ASimpleModel Basics+DCF

Question 1

How can a company build cash on the balance sheet?

Answer 1

1) Debt 2) Equity 3) Retained earnings
(Can also build through 4) selling assets and 5) managing NWC)

Question 2

How is the income statement and balance sheet linked?

Answer 2

They are linked through retained earnings and net income - Re1 = Re0 + net income - dividends (simplified)

Question 3

Why is not all revenue created equal?

Answer 3

Revenue is not created equal because in some cases you need to build NWC to fund the revenue - leading to a higher need to fund the NWC (thus increasing debt/equity need - and thus interest/dividend needs)

Question 4

What’s the formula for change in Equity balance as a supporting schedule?

Answer 4

Beginning equity
(+) stock based compensation expense
(-) repurchase of common stock
(+) Option proceeds
(-) cash dividends
(+/-) Effects from FX
= Ending Equity balance

Question 5

What is the formula for Cash dividend payout ratio?

Answer 5

Dividend / Net income

Question 6

True or False: The repurchase of common stock has a negative impact on the equity account.

Answer 6

True

Question 7

True or False: Cash dividends have a positive impact on the equity account.

Answer 7

False

Question 8

What changes when you purchase an equipment on the 3-statements?

Question 9

How does an increase in the Allowance for Doubtful Accounts impact the income statement?

Answer 9

Pretax income is reduced by the increase in bad debt expense.

Question 10

How does an increase in the Allowance for Doubtful Accounts impact the balance sheet?

Answer 10

The increase will reduce Accounts Receivable, Net and consequently result in a lower Day Sales Outstanding.

Question 11

For payment terms 1/10, net 30, what does the 1 mean?

Answer 11

That the customer will receive a discount of 1% if payment is received within 10 days.

Question 12

Journal entry for a credit sale:

Answer 12

Accounts Receivable Debit
Cash Not Included in Journal
Revenue Credit

Question 13

Journal entry for a payment made by a customer:

Answer 13

Accounts Receivable Credit
Cash Debit
Revenue Not Included in Journal Entry

Question 14

Match the items below to create the journal entry for a write off (customer fails to make a payment) under the Direct Write Off Method.

Answer 14

Cash Not Included in Journal Entry
Accounts Receivable Credit
Bad Debt Expense Debit

Question 15

Under the Direct Write Off Method there is a risk that accounts receivable might be __________?

Answer 15

Overstated

Question 16

Under the Allowance Method how frequently is bad debt expense recorded on the income statement?

Answer 16

In each accounting period.

Question 17

Match the debit and credit with the appropriate line item to record the purchase of equipment with cash:

Answer 17

Cash credit
Equipment debit

Question 18

True or False - An increase in depreciation will cause gross margin to increase by the same amount.

Answer 18

False

Question 19

What is the problem with Allowance for Doubtful Accounts and Accounts Receivable Financial Reporting: the “Direct Write Off Method”

Answer 19

Typically this will happen in a different accounting period, which creates two issues: (1)
it is a problem under the matching principle because the failure to pay is recorded in a
different period, and (2) it means assets (in this case AR) might be overstated.

Question 20

Where can you typically find D&A on the income statement?

Answer 20

It’s not always there, but usually baked into COGS - sometimes written out. To get the correct value look in CFO

Question 21

What best describes the Risk-Free Rate?

Answer 21

Compensation required for the time that elapses before cash flows materialize.

Question 22

What present value impact will a higher cost of capital have on projected future cash flows?

Answer 22

PV decreases

Question 23

The cost of capital is determined by the yield an investor requires to be compensated for time and ________________.

Answer 23

risk

Question 24

Formula for the Discount Factor.

Answer 24

=1 / (( 1 + Cost of Capital ) ^ (Year))

Question 25

True or False: The risk premium is represented by the additional yield required out of concern that the cash flow might not materialize.

Answer 25

True

Question 26

formula for the Cost of Equity:

Answer 26

(risk-free rate of return) + (Beta)*(risk premium)

Question 27

If a company’s Beta is less than one, which of the following is true?

Answer 27

It is theoretically less volatile than the market on average.

Question 28

formula for the Risk Premium.

Answer 28

(expected market return) - (risk-free rate of return)

Question 29

Why is the Cost of Debt multiplied by (1 - Tax Rate)?

Answer 29

To account for the tax shield created by interest expense.

Question 30

True or False: Financing-related tax shields are included in free cash flow.

Answer 30

False