COB 300 B- Exam 1 (Chapters 1, 2, 3, 4)

Operating profit

eBIT gross profit - selling general and admin expenses

commercial banks

ex: bank of america, citibank, wells fargo, etc -department stores of finance -serve a variety of savers and buyers -Historically, commercial banks were the major institutions that handled checking accounts and through which the Federal Reserve System expanded or contracted the money supply

underwriters

facilities the issuance of securities

people and orgs wanting to borrow money are brought together with those who have surplus funds in a

financial markets

payment of dividend is a cash flow from

financing

repaying a loan is a cash flow from

financing

Indirect transfers through investment bankers

go through an investment bank (IB) -underwrites the issue -the companys ells its stocks and bond to the investment bank which then sells the same securities to savers -- they merely pass through the investment bank -investment bank is taking a risk -primary market

investment banks

help companies raise capital 1) help corps design securities with features that are currently attractive to investors 2) buy these securities from corps 3) resell them to savers -- also called underwriters bc they guarantee the firm will raise the needed cap

the sum of the cash flow from operating, investment and financing for an annual statement should be equal to

the change in cash account balance from the previous year end to the current year end

marginal tax rate

the extra taxes paid on an additional dollar of income

future markets

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

equilibrium price

the price that balances buy and sell orders at any given time -he price remains relatively stable until new information becomes available and causes the price to change.

the stock market is where

the prices of firms stocks are established

Outstanding shares of established publicly owned companies that are traded (type of stock transaction)

Allied Food Products has 75 million shares of stock outstanding If the owner of 100 shares sells his or her stock, the trade is said to have occurred in the secondary market. Thus, the market for outstanding shares, or used shares, is the secondary market. -- the company recieves no new money when sales occur in this market

Unleveraged companies

Companies that function without the use of borrowed money are said to have no leverage companies are financed by equity alone and have no debt in their capital structures. Unleveraged firms are less risky, but they might also lose out on the opportunities that they could otherwise pursue if they used borrowed money.

Credit defult swaps (CDS)

Credit default swaps are contracts that offer protection against the default of a particular security -ex: Suppose a bank wants to protect itself against the default of one of its borrowers. The bank could enter into a credit default swap where it agrees to make regular payments to another financial institution the financial institution then agrees to insure the bank will not lose if their borrower defaults

interest

EBIT-EBT

exchange traded funds

ETFs buy a portfolio of stocks of a certain type—for example, the S&P 500 or media companies or Chinese companies—and then sell their own shares to the public

EPS

Earnings per share (EPS) is often called "the bottom line," denoting that of all items on the income statement, EPS is the one that is most important to stockholders.

net ppe =

Gross PPE - Accumulated Depreciation

Additional shares sold by established publicly owned companies (type of stock transaction)

If Allied Food decides to sell (or issue) an additional 1 million shares to raise new equity capital, this transaction is said to occur in the primary market

life insurance companies

Take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties.

primary market transaction

The creation and sale of new securities/stocks

market price

The current price of a stock. ex: Internet showed that on one day, Twitter's stock traded at $29.01.

Market value Ratio

The market value ratios are used in three primary ways: (1) by investors when they are deciding to buy or sell a stock, (2) by investment bankers when they are setting the share price for a new stock issue (an IPO), and (3) by firms when they are deciding how much to offer for another firm in a potential merger. Price/ Earning ratio -shows how much investors are willing to pay per dollar of reported profits. Price per share/earning per share --P/E ratios are relatively high for firms with strong growth prospects and little risk but low for slowly growing and risky firms. Market/ book ratio - The ratio of a stock's market price to its book value gives another indication of how investors regard the company. Companies that are well regarded by investors—which means low risk and high growth—have high M/B ratios. BOOK VALUE PER SHARE Common equity/shares outstanding MAREKT/ BOOK RATIO market price per share/book value per share --M/B ratios typically exceed 1.0, which means that investors are willing to pay more for stocks than the accounting book values of the stocks. This situation occurs primarily because asset values do not reflect either inflation or goodwill. ex: In early April 2018, Alphabet's M/B ratio was 4.59× while MetLife's was only 0.80×. Alphabet's stockholders now have $4.59 in market value per $1.00 of equity, whereas MetLife's stockholders have only $0.80 for each dollar they invested. Enterprise value/ EBITDA ratio --ratio looks at the relative market value of all the company's key financial claims. is not heavily influenced by the company's debt and tax situations. Market value of equity + market value of total debt + market value of other financial claims - (cash and equivalents) --for simplicity, we are assuming that Allied's debt is priced at par, so the market value of its debt is assumed to equal its book value -this adjustment makes it easier to compare companies with very different levels of excess cash. ----his adjustment makes it easier to compare companies with very different levels of excess cash.

