FIL 190 Final Exam (Chapters 1-4)
long-term liabilities
Consist of the face value of long-term debt obligations such as bonds and loans.
Inventory Turnover Ratio
Cost of Goods Sold / Inventory
Current Ratio Equation
Current Ratio = Current Assets / Current Liabilities
Quick Ratio Equation (acid test ratio)
(Current Assets - Inventory- prepaid expenses) / Current Liabilities
Characteristics of a corporation
- Corporate owners - stockholders, or shareholders - elect a board of directors, which appoints corporate management - Shareholders enjoy limited liability - Corporations, being separate legal entities, are subject to taxation. - if a corporation pays a dividend to its shareholders, the shareholders are taxed on the dividends received. Tax treatment of corporate profits and dividends paid to shareholders may be different and change from time to time. - Despite preferential tax treatment of dividends, the double taxation is a disadvantage of the corporate form of business relative to sole proprietorships and partnerships. - The advantages of the corporate form of business - being a separate legal entity, providing limited liability to owners, and transferring ownership with ease - are very important to many potential investors. As a result, it is easier for corporations to raise large amounts of capital. This is why the largest businesses in the world are corporations.
The uses of financial analysis
- Identifying strengths to build on and weaknesses to correct; - Comparing financial performance of the firm's different products, divisions, or market segments; - Evaluating performance of employees and departments. This may help determine compensation; - Evaluating financial conditions of major suppliers, customers, borrowers (for lending institutions), or competitors. This may help the firm decide whether a supplier is stable and likely to stay in business, a customer is sound enough to extend credit to, a loan applicant's risk is acceptable, or a competitor has different strengths and weaknesses compared to the firm; - Assessing investment risk and making investment decisions. E.g., if you are trading stocks or managing a mutual fund, financial analysis will help you determine which stocks, bonds, or other securities to buy and sell.
What happens in: - Annuity due - ordinary annuity - deferred annuity
- If payments start immediately (point 0 on the timeline), we call it an annuity due; - if they start at the end of the first period, it is an ordinary annuity. - If payments do not start for a while, it is a deferred annuity.
The key questions that financial ratios help us answer are:
1) Does the firm have enough liquid assets to pay its bills? (Liquidity ratios) (2) Does the firm generate adequate operating profits? (Operating performance ratios) (3) How does the firm fund its assets? (Financing ratios) (4) Does the firm generate satisfactory return on shareholder capital and create shareholder value? (Return and value creation ratios)
3 ways to reduce angency cost
1) Ensuring boards of directors are independent (not related to management). At the very least, the chairman of the firm should not be the firm's top manager (CEO). 2) Aligning interest of managers with those of shareholders. Examples include performance-based bonuses and stock options for managers. 3) Monitoring. Examples include auditing financial statements and analyzing the firm's finances by debt rating agencies. Monitoring costs are borne by shareholders.
Why is a dollar today worth more than a dollar tomorrow? In other words, why does money have time value? (2 reasons)
1) Inflation erodes the purchasing power of money - the amount of goods and services we can acquire with it; 2) Even in the absence of inflation, we may invest and earn a positive rate of return. If we receive a sum of money a year from now instead of today, we lose an opportunity to invest it for one year. The interest rate we can earn is our opportunity cost.
A firm's net income is $3 million. Its tax rate is 25%, and it paid $800,000 in interest during the year. Calculate 1. EBT 2. EBIT
1. 4,000,000 ( NI/ (1-tax rate) ) 2. 4,800,000 (Add together the EBT +the interest)
A firm has sales of $1 million, COGS of $300,000, SGA expenses of $400,000, depreciation expense of $150,000, and interest expense of $80,000, and its tax rate is 28%. Calculate 1. Net income 2. Tax Rate 3. EBIT
1. 50,400 (use the income statement equation) 2. 19,600 (taxable income * tax rate) 3. 150,000 (subtract COGS, SGA expenses, and depreciation)
Classify each item as an either an asset, liability, or equity. 1. prepaid expenses 2. taxes owed 3. a loan from the founder's uncle 4. capital provided by founders to start operations
1. Asset 2. Liability 3. Liability 4. Equity
Chapter 2 takeaways
1. Balance sheet is a snapshot of a firm's sources and uses of funds at a given point in time. It is described by the expression Assets = Liabilities + Equity. 2. Income statement is a report of a firm's revenues and expenses over a period of time. It is described by the expression Net Income = Revenues - Expenses. 3. Statement of cash flows is a summary of operating, investing, and financing cash inflows and outflows over a period of time. It is described by the expression End-of-period Cash = Beginning-of-period Cash + Cash Inflows - Cash Outflows. 4. Each transaction affects one or more financial statements as it may cause changes in assets, liabilities, or equity (balance sheet); may represent a revenue or an expense (income statement); may represent a cash inflow or an outflow (CF statement).
Key principals of finance
1. Cash is king 2. The timing of cash flows is important 3. There is a trade-off between risk and return 4. Market prices generally reflect public information
Chapter 3 Takeaways
1. Financial analysis is used to compare a firm's performance to other firms in the industry or to itself over time. The most common tool of financial analysis are financial ratios. 2. Liquidity ratios are indicators of a firm's ability to pay its short-term obligations. 3. Efficiency and profitability ratios include margins, turnovers, and returns. A return can be found as a product of a margin and a turnover. 4. Value creation ratios rely on market valuations of the firm's equity (common shares). They tell us, among other things, whether investors are optimistic or pessimistic about a firm's future earnings and cash flows. 5. Comparing a firm's financial ratios to the industry averages allows us to identify the firm's relative strengths and weaknesses, as well as major differences between its business model and that of an average industry peer.
Classify each transaction by cash flow types. Drag and drop options on the right-hand side. (Ch.2, Q4 TH) 1. Paying common dividends to shareholders 2. Paying interest on debt 3. Buying supplies on credit 4. Receiving a payment for a sale made to a customer last month 5. Making a payment to a local radio station for producing and playing the firm's ads 6. Selling bonds to increase cash holdings 7. Receiving a loan from a bank to pay for a building. 8. Paying for a building using the proceeds from a bank loan options: - financing outflow - operating outflow - none - operating inflow - operating outflow - investment inflow - investing outflow - financing inflow
1. Financing outflow 2. Operating outflow 3. None 4. Operating inflow 5. Operating outflow 6. Investment inflow 7. Financing inflow 8. Investment outflow
Chapter 4 Takeaways
1. Money has time value. Compounding is finding a future value of a present amount wherein periodic interest is added to the principal. Discounting is the inverse process - finding a present value of a future amount. 2. An annuity is a stream of equal payments occurring at equal time intervals. Annuities are quite common in finance and investments. 3. Frequency of compounding affects value. The more frequently we earn interest, the greater is the effective rate of interest compared to the quoted annual rate. 4. To find values of uneven CF streams, we approach each CF one by one. The most efficient way to do it is by using spreadsheets such as Excel. 5. Knowing the values of four out of the five TVM variables - FV, PV, N, r (interest rate), and PMT (regular payment) - we can always find the fifth.
