Fina study guide exam 1 - review for the exam PDF

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CHAPTER 1 1.1-Finance and the Financial Manager (T) Finance is the art and science of managing money. Who is a financial manager? (Anyone whose decisions affect the cash flows of the firm.) 1.2-The Corporate Form of Business Organization What are the advantages of the corporate form of business organization? ● Perpetual life ● Easy transfer of ownership ● Ease of raising additional funds 1.2.1 Quiz - Limited Liability (T) Limited liability means that owners of a business are not personally liable for all of its debts – owners can only lose the lessor of the value of their investment or $100,000. 1.2.2 Quiz - Corporate Ownership and Control (T) Shareholders get any assets or cash flows of the corporation that remain after all other debts have been paid. We can think of equity as a degree of ownership in any asset after subtracting all debts associated with that asset. Shareholder equity is calculated as Total Assets minus Total Liabilities Assets (F) By law, the board of directors makes decisions as a fiduciary on behalf of company executives. (T) The board makes decisions concerning the hiring and firing of personnel, dividend policies and payouts, and executive compensation. 1.2.3 Quiz-Agency Problems (T) The separation of ownership (shareholders) and control (managers) in larger corporations with many shareholders can lead to conflicts of interest between managers and owners. 1.2.3.1 - Agency Cost Example - Corporate Scandals 1 According to the video - it took Enron 16 years to grow from a $10 billion company to a $64 billion company and 24 days to go bankrupt According to the video - The other thing about people at Enron is a lot of them were former nerds

1.2.3.2 Quiz - Agency Cost Example - Corporate Scandals 2 The CEO of Audi was arrested in connection with the investigation Audi cheated on emissions tests. After viewing the three videos, what would you tell your daughter? Conflicts of interest can lead managers to act in ways that can destroy shareholder value. 1.2.3.3 Quiz - Agency Cost Example - Corporate Scandals 3 Tyco CEO Dennis Kozlowski spent $2 million on his wife's 40th birthday party. Tyco paid 1/2 of the bill, which is an example of an agency cost. Future President of the United States Donald trump called his behavior Tacky 1.3 - Alternative forms of business organization Amazon and Walmart are examples of corporations because they are controlled by managers acting as agents for shareholders who have limited liability 1.4 Quiz - The goal of corporate finance: maximizing returns to shareholders The goal of maximizing shareholder wealth can be expressed in several equivalent ways (select all correct answers) ● ● ●

Maximizing the long-term value of stock Maximizing shareholder returns Maximizing the market capitalization of the firm

Profit maximization may not lead to the highest possible share price because (check all correct) ● ● ●

Profit maximization fails to account for risk – extremely profitable opportunities may be too risky. Profits do not necessarily result in cash flows available to stockholders. There is a difference in accounting values and cash flows. Timing is important—the receipt of funds sooner rather than later is preferred. Time is money!

(F) Shareholders are also known as the residual owners of the firm's cash flows - they only get paid after other stakeholders are content.

What does the author of the article get wrong about maximizing shareholder value? ● ● ●

creating shareholder value requires creating value for customers. confuses shareholder wealth maximization goals with greed does not acknowledge shareholders are residual owners of cash flows 1.5.2 Quiz-Capital Structure

Once a firm decides to accept a project, then the financial manager must decide where to get the money to pay for the project. Funding for a project can be simplified from ● ●

Debt Equity 1.5.3 Quiz - Working Capital Management

The difference between ... and ... is referred to as Net Working Capital short term assets/short-term liabilities 1.7 Quiz - Business Finance in the Real World BNSF projects must be expected to earn at least what rate of return to be funded (implemented)? 9% CHAPTER 2 2.1 Quiz - Financial Markets Intro. Why do firms need the financial system? ● ● ●

to facilitate short term cash management policies to obtain long term funds accommodate near term cash inflows and outflows

What is the hurdle rate? the cost of financing (T) Financial institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments. (F) Investment banks make loans that individuals and businesses use to buy goods or expand business operations, which in turn leads to more deposited funds that make their way to bank (F) The capital market is where firms obtain external short term financing. (F) The shadow banking system has escaped regulation primarily because it does not accept traditional bank deposits. As a result, many of the shadow banking institutions have been able to employ higher market, credit and liquidity risks, and have higher capital requirements.

