FIN Chapter 1&2 Notes - Intro to Financial Management, Finance, Investments, Sole Proprietorship, Partnership, PDF

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Intro to Financial Management, Finance, Investments, Sole Proprietorship, Partnership, Corporation, Chapter 1 Questions, Practice Problems/Quiz, Financial Statements, Taxes and Cash Flows...

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1/22/2021 Chapter 1 Intro to Financial Management Finance - The study of how economic agents, raise, allocate, and use monetary resources over time, taken into consideration the risk entailed in their endeavors - Every event has its own risk Basic areas of finance 1. Corporate finance = business finance 2. Investments 3. Financial institutions 4. International finance Investments - Work with financial assets such as stocks and bonds - Value of financial assets, risk versus return, and asset allocation - Job opportunities - Stockbroker or financial advisor - Portfolio manager - Security analyst Financial Institutions and Markets - The study of the role of financial institutions and markets - Market Microstructure - Economics of intermediation - Risk Management Financial Institutions - Companies that specialize in financial matters - Banks - commercial and investment, credit unions, savings and loans - Difference between commercial and investment banking - Investment banks underwrite new debt and equity securities, help with selling securities, and drive mergers and acquisitions, reorganizations, and broker trades. Commercial banks make loans to people and small businesses and offer checking and savings accounts and certificates of deposit - Insurance companies - Brokerage firms Corporate Finance - The study of financial decisions made by corporations and the methods and analyses used to arrive at these decisions - Risk and Return

- Capital Budgeting - Capital Structure - Dividend Policy - Working Capital Management International Finance - An area of specialization within each of the areas discussed so far - May allow you to work in other countries or at least travel on a regular basis - Need to be familiar with exchange rates and political risk - Need to understand the customs of other countries; speaking of foreign language fluently is also helpful Finance is important because every part of a business has something to do with money Why study finance - Economic decision made by firms - What to produce - How to produce - For whom to produce - Economic decision shape overall business strategy - Production strategy - Financial strategy - Marketing strategy - Some important questions that must be answered when crafting strategies - What long-term investment should the firm take on? - Capital budgeting - Where will we get the long-term financing to pay for the investment? - Capital structure - How will we manage the everyday financial activities of the firm? - Working Capital Management Forms of Business Organization - Three major forms in the US - Sole proprietorship (most popular) - Mom and Pop stores - Partnership - General - Limited - Corporation - S-Corp - Limited liability company

Sales-COGS=EBIT-int.=EBT-tax=Net Income (Retained EBITEarnings, Dividends) Dividends $10,000/tax EBT is Earning Before Tax

1/27/2021 Sole Proprietorship - Business owned by one person - Advantages - Easiest to start - Least regulated - Single owner keeps all the profits - Texed once as personal income - Disadvantages - Limited ot life of owner - Equity capital limited to owner’s personal wealth - Unlimited liability - Difficult to sell ownership interest Partnership - Business owned by two or more persons - Advantages - Two or more owners - More capital available - Relatively easy to start - Income taxed once as personal income - Disadvantages - Unlimited liability - General partnership - Limited partnership - Partnership dissolves when one partner dies or wishes to sell - Can choose to sell company or continue as sole proprietorship - Difficult to transfer ownership

Corporation - A legal “person” distinct from owners and a resident of a state - Advantages - Limited liability - Unlimited life - Separation of ownership and management - Transfer or ownership is easy - Easier to raise capital - Disadvantages - Separation of ownership and management (agency problem) - Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible) Goal of Financial management - What should be the goal of a corporation? - Maximize profit for owner (shareholders) - Minimize costs - By firing all the workers you are working at minimum costs, but this is not a good idea - Maximize market share - Increase price of stock - Maximize current value per share of the companies existing stock in long term - Maximize the market value of the existing owners’ equity - Does this mean we should do anything and everything to maximize owner wealth? - Outsourcing? - Off-shoring? - Corporate support of charities? - SOX? Principal Agent Problem - Agency relationship - Principal hires an agent to act in its (principal) interests - In a corporation - Stockholders (principals) hire managers (agents) to run the company on their behalf - Agency problem - Conflict of interest between principal and agent - Occurs when management goals differ from shareholder interest Do Managers Act in the Shareholders’ Interests? - Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders) - But the following factors affect managerial behavior:

