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Finance 357 > Exam 3 Review > Flashcards

Exam 3 Review Flashcards

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1
Q

Financial statements are accounting reports issued periodically to:

A

Show past performance
Present a snapshot of the firm’s assets
Provide information about how the assets are financed

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2
Q

Financial statements provide reliable information to who?

A

Investors
Financial analysts
Managers
Creditors

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3
Q

Public companies must file statements with who?

A

Securities and Exchange Commission

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4
Q

How often must the annual report with financial statements be sent to shareholders?

A

Every year

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5
Q

Balance sheet lists:

A

firm’s assets and liabilities

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6
Q

What does the balance sheet provide a snapshot of?

A

The firm’s financial position at a given point in time

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7
Q

The income statement lists:

A

revenues and expenses over a period of time

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8
Q

Another name for the income statement

A

Profit and Loss statement

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9
Q

The bottom line of the income statement is referred to as what?

A

Net income or earnings

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10
Q

What information does the statement of cash flows use?

A

Info from the income statement and balance sheet

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11
Q

What does the statement of cash flows determine?

A

How much cash the firm has generated

How that cash has been allocated during a set period

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12
Q

A forecasting method that assumes that the balance sheet and income statement items grow proportionately with sales

A

Percentage of Sales Method

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13
Q

What do you typically assume about interest expense?

A

That it remains the same

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14
Q

What does the difference between assets and L+E indicate on the pro forma balance sheet?

A

The net new financing to fund growth

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15
Q

When you need new funding on the balance sheet you must choose between what types?

A

Debt or equity

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16
Q

What will change if debt is chosen for the new funding on the balance sheet?

A

The interest assumption

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17
Q

This forecasting method first identifies capacity needs and financing options

A

Capacity-Driven Forecasting

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18
Q

When L+E > A

A

Excess cash is available

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19
Q

Operating cycle

A

Length of time between purchasing inventory and receiving the cash back from selling products

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20
Q

Cash cycle

A

Length of time between payment of cash to purchase initial inventory and receiving cash from the sale of a product

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21
Q

Cash Conversion Cycle

A

= Inventory Days + A/R days - A/P days

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22
Q

The difference between receivables and payables that is the net amount of a firm’s capital consumed as a result of those credit transactions

A

Trade Credit

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23
Q

The credit that a firm extends to its customers

A

Trade Credit

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24
Q

Cost of Trade Credit

A

Effective Annual Rate

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25
Q

Three steps of establishing a credit policy:

A
  1. Establishing credit standards
  2. Establishing credit terms
  3. Establishing a collection policy
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26
Q

5 C’s of Credit

A 
Character
Capacity 
Capital
Collateral
Conditions
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27
Q

Accounts Receivable Days

A

Average number of days that it takes a firm to collect on its sales

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28
Q

Aging Schedule

A

Categorizes accounts by the number of days they have been on the firm’s books

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29
Q

Aging Schedule can be prepared using what two ways?

A

The number of accounts or the dollar amount of the accounts receivable outstanding

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30
Q

Firms should monitor their accounts payable to ensure what?

A

That they are making their payments at an optimal time

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31
Q

When a firm ignores a payment due period and pays later

A

Stretching accounts payable

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32
Q

What might the supplier implement if accounts payables are stretched too far?

A

Cash On Delivery
or
Cash Before Delivery

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33
Q

Benefits of Holding Inventory

A

Minimize stock-out risk

Can pursue most efficient production cycle rather and try to meet demand patterns (like seasonality)

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34
Q

Costs of Holding Inventory

A

Acquisition Costs
Order Costs
Carrying Costs

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35
Q

When a firm acquires inventory precisely when needed so that its inventory balance is always zero, or very close to it

A

Just-In-Time Inventory Management

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36
Q

Motivation for Holding Cash

A

Transaction Balance
Precautionary Balance
Compensating Balance

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37
Q

Transaction Balance

A

To meet day-to-day needs

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38
Q

Precautionary Balance

A

To compensate for the uncertainty associated with cash flows

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39
Q

Compensating Balance

A

To satisfy bank requirements

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40
Q

The first step in short-term financing is to forecast the company’s future cash flows to discover:

A

Cash surplus or deficit?

Temporary or permanent?

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41
Q

Reasons for short-term financing needs

A

Negative cash flow shocks
Positive cash flow shocks
Seasonalities

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42
Q

Matching Principle

A

Short-term needs should be financed with short-term debt and long-term needs should be financed with long-term sources of funds

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43
Q

Permanent working capital

A

The amount that a firm must keep invested in short-term assets to support continuing operations

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44
Q

Temporary working capital

A

The difference between the actual level of investment in short-term assets and the permanent working capital investment

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45
Q

Promissory note

A

Single, end of period payment loan (uses benchmark rate, such as prime rate or LIBOR)

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46
Q

Promissory Note Line of Credit Types

A

Uncommitted
Committed
Revolving
Evergreen

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47
Q

Bridge Loan

A

Often a discount loan with fixed interest rate; with a discount loan, borrower pays interest at the beginning of the loan period

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48
Q

Commercial paper

A

Short-term, unsecured debt used by large corporations

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49
Q

What is commercial paper usually cheaper than?