2.2 Quiz - Market Efficiency (T) From investors’ perspectives, the role of capital markets is to be an efficient market that allocates funds to their most productive uses. A liquid market - has many available buyers and sellers and comparatively low transaction costs Francis Galton's discovery was a diverse collection of independently deciding individuals is likely to make better value decisions than individuals or even experts (T) An efficient market allocates funds to their most productive uses as a result of competition among wealth-maximizing investors and determines and publicizes prices that are believed to be close to their true value. 2.3 Quiz - Markets in Crisis As described in "The 2008 Credit Crisis Visualized," the financial system, commonly known as Wall Street, brings together Investors and homeowners (borrowers) As described in "The 2008 Credit Crisis Visualized," low interest rates incentivized banks to increase leverage Financial leverage is borrowing money to amplify the outcome of a deal (T) A collateralized debt obligation (CDO) bundles house payments and creates safe, okay, and risky investment vehicles. (T) From" The Inside Job" trailer - One criticism leveled at investment banks following the 2008 financial crisis was they were having massive private gains at the expense of public losses. From "The Big Short," the antagonists (those betting against the big banks) individually or together ● ● ●

argued fraud has never worked (long term) argued there is no diffference between stupid and illegal sought to profit from the greed and stupidity of big bank CHAPTER 3 3.1.1 Quiz - Accounting and Finance

(F) Finance is mainly a backward-looking summary of past decisions. 3.1.2 Quiz- Book Values and Market Values (F) The market value of an assets is its cost at the time of purchase

(F) Book values have the disadvantage that they change unpredictably and may not be easy to measure.

3.2.1 Quiz - Structure of an Income Statement Revenues or Sales - Expenses

←money received by the firm ← debts to suppliers and employees

- ??? ← accounting item to estimate a reduction in the value of an asset with the passage of time, due in particular to wear and tear = EBIT

←Earnings before Interest and Taxes

- Interest Expense

← Money owed to banks or bondholders

= EBT

←Earnings before taxes

- Tax

← debt to the government

= Net Income

←Net Income

Depreciation Expense 3.2.2 Quiz - Walmart’s Income Statement What is Walmart's revenue in 2018 (in millions)? (Enter the answer in dollar format without $ sign or thousands comma -> 3519.23 and not $3,519.23 or 3,519.23) 500,343 (revenue is listed on income statement) 3.2.3 Quiz - Depreciation Select all the different methods that can be used to compute depreciation expense ● ● ●

Straight-line Depreciation Modified Accelerated Cost Recovery System (MACRS) Accelerated Cost Recovery System (ACRS)

(F) Depreciation represents a change in cash holdings so it impacts earnings after taxes. 3.2.4 Quiz - Taxes The top corporate tax rate is ... percent for 2018 and after. 21 Here are the U.S. tax rates and their corresponding tax brackets based on filing status for single individuals (i.e. not corporations) If taxable income is:

Then income tax equals:

Not over $9,875

10% of the taxable income

Over $9,875 but not over $40,125

$987.50 plus 12% of the excess over $9,875

Over $40,125 but not over $85,525

$4,617.5 plus 22% of the excess over $40,125

Over $85,525 but not over $163,300

$14,605.5 plus 24% of the excess over $85,525

Over $163,300 but not over $207,350

$33,271.5 plus 32% of the excess over $163,300

Over $207,350 but not over $518,400

$47,367.5 plus 35% of the excess over $207,350

$156,235 plus 37% of the excess over $518,400

Over $518,400

Layla's taxable income for 2019 was $167,518. How much are her federal income taxes to the nearest dollar? Do not enter $ sign or thousands comma -> 1000 and not $1,000 34,621 So if the taxable income is $167,518 you will look at the row on the table that is over $163,300 and under $207,350. You will first subtract $167,518-163,300. You take that number and times it by 32% (given) Then you add that number to $33,271.5 (given) for your answer. 3.2.5 Quiz - Operating Cash Flow Operating Cash Flow (OCF) = X – Y+ Z

X: EBIT Y: taxes Z: depreciation (F) Net income is determined by accounting items such as depreciation and represents actual changes in the cash available to a firm. What was Walmart's operating cash flow in 2014 (in millions)? $27,567

= EBIT or Operating Income ($26,872) - taxes (pretax income-income tax benefit/$8,105) + depreciation expense ($8,800) = $27,567 3.3.1 Quiz - Structure of the Balance Sheet The Balance Sheet shows both the assets of a firm and how those assets were financed. The left-hand side of the balance sheet lists - everything that a firm has (the firm’s assets) The right-hand side of the balance sheet lists - how those assets were originally paid for - either through contributions by the owners (equity) or with borrowed money (debt). Current Assets - Cash, Accounts Receivable, Inventory Current Liabilities-Accounts Payable, Notes Payable 3.3.2 Quiz - Walmart’s Balance Sheet What is Walmart's Total Assets for the year of 2019? (in millions) $219,295 (listed on balance sheet) 3.4 Quiz - Common Size Financial Statements What is the percentage of total current assets in terms of total assets for Walmart for the year of 2016? (Answer in number format with % unit - for example, 25.6%) 30.2% (listed on statement under total current assets) 3.5.1 Quiz - Liquidity Ratios Which of these are liquidity ratios? ● ● ●

Current Ratio Cash Ratio Quick Ratio

(T) Liquidity is the ability to convert assets into cash quickly and cheaply.

