Principles of Finance Study Cards

What is an acceptable current ratio?

Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses.

What does a spontaneous account refer to?

An account on the balance sheet and income statement that tends to vary when sales are changed

Which financial method allows external users to determine the net worth of a business?

Analyzing financial statements

Finance is responsible for what?

Anything money!! Accounting is responsible for reports!

What is the discretionary finance formula?

Assets-Sum of Liabilities and Equity

Market interest rates go up when?

Bond prices go down.

PV to FV is what interest?

Compound

Which type of loan interest is calculated on both the principal of the loan and any accumulated interest called?

Compound interest

What is an example of a potential principal-agent problem?

Corporate executives buying other companies to expand their influence

Which type of data is collected by observing many subjects at the same point in time?

Cross-sectional

Which term describes a bond that is unsecured by any type of collateral?

Debenture

What is a demand pull inflation?

Demand-pull inflation includes times when an increase in demand is experienced and production cannot be increased to meet changing needs. In these cases, product costs rise as a reflection of the imbalance in the supply and demand model.

How does demand pull inflation occur?

Demand-pull inflation results from strong consumer demand. Many individuals purchasing the same good will cause the price to increase, and when such an event happens to a whole economy for all types of goods, it is called demand-pull inflation.

A manager is planning to receive a lump sum in the future and wants to determine the value of that lump sum in today's dollars. What must be done to the future cash flow to determine this value?

Discount

Future Value on the time line represents what?

Discount

What is a discount rate?

Discount rate: the interest rate used to discount future cash flows of a financial instrument; the annual interest rate used to decrease the amounts of future cash flow to yield their present value.

Which activity is financial management responsible for?

Ensuring sufficient financing is available

What is used to calculate the IRR?

Financial calculators, softwares, and spreadsheets.

Financial professionals generally operate how?

Financial professionals generally operate in an environment of uncertainty where they must make forecasts about future events.

Which documents would have the necessary information needed to calculate profitability ratios?

Financial statements

What do financing descions revolve around?

Financing decisions revolve around how to pay for investments and expenses. Companies can use existing capital, borrow, or sell equity.

What is GAAP?

GAAP: Generally Accepted Accounting Principles refer to the standard framework of guidelines, conventions, and rules accountants are expected to follow in recording, summarizing, and preparing financial statements in any given jurisdiction.

Hyperinflation associates with what?

Hyper incurs with too much meaning to much inflation which makes it increase.

In the 1920's, a country experienced a monthly inflation of 30,000%. Which type of inflation occurred?

Hyperinflation

How is the payback period method applied to capital project analysis?

In determining time to recapture the initial investment

What is an example of cost pull inflation?

In the early 1970s, the Organization of the Petroleum Exporting Countries (OPEC) wanted a monopoly over oil prices and tried to decrease the global oil supply by raising prices.

What is inflation?

Inflation: The real value of a single dollar decreases over time with inflation. That means that even if everything else is constant, a $100 item will retail for more than $100 in the future. Inflation is generally positive in most countries at most times (if it's not, it's called deflation, but it's rare).

What is a characteristic of compound interest?

Interest is earned on the principal balance and on all interest earned in previous periods.

What is a characteristic of simple interest?

Interest is only earned on the initial principal balance no matter how many periods have occurred.

Compound interest is?

Interest on principle and interest on interest.

Which account is a spontaneous account?

Inventory

How is variance related to expected return?

Investments with high expected return will have a higher variance.

Net present value considers what?

It does consider the time value of money

Payback doesn't consider what?

It does not consider time money value

What is an advantage of the payback period method?

It is convenient and easy to use. Simple and easy coordinates with payback.

What is a shortcoming of the internal rate of return (IRR) method?

It is mistakenly used to represent the actual annual profitability of an investment.

Another shortcoming of IRR mistakenly used?

It is never annually it's during the lifetime of the project.

Why is internal rate of return used?

It measures investment efficency the higher the IRR the better.

Why is net present value used?

It uses the company's own discount rate with the time value of money math.

What is an advantage of an LLC?

Limited personal liability

What is liquidity preference?

Liquidity preference: People prefer to have their resources available in a form that can immediately be exchanged, rather than a form that takes time or money to realize. If people are willing to hold more money in hands for convenience, the money supply will contract, increasing the market interest rate.

Which concept describes an investor preference for less risky short-term bonds over riskier long-term bonds

Liquidity premium theory

What is liquidity premium?

Liquidity premium: a term used to explain a difference between two types of financial securities (e.g., stocks), that have all the same qualities except liquidity.

Which scenario represents an opportunity cost?

Mary keeps money in her purse instead of partnering in her friend's popular lemonade stand.

According to TVM

Money is worth more today than the same than the future. You would want your money now.. Instead of waiting to retain it.

Liquidity premium theory is what?

Money that is tied up longer. It has a longer loan terms. The longer the loan team the higher the bonds interest rate.

Time value of money

Money today is worth more than the same amount in the future..

Which statement describes the historical cost principle?

Most assets are valued at their original cost when acquired by a company.

