Financial Management Chapter A

Question 1

Dupont Return On Equity

Answer 1

Profit Margin X Total Asset Turnover X Equity Multiplier

Question 2

Fixed Asset Turnover

Answer 2

Net Sales divided by Average Net Fixed Assets. The higher the number the more efficiently fixed assets are being used.

Question 3

Accounting Rate of Return (ARR)

Answer 3

Increase in expected average annual operating income divided by initial required investment.

Question 4

Capital lease is any lease meeting at least one of the following capitalization criterias

Answer 4

1. Lease transfer title at the end of the lease term.
2. Lease has a bargain purchase option allowing purchase at a significantly reduced price.
3. Lease term spans 75% or more of the remaining life of the property.
4. Present value of lease payments equals 90% or more of the current market value of the underlying asset.

Question 5

What type of account is used to deter check fraud?

Answer 5

Positive Pay to prepare a log of all checks to be disbursed and send it to the bank. The bank only pays items that reconcile.

Question 6

What’s the formula for Debt Ratio

Answer 6

Debt / (Current Assets +Fixed Assets)

Question 7

Collected on the basis of the value created by the firm. This is measured as the difference between the value of it’s outputs (sales) and its inputs (purchases)

Answer 7

Value-added tax

Question 8

The process of transferring account balances from sub-ledgers to the trial balance account at the end of an accounting period

Answer 8

Closing

Question 9

What is an interest rate swap?

Answer 9

In an interest rate swap, two companies exchange their debt servicing obligations on some notional amount of debt principal. The actual exchange of funds during the agreement is in the form of a net payment from the party owing the greater amount for the period. The parties to an interest rate swap deal only with each other. They do not make payments on the debt of the counterparty directly to the bank of the counterparty.

Question 10

When comparing two companies, if all else is equal, the company that has a higher dividend payout ratio will have a

Answer 10

Higher marginal cost of capital. The higher the dividend payout ratio, the sooner retained earnings are exhausted, and the company must seek more costly outside equity financing. This drives up the marginal cost of capital.

Question 11

In a two-tier merger offer, shareholders receive a higher amount per share if they?

Answer 11

Tender their stock earlier. An offer that is “two-tier” involves two different offer prices for the shares acquired. In a two-tier offer, shareholders are enticed to sell to the bidder early by a higher stock price offer for those who tender their stock earlier. The terms of the share acquisition do not relate to the issuance or repurchase of bonds in the company.

Question 12

How do you find the inventory processing period?

Answer 12

Inventory Processing Period = Cash Conversion Cycle – A/R Collection Period + A/P Payment Period

Question 13

What’s the formula for Cash conversion cycle?

Answer 13

A/R Collection Period + Inventory Processing Period – A/P Payment Period = Cash Conversion Cycle

Question 14

Under GAAP and IFRS what type of items related to a merger would be expensed as incurred?

Answer 14

Indirect costs such as a merger department or manager time and overhead allocated to the merger that would have been incurred even without the merger are expensed as incurred

Question 15

The amount of cash that a firm keeps on hand in order to take advantage of any bargain purchases that may arise is referred to as its?

Answer 15

Speculative cash balances are held to enable the firm to take advantage of any bargain purchases that might arise.

Question 16

What are the three successive steps in a capital budgeting process?

Answer 16

Identify and define potential projects, evaluate and select the projects, and monitor and review the projects.

Question 17

Notes about permanent and temporary differences.

Answer 17

Permanent differences have no deferred tax consequences because they affect only the period in which they occur. Permanent differences include (1) items that enter into pretax financial income but never into taxable income and (2) items that enter into taxable income but never into pretax financial income. In contrast, temporary differences result in taxable or deductible amounts in some future year(s), when the reported amounts of assets are recovered and the reported amounts of liabilities are settled. Temporary differences therefore do have deferred tax consequences while permanent differences do not.

Question 18

How can fraudulent reporting occur?

Answer 18

1. through manipulation of the accounting records or supporting documents, 2. through omission of events, information, or transactions, or 3. through intentional misapplication of accounting principles (via altering amounts, estimates, classification, method of presentation, or disclosure).

Question 19

The writer of a put option must

Answer 19

purchase the underlying security if required. A put option entitles the holder or buyer of the option to sell a specified amount of a security at a set price (or interest at a specific rate). The seller or writer of the put option agrees to purchase under the terms of the agreement

Question 20

What does times interested earned (TIE) show?

Answer 20

Times interest earned (TIE) shows how well a firm can pay its interest expenses using just income from operations. Low TIE ratios coupled with greater earnings volatility indicate a need to rely less on debt financing.

Question 21

Notes about the efficient markets theory

Answer 21

he weak form says that current prices fully reflect the historical financial data available. The ratio being manipulated and the underlying data are all historical financial data. The semistrong and strong forms also start from the assumption that all historical financial data will be correctly interpreted by the overall market, and then they add additional assumptions not needed for this example.

Question 22

Formula for payback period

Answer 22

Orginal investment / Annual Cash Flow

Question 23

Notes about gross profit margin

Answer 23

The gross profit margin or gross profit over net sales is the proportion of sales that is profit. The higher the gross profit margin, the better a company can control an increase in costs.

Question 24

Formula for return on common equity

Answer 24

ROCE = (Net Income - Preferred Dividends) / Avg Common equity

Question 25

Which area of fraudulent financial reporting would unacknowledged and uncollected liabilities and fictitious sales accounts be red flags?

Answer 25

Improper asset valuation includes these red flags as well as others such as changes made to inventory accounts or fictitious assets backed by forged documents.

Question 26

Explain EVA

Answer 26

Economic value added (EVA) is the after-tax operating income less the actual percentage cost of capital times the average amount of capital employed.

Question 27

What are the two primary functions of an effective budgeting system in an organization?

Answer 27

A budget plan must be aligned with an organization’s strategy to match its strengths with opportunities in the marketplace in order to accomplish organizational goals over the short and long term. A budget also sets standards that can control the use of an organization’s resources and motivate employees. It provides a process of checks and balances on the actions of people within the organization.

Question 28

What is included in Net Income

Answer 28

Unrealized gains and losses on available-for-sale securities are not included in net income because of their volatility but are instead reported as other comprehensive income. Passive interest in a stock held as trading is recognized as part of net income. Investments of between 20 and 50 percent ownership require recognition of the proportional share of the investee’s net income. Realized gains and losses are recorded in net income.

Question 29

Under a regressive tax system, the average tax rate rises or falls as income rises?

Answer 29

The average tax rate falls as income rises, although the amount of tax paid may rise.