Chapter 9 DQ PDF

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Sanchez 1 Norma Sanchez 10/26/20 SID # 0941397 Finance: Acquiring and Using Funds to Maximize Value 1. What is the key goal that guides the decisions of financial managers? What challenges do financial managers face when they try to find the best sources and uses of funds to meet this goal? The key goal that guides the decisions of financial managers is maximizing the market price of stock because they have a legal and ethical obligation, called a fiduciary duty, to make decisions consistent with the financial interests of their firm’s owners. The challenges that financial managers face when they try to find the best sources and uses of funds to meet this goal include having an obligation to respect the needs of employees, customers, creditors, suppliers, and even society as a whole. 2. List the four basic types of financial ratios used to measure a company’s performance, give an example of each type of ratio and explain its significance. The four basic types of financial ratios used to measure a company’s performance are liquidity ratios, asset management ratios, leverage ratios, and profitability ratios. An example of liquidity ratios are current ratios, which are computed by dividing a firm’s current assets. An example of asset management ratios is inventory turnover, which measures how many times a firm’s inventory is sold and replaced each year. It’s significance is it measures how effectively a firm is using its assets to generate revenues or cash. An example of leverage ratios is debt-to-asset ratio, which is computed by dividing a firm’s total liabilities by its total assets.

Sanchez 2 3. What are the key questions financial planning must answer? What role does the budgeted income statement and budgeted balance sheet play in finding answers to these questions? The key questions financial planning must answer are: What specific assets must the firm obtain in order to achieve its goals?, How much additional financing will the firm need to acquire these assets? The role that budgeted income statements and budgeted balance sheets plays in finding answers to these questions is providing a framework for analyzing the impact of the firm’s plans on the financing needs of the company. 4. What is the purpose of a cash budget? How can this tool help firms with rapidly increasing sales? The purpose of a cash budget is to show projected cash inflows and outflows for each month and to help financial managers get a better understanding of the timing of cash flows within the planning period. This tool helps firms with rapidly increasing sales by giving them the cash to meet increasing sales levels, many of which are bought with credit. These firms can use cash budgets to hire more labor and buy more supplies, which must be paid for well before the company’s customers pay their bills. Cash budgets are important to help avoid a temporary cash crunch. 5. Name and describe four commonly used sources of short-term financing. The 4 commonly used sources of short-term financing are trade credit, factoring, short-term bank loans, and commercial paper. Trade credit is spontaneous financing granted by sellers who deliver goods and services to customers without requiring immediate payment. Factoring provides short-term financing to firms by purchasing their accounts receivables at a discount. Short-term Bank Loans are when a firm negotiates a loan with a bank and specifies the

Sanchez 3 length of the loan, usually 30 to 90 days, but can be up to a year and the rate of interest, sometimes they require firms to pledge collateral, sometimes firms establish a line of credit instead of going through the hassle of negotiating a separate loan each time they need more funds. Commercial Paper is a short-term, usually unsecured, promissory note that is issued by large corporations. 6. What is equity financing and what are its major sources? What advantages and disadvantages are associated with equity financing? Equity financing is funds provided by the owners of a company. It’s major sources are retained earnings and money directly invested by stockholders who purchase newly issued stock. The advantages associated with equity financing are the firm is more flexible and less risky than debt financing, it imposes no required payments unlike debt, it can skip dividend payments to stockholders without having to worry that it will be pushed into bankruptcy, and it doesn’t have to agree to burdensome covenants to acquire equity funds. 7. What is financial leverage? How, and under what conditions, can financial leverage benefit a company? How, and under what conditions, can it harm a company? Financial leverage is the use of debt in a firm’s capital structure. Financial leverage can benefit a company by magnifying the return on the stockholders’ investment when the times are good. Financial leverage can harm a company by reducing the financial return to stockholders when times are bad. 8. Is it possible for a firm to have too much money? Explain. What role does cash equivalents play in a financial manager’s strategy to manage cash balances? It is possible for a firm to have too much money because if they hold onto much more cash than needed to meet its required payments, stockholders are likely to ask why the excess