Sam retires today at the age of 60 and invests his life savings into an account that is guaranteed to earn 4.45% per year. Sam expects to live to the age of 88, withdraw $0.071mln from the account at the end of each year, and leave his heirs $1.687mln (this amount will be the account balance at the time of his death). How much is Sam putting in the account today, in $ million? Round to the nearest $0.001 million. E.g., if your answer is $1,234,758, record it as 1.235.
1.623 Feedback: FV = amount left to heirs, PMT = annual withdrawal, N = age at death - age now, I/Y = interest rate the account earns; Solve for PV, ignore the negative sign.
How much would you be willing to pay for a preferred stock that pays $7.6 annually to perpetuity if the appropriate discount rate is 6.52%? Round to the nearest $0.01.
116.56 Feedback: PVperpetuity = PMT/i
You borrow $5635 to buy a car. This is a 46-month loan with an annual rate of 4.29%. What is your required monthly payment? Round to the nearest $0.01 (e.g., if your answer is $385.4789, record it as 385.48).
133.07 Feedback: PV = loan amount, FV = 0, N = # of months, I/Y = annual rate/12 (e.g., if annual rate = 6%, the monthly rate is 0.5%; enter it as 0.5 to the TVM register); Solve for PMT, ignore the negative sign.
You deposit $8.1 thousand at the end of every six months for the next 7 years into an IRA account that earns 7.1% annually (compounded semiannually). How much will you have on the account after making the last deposit? Express the answer in $ thousands, round to the nearest $0.1 thousand. E.g., if your answer is $42,576, record it as 42.6.
143.7 Feedback: TVM register: PV = 0, n = # of years times 2, I/Y = earnings rate divided by 2 (enter 2.5% as 2.5, etc.); Solve for FV, ignore the negative sign.
Find the present value of the following cash flow stream if the discount rate is 5.31%: CF1 = 25, CF2 = 40, CF3 = 56, CF4 = 62. The cash flows are received at the end of each year.Round to the nearest $0.01 (e.g., if your answer is $175.386, record it as 175.39).
158.17 Feedback: Find the PV of each CF and add up all the PVs or use the CF register (CF0 = 0, solve for NPV).
If a firm's net profit margin is 13.6%, asset turnover is 0.5, and the debt ratio is 0.65, what is the firm's return on equity (ROE)? Round to the nearest 0.1%, drop the % symbol. E.g., if your answer is 25.74%, record it as 25.7
19.4
A firm's total current assets are 10.4% of total assets, the current ratio is 1.86, and the quick ratio is 1.41. What is the firm's inventory, in % of assets? Round to the nearest 0.1%, drop the % symbol. E.g., if your answer is 5.45%, record it as 5.5.
2.5
Rural Hydroponics has total equity of $561403,sales of $2250717, current assets of $682199, and total liabilities of $435051. What is Rural Hydroponics' total asset turnover? (Record your answer to the nearest 0.01%, drop the % symbol. E.g., if your answer is 2.13154, i.e., 213.154%, record it as 213.15.)
225.87 add TL + TE = then Sales/TA 435051 + 561403 = 996454 ... 2,250,717/996,454= 2.2587
Find the future value (as of the end of Year 4) of the following cash flow stream if the discount rate is 7.23%: CF1 = 68, CF2 = 52, CF3 = 48, CF4 = 31. The cash flows are received at the end of each year.Round to the nearest $0.01 (e.g., if your answer is $275.386, record it as 275.39).
226.1 Feedback: Find the FV of each CF and add up all the FVs or use the CF register [CF0 = 0, solve for NPV, then multiply it by (1+i)^4].
Given an accounts receivable turnover of 12 and annual credit sales of $908054, the average collection period is
30.42 days. 365 days / AR turnover
You deposit $2319 today into your bank account that pays 3.16% annually. Your account balance in 9 years will be 3068 ? Round to the nearest dollar, no $ symbol in the answer.
3068
Siskiyou Corp. has cash of $75282; short-term notes payable of $99892; accounts receivables of $254571; accounts payable of $146599: inventory of $351852; net fixed assets of $2273353 and accrued expenses of $75591. What is the firm's net working capital?
359,623 (cash + AR + Inventory) - (S-T NP + AP + Accrued expenses)
You pay $505 thousand to buy a 21-year annuity with annual payments to be received at the end of each year. What is the annual payment if the discount rate is 4.4%? Express your answer in $ thousands, round to the nearest $0.1 thousand. E.g., if your answer is $50,583, record it as 50.6.
37.3 Feedback: PV = -(amount paid), N = # of pmts, i = discount rate (for the financial calculator, enter 4% as 4 not as 0.04), FV = 0; cpt PMT.
Rogue Corp. has sales of $5462326; the firm's cost of goods sold is $2372311; selling, general, and administrative expenses are $512621, and depreciation is $1307621. The firm's interest expense is $230860, and the corporate tax rate is 25%. What is Rogue's net income?
779184.75 779,185
What is the value of an annuity that pays $762 at the end of each year in years 4 through 12 at the end of year 13? The discount rate (opportunity cost) is 3.5%. (That is, find the value of this annuity at the end of year 13). Round to the nearest $1, no $ symbol.
8,177
Assume that 27 years ago, the average tuition for one year in the MBA program at a university was $3.8 thousand and now it is $31.5 thousand for one year. What is the compound annual growth rate in tuition over this period? Round to the nearest 0.01% (e.g., if your answer is 6.832%, record it as 6.83).
8.15 Feedback: TVM register: FV = today's tuition, PV = -(tuition n years ago), n = years ago, PMT = 0; solve for I/Y.Algebra: i (in %) = ((FV/PV)^(1/n)-1)*100
Sole Proprietorship
A business owned by one person (the proprietor)
Corporation
A corporation is a legal entity functioning separately from its owners. Ownership is represented by common stock certificates. Corporate owners - stockholders, or shareholders - elect a board of directors, which appoints corporate management - the corporation's top officers Shareholders enjoy limited liability: the amount invested in the common stock shares is the maximum loss they can experience. That is, creditors cannot go after shareholders' personal assets.