intrinsic value

The price at which the stock would sell if all investors had all knowable information about a stock -intrinsic value is based on its expected future cash flows and its risk. -market price tends to fluctuate around the intrinsic value, and the intrinsic value changes over time as the company succeeds or fails with new projects, competitors enter or exit the market, and so forth.

spot markets

Where assets are bought or sold for on the spot delivery. -

Company A uses long-term debt to finance its assets, and company B uses capital generated from shareholders to finance its assets. Which company would be considered a financially leveraged firm?

company a

credit unions

cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm. -members savings are loaned only to other members usually for cars home improvement loans and home mortages -cheapest source of funds available

Net Working Capital (NWC)

current assets - current liabilities

financial asset markets

deal with stocks bonds notes and mortgages

decrease long term debt will

decrease the cash balance

increase accounts receivable will

decrease the cash balance

increase inventory

decrease the cash balance

it is assumed

that market data are sufficiently considered when conducting ratio analysis. This does not represent a weakness or limitation of ratio analysis.

double declining balance formula (Cost - Accumulated Depreciation) x (2/Useful Life) = Depreciation Expense

(Cost - Accumulated Depreciation) x (2/Useful Life) = Depreciation Expense

straight line depreciation formula

(cost - salvage value) / useful life

Recent trends

-more competition -more internationally linked markets

Factors that complicated the globalization coordination among regulators at the international level

1) the different structures in nations' banking and securities industries, 2) the trend toward financial services conglomerates, which obscures developments in various market segments, and 3) the reluctance of individual countries to give up control over their national monetary policies.

asset management ratio example

1. A low days of sales outstanding represents an efficient credit and collection policy. Between the two companies, Like Games is collecting cash from its customers faster than Our Play, but both companies are collecting their receivables less quickly than the industry average. 2.Our Play's fixed assets turnover ratio is lower than that of Like Games. This could be because Our Play is a relatively new company, so the acquisition cost of its fixed assets is higher than the recorded cost of Like Games's net fixed assets. 3.Like Games's total assets turnover ratio is 1.05x , which is lower than the industry's average total assets turnover ratio. In general, a higher total assets turnover ratio indicates greater efficiency.

stockholders equity

2 ways the amount stockholders paid to the company when they bought shares the company sold to raise capitalin addition to all of the earnings the company has retained over the years stockholders equity = paid in capital + retained earnings can also be thought of as residual stockholders equity = total assets - total liabilities

to find dividends

= Previous re - current re =net income - what was retained ^^

Efficient market

A market in which prices are close to intrinsic values and stocks seem to be in equilibrium.

The inventory turnover ratio across companies in the furniture industry is 4.389x. Based on this information, which of the following statements is true for Adams Furniture (inventory turn over rate is 3.99x)?

Adams Furniture is holding more inventory per dollar of sales compared with the industry average.

Decision makers and analysts look deeply into profitability ratios to identify trends in a company's profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply.