A

A short-term bank loan

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50
Q

What is the minimum face value of commercial paper?

A

$25,000

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51
Q

Interest on commercial paper is typically paid how?

A

By selling it at an initial discount

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52
Q

Direct Paper

A

Firm sells directly to investors

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53
Q

Dealer paper

A

Dealers sell to investors in exchange for a spread (or fee) for their services

The spread decreases the proceeds that the issuing firm receives, increasing the effective cost

54
Q

Secured Loans

A

Loans collateralized with short-term assets (usually a/r or inventory)

55
Q

Most common sources of secured loans:

A

Commercial banks
Finance companies
Factors (firms that purchase the receivables of other companies)

56
Q

Pledging of Accounts Receivable

A

Lender reviews the invoices and decides which credit accounts it will accept as collateral, based on its own credit standards

57
Q

Factoring of Accounts Receivable

A
  • The firm sells receivables to the lender

- Lender pays the firm the amount due from its customers at the end of the firm’s payment period less a factor’s fee

58
Q

Lien

A

All of the inventory is used to secure the loan

59
Q

Trust receipts loan or floor planning

A

Distinguishable inventory items are held in a trust as security for the loan

60
Q

Warehouse arrangement

A

Inventory that serves as collateral is stored in a separate warehouse

61
Q

Option

A

Contract which grants the buyer the right - but not the obligation - to buy or sell an underlying asset at a fixed price at or before an expiration date.

62
Q

What is the value of an option based on?

A

The value of some underlying asset

63
Q

The price or value of this asset gives us a “signal” about what?

A

Whether or not to exercise an option

64
Q

Financial options are traded in a what?

A

Market

65
Q

What is the cost of the option?

A

Premium

66
Q

Call option holder has the right to what?

A

Buy underlying asset

67
Q

Put option holder has the right to what?

A

Sell underlying asset

68
Q

Price at which the underlying asset can be bought or sold if the option is exercised

A

Strike price

69
Q

Last date on which the option can be exercised

A

Expiration date

70
Q

These types of options can only be exercised at the expiration date

A

European options

71
Q

These types of options can be exercised at expiration or any time beforehand

A

American

72
Q

Intrinsic Value

A

Payoff if option is exercised immediately

73
Q

“In-the-money”

A

Intrinsic value > 0

74
Q

“Out-of-the-money”

A

Intrinsic value less than 0

75
Q

“At-the-money”

A

Intrinsic value = 0

76
Q

Extrinsic value

A

Value in waiting to exercise

77
Q

Increased volatility of stock price always does what to value?

A

Increases value!!!!

78
Q

Financial options

A

Options to buy and sell market-traded assets (stock, commodities, foreign currency, etc)

79
Q

Real Options

A

Options to alter the cash flow stream associated with a real asset

80
Q

Timing Option

A

Delay a project until expected cash flows are more favorable

81
Q

Expansion Option

A

Increase the scale and scope of an investment in response to realized demand

82
Q

Contract, shut-down, and abandonment option

A

Slow down, halt, or permanently abandon a project

83
Q

Switching Option

A

Switch inputs or outputs in a project

84
Q

The effect of optimal decision making under uncertainty is to change what?

A

The distribution (and expected value) of the project NPV

85
Q

A discrete lattice or tree models what?

A

The uncertain value of the project over time

86
Q

Binomial Lattice Model is a convenient what?

A

Decision-making model

87
Q

Merger Waves

A

More mergers during economic expansions

88
Q

Types of Mergers

A

Horizontal
Vertical
Conglomerate

89
Q

Method of Payment for Mergers & Acquisitions

A

Stock swap
Cash merger or acquisition
Some combination of stock and cash

90
Q

Why do acquirers typically pay substantial premiums?

A 
Economies of Scale and/or Scope
Vertical Integration
Expertise
Monopoly Gains
Efficiency Gains
Tax Savings from Operating Losses
Diversification
Earnings Growth
Managerial motives to merge
91
Q

Valuation Methods in Takeover Process

A

Compare the target to similar companies or use discounted cash flows

92
Q

Tender Offer

A

Public announcement of cash transaction or stock swap

93
Q

A stock swap has a positive NPV transaction if what?

