always informed) investor

Aunt Dottie's Linen Inc. reported no long-term debt in its most recent balance sheet. A company with no debt on its books is referred to as: a) a company with no leverage, or an un-leveraged company b) a company with leverage, or a leveraged company

a) a company with no leverage, or an un-leveraged company

You work for a brokerage firm. Your boss asked you to analyze Blue Parrot Manufacturing's performance for the past three years and to write a report that includes a benchmarking of the company's performance. Which of the following components would be best for you to include in your financial statement analysis? a) a comparison of the firm's performance with other firms in the same industry based on their financial ratios b) financial statements based solely on information given to analysts and brokerage firms

a) a comparison of the firm's performance with other firms in the same industry based on their financial ratios

Identify which of the following statements are true about profitability ratios. Check all that apply. a) a higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both b) if a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes c) an increase in the return on assets ratio implies an increase in the assets a firm owns d) if a company issues new common shares but its net income does not increase, return on common equity will increase

a) a higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both b) if a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes

You bought 1,000 shares of Tund Corp. stock for $75 per share and sold it for $77.25 per share within the same year. How will your gain or loss be treated when you file your taxes? a) as a capital gain taxed at the current ordinary-income tax rate b) as a capital gain taxed at the long-term tax rate

a) as a capital gain taxed at the current ordinary-income tax rate

Different forms of businesses have different characteristics. Which of the following characteristics would apply to a corporation? Check all that apply. a) has unlimited life b) owners have limited liability c) easier to transfer ownership in the form of stock d) chartered by a state and is its own legal entity separate and distinct from its owners and managers e) owned by single individual f) exempt from double taxation

a) has unlimited life b) owners have limited liability c) easier to transfer ownership in the form of stock d) chartered by a state and is its own legal entity separate and distinct from its owners and managers

The annual report is very important for investors, because the information contained in the annual report: a) helps investors forecast expected earnings and dividends b) shows the prices at which each investor purchased the company's stocks and bonds

a) helps investors forecast expected earnings and dividends

Which of the following is true for the statement of cash flows? a) it reflects cash generated and used during the reporting period b) it reflects revenues when earned

a) it reflects cash generated and used during the reporting period

Vision Tech is a software company based out of San Francisco. Its stockholders are mostly individual investors and there is relatively little institutional ownership. If several pension and mutual funds were to take large positions in Vision Tech's stock, would direct shareholder intervention be more or less likely to motivate the firm's management? a) more likely b) less likely

a) more likely

Is the U.S. federal tax system for individuals progressive or regressive? a) progressive b) regressive

a) progressive

Which of the following statements best describes free cash flow? a) residual cash flow after taking into account operating cash flows, including fixed-asset acquisitions, asset sales, and working-capital expenditures b) cash flows generated by operating the business

a) residual cash flow after taking into account operating cash flows, including fixed-asset acquisitions, asset sales, and working-capital expenditures

Economic Value Added (EVA)

also known as economic profit

Earnings Before Interest and Taxes (EBIT)

also known as net operating income

The following table lists descriptions of the major financial statements and reports that a firm publishes. Identify the correct statement or report for each description. Is published once a year and provides stockholders with details about the company's performance and financial condition.

annual report

These ratios, which help determine how efficiently a firm is using its assets to generate sales are called _____ ratios.

asset management or activity

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance. If you wanted to conduct a trend analysis, you would: a) compare the firm's financial ratios with other firms in the industry for a particular year b) analyze the firm's financial ratios over time

b) analyze the firm's financial ratios over time

To offset taxable income in a given year, ordinary corporate operating losses can be: a) carried back for 5 years and carried forward for 10 years b) carried forward indefinitely

b) carried forward indefinitely

If a company ever goes bankrupt, its common stockholders will be paid off first, then its debtholders and preferred stockholders. This statement is incorrect because: a) debtholders are treated as residual investors b) common shareholders are treated as residual investors c) debtholders and preferred shareholders are considered residual investors

b) common shareholders are treated as residual investors

Which of the following statements is true about market value ratios? a) companies with high research and development (R&D) expenses tend to have low P/E ratios b) companies with high research and development (R&D) expenses tend to have high P/E ratios

b) companies with high research and development (R&D) expenses tend to have high P/E ratios