If a company has a profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales. --Profit margin tells you approximately how much earnings a company generated for each dollar of sales. If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. . Return on assets (ROA) because total assets is the denominator, an increase in the total assets with no increase in the net income would actually lead to a decrease in ROA. An increase in ROA indicates an increase in the net income, a reduction in the total assets, or both. An increase in the operating margin would mean that either sales increased, operating costs decreased, or both. However, if the profit margin decreased, it would mean that higher deductions were made from the operating income. These deductions could either be higher interest expenses or higher taxes. Thus, if a company's operating margin increased but its profit margin decreased, it could mean that the company paid more in interest or taxes. Return on common equity (ROE) If a company issues new common shares, its total shares outstanding will increase, which means that the equity base (denominator in the ROE ratio) increases. Net income staying the same will now be available for a larger number of common equity claims, thus leading to a decline in the company's ROE. Save & Continue

leveraging effect

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

electronic dealer-based markets

NASDAQ less formal over-the-counter market, and the recently developed electronic communications networks (ECNs). -buy and sell orders come in more or less simultaneously, and exchange members match these orders -These "dealers" buy when individual investors want to sell, and they sell part of their inventory when investors want to buy. -dealer markets consist of 1) the relatively few dealers who hold inventories of these securities and who are said to "make a market" in these securities, 2) the thousands of brokers who act as agents in bringing the dealers together with investors, and 3) the computers, terminals, and electronic networks that provide a communication link between dealers and brokers.

Physical location exchanges

NYSE -tangible entities -has its own building, allows limited # of people on the floor to trade -has elected governing body -open on all normal working days -auction markets

EBT=

Net income / (1-tax rate)

Profitability ratios

Operating Margin -gives the operating profit per dollar of sales EBIT/Sales --Allied's 9.3% operating margin is below the industry average of 10.0%. This subpar result indicates that Allied's operating costs are too high. Profit Margin -net profit margin Net income/ sales --Allied's 4.9% profit margin is below the industry average of 6.0%, and this subpar result occurred for two reasons. First, Allied's operating margin was below the industry average because of the firm's high operating costs. Second, the profit margin is negatively impacted by Allied's heavy use of debt. (To see this second point, recognize that net income is after interest) --We see then that Allied's operating inefficiency and its high debt ratio combine to lower its profit margin below the food processing industry average Return on total assets -ROA Net income/Total assets --Allied's 7.3% return is well below the 10.8% industry average. This is not good—it is obviously better to have a higher than a lower return on assets. ---low ROA can result from a conscious decision to use a great deal of debt, in which case high interest expenses will cause net income to be relatively low Return on common equity -ROE -Investors like a high ROE, and high ROEs are correlated with high stock prices Net income/Common equity --Stockholders expect to earn a return on their money, and this ratio tells how well they are doing in an accounting sense. -- net income subtracts the company's after-tax interest expense and therefore represents the total amount of income available to shareholders Return on investment capital -ROIC -measures the total return that the company has provided for its investors EBIT(1-T)/total invest capital EBIT(1-T)/ Debt +equity --ROIC differs from ROA in two ways. First, its return is based on total invested capital rather than total assets. Second, in the numerator it uses after-tax operating income (NOPAT) rather than net income -NOPAT is the amount of funds available to pay both stockholders and debtholders. basic earning power (BEP) ratio -This ratio shows the raw earning power of the firm's assets before the influence of taxes and debt, and it is useful when comparing firms with different debt and tax situations EBIT/total assets

Liquidity example

Pellegrini Southern Corporation's current ratio is 1.3334 , and its quick ratio is 0.7467 ; Jing Foodstuffs Corporation's current ratio is 1.6592 , and its quick ratio is 0.9292 . which means that Pellegrini Southern Corporation's ability to finance its short-term liabilities is less than Jing Foodstuffs Corporation's ability to finance its short-term liabilities. Pellegrini Southern Corporation has a greater reliance on outside funds to finance its short-term obligations than Jing Foodstuffs Corporation. If current liabilities are increasing faster than current assets, the company will have fewer current assets to liquidate to meet its short-term obligations, if needed. If this trend persists for too long, the company may have to borrow long-term debt to meet its short-term liabilities. A quick ratio of less than 1 means that the company does not have enough assets, excluding its inventory, to meet its short-term obligations. If the quick ratio is less than 1 and the current ratio is more than 1, then the inventory constitutes a major part of the company's current assets. The company would have to depend on liquidating its inventory to meet its short-term obligations.