Partnership/partnership agreement
A partnership has more than one owner (partner). At least two of the partners must be non-corporations. A partnership agreement spells out each partner's ownership interest and role in the business. Partnerships do not pay taxes (like sole proprietorships). Profit or loss from the partnership then flows through to each partner's personal income tax return.
The Income Statement
A report of the firm's revenues and expenses for a period of time, usually a quarter or year. the top line of the income statement is revenue (sales)
Capital Structure
A specific mix of sources of long-term capital utilized by the firm
What is an annuity?
A stream of equal cash flows paid at regular time intervals. Semiannual or annual bond coupon payments, monthly car loan or mortgage payments are examples of annuities
Cash Accounting
A system in which revenue and expenses are counted as they are actually received.
You sell valuable artifacts from your household estate for $200,000 and want to use the money to supplement your retirement. You receive the money on your 60th birthday, the day you retire. You want to withdraw equal amounts at the end of each of the next 25 years. What constant amount can you withdraw each year and have nothing remaining at the end of 20 years if you are earning 7% interest per year? A. $17,162 B. $28,318 C. $37,574 D. $49,113
A. $17,162
Your daughter is born today and you want her to be a millionaire by the time she is 35 years old. You open an investment account that promises to pay 12% per year. How much money must you deposit each year, starting on her 1st birthday and ending on her 35th birthday, so your daughter will have $1,000,000 by her 35th birthday? A. $2,317 B. $3,455 C. $5,777 D. $9,450
A. $2,317 Let yearly investment be x Present value of all savings = 1,000,000/1.12^35 1,000,000/1.12^35 = x/1.12 + x/1.12^2 + x/1.12^3 + x/1.12^4........ x/1.12^35 x= 2,317
Universal Financial, Inc. has total current assets of $1,200,000; long-term debt of $600,000; total current liabilities of $500,000; and long-term assets of $800,000. How much is the firm's net working capital? A. $700,000 B. $900,000 C. $800,000 D. $1,000,000 E. $600,000
A. $700,000 NWC = Current assets - Current liabs.
If Cindy deposits $12,000 into a bank account that pays 6% interest compounded semiannually, what will the account balance be in seven years? A. 18,151 B. 14,356 C. 16,987 D. 15,555
A. 18,151 Principal = $12000 Rate = 6% compounded Semiannually , so n = 2 as interest will be paid twice in a year. Time = 7 Years Final Amount = $12000 * {[1 + ( 6% / 2)] ^ ( 7 * 2 )} Final Amount = $12000 * [( 1 + 3% ) ^ 14 )] Final Amount = $12000 * [( 1 + 0.03) ^ 14 )] Final Amount = $12000 * [( 1.03) ^ 14 ] Final Amount = $12000 * 1.51 12,000 (1+0.03)^14
One bank offers you 4% interest compounded semiannually. What would the equivalent rate be if interest were compounded quarterly? A. 3.98% B. 1.00% C. 3.92% D. 3.96%
A. 3.98% Compounded Semi-Annually EAR =( 1 + r )^n - 1 EAR=( 1 + 4%/2)^2 - 1 EAR=4.04% Compounded Quarterly EAR =( 1 + r )^n - 1 4.04% =(1+r%/4)^4 - 1 r =3.98%
Anton's Bike Shop has a return on assets of 12%. Anton's assets = $100 while Anton's owner's equity = $40 and its debt equals $60. What is Bill's return on equity? A. 30% B. 12% C. 18% D. 36% E. 20%
A. 30% 100 * 0.12 = 12 ...12/40
TransSystems Inc. has a total equity of $560,000; sales of $2,250,000; total assets of $995,000; and current liabilities of $310,000. What is TransSystems Inc.'s debt ratio? A. 43.7% B. 31.2% C. 66.7% D. 55.4%
A. 43.7% Need TL/TA. Find TL as TA - Equity.
Which of the followings is correct? A. Book value of company's assets reports historical cost of the asset B. On the balance sheet, assets are listed in the order of increasing liquidity C. The balance sheet reports current market values of a company's assets D. Liquid assets generate more return than illiquid assets E. Net working capital is the difference between all assets and liabilities
A. Book value of company's assets reports historical cost of the asset
Which of the following statements concerning net income is MOST correct? A. Net income represents income that may be reinvested in the firm or distributed to its owners. B. Net income represents cash available to pay dividends. C. Negative net income reduces a company's cash balance. D. Net income represents sales minus operating expenses at a specific point in time.
A. Net income represents income that may be reinvested in the firm or distributed to its owners.
Jones, Inc. has a current ratio equal to 1.40. Which of the following transactions will increase the company's current ratio? A. The company transfers $25,000 to a supplier to pay off some existing accounts payable. B. The company sells $100,000 of inventory on credit. C. The company pays back $50,000 of its long-term debt. D. The company collects $100,000 of its accounts receivable.
A. The company transfers $25,000 to a supplier to pay off some existing accounts payable.
High Tech Corp. cut its research and development budget for the year by $4,000,000 in order to improve its cash flow for the year. Which of the following statements is MOST correct? A. The stock price may decrease because investors may predict that future cash flows will decrease due to the lack of innovation and new products. B. The stock price will likely increase because the value of stock is based on reported cash flow. C. The change will have no impact on stock price because the company's profits for the year will not change. D. The stock price will increase only if reported profits for the year are higher than profits reported in the previous year.
A. The stock price may decrease because investors may predict that future cash flows will decrease due to the lack of innovation and new products.
All of the following are equity accounts on a balance sheet EXCEPT A. cash. B. retained earnings. C. common stock. D. paid-in capital.
A. cash.
Which of the following categories of owners enjoy limited liability? A. common shareholders of a corporation B. in a partnership, only the general partners C. sole proprietors D. all partners in a limited partnership
A. common shareholders of a corporation
Financial analysis A. uses historical financial statements to measure a company's performance and in making financial projections of future performance. B. relies on generally accepted accounting principles to make comparisons between companies valid. C. is accounting record-keeping using generally accepted accounting principles. D. uses historical financial statements and is thus useful only to assess past performance.
A. uses historical financial statements to measure a company's performance and in making financial projections of future performance.
What happens in a general partnership?
All partners are personally liable for business debts and other obligations, including court judgments. This is similar to sole proprietorships
Cash inflow vs outflow
An inflow increases the cash balance, and an outflow decreases it.
investing cash flows
Arise from acquiring and disposing of long-term assets, both real and financial. Examples include paying for new equipment or a new building, buying or selling financial investment such as bonds or stocks (not the ones issues by the firm but rather securities held as investments), selling old equipment for cash, acquiring a competitor in a cash offer, or spinning off a division via a cash sale.