(F) The purpose of liquidity ratios is to determine a company's ability to pay off current debt obligations by raising external capital.

(F) Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the cash ratio, the quick ratio, the water ratio, and the current ratio 3.5.1 Quiz - Liquidity Ratios for Walmart What is Walmart's cash ratio for the year of 2018? cash ratio = cash(cash & cash equivalents)/current liabilities 6,256/7,8501=0.086~0.09 What is Walmart's Quick ratio for the year of 2018? quick ratio = (cash + accounts receivable)/current liabilities 6756+5614/78521 = 0.158 0.158 What is Walmart's current ratio for the year of 2018? current ratio = current assets/current liabilities 59664/78521 = 0.759~0.76 3.5.2 Quiz - Leverage Ratios Which of these are leverage ratios? ● ● ● ●

Debt/Equity Ratio Equity Multiplier Long-term Debt Ratio Debt Ratio

(T) Leverage may increase both the risk and the return to a firm’s shareholders. 3.5.2 Quiz - Leverage Ratios for Walmart What is Walmart's debt ratio (Total liabilities/Total Assets) for the year of 2018? 0.605 What is Walmart's Equity Multiplier for the year of 2018? equity multiplier = total assets/total equity (equity before minority interest) 2.626 What is Walmart's EBIT for the year of 2018? EBIT= net income + net income attributable to noncontrolling interest + income taxes + interest expense ("Interest Expense Net" plus "Interest Income" ) 17,101

What is Walmart's Times Interest Earned Ratio for the year of 2018? times interest earned ratio = EBIT/interest expense 8.646 What is Walmart's Cash Coverage Ratio for the year of 2018? cash coverage ratio = (EBIT + depreciation)/interest expense 13.953 3.5.3 Quiz - Turnover Ratios Which of these are Turnover ratios? ● ● ● ●

Receivables turnover Days sales in inventory Total asset turnover ratio Inventory turnover ratio

(T) Firms with higher turnover ratios are generally more operationally efficient than firms with lower turnover ratios. 3.5.3 Quiz - Turnover Ratios for Walmart What is Walmart's inventory turnover ratio for the year of 2018? Inventory turnover ratio = cogs/inventory 373396/43783 =8.528 What is Walmart's Days’ Sales in Inventory ratio for the year of 2018? days sales in inventory = 365/inventory turnover ratio 42.8 What is Walmart's Total Asset Turnover Ratio ratio for the year of 2018? total asset turnover ratio = sales(revenue)/average total assets 500343/(204522+198825)/2) =2.481

3.5.4 Quiz - Profitability Ratios Which of these are profitability ratios? ●

Net profit margin

● ●

ROE ROA

(F) Profitability ratios give measures of how the firm’s accounting measures of profits are related to its other accounting items. A Profit Margin is the firm’s profit per dollar of assets and there are three main profit margin measures

3.5.4 Quiz - Profitability Ratios for Walmart What is Walmart's net profit margin for the year of 2018? Net profit margin = net income/sales (revenue) 1.97 What is Walmart's ROA for the year of 2018? ROA = net income/total assets 4.82 What is Walmart's ROE for the year of 2018? ROE = net income/total equity (equity before minority interest) 12.66 3.5.5 Quiz - Market Value Ratios Which of these are market ratios? ● ● ● ●

Market capitalization p/e ratio Market-to-book ratio Earnings per share

(T) The market value of healthy companies exceeds their book value. After all, if managers are not creating value investors will close the business and liquidate (sell) the assets and be better off. 3.5.6 Quiz - Payout and Growth Rates Which are payout and growth rate ratios? ● ● ● ●

Dividend Payout Ratio Sustainable Growth Rate Internal Growth Rate Retention Ratio

3.5.6 Quiz - Payout and Growth Rates for Walmart (REVIEW) Walmart's Dividend Payout Ratio for the year of 2018? Dividend payout ratio = dividends (total cash common dividends)/net income 62.1 Walmart's Sustainable Growth Rate for the year of 2018? = ROE*Retention Ratio (addition to retained earnings/net income) or 1 - dividend payout ratio 4.8 3.6 Quiz - Berkshire Hathaway According to the letter to shareholders in Berkshire Hathaway's 2019 Annual Report, Berkshire seeks to buy new businesses that ● ● ●

earn good returns on the net tangible capital required in their operation are run by able and honest managers are available at a sensible price Chapter 3 Formulas

