Financial Management

Question 1

Short-term debt

Answer 1

Short-term debt
1. spontaneous financing through accounts payable/accurals
2. bank loans
3. unsecured bank loans
4. commercial paper

Spontaneous financing through accounts receivable is not a type
of short term debt

Question 2

Operating cycle

Answer 2

Operating cycle:
extends from date the inventory is purchased until the date it is finally
converted back to cash

Number of days in Operating cycle =
(purchase to collection of cash)

Number of days sales in inventory +
(purchase to sale)

Number of days sales in Acc. Rec
(Sale to collection)

The operating cycle is the period of time between the expenditure of cash for goods and services and their conversion back to cash (from cash to inventories, to accounts receivable, and back to cash).

Question 3

Increase in tax rate:

Answer 3

Increase in tax rate:
- firms respond by increasing their explicit costs (those that are tax
deductible)
-debt financing which requires specific (tax deductible) interest
payments would be preferred to equity (dividends are not tax deductible)
financing when rates rise

Question 4

Dividend Yield =

Answer 4

Dividend Yield =
Dividend per share /
Market price per share

Question 5

Receivables turnover ratio =

Answer 5

Receivables turnover ratio =
Net credit sales /
Average accounts receivable

Question 6

Budgeting effort - most important

Answer 6

Top managers determined and significantly influence how budgets
are perceived in their companies. Planning and budgeting are
initiated by top management and approves policies and procedures
regulating it which makes Top management’s support a crucial
success factor for the budgeting factor.

Question 7

Net Present value

Answer 7

Net Present Value (NPV)
1. compares present value of expected cash of the project to initial
cash investment in the project.

If NPV >= 0 project is economically feasible

Question 8

NPV Advantages and Disadvantages

Answer 8

Net Present Value (NPV) method
Advantages
1. Time value of money is considered ( compounding of returns)
2. In a perfect market, correct decision advice will be obtained
3. A correct ranking will be obtained for mutually exclusive projects
given smaller lives and investments.

4. An absolute value is obtained

Disadvantages for decision making
1. The discount rate is difficult to determine
2. Assumptions to cash flows have to be made which may not be
correct

Question 9

Return on Assets (ROA)

Answer 9

ROA
- return on assets
- how efficiently a company uses it’s assets to generate income

ROA = Net Income / Average assets

Question 10

Annuity

Answer 10

Ordinary Annuity:
- series of equal cash flows received a the end of reg. intervals of time
eg. monthly

Annuity Due: (Annuity in advance)
-series of equal cash flows received at the beginning of equal intervals
of time

Present Value of an Annuity
- value today of a furfure series of payments discounted at a particular
interest rate
- said another way, the present value of an annuity can be calculated
by restarting each of the annuity amounts to the present time period
using an annuity formula

Question 11

Portfolio Theory

Answer 11

Portfolio Theory

Non market risk:
- if you invest in one security you are taking company specific risk
- subject to the market reactions to that firm. policies and decisions

Market Risk:
1. all investments are or portfolios are affected by the general trends of
the economy eg. interest rates, rate of inflation, rate of economic growth
- since these variable influence the prices of all assets, the systemic risk is non diversable.

Liquidity Risk:
the risk associated with the possibility that an investment or asset
cannot be sold in the short run for its current market value.

Investment Risk:
related to the probability that the actual return of the asset will be less
that the expected return.

Question 12

Return on Investment (ROI)

Answer 12

Return on Investment (ROI) =
Net Income / Investment capital

Investment capital can be measured at a point in time or by taking the
average over a period of time

Question 13

Internal rate of return (IRR)

Answer 13

Internal Rate of return (IRR)
- referred to as the yield (return) expected over the life of a project.
It is computed by equating the initial investment with the present value
of the cash flows over the life of the project. I
- IRR is the discount rate if the net present value of all cash flows to be
zero

Accounting rate of return nor payback methods consider the time value of money.

Cost benefit ratio is not a capital budgeting tool

Question 14

Market beliefs related to Efficient markets (Efficient Market Hypothesis)

Answer 14

Market beliefs related to Efficient markets (Efficient Market Hypothesis)
1. Weak form efficiency - past price action would not be of use
in predicting future performance

2. Semi-strong efficient markets suggets that all publicly available
   information is incorporated in market prices
3. Strong-form efficient markets - suggests that all available information
   is incorporated in current market prices

Question 15

Market or Systematic risk

Answer 15

Market or Systematic risk that cannot be eliminated through diversification
included non controllable factors
1. Inflation
2. Recession
3. Fluctuations in world energy markets
4. Congressional tax reform

Question 16

Capital Asset Pricing Model (CAPM)

Answer 16

Capital asset pricing model (CAPM)
- computes the expected return on a security ba adding the risk-free
rate of return to the incremental yield of the expected market return which
is adjusted by the company’s beta.

A company’s beta measures the sensitivity of the stock’s return to the
market

Treasury bonds are considered risk free

CAPM Expected rate of return =
(Risk-Free Return + (Market Return - Risk-Free Return) x Beta)

.05+(.12-.05)*.60 = 9.2%

Question 17

Tax Depreciation

Answer 17

Accelerated methods of tax depreciation that recognize more depreciation
in the early years of a project generate tax savings that have greater present
value than tax savings generated in later years of a project. Saving money
today is worth more than saving an equal amount of money in the future

Taxes represent an important capital budgeting consideration, tax depreciation
and not financial accounting depreciation should be considered for cash
flow purposed, and cash flows should be evaluated over the entire life of the
project.

Question 18

Fair Value vs. Fair Market Value

Answer 18

1. Fair market value implies a willing buyer and seller; Fair value does not
   necessarily have a willing buyer and seller
2. Fair market value defines the seller as hypothetical, Fair value has a
   specific seller
3. Fair market value takes advantage of an unrestricted market, Fair value
   used the principal or most advantageous market

Question 19

Number of days in Receivable

Answer 19

Number of days sales in receivables
1. Ratio measures the number of daily sales tied up in receivables
2. how quickly the company converts receivable to cash
3. measures the efficiency (also called asset utilization) of the company’s use
of accounts receivable

Average collection period =

Avg. Accounts Receivable
credit sales / 360 days

or

360 days / yr
Accounts Receivable Turnover

Question 20

Ratios

Answer 20

The fact that ratios are compared to industry averages (rather than overall
ratios) is a strength rather than a limitation of ration analysis

Limitations or Weakness of ratio analysis:
1. Accounting data is affected by estimates
2. Seasonal factors may affect some balances
3. Use of historical data