Operating cash flows
Arise in the course of the firm's normal business operations. Examples include getting paid for goods sold and services provided, paying for inventory, paying wages and salaries to employees, getting refunds from suppliers for bad shipments, etc.
Baker Corp. is required by a debt agreement to maintain a current ratio of at least 2.5, and Baker's current ratio now is 3. Baker wants to purchase additional inventory for its upcoming Christmas season, and will pay for the inventory with short-term debt. How much inventory can Baker purchase without violating its debt agreement if their total current assets equal $15 million? A. $6.00 million B. $1.67 million C. $0.50 million D. $4.50 million E. $2.5 million
B. $1.67 million CL = CA/3 = 5. Solve for X in (15 + X)/(5 + X) = 2.5
The present value of $1,000 to be received in 5 years is ________ if the discount rate is 12.78%. A. $687 B. $548 C. $361 D. $494 E. $872
B. $548 Present Value = Future value/ (1 + r)t Where future value = $1,000 r is the rate = 12.78% = 0.1278 t is the time = 5 years By substituting the values in the formula PV = 1,000/ (1 + 0.1278)5 PV = 1,000/ (1.1278)5 By further calculation, PV = 1,000/1,825 PV = $548
Standard Inc. has an annual interest expense of $40,000. If Standard's times-interest-earned ratio is 3.0, what is Standard's Earnings Before Taxes (EBT)? Standard's tax rate is 25%. A. $60,000 B. $80,000 C. $47,000 D. $160,000 E. $120,000
B. $80,000 Find EBIT as TIE*Interest. EBT = EBIT - Interest. (40,000*3) = 120,000 - 40,000 = 80,000
An investment is expected to yield $300 in three years, $500 in five years, and $300 in seven years. What is the present value of this investment if our opportunity rate is 5%? A. $735 B. $864 C. $885 D. $900
B. $864
Acme Incorporated has a debt ratio of .42, long-term liabilities of $20,000 and total assets of $70,000. What is Acme's level of current liabilities? A. $12,348 B. $9,400 C. $10,600 D. $8,400
B. $9,400 TL = 58% of assets (find it). Then, CL = TL - LongTermL 70,000*0.42 = 29,400-20,000= 9,400
You discover an antique in your attic that you purchased at an estate sale 10 years ago for $400. You auction it on eBay and receive $8,000 for your item. What annual rate of return did you earn? A. 200.00% B. 34.93% C. 30.47% D. 20.00%
B. 34.93% Given data, Investment = Present Value = $400 Investment period = n = 10 years Proceeds received on maturity = Future Value = $8000 Let annual rate of return be x Future Value = Present Value (1+rate of return)n $8000 = $400 (1+x)10 (1+x)10 = $8000 / $400 (1+x)10 = 20 1+x = 1.3492989 x = 0.3492989 x = 0.3493 (approx.) Annual Rate of Return = 34.93%
You bought a racehorse that has had a winning streak for six years, bringing in $250,000 at the end of each year before dying of a heart attack. If you paid $1,155,720 for the horse 6 years ago, what was your annual return over this 6-year period? A. 18% B. 8% C. 33% D. 12%
B. 8% you can calculate it using IRR in excel
Company A and Company B have the same gross profit margin and the same total asset turnover, but company A has a higher return on equity. This may result from A. Company A having lower cost of goods sold, resulting in a higher net profit margin. B. Company A having lower selling and administrative expenses, resulting in a higher net profit margin. C. Company A having a lower debt ratio. D. Company B having more common stock.
B. Company A having lower selling and administrative expenses, resulting in a higher net profit margin.
Company A and Company B have the same gross profit margin and the same total asset turnover, but company A has a higher return on equity. This may result from A. Company A having lower cost of goods sold, resulting in a higher net profit margin. B. Company A having lower selling and administrative expenses, resulting in a higher net profit margin. C. Company A having a lower debt ratio. D. Company B having more common stock.
B. Company A having lower selling and administrative expenses, resulting in a higher net profit margin.
Which of the following statement is NOT correct? A. Depreciation expense is a component of operating expense B. Operating income is equivalent to the sales less cost of goods sold add operating expenses C. Cost of goods sold is the cost of producing or acquiring a product or service to be sold D. Operating income is not affected by how much debt the company owes E. Firm's financing expense resulting from borrowing money has no effect on operating income
B. Operating income is equivalent to the sales less cost of goods sold add operating expenses
The income statement uses ______ basis accounting; the statement of cash flows uses ______ basis accounting. A. accrual; accrual B. accrual; cash C. cash; cash D. cash; accrual
B. accrual; cash
Two companies have identical operating income (EBIT). The also face the same interest rates on debt and the same tax rates. The company with less debt will have a _____. A. lower net income B. higher net income C. higher interest expense D. lower tax expense E. both a and d
B. higher net income
Shareholder wealth maximization means A. maximizing dividends per share. B. maximizing the price of existing common stock. C. maximizing earnings per share. D. maximizing stockholder's equity.
B. maximizing the price of existing common stock
Company A has a higher days sales outstanding ratio than Company B. Therefore, A. Company A sells more on credit than Company B. B. other things being equal, Company B has a cash flow advantage over Company A. C. Company A has a higher percentage of cash to credit sales than Company B. D. Company A must be collecting its accounts receivable faster than Company B, on average.
B. other things being equal, Company B has a cash flow advantage over Company A. B collects cash for the sold inventory faster.
What financial statement explains the changes that took place in the firm's cash balance over a period? A. statement of owners' equity B. statement of cash flows C. income statement D. balance sheet E. reconciliation of free cash flow
B. statement of cash flows
Assuming two investments have equal lives, a high discount rate tends to favor A. the investment with large cash flows late. B. the investment with large cash flows early. C. neither investment since they have equal lives. D. the investment with even cash flow
B. the investment with large cash flows early.
Joe is deciding whether or not to invest $10,000 in a business that has pending lawsuits against it. If Joe invests and the business loses the lawsuits, the most Joe can lose is A. $10,000 plus his share of the lawsuits if Joe is a limited partner. B. $10,000 if Joe is a general partner. C. $10,000 if Joe is a limited partner. D. $10,000 if Joe is a sole proprietor.