A

The share price of merged firm exceeds pre-merger acquirer price

94
Q

Stock swap is positive NPV if:

A

Share Price of Merged Firm > Pre-merger Share Price of Acquirer

95
Q

Friendly Takeover

A

Target board of directors supports takeover

96
Q

Hostile takeover

A

Corporate raider

97
Q

Reasons board may not approve even if a premium is offered:

A

Might think offer price is too low
In a stock swap, might think acquirer is overvalued
Might be self interest (agency problem)

98
Q

Proxy Fights

A

In a hostile takeover, the acquirer attempts to convince target shareholders to use proxy votes to support acquirers’ candidates for election to the target board

99
Q

Strategies to stop proxy fights:

A

Can force a bidder to raise the bid

Can entrench management more securely

100
Q

Posion Pills

A

Rights offering that gives existing target shareholders the right to buy shares in the target at a deeply discounted price under certain conditions

101
Q

Poison Pills do what to the value of shares held by acquirer?

A

Dilutes them

102
Q

Downside of Poison Pills

A
  • Makes it more difficult to replace bad managers
  • Firm’s stock price drops when poison pill is adopted
  • Firms with poison pills have below average financial performance
103
Q

Staggered boards do what to acquirers?

A

Makes it more difficult for them to gain board control because only one-third of directors are up for election each year

104
Q

White Knights

A

Target looks for a friendlier company to acquire it

105
Q

White Squire

A

Large friendly investor only purchases substantial block of shares and does not exercise control rights

106
Q

Golden Parachutes

A

Lucrative severance packaged guaranteed to senior managers in the event that the firm is taken over and the managers are let go

107
Q

Golden Parachutes are suggested to do what to value?

A

Increase value because management is more likely to be receptive to a takeover.

108
Q

Recapitalization

A

Company changes capital structure to make itself less attractive (for example, pay out large dividend)

109
Q

Other Defensive Strategies for Takeover

A
  • Supermajority voting requirements for merger approval
  • Restricted voting rights for large shareholders
  • “Fair” price requirements, defined by BOD
110
Q

Toeholds

A

Initial ownership stake in a firm that a corporate raider can use to initiate a takeover attempt

111
Q

In a toehold, a raider can acquire what percent of the firm in secret?

A

10%

112
Q

In a toehold, a corporate raider performs what?

A

An important service because management knows they exist

113
Q

Leveraged Buyout

A

A lower-cost mechanism for corporate raiders. Instead of using their own cash, the raider borrows money through a shell corporation with the shares as collateral. If the tender offer succeeds, the raider can merge the target with the shell corporation and debt is owed by the target.

114
Q

Freezout Merger

A

Used by companies acquiring other companies. The acquiring company makes a tender offer at a slight premium and if offer succeeds, acquirer gains control and merges into a new corporation.
Non-tendering shareholders faced with losing their shares, because target firm ceases to exist.
No benefit to holding out so existing shareholders will accept offer.

115
Q

Floating Rate

A

Exchange rate that changes constantly depending on the supply and demand for each currency in the market

116
Q

Supply and demand for each currency is driven by three factors:

A
  1. Firms trading goods
  2. Investors trading securities
  3. The actions of the central banks in each country
117
Q

Importer-Exporter Dilemma

A

If companies set prices in a certain currency, they risk losing money if the exchange rate rises or falls

118
Q

Currency Forward Contract

A

A contract that sets a currency exchange rate, and an amount to exchange, in advance of a future delivery date

119
Q

Forward Exchange Rate

A

The exchange rate set in a currency forward contract, it applies to an exchange that will occur in the future

120
Q

Cash-and-Carry Trades

A
  1. Borrow dollars today at the dollar interest rate
  2. Exchange the dollars for euros at the spot exchange rate
  3. Deposit the euros for one year at the euro interest rate
121
Q

The difference between the forward and spot exchange rates is related to the _______ _________ ___________ between the currencies.

A

interest rate differential

122
Q

What allows firms to lock in a future exchange rate?

A

Currency Forward Contracts

123
Q

In a currency forward contract must the firm pay the rate it locks in no matter what?

A

Yes

124
Q

Allows firms to insure themselves against the exchange rate moving beyond a certain level

A

Currency Options

125
Q

In a currency options must the firm pay the rate in the option contract?

A

No! They can pay the rate in the option or the current - whichever is better

126
Q

Differences in the forward rate vs option hedge:

A
  • cost of premium (if exchange rate goes up)

- benefit (cost reduction if exchange rate goes down)

127
Q

When any investor can exchange currencies in any amount at the spot or forward rates and is free to purchase or sell any security in any amount in any country at its current market prices

A

Internationally Integrated Capital Markets

128
Q

In Internationally Integrated Capital Markets, the value of an investment does not depend on the ________ used in analysis

A

currency

129
Q

Given future expected cash flow in foreign currency, you can either:

A
  • Discount with foreign rate and convert using the spot rate
  • Convert future cash flows and discount using dollar rate
130
Q

When L + E is less than Assets

A

Additional financing is needed

131
Q

Internationally Integrated Capital Markets

A

When any investor can exchange currencies in any amount at the spot or forward rates and is free to purchase or sell any security in any amount in any country at its current market prices

Finance 357 (2 decks)

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