Sanchez 4 cash isn’t being invested in more profitable assets and if the firm can’t find a profitable way to invest the money, the stockholders are likely to ask management why it doesn’t use the excess cash to pay them a higher dividend. The role that cash equivalents play in a financial manager’s strategy to manage cash balances is they are included with the firm’s actual cash when reporting their cash holding on the balance sheet. 9. Why is the $1,000 you receive today worth more than $1,000 you receive next year? What concept does this illustrate? Why is this concept particularly important when firms evaluate capital budgeting proposals? The $1,000 you receive today is worth more than $1,000 you receive next year because the sooner you receive a sum of money, the sooner you can put that money to work to earn even more money. The concept that this illustrates is time value of money, the principle that a dollar received today is worth more than a dollar received in the future. This concept is particularly important when firms evaluate capital budgeting proposals because these cash flows are likely to be negative at the start of a project. 10. What is the net present value (NPV) of a long-term investment project? Describe how managers use NPVs when evaluating capital budget proposals. The net present value (NPV) of a long-term investment project is the sum of the present values of expected future cash flows from an investment, minus the cost of that investment. The NPV of an investment proposal is found by adding the present values of all its estimated future cash flows and subtracting the initial cost of the investment from the sum. Managers use NPVs when evaluating capital budget proposals by using them to decide with to approve projects. If a proposal has a positive NPV, managers will approve it and if proposals have a negative NPV, managers will reject them.

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Sanchez 6 1. You recently opened a natural foods company that specializes in organic ingredients sourced from farms just a few hours away from your factory. Sales have been surprisingly brisk, and a very large company wants to purchase 50 percent of your company for $25 million. The problem? Your potential investor is one of the largest snack foods companies in the world and doesn’t much care for your organic, natural image. Would you accept the offer or not, and why? With the provided output such as farms being nearest to the factory, company having a reputation for specialized in organic ingredients, investor who is interested in buying the firm doesn't care for the organic reputation or the other way that he's not willing to pay off goodwill probably, also last but not least the investor is a strong opponent and a competitor who can pull off the other 50% of firm after acquiring the proposed 50% of firm, one wouldn't want to accept if the firm valuation is worth more than a $25 million. Company's valuation, mission, vision, integrity, reputation of organic and natural image, and also the factory located nearby the source should be considered while evaluating the offer to be accepted or not. Sales could be slow for one time to another, but losing the entire enterprise value to some competitor wouldn't solve the problem, unless there is a consistent drop in the sales and revenue growth or the company is in distress. New companies could face a lot of problems in the starting years but with the right amount of cash and goodwill it can always push it's limits off and can pull itself to the growth stage of a company. 2. Choose a company and obtain a copy of its most recent annual report. (In most cases, you can access annual reports simply by clicking on the link for investors, usually found on the company’s home page. You can also try the IRIN Annual Report Resource Center at www.irin.com, or Annual Reports.com at

Sanchez 7 http://www.annualreports.com.) Using the financial statements, calculate three of the ratios described in this chapter. What conclusions can you draw from these ratios about the company’s financial strengths and weaknesses? U.S. Bancorp, a financial services holding company, provides various banking and financial services in the United States. The company’s Financial Ratios on returning on average assets of 1.55% 1.39% 1.36%. The return on average common equity is 15.4 13.8 13.4. The Net interest margin (taxable-equivalent basis) 3.14 3.10 3.04. Efficiency ratio of 55.1 58.5 54.5. The Company earned $7.1 billion in 2018, an increase of $878 million (14.1 percent) over 2017, principally due to total net revenue growth, lower noninterest expense and the impact of the Tax Cuts and Job Act (“tax reform”) enacted by Congress in late 2017. Net interest income increased as a result of the impact of rising interest rates on assets, earning assets growth, and higher yields on the reinvestment of securities, partially offset by higher rates on deposits and changes in funding mix. The Company’s continued focus on controlling expenses allowed it to achieve an industry-leading efficiency ratio of 55.1 percent in 2018. In addition, the Company’s return on average assets and return on average common equity were 1.55 percent. 3. You are the owner of a small landscaping company. Usually, business is always good in the spring and summer, leaving enough resources to ride out the slow winter. But the revenue from last summer was unusually slow due to a severe drought, leading to less business than usual in the fall, and causing a cash shortage this winter. You need a short-term injection of cash so that you can maintain equipment, pay employees, and keep your company going for a few months until spring arrives. Which of the options for short-term financing discussed in the text would you choose and why?