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Managerial compensation packages - Deferred compensation? - Direct intervention by shareholders - The threat of firing - The threat of takeover McGraw Hill Chapter 1 Questions https://quizlet.com/227635937/finance-ch-1-flash-cards/ 1. Uptown Markets is financed with 45% debt and 55% equity. This mixture of debt and equity is referred to as the firm’s a. Capital structure b. Capital budget c. Asset allocation d. Working capital e. Risk structure 2. Margie opened a used bookstore and is both the 100% owner and the store’s manager. Which type of business entity does Margie own if she is personally liable for all the store's debts? a. Sole proprietorship b. Limited partnership c. Corporation d. Joint stock company e. General Partnership 3. The potential conflict of interest between a firm’s owners and its managers is referred to as which type of conflict? a. Organizational b. Structural c. Formative d. Agency e. Territorial 4. Capital budgeting includes the evaluation of which of the following? a. Size of future cash flows only b. Size and timing of future cash flows only c. Timing and risk of future cash flows only d. Risk and size of future cash flows only e. Size, timing, and risk of future cash flows 5. A corporation: a. Is ultimately by its board of directors b. Is a legal entity separate from its owners c. Is prohibited from entering into contractual agreements d. Has its identity defined by its bylaws

e. Has its existence regulated by the rules set forth in its charter 6. Which one of the following is contained in the corporate bylaws? a. Procedures for electing corporate directors b. State of incorporation c. Number of authorized shares d. Intended life of the corporation e. Business purpose of the corporation 7. A limited liability company (LLC): a. Is a hybrid between a sole proprietorship and a partnership b. Prefers its profits be taxed as personal income to its owners c. That meets the IRS criteria to be an LLC will be taxed like a corporation d. Provides limited liability for some, but not all, or its owners e. Cannot be created for professional service firms, such as accountants and attorneys 8. Limited liability companies are primarily designed to: a. Allow a portion of their owners to enjoy limited liability while granting the other portion of their owners control over the entity b. Provide the benefits of the corporate structure only to foreign-based entities c. Spin off a wholly owned subsidiary d. Allow companies to reorganize themselves through the bankruptcy process e. Provide limited liability while avoiding double taxation 9. The primary goal of financial management is most associated with increasing the: a. Dollar amount of each sale b. Traffic flow within the firm’s stores c. The fixed costs while lowering the variable costs d. Firm’s liquidity e. Market value of the firm 10. You contacted your stock broker this morning and placed an order to sell 300 shares of a stock that trades on the NYSE. This sale will occur in the: a. Dealer market b. Over-the-counter market c. Secondary market d. Primary market e. Tertiary market Chapter 1 Practice Problem/Quiz 1. Jenna has been promoted and is now in charge of all external financing. In other words, she is in charge of a. Capital structure management 2. Which one of the following is an advantage of being a limited partner? a. Losses limited to capital investment

3. Which one of the following statements about a limited partnership is correct? a. There must be at least one general partner 4. A corporation: a. Is a legal entity separate from its owners 5. One advantage of the corporate form of organization is the: a. Ability to raise larger sums of equity capital than other organizational forms 6. Corporate shareholders a. Have the ability to change the corporation’s bylaws 7. A limited liability company(LLC) a. Prefers its profits be taxed as personal income to its owners 8. Limited liability companies are primarily designed to: a. Provide limited liability while avoiding double taxation 9. The primary goal of financial management is to maximize: a. The market value of existing stock 10. The primary goal of financial management is most associated with increasing the: a. Market value of the firm 11. Which one of the following situations is most apt to create an agency conflict? a. Basing management bonuses on the length of employment 12. Margie opened a used bookstore and is both the 100 percent owner and the store's manager. Which type of business entity does Margie own if she is personally liable for all the store's debts? a. Sole proprietorship 13. An agency issue is most apt to develop when: a. The control of a firm is separated from the firm’s ownership 14. One example of a primary market transaction would be the: a. Sale of 100 shares of stock by Maria to her best friend (INCORRECT) b. Sale by Terry of 50,000 shares of stock to his brother c. Sale of 5,000 shares of stock owned by a corporate CEO to his son d. Purchase by Teho of 5,000 shares of stock from his father e. Sale of 1,000 shares of newly issued stock by Alt Company to Miquel 15. You contacted your stock broker this morning and placed an order to sell 300 shares of a stock that trades on the NYSE. This sale will occur in the: a. Secondary market 16. Security dealers a. Buy and sell from their own inventory 17. An auction market a. Has a physical trading floor 18. Which of the following statements is correct a. NASDAQ has the most stringent listing requirements of any US exchange (INCORRECT)

