C124 Flashcards
If accounts receivable increases, what is impact on CFO?
CFO decreases
Are actual taxes paid the same as shown on GAAP income statement?
No. Actual taxes: IRS rules Income statement: GAAP
Which decisions require using subjective estimates?
Economic life of a new asset
If there is a 30% chance of a recession, what is the probability of expansion?
70% - - the sum of the probabilities must equal 100%
How much interest is paid on a 6% bond over 2 years and 3 months?
6% x 1000 = $60 per year $60 x 2.25 = $135
How does a “prudent investor” select investments?
Seeks the highest return for “appropriate” amount
What do points on the Efficient Frontier measure?
The maximum return for a given level of risk; maximum Return-to-risk ratio
What is Beta?
Measure of a stock’s risk relative to the market
Why are accurate forecasts important?
Plan for resources for production; accurate evaluation of capital projects
Which ratio is used in valuing a private company?
PE ratio in the “Comparable Multiples” method
What are the 3 costs associated with holding inventory?
Product, storage, and opportunity
What risk is eliminated by a diversified portfolio?
Idiosyncratic risk – risk affecting a single firm
What are the impacts of outsourcing?
Fewer U.S. jobs and lower priced products
What are the impacts of tariffs?
More U.S. jobs and higher product costs for consumers
What securities are exempt from federal income taxation?
Municipal bond interest is tax-exempt. Treasury securities ARE taxable
Why would a firm prefer to issue bonds rather than stock?
Debt has lower required return; debt interest is tax deductible
Impact on APY as the number of interest payments per year increase?
APY increases
What is the present value of future cash flows of a stock called?
Intrinsic value = it is the “real” value of the stock; PV of cash to investor
What indicates if a stock is a “good investment”?
The price of the stock is less than the “intrinsic value”
In event of bankruptcy, what is the order of claims settlement?
Creditors, bonds, subordinated debt, Preferred stock, Common stock.
What is a spontaneous account?
One that changes with the level of sales - - current assets & liabilities.
What is a discretionary account?
One that changes due to management decision - - bonds outstanding.
If the financial ratios of 2 firms are compared, what is it called?
Cross-sectional analysis
What financial structure causes profitability to be more volatile?
Leverage: higher leverage ratios mean more volatile profits
If debt is cheaper than equity, why not all debt?
Bankruptcy risk: equity is the cushion against bankruptcy.
If interest rates increase, what is the impact on WACC?
Required returns on debt and equity increase - - thus WACC increases.
The Prospectus contains what information?
Audited financial statements, description of security, operating info.
What is the purpose of the SEC?
To ensure that US investors in the U.S. markets are well informed.
Why would totally domestic firm worry about international trade?
Competition from foreign firm imports to US
If a firm’s ROE is greater than ROA, what does that mean?
The firm uses debt financing wisely to increase profitability.
What is term that refers to corporate managers acting in their own interests rather than the stockholders?
Agency Cost. How to avoid? Tie compensation to stock price
What is a “secured loan” or “secured bond”?
Firm pledges collateral to back the loan or bond, eliminating bankruptcy risk.
What is “free cash flow”?
Cash flows from operations minus cash necessary for reinvestment in PPE
Why would APY be greater than APR?
Interest payments more frequently than annually
What determines when revenue is “recognized” on the income statement?
When the product is shipped or delivered to the customer
What is possible bad side-effect of a high sales-to-inventory ratio?
Lost sales because of lack of inventory
What type of security can be exchanged for stock?
Convertible bond
What are the results of a firm moderately increasing leverage?
Increased ROE, increased profit volatility, and decrease in WACC.
What is goal of IFRS (International Financial Reporting Standards)?
Create a uniform set of accounting rules across countries.
What is difference between Gordon Growth and CAPM?
CAPM: statistically measured; Growth model is just conceptual.
How does a good credit rating from S&P and Moody’s affect the firm?
Lowers the cost of financing.
What are the 4 categories of financial ratios?
Liquidity, efficiency, financing, profitability
What are the 3 pitfalls of using financial ratios?
Seasonal, timing, accounting
Why does a firm hold cash?
“Operating balance”: pay bills; “Reserve balance”: for unforeseen cash needs.
What permits the sales of securities without detailed SEC registration?