Sanchez 8 The options for short term financing that I would choose would be short term bank loans. I would choose these because it's clearly a case of short term cash flows mismatch, hence i will go for short term bank loan in the form of cash credit or a line of credit, a revolving credit agreement. It would be unsecured and easy to obtain, less cumbersome, less time consuming. This option is cheaper than trade credit, and factoring. The process is less oriented than issuance of commercial paper. Finally, it doesn't put pressure on the owners' pocket as other options would. 4. Your small company has $25,000 in surplus cash right now. You don’t want to commit these funds to any long-term investments because you know of some expenses coming up in about eight months that will require the use of this cash. But you would like to find some safe, liquid interest-earning investments where you could park your cash until it is needed. You’ve decided that T-bills and money market mutual funds are your best options, but you want to find out more about both. Use the Internet to do some research about these cash equivalents, and then answer the questions below. ● How do you purchase T-bills? If you want to invest in T-bills, what is the minimum amount you can invest? Can you sell these bills before they mature? How do you receive the interest on T-bills? What is the interest rate earned on the most recent T-bills? You can purchase treasury bills at a bank, through a dealer or broker, or online from a website like TreasuryDirect. The bills are issued through an auction bidding process, which occurs weekly. Treasury bills are now issued only in electronic form, though they used to be paper bills. Bills are sold in increments of $100. The minimum purchase is

Sanchez 9 $100. All bills except 52-week bills and cash management bills are auctioned every week. You can hold Treasury bills until they mature or sell them before they mature. To sell a bill you hold in TreasuryDirect or Legacy Treasury Direct, first transfer the bill to a bank, broker, or dealer, then ask the bank, broker, or dealer to sell the bill for you. The rates currently range from 0.09% to 0.17% for T-bills that mature from four weeks to 52 weeks. ● How do you purchase money market mutual funds? How do these funds differ from money market accounts? What are the different types of money funds? Are there any drawbacks to investing in these funds? A money market fund is a kind of mutual fund that invests in highly liquid, near-term instruments. These instruments include cash, cash equivalent securities, and high-credit-rating, debt-based securities with a short-term maturity (such as U.S. Treasuries). The most important difference between a money market account and a money market fund is that the first is a risk-free deposit and the second is an investment product that is not free of risk. ● Investigate two specific money market mutual funds. What interest rate does each currently offer is the minimum required investment for each? Based on your research, how much of the $25,000 would you invest in T-bills and how much in money market mutual funds? Why? Of the $25,000, I would invest $15,000 in money market mutual funds and $5,000 in T-bills. T-bills are issued by the U.S. government and are considered among the safest investments in the world, so risk should never be a significant deterrent. However, the return on T-bills is typically quite low when compared to other types of securities, such

Sanchez 10 as stocks, bonds, and mutual funds. With no maturity date, one of the main benefits of a money market account is its liquidity, Denney says. This comes in handy if you want to set up an account that earns interest and where the cash is accessed easily, like an emergency fund, or, if you're lucky, a splurge fund. 5. Suppose that soon after earning your bachelor’s degree you are accepted into an MBA program at a prestigious university. It is an intensive program that would require you to be a full-time student for about eighteen months. What are the major financial costs and benefits of enrolling in this program? (Hint: be sure to consider not just the out-of-pocket costs, but also any other financial sacrifices you might have to make if you became a full- time student.) Describe how you could evaluate whether enrolling in this program is a good financial decision. (Hint: Keep in mind that the benefits of your education will be in the form of higher cash flows over your entire career.) The expenses when choosing the MBA option would lead to an opportunity cost of loss of salary. Due to being a full-time student, it would be almost impossible to keep a full time job. The annual tuition would range about $60,000 assuming it is a public university. Books and supplies would seemingly be about $3,000 per year. Some colleges require health insurance which would be around $6,000. If living on campus, room and board for one year would be about $5,000. If living off campus, this could range from 3,000 - $4,000. If the college is not in your state/city, this would require moving expenses at around $2,000. However, in the long run, this would have its benefits. There are sign on bonuses on new jobs at about $20,000. In a year, your salary could possibly increase to $100,000 or by 4.50%. In my opinion, I would take the risks and financial costs and enroll for an MBA after my bachelor’s degree.

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