Exam 1 Flashcards
Financial management
How to run a firm to max value. How to raise funds.
Financial institutions
Where savers meet borrowers. Supply capital to firms
Forms of business organization
Propietorship, parternship, corporations
Proprietorship
Unincorporated, owned by individual
Partnership
Unincorporated, owned by two or more
Corporation
A legal entity, separate ownership and management
Proprietorship and partnership advantages
Ease of formation, subject to few regulations, no corporate income taxes
Proprietorship and partnership disadvantages
Difficult to raise capital, unlimited liablitiy, limited life
LLC/LLP
Hybrid: low income taxes and limited liability
Corporation advantages
Unlimited life, easy transfer of ownership, limited liability, ease of raising capital
Corporation disadvantages
Double taxation and cost of setup and report filling
S corporation
Private less than 100 owners. Avoid tax
C corporation
Public
The primary financial goal of management is
Shareholder wealth max and max stock price
Managers reocognize
That being socuially responsible is consistent with maxing shareholder value
Intrinsic value
True value
Market value
The extent that investor perceptions are incorrect
Important business trends
Increased business ethics, increased globalization, improving tech, stockholders have more control of corporate governance
Conficts between stockholders and bondholders
Stockholders prefer riskier projects, bondholders concerned about use of addional debt, bondholders limit use of addional debt
Stockholders
Have owners stake and get more when company has higher profit
Bondholders
Recieve fixed payment of interst regardless of how well the company does
Suppliers of capital
Excess funds and looking for a rate of return on their investments
Demanders of capital
Need to raise funds and are willing to pay a rate of return on captial
Direct transfers
From savers to business: private placement. Underwriters
Investment banks
Indirect transfer. Investment to JPM to FB. Money from FB to JPM to investor
Financial intermediaries
Indirect. Money from You to bank of america to syco. Investment from sysco to bofa to you
Market
Venue where goods and services are exchanges
Financial market
Place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds
Physical asset market
Tangiable or real assets
Finacial assets
Stocks bonds notes mortages
Spot markets
Assets are bought and sold for an on the spot delivery
Future market
Buyer seller agree today to buy sell something in the future
Money market
Funds borrowed or loaned for short periods
Capital markets
For stocks and longer term debt
Primary market
Firms raise capital by issuing new securities. Moving to a c corp
Secondary marker
Exisitinf securites are traded
Public market
Standard exchange on the stockmarket
Private market
Directly involve buyers and sellers
Derivatives
Securities value derived from the price of another security
Derivatives for hedging
An importer whos profit falls when the dollar loses value could purchase currency futures that do well when the dollar weakens
Speculators using derivatives
To bet on direction of future stock prices. Increase risk
Investment banks
Sell securities on behalf of the company
Financial service corporations
Large mix include many different financial markets
Pension funds
Returement fund funded by employer
Mutal funds
Collect money from investors and invest
Exchange traded funds
Invest in specific
Private equity comapanies
Buy companies manage for a few years then resell
Bull market
Stockmarket increasing
Bear market
Stockmarket decreasing
Frame dependence
How being asked will change outcome. Overconfidence and regret avoidance
Heuristics decisions
Too much weight on negative and recent
Proponents of market effieciency
Increase number of analysis and lower transaction cost would make markets to become increasingly efficient
Opponents to markets efficient
The existence of recent housing buble and previous IT bubble provides contrary evidence
Performance measures for evaluating managers
MVA and EVA
MVA
Difference between market value and bookvalue
EVA
Estimate of a business true economic profit for a given year
EVA equation
EBIT(1-T)-(invesor supplied capital x cost of capital)
Net operation working capital
Current assets-current liabilites-notes payable
EVA positive
AT operating income> cost of cap needed to produce that income. Managers added back
Decrease depreciation years
Fixed assets, net income, and tax payments would all decline. Cash position would increase
Corp taxes
Rates begin at 15% and rise to 35% for corps with income over 10m. Between 15-18.33m pay 38%. State tax of 5%
Individual taxes
Rates at 10% raise to 35% over $372950. May have state tax
Interest paid
Tax deductable for corps not individual expect interst on home loans
Interest earned
Fully taxable except muni taxes
Dividends paid
Paid out of after tax income
Captial gains
Profits from the sale of assets not normally transacted. Individual taxed as ordinary income
Why are ratios useful
Standardize numbers and facilitate comparisons, highlight weaknesses and strengths
Different ratio analysis
Trend, industry, benchmark (compare with simalar sized companies)
Liquidity
Can we make required payments
Asset management
Right amount of assets vs sales
Debt management
Right mix of debt and equity
Profitability
Do sales prices exceed unit cost and are sales high enough as reflected in PM ROE and ROA
Market value
Do investors like what they see as reflected in P/E and M/B ratios
Liquidity ratios
Current ratio and quick ratio
Current ratio
How fast company can pay off liability. Higher is better
If liqudity ratios are lower than industry
Cant make payments as easily as others in the industry
Asset management ratios
Inventory turnover, days sales outstanding, fixed assets turnover, total asset turnover
Inventory turnover ratio
How many times restocked and sold
Inventory turnover below industry
Have old inventory or control might be poor: carrying too much inventory
Days sales outstanding ratio
Has to do with the firms credit policy
Cash in advance
Buyer pays first because they have no or bad credit or demand is higher than supply
Open account
Seller sends supply first
TA turnover below industry
Caused by excessice current assets
Debt management ratios
Debt ratio, time interest earned
Debt ratio and TIE
Lower is better
Debt ratio and TIE better than industry
Firm is using a manageable amount of debt and a low interest payment is a result
Better leveraged or unleveraged
Tradeoff between higher expected return and increased risk
Profitability ratios
Operating margin, profit margin, basic earning power, return on assets, return on equity
Basic earning power
Removes the effects of taxes and financial leverage and is useful for comparison
Return on equity is important
Because it shows how much stockholders earn as a return on their money
Holding assets constant, if debt increases
Equity declines, interest expense increases(reduce NI), ROA declines, ROE either
ROE problems
Doesnt consider risk, doesnt consider amount of capital invested
Market value ratios
Price earnings and market book
Price earnings ratio
How much investors are willing to pay for $1 of earnings. High for firms with strong growth and low risk. Low for slow growth and high risk
Market book ratio
How much investors are willing to pay for $1 of book value equity
DuPont equation
ROE= profit marginTATOEquity multiplier
DuPont equatio reasoning
Focuses on expense control, asset utilization, and debt utilization
Limitations if ratios
Comparisons hard with multiple divisions, different accounting can distort, hard to tell if good or bad strong or weak, average not good, seasonal factors, window dressing, inflation
Nominal rate
Stated rate that is the annual rate
Periodic rate
Amount of interest charged each period
Effective rate
Annual rate of interest actually being earned. (1+I/M)^N*M-1
Nominal used
For contracts, quotes, and brokers
Perpetual used
Calculations and shown on time lines
Effective rats
Compare returns on investments
Can effective ever equal nominal
Yes if compounded annually
Amoritized loan
Deals with a loan that is repaid in equal payments over time (includes the principal and the interest)
Step one amortized loan
Find the required annual payment
Step two amorization
Find the interest paid in year one
Begining balance*interest rate
Step three amortization
Find the principal repaid in year one
PMT-INT
Step four amoritzation
Find the ending balance after year one
Beginning balance-principal
You sold 100 shares of stock and got the money then and gave the certificate up then what is this transaction?
Direct transfer of captial