DuPont Equation

ROE=ROA* equity multiplier The first term, the profit margin, tells us how much the firm earns on its sales. This ratio depends primarily on costs and sales prices. if a firm can command a premium price and hold down its costs, its profit margin will be high, which will help its ROE. =profit margin * total asset turnover *equity multiplier -is the total assets turnover. It is a "multiplier" that tells us how many times the profit margin is earned each year = Net income /sales * sales/total assets * total assets /total common equity -the equity multiplier, which is the adjustment factor. Allied's assets are 2.13 times its equity, so we must multiply the 7.3% return on assets by the 2.13× equity multiplier to arrive at its ROE of 15.6%

how to improve ROE

Reduce the company's operating expenses, its cost of goods sold, and/or the interest rate on its borrowed funds because this will increase the company's net profit margin. Use more debt financing in its capital structure and increase the equity multiplier.

weakness or limitation of ratio analysis

Window dressing is something a firm may do at critical times when it wants to temporarily enhance its image. A firm uses window-dressing techniques to enhance certain aspects of its business so that analysts looking at the firm's financial statements may assess its performance or position as being stronger than it actually is. Seasonal factors may distort data for firms that do the majority of their business at a certain point during the year. This can certainly cause distortions during ratio analysis. A good way to reduce the amount of distortion is to analyze ratios on a month-to-month basis to get a better picture of the firm as it progresses throughout its normal operating cycle.

Can a company's shares exhibit a negative P/E ratio?

Yes, a company's shares can exhibit a negative P/E ratio. You know that the P/E ratio is equal to the market price of a company's shares divided by the shares' EPS. For a negative P/E ratio to exist, either the share price must be less than zero or the shares' EPS must be negative. Remember, share prices cannot be negative, but companies can incur negative earnings (a loss). This can lead to a negative EPS, and therefore, a negative P/E ratio. A negative P/E ratio means that investors are willing to buy a share of a company that has been losing money on every share of its stock.

if you bought a share of common stock you would probably expect to receive dividends plus an eventual cap gain would the distribution between the dividend yield and the capital gains yield be influenced by the firms decision to pay more dividends rather than to retained and reinvest more of its earnings

Yes. If a company decides to increase its payout ratio, then the dividend yield component will rise, but the expected long-term capital gains yield will decline.

Two investors are evaluations stock for possbile purchase they agree that the expected value of D1 and on the expected future dividend growth rate further they agree on the riskiness of the stock however one investory normally holds the stock for two years while the other holds it for 10 years on the basis of the dividend discount valuation models should they be willing to pay the same price for the stock

Yes. The value of a share of stock is the PV of its expected future dividends.If the two investors expect the same future dividend stream, and they agree on the stock's riskiness, then they should reach similar conclusions as to the stock's value. The difference in their holding periods doesn't matter.

future vs spot markets example

a farmer may enter into a futures contract in which he agrees today to sell 5,000 bushels of soybeans 6 months from now at a price of $10.275 a bushel --a food processor that needs soybeans in the future may enter into a futures contract in which it agrees to buy soybeans 6 months from now

mutual funds

are corpoerations that accept money from savers and then use these funds to buy stocks long term bonds or short term debt instruments issued by businesses or gov't units -they also pool funds reducing risk by diversification -they manage portfolios, buy and sell securities

indexed funds

are designed to simply replicate the performance of a specific market index -tracks the S&P 500 index will simply hold the basket of stocks that comprise the S&P 500

physical asset markets

are for products like wheat, cars, real estate

money market funds

are used as interest bearing checking accounts

balance sheet

assets the company owns and who has claims on those assets as of a given date -snap shot at a point in time

indirect transfers through a financial intermediary

bank, insurance company or mutal fund -intermediary obtains funds from savers in exchange for its securities they use this money to buy and hold businesses securities and the savers hold intermediary securities --ex: saver deposites dollars in a bank receiving a certificate of deposit and then the bank lends this money to a business in the form of a mortgage loan = new form of capital

leveraged companies

companies that use debt funding are called leveraged companies and are riskier than unleveraged firms. Leverage allows a company to take advantage of investment opportunities that it could otherwise not afford. Borrowed money could be used to expand more quickly and to capture market share faster than if its business growth were financed solely with equity financing.