C. $10,000 if Joe is a limited partner.
If you invest $750 every six months at 8 percent compounded semiannually, how much would you accumulate at the end of 10 years? A. $10,065 B. $10,193 C. $22,334 D. $21,731
C. $22,334 Future Value of Annuity= PMT [(1+i)^n -1]/i ; where you have 4% every 6 months(8% annually); i =4%, n = 20 (twice a year for 10 years)
How much would you be willing to pay (rounded to the nearest dollar) for a 20-year annuity due if the payments are $4,500 per year and you want to earn a rate of return equal to 5.5% per year? A. $84,500 B. $63,445 C. $56,734 D. $53,777
C. $56,734
You are currently earning 12% compounded semiannually. Your investment company is switching all accounts to daily compounding. What rate will give you the same effective annual rate of return as you are receiving now? A. 10.83% B. 10.97% C. 11.66% D. 11.89%
C. 11.66% EAR = (1 + 12%/2)^2 - 1 EAR= (1 +0.06)^2 - 1 = 12.36% Compounded Daily: EAR =( 1 + x%/365)^365 - 112.36% =( 1 + x%/365)^365 - 1x =11.66%
The key principles of finance include all of the following EXCEPT: A. Cash flows are more important than profits. B. Risk requires a reward C. Incremental profits determine value D. Money has time value
C. Incremental profits determine value
The key principles of finance include all of the following EXCEPT A. Money has a time value. B. Cash flow is what matters. C. Incremental profits determine value. D. Risk requires a reward.
C. Incremental profits determine value.
The current ratio of a firm would be increased by which of the following? A. Inventories are sold on a credit basis. B. Inventories are sold for cash. C. Land held for investment is sold for cash. D. Equipment is purchased, financed by a long-term debt issue.
C. Land held for investment is sold for cash.
Which of the following is NOT a way to reduce agency costs? A. Performance-based bonuses and stock options for managers. B. Ensuring boards of directors are independent. C. Paying managers high fixed salaries. D. Monitoring of managerial actions by shareholders.
C. Paying managers high fixed salaries.
The CEO of JLI Corp. decided to expand into a new market in 2020. At the end of 2020, JLI's stock price had decreased 5% since the beginning of the year. Which of the following statements is MOST correct? A. The CEO made a poor decision to expand because the stock price decreased during the year. B. The CEO made a poor decision to expand because the company's profits for the year obviously decreased, causing the drop in stock price. C. The CEO's decision may have been optimal, keeping the stock price from falling more than 5% for the year. D. CEO decisions are irrelevant because the efficient market determines the value of a company's stock.
C. The CEO's decision may have been optimal, keeping the stock price from falling more than 5% for the year.
In which of the following cases will the agency problem between shareholders and managers be the greatest? A. 100% of the common stock is owned by the founder of the company who decided to retire and hired a manager to run his business for him. B. All top managers in the company own significant amounts of stock and stock options. C. The common stock of the company is owned by many diverse shareholders, with no shareholder owning more than 1% of the outstanding stock. D. The Johnson family owns 50% of the common stock of the company. The other 50% is owned by 5 mutual funds.
C. The common stock of the company is owned by many diverse shareholders, with no shareholder owning more than 1% of the outstanding stock. Dispersed (as opposed to concentrated) ownership reduces the motivation of individual investors to closely follow the company and question managerial actions.
Which of the following statements about the corporate form of business organization is true? A. The corporate form is preferred over the sole proprietorship because a corporation is easier to form and faces less regulation. B. Sole proprietorships are the most common form of business organization because liability is limited to the amount invested in the business by the sole proprietor. C. The corporate form has the disadvantage of double taxation relative to a sole proprietorship. D. The corporate form has the advantage of unlimited liability
C. The corporate form has the disadvantage of double taxation relative to a sole proprietorship.
What should be the long-term focal point of financial management of a firm? A. The minimization of the amount of taxes paid by the firm B. The maximization of profit earned by the firm C. The creation of value for shareholders D. The number and types of products provided by the firm E. All of the above
C. The creation of value for shareholders
HighLev Incorporated borrows heavily and uses the leverage to boost its return on equity to 30% this year, nearly 10% higher than the industry average. However, HighLev's stock price decreases relative to its industry counterparts. How is this possible? A. Markets are inefficient and fail to recognize the benefits of leverage. B. Shareholders are not interested in return on equity. C. The high levels of debt increased the riskiness of HighLev relative to its competitors. D. The increased debt resulted in interest payments that made HighLev's operating income drop even though return on equity increased.
C. The high levels of debt increased the riskiness of HighLev relative to its competitors.
The principle of risk-return trade-off means that A. an investor who takes more risk will earn a higher return. B. an investor who bought stock in a small corporation five years ago has more money than an investor who bought U.S. Treasury bonds five years ago. C. a rational investor will only take on higher risk if he expects a higher return. D. higher risk investments must earn higher returns.
C. a rational investor will only take on higher risk if he expects a higher return.
The two major types of decisions finance deals with are ________ decisions. A. cash management and capital budgeting B. product development and asset acquisition C. financing and investment D. debt financing and equity financing
C. financing and investment
Which of the following represents an attempt to measure the net results of the firm's operations (revenues versus expenses) over a given time period? A. sources and uses of funds statement B. statement of cash flows C. income statement D. balance sheet
C. income statement
All of the following will improve a firm's liquidity position EXCEPT A. increase accounts receivable turnover. B. increase inventory turnover. C. increase the average collection period. D. increase long-term debt and invest the money in marketable securities.
C. increase the average collection period.
A firm's financing costs include A. costs of goods sold. B. depreciation expense. C. interest expense D. selling, general, and administrative (SGA) expenses.
C. interest expense
A firm's financing costs include A. costs of goods sold. B. depreciation expense. C. interest expense D. selling, general, and administrative (SGA) expenses
C. interest expense
Which of the following items belongs on the asset side of a balance sheet? A. depreciation expense B. accrued expenses C. inventory D. retained earnings E. accounts payable
C. inventory
Smith Corporation has earned a return on capital invested of 10% for the past two years, but an investment analyst reviewing the company has stated the company is not creating shareholder value. This may be due to the fact that A. investors' required rate of return is 8%. B. the corporation's inventory turnover is high. C. investors' required rate of return is 12%. D. the risk-free rate of interest is 3%.
C. investors' required rate of return is 12%.
You have contracted to buy a house for $250,000, paying $30,000 down and taking out a fully amortizing loan for the balance, at a 5.7% annual rate for 30 years. What will your monthly payment be (to the nearest dollar)? A. $1,123 B. $1,035 C. $1,189 D. $1,277
D. $1,277
Bill, a local inventor, developed a diet pill that he believes will solve the obesity problem in the United States. Bill wants to create a new company, 50% owned by Bill and 50% owned by a major drug company. Although he believes the pills are safe, Bill is concerned about liability if someone becomes sick or dies. The best form of business organization for the new company is A. general partnership with Bill and the drug company as equal partners. B. S-type corporation with Bill and the drug company owning equal shares. C. limited liability company with Bill and the drug company owning equal shares. D. sole proprietorship with Bill as owner and the drug company as creditor.
