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Corporate Finance > Exam 1 > Flashcards

Exam 1 Flashcards

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1
Q

3 types of questions financial manager should be concerned with

A

-Capital budgeting
-Capital structure
-Working capital management

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2
Q

Capital Budgeting

A

the process of planning and managing a firm’s long-term investments – evaluating the size, timing, and risk of future cash flows

-What long-term investments should you take on?

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3
Q

Capital Structure

A

the mixture of debt and equity maintained by a firm

-Where will you get the long-term financing to pay for your investment? Will you bring in other owners, or will you borrow the money?
-How much should the firm borrow (i.e., what mixture of debt and equity is best)?
-What are the least expensive sources of funds for the firm?

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4
Q

Working Capital Management

A

a firm’s short-term assets and liabilities

-How will you manage your everyday financial activities, such as collecting from customers and paying suppliers?

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5
Q

Owners

A

i.e. stockholders, usually not directly involved in making business decisions for large corporations, especially on a day-to-day basis

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6
Q

Managers

A

Employed by corporations to represent the owners’ interests and make decisions on their behalf

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7
Q

Financial Management Function

A

Usually associated with a top officer of the firm, such as a vice president of finance or the chief financial officer (CFO)

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8
Q

The Vice President of Finance

A

Coordinates the activities of the treasurer and the controller

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9
Q

The Controller’s Office

A

Handles cost and financial accounting, tax payments, and management information systems

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10
Q

The Treasurer’s Office

A

manages the firm’s cash and credit, financial planning, and capital expenditures

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11
Q

Chief Financial Officer

A

-Involved in the management and strategy of the organization from a financial perspective
-Part of the executive committee and sits on the board of directors
-The Treasurer and Controller report to the CFO
-Regarding financial matters, the buck stops here
-HR often reports to the CFO, and when that happens, they must speak the language (i.e., accounting and finance)

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12
Q

Treasurer

A

-Focuses on internal and external financial matters
-Building and maintaining banking relationships
-Managing cash flow and forecasting
-Making equity and capital structure decisions
-Responsible for investor relationships
-Handles stock-based equity decisions
-Ideally, a finance person with a personality

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13
Q

Controller or Comptroller

A

-Purely internal focus
-Provides reliable and accurate financial reporting
-Responsible for general accounting
-Handles reporting, financial analysis, and planning
-Ensures the day-to-day transactions are recorded accurately and correctly
-Without excellent and consistent data from the controller, the CFO and Treasurer can’t do their jobs.

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14
Q

Factors to consider in starting a business

A

-COST of creating the organization
-CONTINUITY or stability of the organization
-CONTROL of decision
-PERSONAL LIABILITY of the owners
-TAXATION of the organization’s earnings
-PROFIT distribution to the organization’s owners

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15
Q

Sole Proprietorship

A

A business owned by one person

Advantages: simplest type of business, least regulated, complete managerial control, owner keeps all profits, all income taxed as personal

Disadvantages: unlimited personal liability, limited lifespan, limited equity/capital, difficult to transfer ownership

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16
Q

Partnership

A

A business formed by 2 or more owners

Advantages: Simple and inexpensive to form, owners share profits, income taxed as personal

Disadvantages: unlimited liability in most cases, limited life of business, difficult to transfer ownership

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17
Q

Corporation

A

A business created as a distinct legal entity composed of one or more individuals or entities.

Advantages: public ownership, limited liability, ease of transferring ownership, unlimited life of the business, ease in raising cash/equity

Disadvantages: strict regulation, can be difficult/expensive to form, income subject to double taxation

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18
Q

Articles of Incorporation

A

A document that includes the corporation’s name, owners, intended life, business purpose, and the number of shares to be issued

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19
Q

Corporate Bylaws

A

Description of how the business will operate and how the corporation regulates its own existence

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20
Q

Limited Liability Corporation

A

Hybrid of partnership and corporation

Advantages: retains limited liability for owners

Disadvantages: operated and taxed like a partnership

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21
Q

Other corporate names for organizations

A

Joint stock companies, public limited companies, limited liability companies

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22
Q

Benefit Corporation

A

For profit
Legal attributes:
1. Accountability- must consider how an action will affect shareholders, employees, customers, the community, and the environment
2. Transparency- must provide an annual report detailing how the company pursued a public benefit during the year or any factors that inhibited the pursuit of this goal
3. Purpose- must provide a public benefit to society as a whole or the environment