Companies with high research and development (R&D) expenses tend to have

high P/E ratios. -Companies, especially those in the pharmaceutical and biotech sectors, make money by inventing and selling new products; as a result, they invest heavily in R&D. Arguably, this investment in R&D is actually what will create value for their shareholders. Companies in other sectors consider investments as assets and depreciate these investments over time, whereas R&D is treated as an expense. So companies with high R&D expenses will tend to realize lower earnings, a lower EPS, and therefore a higher P/E ratio. --However, it is important to note that investments in R&D don't always lead to stable future earnings.

is the economic development highly or barely correlated with the level and efficiency of financial markets and institutions

highly

to raise capital what do the managers have to understand?

how the markets and institutions work

Initial public offerings made by privately held firms: the IPO market.

in the summer of 2004, Google sold shares to the public for the first time at $85 per share. By March 2018, its parent company's stock (Alphabet Inc.) was selling for more than $1,030.

Issuing new shares of common stock will

increase the cash balance

IPO

initial public offering, in which the prices are usually determined by the investment bankers based on indications of interest from investors. -investors commit to buying shares at a specific price -An IPO is considered to be undersubscribed if investors don't want to buy the shares offered, and the company is not obligated to issue shares to satisfy demand.

capital markets

intermediate or long term debt and corporate stocks (new york stock exchange)

purchase of new factory is a cash flow from

investing

change in cash balance =

investing activity + operating activity + financing activity

when markets are efficient

investors can buy and sell stocks and be confident that they are getting good prices.

when markets are inefficient

investors may be afraid to invest

How could an increase in a companys SGA affect the company's balance sheet?

it would make the equation unbalanced and the expense would also have to affect assets

financial services corporations

large conglomerates that combine many different financial institutions within a single corporation -most started in one area but now diversified to cover the financial spectrum

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

low debt ratios A high debt ratio would mean that the firm has taken on a lot of debt to finance its assets, making it difficult for it to take on more debt. With more and more debt, a company may not be able to pay the interest and the principal. To avoid this potential problem, creditors prefer to give loans to companies that have low debt ratios.

Dodd-Frank Act

main goals were to create a new agency for consumer protection, work to increase the transparency of derivative transactions, and force financial institutions to take steps to limit excessive risk taking and to hold more capital.

money markets

markets for short term highly liquid debt securities (ny, london and tokyo money markets)

Primary markets

markets in which corporations raise capital by issuing new securities --If GE were to sell a new issue of common stock to raise capital, a primary market transaction would take place -the company receives the proceeds

secondary markets

markets in which existing, already outstanding securities are traded among investors. -New york stock exchange -outstanding bonds -also exisit for mortgages and other types of loans

asset management ratios

measure how effectively the firm is managing its assets --These ratios answer this question: Does the amount of each type of asset seem reasonable, too high, or too low in view of current and projected sales? inventory turnover ratio -these ratios show how many times the particular asset is "turned over" during the year sales / inventories = x times a year -- low turnover, the firm may be holding obsolete goods that are not worth their stated value. Days sales outstanding -Accounts receivable are evaluated by this represents the average length of time the firm must wait after making a sale before receiving cash. Receivables/ average sales per day - can look at credit sales to determine if this number is acceptAble fixed asset turnover ratio -ratio of sales to net fixed assets, measures how effectively the firm uses its plant and equipment Sales/net fixed assets --Allied's ratio of 3.0 times is slightly above the 2.8 industry average, indicating that it is using its fixed assets at least as intensively as other firms in the industry. -Allied seems to have about the right amount of fixed assets relative to its sales total asset turnover ratio -measures the turnover of all of the firm's assets Sales/total assets -Allied's ratio is somewhat below the industry average, indicating that it is not generating enough sales given its total assets ---We just saw that Allied's fixed assets turnover is in line with the industry average; so the problem is with its current assets, inventories, and accounts receivable, whose ratios were below the industry standards