b. NASDAQ is an auction market c. NASDAQ has more listed stocks than does the NYSE d. The NYSE is a dealer market e. The trading flood for the NASDAQ is located in Chicago 19. Matt and Alicia created a firm that is a separate legal entity and will share ownership of that firm on a 75/25 basis. Which type of entity did they create if they have no personal liability for the firm's debts? a. Corporation 20. The shareholders of Weil’s Markets would benefit if the firm were to be acquired by Better Foods. However, Weil’s board of directors rejects the acquisition offer. This is an example of: a. An agency conflict 21. Jamie is employed as a currency trader in the Japanese yen market. Her job falls into which one of the following areas of finance? a. International finance 22. If you accept a job as a domestic security analyst for a brokerage firm, you are most likely working in which one of the following financial areas? a. Investments 23. A sole proprietorship a. Has its profits taxed as personal income 24. Which one of the following forms of business organization offers liability protection to some of its owners but not to all of its owners? a. Limited partnership 25. Which one of the following statements correctly applies to a sole proprietorship? a. Obtaining additional equity is dependent on the owner’s personal finances The primary goal of financial management is to maximize - The market value of existing stock in the long run

Chapter 2 Financial Statements, Taxes and Cash Flows The Balance Sheet - A snapshot of the firm’s assets and liabilities at a given point in time(“as of…”) - Assets - Left-hand side (or upper portion) - In order of decreasing liquidity (how fast you can turn assets into cash without losing its significant value) - Liabilities and Owners’ equity - Right-hand side (or lower portion) - In ascending order of when due to be paid - Balance sheet identity - Assets = liabilities + stockholders’ equity

SHS approves of using debt to raise capital. Why? - % of share ownership - Tax benefit - Sales - COGS= EBIT - Int. exp. = EBT (Earnings before tax) - tax exp. = Net income Financial Leverage - the use of debt will result in the multiplication or exponential increase Risk averse - disinclined or reluctant to take risk

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Net working Capital

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- Current assets minus current liabilities - Usually positive for a healthy firm Liquidity - Speed and ease of conversation to cash without significant loss of value

2/3/2021 Market vs. Book value - Book value - the balance sheet value of the assets, liabilities, and equity - The value in the past - Market value - true value; the price at which the assets, liabilities, or equity can actually be bought or sold - Subtracting depreciated value from the book value - Market value and book value are often very different. Why? - Brand name, - Which is more important to the decision-making process? Income statement - The income statement measures performance over a specified period of time (period, quarter, year) - Report revenues first and then deduct any expenses for the period - End result = Net income = Bottom lone - Dividends paid to shareholders - Addition to retained earnings - Income statement equation - Net income = revenue - expenses Comments on Income statement - GAAP matching principle - Recognize revenue when it is fully earned - Match expenses required to generate revenue to the period of recognition - Noncash items - Expenses charged against revenue that do not affect cash flow - Depreciation = most important - Time and costs - break even point : break even = Fixed cost/(sales per unit-variable cost per unit) or revenue per unit - Fixed or variable costs

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- not obvious on income statement Earnings management - Smoothing earnings - GAAP leaves “wiggle room” - Company A in 2019 has -2% return on investment 2020 has 6% return on investment - Company B in 2019 has 2% return on investment - 2020 has 2% return on investment - Would choose company A because they show they can accumulate an 8% increase so they would probably increase more within the next year - However there is always the possibility that it will go down as well - Would choose company B because it shows steady return on investment

Taxes - If considering a project that will increase taxable income by $1million which tax rate should you use in your analysis - Marginal vs. Average tax rates - Marginal - % tax paid on the next dollar earned - Average - total tax bill/taxable income Example: Marginal vs. Average rates - Suppose your firm earns $4million in taxable income - What is the firm’s tax liability? - What is the average tax rate? - What is the marginal tax rate?