1) Liquidity Ratios Cash Ratio = Cash/Current Liabilities (3.5.1a) Quick Ratio=(Cash + Accounts Receivable)/Current Liabilities = (Current Assets - Inventory)/Current Liabilities(3.5.1b) Current Ratio = Current Assets/Current Liabilities(3.5.1c)

2) Leverage Ratios Debt Ratio=Total Liabilities/Total Assets (3.5.2a); Debt Ratio = Debt/Equity 1+(Debt/Equity)=Debt ratio /1−Debt ratio Long-term Debt Ratio= Long-term debt/Total Assets(3.5.2b) Debt/Equity Ratio = TotalLiability/Total Equity (3.5.2c) Equity Multiplier = Total Assets/Total Equity(3.5.2d) Times Interest Earned Ratio = EBIT/Interest Expense (3.5.2e)

Cash Coverage Ratio = (EBIT+Depreciation)/Interest Expense (3.5.2f)

3) Turnover Ratios Inventory Turnover Ratio =Cost of Goods Sold/Inventory (3.5.3a) Days’ Sales in Inventory = Inventory Period = 365/Inventory Turnover Ratio (3.5.3b) Receivables Turnover = Credit Sales/Accounts Receivable (3.5.3c) Days Sales in Receivables = Receivables Period = 365/Receivable Turnover (3.5.3d) Total Asset Turnover Ratio = Sales/Total Assets (3.5.3e)

4) Profitability Ratios Net Profit Margin = Net Income/Sales (3.5.4a) ROA = Net Income/Total Assets (3.5.4b) ROE = Net Income/Total Equity (3.5.4c) ROE = (Net Profit Margin)(Total Asset Turnover)(Equity Multiplier) (3.5.4d) 5) Market Value Ratios Market Capitalization = (Price per share)(Shares outstanding) (3.5.5a) Earnings Per Share (EPS) = Net Income/Shares Outstanding (3.5.5b) P/E Ratio = Price per share/EPS (3.5.5c) P/E Ratio = Market Capitalization/Net Income (3.5.5d) Market-to-Book Ratio = Market Value per share/Book Value per share (3.5.5e)

6) Payout and Growth Rates Dividend Payout Ratio = Dividends/Net Income (3.5.6a) Retention Ratio =Addition to retained earnings/Net Income= 1- Dividend Payout Ratio (3.5.6b) Sustainable Growth Rate = ROE* Retention Ratio (3.5.6c)

CHAPTER 4 4.1 Quiz - Time Value of Money What tools can be used to solve time value of money problems? ● ● ● ●

Manually by a mathematical formula Financial calculator Excel spreadsheet Tables of TVM factors

Which of the following is NOT true about the time value of money concept? The general approach is to take money received in the future as a benchmark and compare that to how much the same amount of money is worth now. 4.2 Quiz - Present Values, Future Values, and the Discount Rate What is the future value of $100 invested at 10% simple interest for 1 year? FV=PV(1+r) FV=100 (1+0.10) FV=110 (T) If you feel that the value of $107 in one year is just as good as $100 now. The $100 is the Present Value (PV) of the $107 to be received in one year. 4.3 Quiz - Compound and Simple Interest What is the future value of $100 invested at 10% compounded annually for 3 years? Enter the answer in dollar format without $ sign or thousands comma -> 3519.23 and not $3,519.23 or 3,519.23 FV=PV(1+r)^t FV=100(1+0.10)^3 FV=133.1 (T) You should never compare cash flows occurring at different times without first discounting them to a common date. (F) The advantage to savers and investors of receiving compound interest rather than simple interest is that future values are larger because interest is earned on accumulated interest payments. Also, the difference in future values becomes smaller as time goes by.

4.4 Quiz - PV and FV with Multiple Time Periods

What is the future value of $100 invested at 10% compounded annually for 10 years? (Enter the answer in dollar format without $ sign or thousands comma -> 3519.23 and not $3,519.23 or 3,519.23) FV=PV(1+r)^t FV=100(1+0.10)^10 FV=259.37

What is the present value of an investment that will give you $100 after 10 years with a rate of 10% compounded annually? (Enter the answer in dollar format without $ sign or thousands comma -> 3519.23 and not $3,519.23 or 3,519.23) PV=FV/(1+r)^n PV=100/(1+0.10)^10 PV=38.55 (T) Future values are positively related to interest rates and time - the bigger the interest rate and the more compounding periods, the greater the future value will be. 4.5 Quiz - Using a financial calculator to solve TVM problems You end up with $20,000 after investing for 20 years at 8% annually. What was the PV? (Enter the answer in dollar format without $ sign or thousands...