Rule 144A (in U.S. markets) and Reg S (in foreign markets)
The market risk premium for stocks is compensation for what?
Systematic risk: that is, risk that cannot be diversified away.
What happens if a firm adopts a project with a negative NPV?
Since the value of the firm is decreased, the stock price falls.
If a bond’s yield is greater than the coupon rate, what is its price?
Discount price
What does the Modigliani-Miller (M&M) theory state?
The debt-equity ratio does not affect WACC.
What does recent evidence say about the M&M theory?
The debt-equity ratio does affect WACC.
If forecasted sales is greater SGR, what actions might a firm take?
Sell bonds or stock and reduce dividend payouts.
Are “sunk costs” included in the Initial Cash Flow of a capital project?
No. Sunk costs have already been incurred, before evaluating the project.
Which type of stock has voting rights?
Common stock has voting rights; preferred stock does not.
Which type of stock has voting rights?
Common stock has voting rights; preferred stock does not.
What are two ways to incent customers to pay sooner?
Discount for early payment; shorter period for full payment (i.e., shorter credit cycle)
Firm A has greater operating leverage than firm B. If sales of both increase, what is impact?
Firm A’s profit increases more than Firm B’s profit
What items appear in an income statement, but not in statement of cash flows?
Accrual items such as depreciation expense and credit sales.
- Investment grade bonds have what Standard & Poor’s rating?
BBB or higher. Below BBB is deemed as “junk bonds”
If a bond is down- graded (i.e., from AAA to A), what happens?
The price drops to increase the required return to compensate for increased risk.
If corporate income tax rates increase, what is impact on WACC?
WACC decreases because the after-tax cost of bonds decreases.
Diversification can eliminate what type of risk?
It eliminates idiosyncratic risk, but not systematic risk.
What ratios are used in Working Capital Management?
Ratios that contain a current asset and/or current liability
Capital budgeting require what 3 cash flows?
Initial cash outlay, yearly cash inflows, terminal cash flow
Which security includes to right to vote in annual meetings?
Common stock
What technique reduces risk in an investment portfolio?
Diversification
What is a leveraged buyout?
Firm uses debt to buy another firm.
Who oversees the systematic risk in banks?
FSOC Financial Stability Oversight Council
Which cash flow statement refers to daily operations?
Cash Flow Operations
If a firm changes the mix of bonds and stock, what impact on WACC?
It changes. I may increase or decrease
What item is added to the balance sheet from the income statement?
Depreciation expense is added to Accumulated Depreciation
What is impact of inflation?
Increases the cost of items; decreases the “real value” of cash flows
What should a company do to manage working capital?
Collect quickly and pay slowly.
What technique is used to reduce risk?
Hedging through futures, forwards, or swaps
What are “recorded entries” versus “estimated entries”?
Purchase price of machine is “recorded”; depreciation is “estimated”
Why would a firm’s stock price increase more than the industry average?
The firm’s profits from operations were better.
How does WACC affect a firm’s growth rate?
A low WACC means there are more profitable investment opportunities
The Prospectus includes what information?
Audited financial statements and firm business risks.
Sarbanes Oxley requires what information to be disclosed?
Off-balance sheet risk, annual audit of internal controls.
What does the Volker rules state?
Prohibits hedge fund investments by banks.
What does FINRA do?
Monitor sales practices by securities dealers
Why are investors more willing to sell stocks with gains than stocks with losses?
Investors are reluctant to acknowledge losses; hope for price rebound.
What types of investments are most liquid?
Short term securities such as Treasury bills
If a firm elects to skip scheduled dividends on preferred stock, what must it do?
Pay skipped preferred stock dividends before paying any common stock dividends.
Why is it difficult to determine the value of a stock?
Uncertainty about the right inputs to the formulas
What is Pecking Order Theory?
Preferred order of financing: retained earnings, debt, and lastly equity.
What is “dividends in arrears”?
The firm elects to delay paying preferred stock dividends
What security is referred to as a “hybrid”?
Preferred stock: has features like bonds and common stock
How is the value of a firm measured in the “replacement cost” method?
Firm value based on the current market prices of the firm’s assets.
The replacement cost method works for what type of assets?
Tangible assets with a market value; not intangible assets
What types of borrowing does not required collateral?
“Unsecured” bonds/loans as opposed to “secured” bonds/loans