Performance Measures for Evaluating Managers - MVA (Market Value Added) - = Difference between market value and book value of a firm’s common equity - = MVE-BE - = (Price of stock x # shares outstanding) - BE - EVA (Economic Value Added) - = Estimate of firm’s true economic profit - = EBIT (1-T) - (Investor-supplied capital x cost of capital) - For 2011 Everyday Electronics reported $22.5 million of sales and $18 million of operating costs (including depreciation). The company has $15 million of investor-supplied operating capital. Its weighted average cost of capital is 9% and its federal-plus-state income tax rate is 35%. Current stock price is $25 and there are 2

million shares outstanding. Total value of common equity on the Balance sheet is $47million - MVA = MVE - BVE = ($25 x 2million)-$47 million = $3million - What is the firms (MVA and EVCA? - EVA= EBIT (1-T)- (capital x WACC_ - 4.5x (1-0.35) - ($15 mil x 0.09) = $1.575 million The Concept of Cash Flows - Cash flow = one of the most important pieces of information that can be derived from financial statements - The accounting Statement of Cash Flows does not provide the same information that we are interested in here - Our focus: how cash is generated from utilizing assets and how it is paid to those who finance the asset purchase Cash Flow From Assets - Cash Flow From Assets (CFFA) Asset Side - = Operating Cash Flow (OCF) - - Net capital Spending (NCS) - - Changes in NWC ( Change NWC) - Cash Flow From Assets (CFFA) Liability Equity side - = Cash Flow to Creditors (CF/CR) - net amount - + Cash Flow to Stockholders (CF/SH) - net amount - A=L+E (TRUE) - otherwise the balance sheet is not balanced

OCF = 694+ 65-212 = 547 NCS = (1709-1644) +65=130

Changes in NWC = (1403-389)-(1112-428)= 330 CFFA = 547-130-330 = $87 The $87 is good because what is generated is greater than what you spent to purchase the asset. It can generate $87 after using money to purchase the asset. Meaning the company is performing well. If the number is positive that means the company is performing well.

CFC (NET)= 70 - (454-408) = 24 CFS(NET) = 103 - (640-600) = 63 CFFA = 24+63 = $87

Answer: $16,452 Computations in notebook

answer: $18,319 Computations in notebook

1. Net working capital is defined as: a. Total assets minus total liabilities b. Available cash minus current liabilities c. The depreciated book value of a firm’s fixed assets d. The value of a firm’s current assets e. Current assets minus current liabilities 2. Donut Delite has total assets of $31,300, long-term debt of $8,600, net fixed assets of $19,300, and owners' equity of $21,100. What is the value of the net working capital? a. 10,4000 b. 23,2000 c. 9,800 d. 21,300 e. 18,900 3. Marcie’s has sales of $179,600, depreciation of $14,900, costs of goods sold of $138,200, and other costs of $28,400. The tax rate is 35 percent. What is the net income? a. 1,204 b. 382 c. 13,665

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d. -1,235 e. 14,660 Holly Farms has sales of $509,600, costs of $448,150, depreciation expense of $36,100, and interest paid of $12,400. The tax rate is 28 percent. How much net income did the firm earn for the period? a. 9,324 b. 5,886 c. 7,778 d. 10,380 e. 8,671 The Plaza Cafe has an operating cash flow of $83,770, depreciation expense of $43,514, and taxes paid of $21,590. A partial listing of its balance sheet accounts is as follows: What is the amount of the cash flow from assets? a. 47,949 b. 43,909 c. 61,487 d. 35,953 e. 26,359 Outdoor Sports paid $12,500 in dividends and $9,310 in interest over the past year. Sales totaled $361,820 with costs of $267,940. The depreciation expense was $16,500 and the tax rate was35 percent. What was the amount of the operating cash flow? (Nearest $) a. 57,556 b. 65,306 c. 64,232 d. 70,056 e. 70,568 Andre's Dog House had current assets of $67,200 and current liabilities of $71,100 last year. This year, the current assets are $82,600 and the current liabilities are $85,100. The depreciation expense for the past year is $9,600 and the interest paid is $8,700. What is the amount of the change in net working capital? a. 1,400 b. -2,800 c. 2,100 d. 2,800 e. -1,400 A firm has earnings before interest and taxes of $27,130, net income of $16,220, and taxes of $5,450 for the year. While the firm paid out $31,600 to pay off

existing debt it then later borrowed $42,000. What is the amount of the cash flow to creditors? a. -14,040 b. 14,040 c. 4,940 (not this one) d. 0 e. -4,940 9. The balance sheet of Binger, Inc. has the following balances:What is the amount of the change in net working capital? a. 1,800 (not this one) b. -7,400 c. 8,100 d. ...