Fin 301 Mid Term MAIN Flashcards
Explain Capital Budgeting
planning and managing a firm’s long-term investments (fixed assets) , identify investments where the value of cash flow generated by the asset exceeds the cost of the asset
Explain Net Working Capital Management
Involves managing the firm’s short-term assets and liabilities (everyday activities)
Explain Capital Structure
determining the mix of long-term debt and equity that is used to finance its operations
What is an example of Capital Budgeting?
Opening a Walmart in a new town (do we need it?) and updating an operating system
Explain a Sole Proprietorship
owned by one person, least regulated, unlimited personal liability, owner keeps all profits
Explain a General Partnership
partners share in gain/loss, both equal in unlimited liability
Explain a Limited Partnership
limited partner that does not participate in business and is only liable for their portion of particpation
Explain a Corporation
a business created as a formal legal entity, separate and distinct from its owner, public ownership, limited liability, strict regulation
How often are Corporations taxed?
Taxed twice, once when profits are reported and once if dividends are paid
Explain an LLC
hybrid of partnership and corporation, limited liability for owners but operated and taxed like a corporation
What is the primary goal of financial management?
maximize current value per share of existing stock
What are five secondary goals of financial management? (SAMMM)
Survive
Avoid Bankruptcy
Minimize Costs
Maximize Profits
Maintain Steady Growth
Explain the Sarbanes Oxley Act
Enacted by Congress, aimed to protect investors from corporate abuse
Management is responsible for accuracy of financial statements
No false statements
Annual report that contains an assessment of internal control structure and financial reports
Explain the Agency problem
Highlights potential conflicts of interest between stockholders and management
Owners: priority to seek new investment and raise share value
Management: pursue job security, corporate luxury, higher compensation at expense of shareholders
What is a primary market?
Markets in which the original sale of securities by governments and corporations occurs (IPO)
Public Offering, securities sold to public and debt/equity registered with SEC
Private Placement, negotiated sale with another company, avoids expense of IPO
What is a secondary market? (etrade)
Markets in which securities are bought and sold to the public after original sale
Owners or creditors sell to one another
Corporation is not directly involved
What is a dealer Market?
no physical location, transactions are made by a dealer electronically
What is an auction market?
sellers and buyers of securities are matched at a physical site
What is a balance sheet?
One day snapshot of the firms accounting value
What the firm owns and what they owe
Prepared at the end of the month
What is Net Working Capital?
Difference between Current Assets and Current Liabilities
Debt vs Equity
Financial Leverage: The amount of debt in a firm’s capital structure
More debt a firm has, the greater its leverage
Too much leverage puts the firm at risk of financial distress or failure
Market Value vs Book Value
Market Value: True worth of the firm TODAY
Book Value: Historical cost of the firm Used for GAAP
No relationship between the two
What is GAAP?
Generally Accepted Accounting Principles
What is the realization principle?
Recognize revenue when earnings process is virtually complete, and the transaction value is known
What is the matching principle?
Revenues must be matched with costs incurred to generate them
Average Tax Rate
Total Tax Bill / Taxable Income
Marginal Tax Rate
The tax rate charged for one additional dollar of income
What is Cash Flow Identity?
Difference between the number of dollars that came in and the number that went out
NOT the same as statement of cash flows, not equal
What is a statement of cash flows?
A firm’s financial statement that summarizes its sources and uses of cash over a specified period
Common size statements for balance sheet
Show items as percentages of asset, found by dividing by total assets
Common size statements for income statement
Show items as percentages of sales
Percentages are found by dividing by Total Net Sales
Current Ratio
One of the most widely used measures of short-term liquidity
To a creditor, the higher the current ratio, the better; (2:1) or better is desired
Debt to Equity Ratio
shows how much of a company is owned by creditors
(Important Variation of Total Debt Ratio) = Total Debt / Total Equity
Long Term Debt to Equity
shows how much of a business’ assets are financed by long-term financial obligations, such as loans
Long Term Debt to Equity = Long Term Debt / Total Equity
Comfortable figure is 1/3
Total Asset Turnover Ratio
Sales / Total Assets
Reciprocal of Capital Intensity Ratio
Also known as 1 / Capital Intensity Ratio
Market Value Ratio
Based on the market price per share of a stock, not on financial statements (must be publicly traded)
Price Earning Ratio
how much an investor is willing to pay for a dollar of current earnings
DuPont Identity
Breaks return on equity (ROE, net income / equity) into three parts
Operating Efficiency
(Measured by Profit Margin)
Asset Use Efficiency
(Measured by Total Asset Turnover)
Financial Leverage
(Measured by Equity Multiplier)
What are the six ingredients to a successful financial plan? (FESAPP)
Financial Requirements
Economic Assumptions
Sales Forecast
Asset Requirements
Pro Forma Statements
Plug it in
Financial Planning
Formulates the way in which financial goals are to be achieved
Avoids “stumbling into the future backwards”
Anticipating possible problems before they arrive
Short Run
(1 Year): the budget
Long Run
Planning Horizon, (2-5 years), what financial planning focuses on
External Financing Needed
Assets does not equal liabilities + owners’ equity (HAS TO)
Capital Intensity Ratio
Represents the amount of assets needed to generate $1 of sales
Reciprocal of Total Assets Turnover
For Rosengarten, it was 3:1, took $3 to generate $1 of sales
EFN and Growth Rate
External Financing Needing (EFN) and growth are related
Growth is a convenient means of examining the interactions between investment and financing decisions
All other things being equal, the higher the rate of growth in sales or assets, the greater the need external financing
Internal Growth Rate (%IGR)
The maximum growth rate a firm can achieve without external financing of any kind (taking on additional long-term debt or raising new equity)
ROA = return on assets
B = retention ratio
Sustainable Growth Rate (%SGR)
The maximum growth rate a firm can achieve without equity financing while maintaining the same debt/equity ratio (taking on debt is ok). Use year 1
Rule of 72
(time it takes for money to double): t = 72/%r or %r = 72/
Future Value
amount an investment is worth after one or more periods
Compounding
accumulating interest on an investment over time to earn more interest
Investing for a Single Period
If you invest $100 in a savings account yearly that has a 10% annual interest rate…
Your investment will grow 1+r per dollar invested
R = .10, so 1.10 dollars per dollar invested
Have $110 dollars at the end of the year
Investing for More than One Period
Interest on Interest
Interest earned on the reinvestment of previous interest earned
Compound Interest
Interest earned on both the initial principal and the interest invested from the prior periods
Simple Interest
Interest earned only on the original principal amount invested
Present Value vs Future Value
The Present Value Factor is the reciprocal or the inverse of the Future Value Factor
Present Value of Annuities
A series of constant or level cash flows that occur at the end of a period or some fixed number of periods
College loans, home loans, car loans,
Annuity Due
An annuity for which the cash flows occur at the beginning of a period
Lease and rental payment
Perpetuities
An annuity in which the cash flows continue forever, the cash flow is the same each year
Preferred stock
Stated Interest Rate
The interest rate expressed in terms of the interest payment made each period.
%APR on a loan or a quoted loan
Effective Annual Rate (%EAR)
The interest rate expressed as if it were compounded once per year. It is the compounded interest during the year as if it only happened once a year
Use EAR when you see compounded
Annual Percentage Rate (APR)
Interest rate charged per period multiplied by the number of periods per year
All lenders must disclose a %APR on consumer loans
%APR is a quoted rate or stated rate