C. limited liability company with Bill and the drug company owning equal shares.
Which of the following transactions will increase a corporation's operating return on assets? A. sell stock and use the money to pay off some long-term debt B. sell 10-year bonds and use the money to pay off current liabilities C. negotiate a new contract that lowers raw material costs by 10% D. increase sales by 10%
C. negotiate a new contract that lowers raw material costs by 10%
Suppose XYZ Corporation is traded on the New York Stock Exchange. XYZ's closing price on Monday is $20 per share. After the market closes on Monday, XYZ makes a surprise announcement that it has obtained a major new customer. XYZ's stock will likely ______. A. open below $20 because the surprise announcement creates more uncertainty. B. remain at $20 per share because in efficient markets the price already reflects all information. C. open above $20 because the positive news will result in a higher valuation even though the stock has not yet traded. D. open at $20 per share on Tuesday and then increase as more investors read the announcement in the Wall Street Journal.
C. open above $20 because the positive news will result in a higher valuation even though the stock has not yet traded. Information that becomes public is quickly incorporated into security prices. The positive news will cause the stock to open on the new trading day at a higher price.
Which of the following ratios would be the most useful to assess the risk associated with a firm being able to pay off its short-term line of credit? A. return on equity B. times interest earned C. the acid test ratio D. the operating profit margin E. the fixed asset turnover
C. the acid test ratio
Determining the best way to raise money to fund a firm's long-term investments is called A. the portfolio decision. B. the money flow processing decision. C. the capital structure decision. D. the capital budgeting decision.
C. the capital structure decision.
Assume that an investor is offered a choice of a risk-free government bond or a high-risk corporate stock. Assume that the expected return is the same for both. According to one of the key principles of finance, which investment would be chosen? A. the investor would be indifferent because the expected return is the same for both investments. B. the investor would be indifferent as long as the expected return is positive for both investments. C. the government bond D. the corporate stock
C. the government bond An investor chasing the highest expected return regardless of risk is risk-neutral rather than risk-averse.
selling, general and administrative (SGA) expenses,
COGS excludes indirect costs such as overhead and sales & marketing. Such expenses are part of the next income statement item - selling, general and administrative (SGA) expenses, sometimes also called operating expenses.
What does "cash is king" mean?
Cash flows rather than accounting profits are the most important indicator of a business's financial success. Cash flows are the main driver of the firm's value. While profits are important, the accounting standards allow for discretion in computing profits, and different accounting profits may be reported depending on the accounting methods used. In addition, even a profitable business may fail due to lack of cash flow - a situation called illiquidity.
Chapter 1 takeaways
Chapter 1 takeaways 1. The goal of the firm is maximization of the shareholder wealth. This is equivalent to maximizing the company's share price. Ethical behavior is usually consistent with this goal, while separation of ownership and control (corporate managers not necessarily being its owners) gives rise to agency costs. 2. In corporations, the finance function deals with financing decisions (raising capital) and investment decisions (using capital). 3. A business can be organized as a sole proprietorship, partnership, traditional corporation (C-corp), S-corporation, or a limited liability company (LLC). Each form has its advantages and disadvantages. Corporate form of business lends itself to raising large amounts of capital from various investors. 4. Cash flows are more important than profits, and the timing of cash flows is important, too. Risk requires a reward, and market prices generally reflect public information. 5. There is a multitude of career paths in finance that suit different preferences and skill sets.
The agency problem
Conflicts of interests that arise when an agent (manager) has incentives or motivations to to not act in the full best interest of a principal
Today is your 20th birthday and your bank account balance is $25,000. Your account is earning 6.5% interest compounded semiannually. How much will be in the account on your 50th birthday? A. $159,795 B. $162,183 C. $163,823 D. $170,351
D. $170,351
How much money must you pay into an account at the end of each of 20 years in order to have $100,000 at the end of the 20th year? Assume that the account pays 6% per year, and round to the nearest $1. A. $1,840 B. $2,028 C. $2,195 D. $2,718
D. $2,718 100000= C[ (1+0.06)^20 -1] /0.06 100000= C[ (1.06)^20 -1] /0.06 100000= C[ (3.2071 -1] /0.06]
How much would you be willing to pay (rounded to the nearest dollar) for a 20-year ordinary annuity if the payments are $4,500 per year and you want to earn a rate of return equal to 5.5% per year? A. $84,500 B. $63,445 C. $56,734 D. $53,777
D. $53,777
What is the present value of an annuity of $120 received at the end of each year for 11 years? Assume a discount rate of 7%. The first payment will be received one year from today (round to nearest $1.) A. $250 B. $400 C. $570 D. $900
D. $900
Rural Hydroponics has total equity of $560,000; sales of $2,250,000; current assets of $700,000; and total liabilities of $435,000. What is Rural Hydroponics' total asset turnover? A. 3.21 B. 4.02 C. 5.51 D. 2.26 E. 1.98
D. 2.26 Need Sales/TA. Find TA as Liabs. + Equity (560,000+435,000 = 995,000)... (2,250,000/995,000)
When comparing inventory turnover ratios, other things being equal, A. a lower inventory turnover is preferred in order to keep inventory costs low. B. higher inventory turnover results from old or obsolete inventory increasing the inventory balance on the balance sheet. C. higher inventory turnover results from an increase in the selling price of the product. D. a higher inventory turnover is preferred to improve liquidity
D. a higher inventory turnover is preferred to improve liquidity
Which of the following is true if a firm wishes to collect its accounts faster by imposing stricter credit terms on its customers? A. The firm's average collection period is likely to fall. B. The firm's accounts receivable turnover might rise. C. The firm's sales might decrease. D. all of the above
D. all of the above Sales may fall due to losing some customers.
A company borrows $2,000,000 and uses the money to purchase machinery for its operations. These are examples of cash flow from _______ and _______ activities, respectively. A. financing; operating B. investing; operating C. financing; operating D. financing; investing E. investing; financing
D. financing; investing
Which of the following assets and liabilities is NOT a component of the calculation of net working capital? A. cash B. accounts receivable C. accounts payable D. net fixed assets (i.e., gross fixed assets minus accumulated depreciation) E. inventory
D. net fixed assets (i.e., gross fixed assets minus accumulated depreciation) NWC only includes current (short-term) assets and liabilities.