Which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply. a) a firm's financial statements show only one period of financial data b) different firms may use different accounting practices c) a firm may operate in multiple industries

b) different firms may use different accounting practices c) a firm may operate in multiple industries

Which of the following best describes shareholders' equity? a) equity is the initial claim on value of the assets before the firm pays off its liabilities b) equity is the difference between the company's assets and liabilities

b) equity is the difference between the company's assets and liabilities

Based on your understanding of the uses and limitations of ROE, a rational investor is likely to prefer an investment option that has: a) high ROE and high risk b) high ROE and low risk

b) high ROE and low risk

Which of the following is true about the leveraging effect? a) interest on debt can be deducted from pre-tax income, resulting in a greater taxable income and a smaller available operating income b) interest on debt is a tax-deductible expense, which means that it can reduce a firm's taxable income and tax obligation

b) interest on debt is a tax-deductible expense, which means that it can reduce a firm's taxable income and tax obligation

Vision Tech's stock price is currently trading at $37 per share. The consensus among analysts is that the intrinsic value of Vision Tech's stock is $30 per share. Is Vision Tech more or less likely to receive a hostile takeover bid? a) more likely b) less likely

b) less likely

The U.S. Securities and Change Commission (SEC), a U.S. federal agency, is considered to be an investor's advocate. Its purpose is to protect investors, maintain market integrity, and facilitate capital formation. Under the Sarbanes-Oxley Act of 2002, the SEC requires CFOs to certify that the firm's: a) financial statements are audited b) growth plans are on track c) earnings numbers are accurate d) shareholders are protected

c) earnings numbers are accurate

Which of the following actions will help ease agency conflicts and better align managers' objectives with the firm's shareholder wealth? a) pay the manager a large base salary with a huge stock option package that matures on a single date b) pay the manager a combination of salary and stock options (phased in over several years) that reward him or her for consistently increasing shareholder wealth

b) pay the manager a combination of salary and stock options (phased in over several years) that reward him or her for consistently increasing shareholder wealth

The following table lists descriptions of the major financial statements and reports that a firm publishes. Identify the correct statement or report for each description. Provides a quantitative summary of a company's assets, liabilities, and net worth at a specific point in time.

balance sheet

Which financial statements are at a point in time?

balance sheet

During the last year, Len Corp. generated $1,170.00 million in cash flow from operating activities and had negative cash flow generated from investing activities (-640.00 million). At the end of the first year, Len Corp. had $200 million in cash on its balance sheet, and the firm had $280 million in cash at the end of the second year. What was the firm's cash flow (CF) due to financing activities in the second year? a) $337.50 million b) $-225.00 million c) $-450.00 million d) $562.50 million

c) $-450.00 million explanation: change in cash = $280 million - $200 million change in cash = $80 million $80 million = $1,170.00 million + ($-640.00 million) + CF from financing activities CF from financing activities = $80 million - $530 million CF from financing activities = $-450 million

NOW Inc. released its annual results and financial statements. Grace is reading the summary in the business pages of today's paper. In its annual report this year, NOW Inc. reported a net income of $148 million. Last year, the company reported a retained earnings balance of $476 million, whereas this year it increased to $560 million. How much was paid out in dividends this year? a) $232 million b) $4 million c) $64 million d) $325 million

c) $64 million explanation: dividends paid = net income - (ending retained earnings - beginning retained earnings) dividends paid = $148 million - ($560 million - $476 million) dividends paid = $64 million