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23
Q

Primary Goal of Financial Management

A

to maximize the current value per share of the existing stock

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24
Q

Other Goals of Financial Management

A

-survive
-avoid bankruptcy
-minimize cost
-maximize profit
-maintain steady growth

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25
Q

The Sarbanes-Oxley Act (SOX)

A

A U.S. law passed in 2002 to protect investors from corporate accounting fraud by improving financial reporting and auditing standards

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26
Q

Agency Relationship

A

The relationship between stockholders and management
-exists when someone (the principal) hires another (the agent) to represent their interests

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27
Q

The Agency Problem

A

the possibility of a conflict of interest between the stockholders and the management of a firm

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28
Q

Agency Costs

A

the costs of the conflict of interest between stockholders and management

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29
Q

Indirect Agency costs

A

lost opportunities

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30
Q

Direct Agency Costs

A

-Corporate expenditures benefit management but cost the stockholder (e.g., luxurious and unneeded corporate jets).
-Expense arises from the need to monitor management actions.

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31
Q

Two Incentives for Management to Increase Share Value

A

-Managerial compensation is usually tied to financial performance and often to share value.
-Managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries.

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32
Q

Stockholders

A

Ultimately control the firm, as they elect the board of directors, who hire and fire managers
-May replace existing management via proxy fights and takeovers

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33
Q

Stakeholder

A

Someone other than a stockholder or creditor who potentially has a claim on the firm’s cash flows.
-May attempt to exert control over the firm, perhaps to the detriment of the owners.

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34
Q

Financial Market

A

Brings buyers and sellers together to buy and sell debt and equity securities.

-The most important differences between financial markets concern the types of securities traded, how trading is conducted, and who the buyers and sellers are.

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35
Q

Primary Markets

A

the corporation is the seller, and the transaction raises money for the corporation

-Involves public and private offerings/placements

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36
Q

Public Offerings

A

Selling securities to the general public

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37
Q

Private Placements

A

Negotiated sales involving a specific buyer
-Key feature: avoids regulatory requirements and expenses associated with a public offering

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38
Q

Secondary Market

A

Transfers ownership of corporate securities via one owner or creditor selling to another

-Securities are bought and sold to public after the original sale

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39
Q

Dealer market

A

A type of secondary market in stock and long-term debt, aka over-the-counter (OTC) markets, meaning the dealers are connected electronically instead of transacting in a central location

ex) Nasdaq

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40
Q

Auction market

A

Has a physical location, primary purpose is to match those who wish to sell with those who want to buy (with dealers playing a limited role)

ex) NYSE

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41
Q

Balance Sheet

A

a financial statement showing a firm’s accounting value on a particular date, shows assets, liabilities, and the difference between the two (equity)

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42
Q

Assets

A

Can be current or fixed
-current: life of less than one year ex. cash, inventory, accounts receivable
-fixed: relatively long life ex. truck or trademark

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43
Q

Liabilities

A

on right side of the balance sheet, can be current or long-term
-current: life of less than one year ex. accounts payable
-long-term: debts not due in the coming year ex. a loan that will be paid in 5 years

44
Q

Shareholders Equity

A

the difference between the total value of the assets (current and fixed) and the total value of the liabilities (current and long-term).

45
Q

Net Working Capital

A

the difference between a firm’s current assets and its current liabilities

-usually positive in healthy firm
-positive when cash that will become available over the next 12 months (i.e., current assets) exceeds cash that must be paid over the same period (i.e., current liabilities)

46
Q

3 Things to Consider when Examining Balance Sheet

A

-liquidity
-debt vs equity
-market value vs book value

47
Q

Liquidity

A

the speed and ease with which an asset can be converted to cash

-Consider ease of conversion vs the loss of value

48
Q

Financial Leverage

A

the use of debt in a firm’s capital structure

-If a firm borrows money, it usually gives the first claim to the firm’s cash flow to creditors, with equity holders entitled to only the residual value.

49
Q

Book Value

A

-The real worth of assets
-The historical transactions and cost of assets
-Fluctuations are periodic & infrequent
-Asset value reported on the balance sheet

50
Q

Market Value

A

-Financial market asset worth
-Based on supply and demand
-Frequent fluctuations. Market dependent
-Max. price of assets as traded in the markets

51
Q

The Income Statement

A

a financial statement summarizing a firm’s performance over a period of time, usually a quarter or a year.