Which of the following is an advantage of the sole proprietorship? A. easily transferred ownership B. limited liability for its owners C. double taxation for its owners D. no significant legal requirements for starting the business
D. no significant legal requirements for starting the business
All of the following measure liquidity EXCEPT A. current ratio. B. inventory turnover. C. acid-test ratio. D. operating return on assets. E. All of the above measure liquidity.
D. operating return on assets.
Gross profit is equal to A. revenues - expenses. B. EBIT - interest expense C. profits plus depreciation. D. sales - cost of goods sold. E. earnings before taxes minus taxes payable.
D. sales - cost of goods sold.
compounding
The process of computing future values of today's money
Captial Budgeting
The process of evaluation of potential investment projects
Which of the following is true about the statement of cash flows? A. It is also known as the statement of operations B. It reports revenues, expenses and liabilities C. It represents the financial position of a business at a particular point of time D. It represents the basic accounting equation for a particular business E. It includes only those revenues for which cash was received during the period
E. It includes only those revenues for which cash was received during the period
The two principal sources of financing for corporations are A. common equity and preferred equity. B. assets and liabilities C. cash and common equity. D. debt and accounts payable. E. debt and equity.
E. debt and equity.
A margin is a measure of profit relative to A. assets B. total assets C. cash D. equity E. sales
E. sales
Equation for effective annual rate (EAR)
EAR = (1 + r/m)m where r is the quoted annual rate and m is the number of compounding periods per year.
The statement of cash flows in one equation
End-of-period Cash = Beginning-of-period Cash + Cash Inflows - Cash Outflows
Equations for calculating the future value of an annuity
FVn = (PMT/r)*[(1+r)n - 1] for an ordinary annuity and FVn = ((PMT/r)*[(1+r)n - 1])*(1+r) for an annuity due. The two values differ by the factor of (1+r) because each payment in an annuity due is compounded one extra year, compared to an otherwise similar ordinary annuity.
Equation to calcuate the future value of a single sum
FVn = PV*(1+r)n where FV is the future value (the amount accumulated by the end of the investment horizon), PV is the present value (the amount we invest today), r is the annual interest rate that we earn, and n is the investment horizon in years.
What is the role of finance in business?
Financial decisions, too, may create or destroy shareholder value. Moreover, the effects of superior production and excellent marketing may be undermined by poor financial decisions. Financial decisions are not directly related to product pricing - this is part of marketing. Rather, they can be of two types: - Financing decisions - dealing with raising capital to run a business, and - Investment decisions - dealing with how to use capital.
This is the balance sheet in a nutshell.
Firms own assets and owe liabilities, with equity being the difference. Liabilities and equity are sources of funds used to acquire assets. Therefore, assets are uses of funds.
Growing annuities
If payments are made at regular time intervals and they are growing at a constant rate, we have a growing annuity.
What happenes in a limited partnership?
In a limited partnership, at least one partner has unlimited liability—the general partner(s). The other partners - limited partners - have limited liability. It is limited to their investment in the partnership, and their personal assets cannot be used to satisfy business debts and liabilities. General partners manage the day-to-day business operations, while limited partners do not participate in management.
Cost of Goods Sold (COGS)
Includes the direct costs of producing or acquiring inventory (the products that the company sells) - direct labor, direct materials, and overhead costs of the production facility. - On the balance sheet, inventory is recorded at this cost. After subtracting COGS from revenue, we arrive at gross profit. The higher the gross profit, the more capital a company has to pay other costs or satisfy debt obligations.
What is a subchapter S corporation? (an S-corporation, or an S-corp for short)
It is taxed as a partnership: income is passed through to individual shareholders, who must pay personal income tax. The number of shareholders is limited to 100, and all shareholders must be US citizens or residents. An S-corp cannot set up subsidiaries and thus cannot participate in joint ventures. You can think of an S-corp as a tax election rather than a form of business.
What is a LLC? (Limited Liability Corporation)
LLC owners can elect it to be taxed either as a partnership or as a corporation. It can set up subsidiaries but cannot issue stock. An LLC can be a general partner in a limited partnership, effectively protecting its owners from personal liability.
Current Liabilities
Must be paid off within one year. Most often, they include short-term debt (wages owed, short-term notes or bank loans, as well as interest payments on long-term debt coming due in the near future) and accounts payable - what the firm owes its suppliers after buying inventory or supplies on credit.
The income statement in one equation
NI = (Sales - COGS - SGA - Depr. - Int.)*(1 - t), or NI = (EBIT - Int.)*(1 - t)
Earnings before interest and taxes (EBIT)
Net income before income tax expense and interest expense is deducted. This is a common way to compare the earning power of companies because it eliminates the impact of capital structure and effective tax rates, two non-operating factors. After subtracting COGS, SGA expenses, and depreciation, we arrive at the intermediate result - operating income, operating profit, or earnings before interest and taxes
Characteristics of a sole proprietorship
Owned by one person - There is no formal legal structure to a sole proprietorship. The owner has a title to the business's assets and is responsible for its liabilities, usually without limitation. That is, if you run a sole proprietorship and are sued by customers, you may lose much more than you invested in the business. This is a big disadvantage of this form of business. - The main advantages is minimal legal requirements. - No separate tax return is filed by a sole proprietorship. Profit or loss from the business is an adjustment to the owner's personal income.
Equation to calculate the present value of a single sum
PV = FVn/(1+r)n where PV is present value, FV is future value, and r is the annual interest rate.
the equation for calculating the present value of annuity due
PVann.due = PVann.*(1+r)
Retained earnings
Profits not distributed to shareholders but reinvested into the business
Accural Accounting
Recording sales and purchases when transactions are made rather than when payments are received or made
Agency Costs
Reductions in shareholder wealth caused by the agency problem. When managers do not act in the best interests of shareholders, it creates agency costs borne by shareholders.
Assets
Resources owned or controlled by the firm. They are listed on the balance sheet in order of liquidity: how quickly an item could generate cash for the company to use in paying bills How are the assets paid for? With money from lenders and owners, who in turn have financial claims against the company's assets and productivity. Lenders' claims, called debt (or liabilities), can be of the short-term or long-term variety.
The statement of cash flows
Shows a change in the cash position over a reporting period - a quarter or year.
The balance sheet
The balance sheet is a snapshot of a company's assets, liabilities, and equity at a point in time.
What is market efficiency?
The degree to which market prices reflect available relevant information.
Leverage
The extent to which a firm uses debt
discounting
The reverse operation of compounding - finding present values of future expected cash flows
What is risk aversion?
The tendency to avoid taking risks. Risk aversion means that we require a higher return for investments of higher risk. The higher the perceived risk, the higher the return we would require.
How do deal with uneven cash flows
There is no shortcut to value uneven cash flows - we have to discount them one by one and add up their PVs or compound them one by one and add their FVs.