Free Cash Flow

net cash provided by operating activities after adjusting for capital expenditures and cash dividends paid

retained earnings

net income leftover for a busienss to either keep or pay out as dividends

what is the most commonly used base item for a common size income statement?

net sales

direct transfer

of money and securities occur when a business sells its stocks of bonds directly to savers without going through any financial institution --usually used by small firms

behavioral finance theory

on average, asset prices are about equal to their intrinsic values -many events in the real world are inconsistent with this theory

purchase of inventory is a cash flow from

operating

receiving cash payment from a credit sale is a cash flow from

operating

operating income

or EBIT = sales revenue - operating expenses

private equity companies

organizations that operate much like hedge funds, but rather than purchasing some of the stock of a firm, private equity players buy and then manage entire firms. -most of the money to buy the target companies is borrowed -UNREGULATED

current re =

previous re + (NI - dividends)

closely held corporations

privately owned -closely held stock

hedging

protecting against cost increases with contracts that allow a company to buy supplies in the future at designated prices -reduce risk exposure -similar to mutual funds because they accept money from savers and use the funds to buy various securities, but - UNREGULATED ----hedge funds typically have large minimum investments (often exceeding $1 million) and are marketed primarily to institutions and individuals with high net worths.

pension funds

retirement plans funded by corporations or government agencies for their workers -administered primarily by the trust departments of commercial banks or life insurance companies

gross profit

revenue - COGS

The equation used to find the annual rate of return on any given stock is

stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price.

tax expense

taxable income (EBT) * tax rate

Debt Management Ratios

total debt to total capital -measures the percentage of the firm's capital provided by debtholders: total debt/ total capital = total debt / total debt + equity --Creditors prefer low debt ratios because the lower the ratio, the greater the cushion against creditors' losses in the event of liquidation. -Stockholders, on the other hand, may want more leverage because it can magnify expected earnings Times interest earned ratio -measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs. EBIT/ Interest chargers -the firm's ability to pay current interest is not affected by taxes.

average tax rate

total taxes paid / total income

actively managed funds

try to outperform the overall markets -portfolio manager of an actively managed stock fund uses his or her expertise to select what he or she thinks will be the best-performing stocks over a given time period.

public markets

where standardized contracts are traded on organized exchanges --securities that are traded in public markets (for example, common stock and corporate bonds) are held by a large number of individuals -fairly standardized contractual features

private markets

where transactions are negotiated directly between two or more parties -bank loans and private debt placements with insurance companies -both parties must agree

oversubscribed

which means that the demand for shares at the offering price exceeds the number of shares issued

statement of cash flows

which shows how much cash the firm began the year with, how much cash it ended up with, and what it did to increase or decrease its cash

statement of stock holders equity

which shows the amount of equity the stockholders had at the start of the year, the items that increased or decreased equity, and the equity at the end of the year.

income statement

which shows the firms sales and costs during some past period

derivative securities

whos values are derived from changes in the prices of other assets ex: a share of ford stock is a pure financial asset while an option to buy ford shares is a derivative security whose value depends on the price of ford stock - can reduce risk or to speculate

liquidity ratios

will the firm be able to pay off its debts as they come due and remain a viable organization current ratio current asset/current liabilities -- If current liabilities are rising faster than current assets, the current ratio will fall, and this is a sign of possible trouble. Quick Ratio -which measures the firm's ability to pay off short-term obligations without relying on the sale of inventories, is important. current assets-inventories / current liabilities -Inventories are typically the least liquid of a firm's current assets, and if sales slow down, they might not be converted to cash as quickly as expected --want a higher number for both ratios