Which of the following compensation proposals is most likely to be in the best interest of the company's shareholders? a) a base salary of $500,000 plus perquisites worth $250,000 b) a base salary of $500,000 plus a stock option package for 250,000 shares that mature in six months c) a base salary of $500,000 plus a stock option package for 250,000 shares, with 20% of shares maturing at the end of each of the next five years

c) a base salary of $500,000 plus a stock option package for 250,000 shares, with 20% of shares maturing at the end of each of the next five years

The CFO is not responsible for which of the following departments? Check all that apply. a) capital budgeting b) accounting c) research and development d) treasury e) investments

c) research and development

Categorize the decisions according to the area of finance to which they belong (corporate finance, capital markets, or investments). Willie works for an investment bank and makes decisions about the sale of new common stock by ABCL Inc.

capital markets

What is reported in the investing section of the statement of cash flows?

cash flows generated or utilized by selling or buying long-term assets

Stockholder's Equity

consists of both earned equity (retained earnings) and paid-in equity (issuing stock)

Categorize the decisions according to the area of finance to which they belong (corporate finance, capital markets, or investments). Radford is a small company that manufactures automobile bearings. Managers at the company must make decisions on the kind and the cost of equipment to buy.

corporate finance

Using the description of each business, classify it as a sole proprietorship, a partnership, a corporation, or a limited liability company/limited liability partnership. James, the CEO of a beverage company, is required to certify the accuracy of information provided in the company's quarterly reports.

corporation

Consider the following scenario and determine whether an agency conflict exists: Daniel and Ashley equally own and manage A New Beginning (ANB), a store that sells preowned clothing and furniture. Daniel is responsible for ANB's back-office activities, and Ashley staffs the store and makes deliveries to customers. Both have equal-decision making authority and, under the terms of their partnership agreement, both are prohibited from making personal purchases using company funds without prior approval of the other partner. Daniel, without Ashley's knowledge, used the company's bank account recently to purchase a new sports car. Daniel has acknowledged that the car will not be used to support the business. Is this a potential agency conflict between Daniel and Ashley? a) no; since Daniel acknowledged that the car would not be used to support the business, no agency conflict can arise b) no; Daniel and Ashley co-own and co-manage ANB and have a partnership agreement that makes them equal, so an agency conflict cannot exist c) no; Daniel and Ashley are both authorized to spend ANB's money, so no conflict of interest can occur d) yes; Daniel is misappropriating some of Ashley's wealth by unilaterally purchasing a non-business asset using ANB's funds

d) yes; Daniel is misappropriating some of Ashley's wealth by unilaterally purchasing a non-business asset using ANB's funds

Balance Sheet

deals with the accounting equation (assets = liabilities + equity); focuses on a point in time

Ratios that help assess a company's ability to service the interest and repayment obligations on its long-term debt and the degree to which it uses borrowed versus invested financial capital are called _____ ratios.

debt or financial leverage management

Chilly Moose Fruit Producer has a total asset turnover ratio of 3.50x, net annual sales of $40 million, and operating expenses of $18 million (including depreciation and amortization). On its balance sheet and income statement, respectively, it reported total debt of $2.50 million on which it pays a 11% interest rate. To analyze a company's financial leverage situation, you need to measure the firm's debt management ratios. Based on the preceding information, what are the values for Chilly Moose Fruit's debt management ratios?

debt ratio = 21.87% times-interest-earned ratio = 80.00x explanation: step 1: total asset turnover ratio = sales / total assets 3.50 times = $40 million / total assets total assets = $40 million / 3.50 times total assets = $11.43 million step 2: debt ratio = total debt / total assets debt ratio = $2.50 million / $11.43 million debt ratio = 21.87% step 3: EBIT = total sales - total operating costs EBIT = $40 million - $18 million EBIT = $22 million step 4: interest charges = interest rate x debt outstanding interest charges = 11% x $2.50 million interest charges = $0.2750 million step 5: TIE ratio = EBIT / interest charges TIE ratio = $22 million / $0.2750 million TIE ratio = 80.00x