Equation:
Revenues - Expenses = Income

52
Q

3 thing financial manager should keep in mind when looking at income statement

A

-GAAP
-Cash vs noncash items
-time and costs

53
Q

Taxes

A

Can be one of the largest cash outflows of a firm

-the size of a company’s tax bill is determined by the tax code, an often amended set of rules.

54
Q

Tax Cuts and Jobs Act of 2017

A

Made federal corporate tax rates a flat 21%

-Tax rates on other business forms did not become flat

55
Q

Average tax rate

A

total taxes paid divided by total taxable income

56
Q

Marginal tax rate

A

the amount of tax payable on the next dollar earned

57
Q

Cash flow

A

the difference between the number of dollars that came in and the number of dollars that went out

-No standard financial statement for this, statement of cash flows is a different issue

58
Q

Cash Flow Identity

A

says the cash flow from the firm’s assets is equal to the cash flow paid to suppliers of capital to the firm

cash flow from assets = cash flow to creditors + cash flow to stockholders

59
Q

Operating Cash Flows

A

the cash generated from a firm’s normal business activities

revenues - cost, tells us whether a firm’s cash inflows from its business operations are sufficient to cover its everyday cash outflows.

60
Q

Capital Spending

A

the net spending on fixed assets (purchases of fixed assets less sales of fixed assets)

ie. CAPEX
-can be negative if firm sells more assets than it purchases

61
Q

Change in Net Working Capital

A

measured as the net change in current assets relative to current liabilities for the period being examined and represents the amount spent on net working capital

62
Q

Cash Flow from Assets

A

aka free cash flow, the total cash flow to creditors and cash flow to stockholders

Consists of operating cash flow, capital spending, and change in net working capital

63
Q

Sources of Cash

A

activities that bring in cash
-Increase in accounts payable
-Increase in common stock
-Increase in retained earnings

64
Q

Uses of cash

A

activities that involve spending cash
-Increases in accounts receivable
-Increase in inventory
-Decrease in long-term debt
-Decrease in notes payable
-Purchase of net fixed assets (PPE)

65
Q

Statement of Cash Flows

A

a firm’s financial statement that summarizes its sources and uses of cash over a specified period
Groups into 3 categories:
-Operating activities.
-Investment activities.
-Financing activities.

66
Q

Common-size statements

A

Financial statements presenting all items in percentage terms in order to compare statements from different sized companies
(can be common-size balance sheet, income statement, or statement of cash flows)

67
Q

Common-base year statements

A

Present all items relative to a certain base year amount, i.e. trend analysis
-often used to investigate trends in the firm’s pattern of operations

68
Q

Financial Ratios

A

relationships determined from a firm’s financial information and used for comparison purposes

69
Q

Liquidity Ratios

A

Assess the company’s ability to pay out short-term debt

70
Q

Leverage Ratios

A

Evaluate the company debt level in the capital structure

71
Q

Efficiency Ratios

A

Investigate the company’s efficiency in utilizing its resources

72
Q

Profitability Ratios

A

Assess the company’s ability to generate income from revenue

73
Q

Valuation Ratios

A

Examines the company’s share price

74
Q

The DuPont Identity

A

shows a company’s return on equity

ROE = Income/Equity

75
Q

Internal Uses of Financial Statements

A

Performance evaluation and planning purposes

76
Q

External Party Using Financial Statements

A

-Short-term and long-term creditors
-Potential investors
-Suppliers and large customers
-Credit rating agencies
-Competitors
-Potential targets for acquisition

77
Q

Internal Uses of Ratio Analysis

A

-Future Planning
-Performance Evaluations
-Performance Comparison (e.g., Divisions, Managers & Employees)
-Salary Decisions

78
Q

External Uses of Ratio Analysis

A

-Evaluation of Suppliers
-Evaluation of Competitors
-Evaluation of Outside Parties (e.g., creditors & Investors)
-Acquisitions & Mergers

79
Q

Time Trend Analysis

A

uses a firm’s historical data as the standard for evaluation

80
Q

Peer Group Analysis

A

compares firms to their peer group– firms similar in the sense that they compete in the same markets, have similar assets, and operate in similar ways

81
Q

Standard Industrial Classification (SIC) Codes

A

four-digit codes established by the U.S. government to classify a firm by its type of business operations, can be used to identify potential peers