How is discretionary financing calculated?

Net change in assets minus the sum of the net change in liabilities and retained earnings

Rate of Return

New minus Old divided Old.

What is payback?

Payback determines the time needed to recover the orginial investment.

What are preputities?

Perpetuities are a special type of annuity; a perpetuity is an annuity that has no end, or a stream of cash payments that continues forever.

preferred stock

Preferred Stock: stock with a dividend, usually fixed, that is paid out of profits before any dividend can be paid on common stock.

Which term describes the gain or loss on an investment over a period of time?

Rate of return

Which are components of an income statement?

Revenue and expenses

Spontaneous accounts are driven by?

Sales from customers. The more a customer buys items the less the inventory. They would have more accounts payable notes. Inventory would specifically increase/decrease.

A statement of cash flow determines what?

Short term viablity of the company. It shows specifically in depth of where cash is going.

What are spontaneous assets?

Spontaneous assets are balance sheet items that typically grow in proportion to sales such as accounts receivable or inventory.

What are spontanous liabilites?

Spontaneous liabilities are obligations of a company that are accumulated automatically as a result of the firm's day-to-day business. An increase in spontaneous liabilities is normally tied to an increase in cost of goods sold (or cost of sales), which in turn depends on sales of goods or services.

Which type of financial statement is used to determine the short-term viability of a company?

Statement of cash flows

How are stock prices determined?

Stock prices are most strongly determined by earnings per share (EPS) as opposed to return on equity.

What are some examples of spontaneous liabilities?

The common types of spontaneous liabilities are accounts payable, wages payable and taxes payable.

What is opportunity cost?

The cost of money is the opportunity cost of holding money instead of investing it, depending on the rate of interest. The cost of not having the cash on hand at a certain point of time. If the investor/creditor had the cash s/he could spend it, but since it has been invested/loaned out, s/he incurs the cost of not being able to spend it.

Internal Rate of Return IRR is what?

The discount rate that results in net present value of 0

What is the main purposes for capital budgeting?

The main purposes of capital budgeting are to determine if proposed capital projects should be accepted and to rank such proposals.

What is an ideal method for to evaluate capital investment projects

The method must consider time money of value

How does cost push inflation go up?

The most common cause of cost-push inflation starts with an increase in the cost of production, which may be unexpected.

The time to maturity of bond A is 20 years, whereas the time to maturity of bond B is 5 years. What happens to the market prices of these bonds if market interest rates rise?

The price of bond A decreases faster than the price of bond B decreases.

What is the primary goal for investing and financial decsions?

The primary goal of both investment and financing decisions is to maximize shareholder value

What does retained earnings on the balance sheet represent?

The total of firm earnings that have been reinvested in the firm

What are the two main drivers of finance?

The two main drivers of finance are the time value of money and risk.

What happens to assets when they are acquired?

They are specifically valued at original cost. They don't increase/decrease over time.

What describes the rights of creditors holding secured debt?

They have recourse to specific assets of the company should the loan default.

What is a key feature in common stock?

They have voting rights. Peferred stock does not.

Executives perks can be abusive how?

They possible can get involved with other product lines. They could potentially serve on other boards

Net Present Value is a preferred method to do what?

To rank capital budgeting projects.

What are tresuary bill?

Treasury bills: treasury bills (or T-Bills) mature in one year or less. Like zero-coupon bonds, they do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield to maturity.

An individual is interested in establishing a lawn care business as a sole proprietorship. What will be a disadvantage of choosing this business model?

Unlimited liability

What is time value of money (TVM)?

What is time value of money (TVM)?

What is price risk?

When interest rates go down bond prices go up when you have to sell the bond

Payback period method applied to capital projects analysis applies to the companies how?

When the company needs a large purchase. For example a new product line, new computers, etc.

Are financial statements public?

Yes!

Which term describes a graphic representation that uses a line to depict the relationship between the cost of borrowing (interest rates) and the term of a debt contract?

Yield Curve

What is yield?

Yield: commonly refers to the dividend, interest or return the investor receives from a security like a stock or bond, and is usually reported as an annual figure.

Opportunity cost does what?

You do nothing with the money or investment.

A yield curve has a relationship by?

between the cost of borrowing interest rates the longer the loan term the higher the interest rate.

If something has a higher risk has what?

higher expected return has a higher variance

What is goodwill?

intangible asset "goodwill" reflects the difference between the firm's net assets and its market value;

What is the formula for rate of return?

new investment dollars-old investment dollars/old investment dollars

Does the IRR represent the annual rate of return of a project?

no because it represents the cashflows for mutiple years.

What is reinvestment risk?

occurs when interest rates go down when you are used to earning a higher interest rate and we are ready to invest our money again.

Capital budgeting tests what?

proposed projects for acceptance and ranks them.

How is present net value used?

proposed projects with positive net present values are acceptable. The higher the NPV the more desireable the proposed project.

what is yield?

the less the loan term the less the interest rate.

Sole proprietorships and partnerships have what?

unlimited liability creditors can come after personal assets, cars, houses, and bank accounts