In a state of market equilibrium, the intrinsic value of the stock will be _____ the market price of the stock.

equal to

What are non-cash items?

expenses charged against revenues that do not directly affect cash flow, such as depreciation

In the following table, identify which type of activity is described by each statement (operating, investing, or financing). Yum Co. uses cash to repurchase 10% of its common stock.

financing activity

Income Statement

focused on what the company's net earnings are; revenue - expenses = net income

Statement of Cash Flows

focuses on increases and decreases to cash; has three sections: operating, investing, and financing

According to a tax law established in 1969, taxpayers must pay the _____ of the Alternative Minimum Tax (AMT) or regular tax.

higher

When referring to an individual asset, such as a piece of equipment, book value refers to the asset's _____, adjusted for any accumulated depreciation or amortization expense.

historical value or original purchase price

Working Capital

in the short run, we can utilize our current assets to pay off our current liabilities; current assets - current liabilities

Indicate which financial statement you would refer to when answering the questions in the following table: How profitable has the firm been?

income statement

The following table lists descriptions of the major financial statements and reports that a firm publishes. Identify the correct statement or report for each description. Is divided into two important parts: operating and non-operating sections; also known as the profit and loss statement.

income statement

Which financial statements cover a period of time?

income statement, statement of stockholders equity, and statement of cash flows

In the following table, identify which type of activity is described by each statement (operating, investing, or financing). DigiInk Printing Co. buys new machinery to ramp up its production capacity.

investing activity

Categorize the decisions according to the area of finance to which they belong (corporate finance, capital markets, or investments). As a technical trader, you will be analyzing investor psychology and making investment decisions based on how investors behave during certain situations.

investments

Influenced by a firm's ability to make interest payments and pay back its debt, if all else is equal, creditors would prefer to give loans to companies with _____ debt ratios.

low

Market Value Added (MVA)

market value - book value

_____ ratios examine the market value of a company's share price, its profits and cash dividends, and the book value of the firm's assets and relate them to other data items to determine how the firm is perceived in the stock market.

market value or market based

Amalgamated Metals Corporation's stockholders are mostly individual investors, and there is relatively little institutional ownership. If several pension and mutual funds were to take large positions in Amalgamated Metals Corporation's stock, direct shareholder intervention would be _____ likely to motivate the firm's management.

more

The _____ value, or difference between two values, is called the asset's book value.

net

If a firm takes steps that increase its expected future ROE, its stock price will _____ increase.

not necessarily

In the following table, identify which type of activity is described by each statement (operating, investing, or financing). A company records a loss of $70,000 on the sale of its outdated inventory.

operating activity

In the following table, identify which type of activity is described by each statement (operating, investing, or financing). D and W Co. sells its last season's inventory to a discount store.

operating activity

Using the description of each business, classify it as a sole proprietorship, a partnership, a corporation, or a limited liability company/limited liability partnership. Willie started a business, based in a different state, with his uncle. Due to the business's underperformance, they had to close the business. Willie, however, ended up losing his house due to a litigation claim.

partnership

_____ ratios help measure a company's ability to generate income and profits based on its invested capital.

profitability

How are retained earnings calculated?

retained earnings + net income - stockholder dividends = final retained earnings.

The following table lists descriptions of the major financial statements and reports that a firm publishes. Identify the correct statement or report for each description. Reconciles (1) the amount of stockholders' equity recorded at the beginning of the reporting period, (2) changes during that period, and (3) the amount of stockholders' equity at the end of the reporting period.

statement of stockholders' equity

Free Cash Flow

the amount of cash that can be withdrawn without hampering the company's ability to operate and produce future cash flows

Intrinsic Value

the estimate of a stock's true value based on accurate risk and return data; a long-run concept

What is the primary goal of the corporate management team?

to maximize the shareholders' wealth by maximizing the company's stock price over the long run

When is a stock price in equilibrium?

when the intrinsic value (IV) is equal to the market value (MV)