82
Q

North American Industry Classification System (NAICS)

A

a new industry classification system initiated in 1997, will eventually replace the older SIC codes

83
Q

Problem with Financial Statement Analysis of Conglomerates

A

consolidated financial statements for these firms do not fit any neat industry category due to owning unrelated lines of business

84
Q

Problems with Financial Statement Analysis

A

-No underlying theory exists to help us identify quantities to look at and establish benchmarks
-Financial statements outside the U.S. do not necessarily conform to all GAAP principles, making comparison difficult
-Even companies that are clearly in the same line of business may not be comparable
-Different firms use different accounting procedures
-Different firms end their fiscal years at different times.
-Unusual events may affect financial performance

85
Q

Financial Planning

A

Establishes guidelines for change and growth in a firm

Concerned with the major (macro) elements of a firm’s financial and investment policies without examining the individual (micro) components of those policies in detail

86
Q

4 Basic Elements of Financial Policy Needed for Financial Planning

A
  1. Capital Budgeting- What investments to take on (i.e., Assets)?
  2. Capital Structures- Where to get financing to pay for these investments (i.e., leverage)?
  3. Working Capital Management- How to manage these financial activities (i.e., liquidity & Working Capital)?
  4. Profit Sharing- What is the appropriate amount to pay shareholders?
87
Q

An appropriate goal of financial planning

A

NOT growth on its own
-increasing the market value of the owner’s equity; if a firm is successful, growth will usually result.

88
Q

Planning Horizon

A

the long-range time period on which the financial planning process focuses (usually the next two to five years)

89
Q

Aggregation

A

a process by which small investment proposals of each of a firm’s operational units are added up and treated as one big project

90
Q

Budget

A

A one year financial plan

91
Q

Strategic Plan

A

A five year financial plan

92
Q

What can financial planning accomplish?

A

-Examining interactions: must make explicit links between investment proposals for the different operating activities of the firm and available financing choices
-Exploring options: Allows firm to develop, analyze, and compare many different scenarios in a consistent way
-Avoiding surprises: Should identify what may happen to the firm if different events take place
-Ensuring feasibility and internal consistency: Verifies that the goals and plans made for specific areas of a firm’s operations are feasible and internally consistent
-Conclusion: Most important result of the planning process is that it forces managers to think about goals and establish priorities.

93
Q

Sales Forecast

A

Required by nearly all financial plans and often given as the growth rate in sales

94
Q

Pro Forma Statements

A

The forecast balance sheet, income statement, and statement of cash flows on a financial plan

Pro formas are projections, not guarantees.

95
Q

Asset Requirements

A

Financial plan will describe projected capital spending, the projected balance sheet will contain changes in total fixed assets and net working capital

96
Q

Financial Requirements

A

Financial plan will include a section about the necessary financing arrangements (e.g., dividend and debt policy)

97
Q

The Plug

A

the designated source(s) of external financing needed to deal with any shortfall (or surplus) in financing and thereby bring the balance sheet into balance

98
Q

Economic Assumptions

A

Financial plan will explicitly state the economic environment in which the firm expects to reside over plan’s life

99
Q

Simple Model Financial Planning

A

A financial planning model in which every item increased at the same rate as sales

-SALES IS THE DRIVER

100
Q

The Percentage of Sales Approach

A

a financial planning method in which accounts are varied depending on a firm’s predicted sales levels

-separate the income statement and balance sheet accounts into two groups, those that vary directly with sales and those that do not

101
Q

External Financing Needed (EFN)

A

The amount of financing the business requires from outside sources to remain profitable

102
Q

Sources of EFN

A

-short-term borrowing,
-long-term borrowing
-new equity

103
Q

Internal Growth Rate

A

the maximum growth rate a firm can achieve without external financing of any kind

104
Q

Sustainable Growth Rate

A

the maximum growth rate a firm can achieve without external equity financing while maintaining a constant debt-equity ratio

105
Q

Determinants of Growth

A

-Profit margin
-Dividend policy
-Financial policy
-Total asset turnover

106
Q

Caveats of Financial Planning

A

-do not always ask the right questions
-tend to rely on accounting relationships, not financial relationships
-leaves out the 3 basic elements of firm value (cash flow size, risk, timing)
-it is an iterative process
-implicitly contains different goals in different areas and satisfies many constraints

Corporate Finance (1 decks)

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