Why is the timing of cash flows important?
This is because money has time value. In other words, we would prefer a dollar today to a dollar tomorrow, all else equal. This is because we can invest our money today and start earning a return sooner. The interest you can earn by investing is the opportunity cost. If you are entitled to receive $1,000 in one year as opposed to today, you are losing the opportunity to earn the interest on $1,000 for one year.
TIE ratio (interest coverage ratio)
Times Interest Earned (TIE) = EBIT/InterestExpense
Equity Multiplier
Total Assets/Total Equity
Calculating the present value of an annuity
We may find the PV of an ordinary annuity by finding the PVs of all the individual payments and adding them up: PVann. = PMT1/(1+r) + PMT2/(1+r)2 + PMT3/(1+r)3 + ... + PMTn/(1+r)n. Here, we replaced CF with PMT. However, because the payments are equal, there is a quicker way to find the PV of an annuity: PVann. = (PMT/r)*[1 - 1/(1+r)n]
net working capital
current assets - current liabilities
DuPont Analysis
a breakdown of ROE into three major components (sources ): net profit margin (NPM), total asset turnover (AT), and leverage (measured by the equity multiplier, EM).
A margin
a measure of profitability, a ratio of profit to sales. The three margins are: Gross Profit Margin = Gross Profit/Sales Operating Profit Margin = EBIT/Sales Net Profit Margin = NI/Sales
A return on investment
a periodic rate of change in the amount invested. The total investment in the firm is its total assets. As a result, the return on assets (ROA) is one of the key metrics of a firm's success.
Which of the following is true? (select) a. Agency costs are difficult to measure. b. Agency costs are caused by conflicts of interest c. A firm that is managed by its owner would have no agency problems d. A good way to reduce agency costs is to offer managers high fixed salaries e. An immediate threat of takeover increases agency costs
a. Agency costs are difficult to measure. b. Agency costs are caused by conflicts of interest c. A firm that is managed by its owner would have no agency problems
A firm sells old equipment for cash above its book value (taxes will have to be paid on gain above the book value). Mark all accounts/items this transaction affects. a. Cash b. Accumulated depreciation c. Financing Cash flow d. Tax expense e. Interest expense f. Sales revenue g. Investment cash flow h. Common stock i. Net income
a. Cash b. Accumulated depreciation d. Tax expense g. Investment cash flow i. Net income
A top executive of a retail store chain tells her nephew that the company sales and earnings (to be announced publicly next week) are much higher than expected by the markets. The nephew tells it to his friend, who immediately buys shares of the company. Which of the following is true? Mark all that applies. a. Trading on such information is illegal b. This is material nonpublic information c. Trading on this information is perfectly fine
a. Trading on such information is illegal b. This is material nonpublic information
Assume you may earn 0.5% on a one-year CD (a bank deposit fully insured by the US government), and the overall level of interest rates is low. You receive an offer in the mail to buy a debt security that offers interest payments of 10% per year. Your friend says it must be a highly risky investment. Should you agree with your friend? a. Yes b. No
a. Yes
Days Sales Outstanding Equation
accounts receivable/ daily credit sales
Financial Analysis
an examination of a company's business model and its financial performance by using financial information.
Accounts Receivable Turnover Equation
annunal credit sales/ accounts receivable
Financing cash flows
arise when firms raise new capital or pay their capital providers - debtholders and shareholders. Equity contributions made by shareholders, loan advances from banks or other lenders, sales of bonds to investors, dividend payments to or stock repurchases from shareholders, payoffs of loan or bond outstanding balances are all examples of financing CFs.
A risk-averse investor would never invest in securities with a significant risk of price declines. a. True b. False
b. False Requiring additional return for higher perceived risk is different from stay away from risk altogether.
If you wish to open a small business and protect your non-business assets, the best form of organization for you is most likely a(n) ____. a. Sole proprietorship b. C-corporation (regular corporation) c. LLC d. General partnership
c. LLC
The three main equity accounts
common stock (at par value) surplus retained earnings.
Investment decisions
deals with how to use capital. Examples of investment decisions include buying new equipment, spending money on research, implementing new inventory management software, foregoing a project that is not expected to generate sufficient cash flows, and even abandoning a project that did not turn out as successful as originally anticipated.
Financial decisions
deals with raising capital to run a business. Examples of financing decisions include issuing stock, borrowing money from banks or issuing other forms of debt such as bonds, determining the mix of debt and equity to fund the assets, shopping around for the best loan terms, etc.
Liquidity
ease of converting an asset into cash at a fair market value
Liabilities
financial obligations that a firm owes and must pay at some point in the future. All forms of debt - wages and salaries owed to employees, loans owed to lenders, trade credit owed to suppliers, or taxes owed to governments .Equity is the value of the owner's (shareholder's) stake in the firm. It is a residual claim on the firm's assets, or the different between assets and liabilities.
days in inventory ratio
inventory/ daily cogs
A turnover
is a measure of speed with which inventory is sold and efficiency with which the company uses its assets to produce sales. The three common measures of turnover are: Inventory Turnover = CoGS/Inventory Fixed Asset Turnover = Sales/NetFixedAssets Total Asset Turnover = Sales/TA
A return
is a rate at which money is made or lost on an investment over a period of time. The three common measures of return used in the analysis of financial statements are: Operating Return on Assets = EBIT/TA Return on Assets (ROA) = NI/TA Return on Equity (ROE) = NI/Equity (NI is net income, TA are total assets.)
Perpetuity (Perpetual Annuity)
is a stream of equal cash flows that has no end date. PVperp. = Pmt/r - ordinary perpetuity; PVperp.due = Pmt + (Pmt/r) - perpetuity due (first payment occurs today); PVgr.perp. = PMT1/(r - g) -perpetuity growing at a constant rate, where Pmt1 is the payment expected one period from now and g is a constant annual growth rate; PVgr.perp.due = PMT0 + PMT1/(r - g) -perpetuity due growing at a constant rate, where Pmt0 is the payment received today and Pmt1 is the payment expected one period from now and g is a constant annual growth rate. Because payments grow at a constant rate g, P1 = P0*(1 + g);
The three broad categories of performance and profitability ratios
margins, turnovers, and returns.
What is the goal of the firm?
maximize shareholder wealth
The three types of Cash Flows
operating, investing, financing
The three major financial statements every business generates
the balance sheet the income statement the statement of cash flows.
Equity
the value of the owner's (shareholder's) stake in the firm. It is a residual claim on the firm's assets, or the different between assets and liabilities.
Debt Ratio
total liabilities/total assets