fnce Powerpoint review Flashcards
________ _______ is about the potential conflict between shareholders and managers.
Agency theory
The goal of maximizing shareholder wealth may conflict with interests of management (their compensation) and ______/______ ______.
social/ethical goals
Money markets deal in short-term securities
(Less than 1 year)
give an example
Treasury Bills, commercial paper
Capital markets deal in long-term securities
(Greater than 1 year)
give some examples
. common stock, preferred stock, corporate bonds, government bonds
what is the primary market
what is the secondary market?
Primary market is where a firm issues new bonds or shares to raise new funds.
Secondary market is where investors buy and sell (trade) outstanding bonds or shares.
Bond = debt or liability
Bondholders are owed money by company
Common Stock (Common Share) = Ownership or Equity
Shareholders own the company
Financial managers make ________ and _______ decisions.
investment and financing
Financial markets are?
Financial markets are where financial managers raise funds and are given feedback about the effect of their decisions.
Finance helps managers by
It helps managers make decisions to maximize shareholder wealth.
Leverage is using fixed costs to _____ the potential return to a firm
magnify
2 types of leverage:
Operating Leverage = the degree to which capital assets and associated fixed costs are utilized
Financial Leverage = the amount of debt used in the capital structure (debt/equity mix)
operating leverage on the income statement
sales (total revenue) - Variable costs Contribution margin -Fixed costs Operating Income
Financial leverage on the income statement
EBIT -I EBT Tax @ EAT shares Earning per share
Break-even analysis is the technique used to study the effect of sales volume on costs and profit.
The interesting sales volume is the break-even (BE) sales level, at which a firm’s total revenue equals total cost, that is, the firm does not make money nor lose money (breaks even)
Operating leverage
Measures the amount of fixed operating costs used by a firm
Degree of Operating Leverage (DOL)=
Percent change in operating income
_______________________
Percent change in unit volume
What is Degree of Operating Leverage
DOL measures the sensitivity of a firm’s operating income to a change in sales
A change in Sales brings
a larger change in Earnings Before Interest and Taxes (EBIT) or Operating Income if DOL is greater than 1
A leveraged firm has high fixed costs, a _____ BE point and high DOL.
high
A non-leveraged firm has low fixed costs, a ____ BE point and low DOL.
low
Leverage is a double-edged sword.
because
It magnifies losses as well as profits
Financial leverage is the measure of the amount of debt used by a firm
Degree of Financial Leverage (DFL) =
Percent change in EPS
___________________ Percent change in EBIT
A change in Earnings Before Interest and Taxes (EBIT) or Operating Income brings a larger change in EPS if the DFL is greater than1
DFL measures the sensitivity of a firm’s earnings per share to a change in operating income.
Degree of Financial Leverage (DFL) =
Operating profit EBIT \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_= \_\_\_ Earnings before taxes (EBT) EBT
The formula for degree of financial leverage related to the income statement is:
Combined or Total Leverage represents maximum use of leverage
Degree of Combined Leverage (DCL ) =
Percent change in EPS
__________________ Percent change in sales (or volume)
Combining both leverage formulas:
DCL = DOL x DFL
Summary notes
Leverage refers to the use of fixed costs to magnify the profits (or losses) of a firm
It is a double-edged sword. Management must be sure of the level of risk assumed
Operating leverage refers to using fixed operating costs, such as lease or amortization expense
The degree of operating leverage (DOL) measures the percentage change in operating income as a result of a percentage change in sales
Financial leverage refers to the fixed financing charge such as interest cost on debt
The degree of financial leverage (DFL) measures the percentage change in earnings per share (EPS) as a result of a percentage change in operating income
The higher the level of fixed costs (both operating and financing costs), the greater the effect on net income of an increase in sales revenue (This is the degree of combined leverage (DCL))
Maximization of shareholder wealth is a concept in which:
Select one:
a. increased dividends are of primary importance.
b. increased cash flows are of primary importance.
c. increased earnings are of primary importance.
d. increased share price is of primary importance.
d. increased share price is of primary importance.
A conservative financing plan involves: Select one: a. heavy reliance on equity. b. high degree of combined leverage. c. heavy reliance on debt. d. high degree of financial leverage.
a. heavy reliance on equity.
A firm would be indifferent between financing plans when:
Select one:
a. return on assets equals return on equity.
b. the cost of borrowed funds equals the return on assets.
c. debt is equal to equity.
d. the cost of borrowed funds equals the return on equity.
b. the cost of borrowed funds equals the return on assets.
Money markets would include which of the following securities?
Select one:
a. Common stock and corporate bonds
b. Treasury bills and commercial paper
c. Certificates of deposit and preferred stock
d. Government bonds.
b. Treasury bills and commercial paper
Which of the following is true about the concept of leverage?
Select one:
a. At the break-even point, operating leverage is equal to zero.
b. Financial leverage measures the impact of fixed costs on earnings.
c. Combined leverage measures the impact of operating and financial leverage on EBIT.
d. Combined leverage measures the impact of operating and financial leverage on EPS.
d. Combined leverage measures the impact of operating and financial leverage on EPS.
When a corporation uses the financial markets to raise new funds, the sale of securities is made in the: Select one: a. primary market. b. third market. c. on-line market. d. secondary market.
a. primary market.
A limited partnership limits the profits partners may receive.
Select one:
True
False
False
TJim Wilson is considering the possibility of opening his own machine shop. He expects first-year sales to be $600,000 and he feels that his variable costs will be approximately 50% of sales.
Jim is considering two ways of financing the firm’s $800,000 in assets:
Plan A 60% equity financing and 40% debt financing, debt costing 14%.
Plan B 100% equity financing.
Jim can sell common stock to his relatives for $10 per share.
The financing structure of the two alternatives can be described as follows:
Plan A is leveraged because it has more debt than Plan B which is conservative
Plan A is conservative because it has more debt than Plan B which is leveraged
Plan A is leveraged because it will offer “cheaper” financing than Plan B
None of the above
…..
For Plan A, the annual interest expense will be
$44,800 $32,000 $48,000 $67,200 ........ What number of shares would be outstanding for each plan?
Plan A 48,000 shares Plan B 80,000 shares
Plan A 480,000 shares Plan B 800,000 shares
Plan A 800,000 shares Plan B 800,000 shares
Plan A 48,000 shares Plan B 48,000 shares
Plan A is leveraged because it has more debt than Plan B which is conse$44,800rvatPlan A 48,000 shares Plan B 80,000 sharesive
If EBIT equals $140,000 and interest equals $21,000, with a tax rate of 31%, what is the degree of financial leverage? Select one: a. 6.67x b. 1.18x c. 3.91x d. 5.67x
b. 1.18x
A high DOL means: Select one: a. there is a large amount of equity. b. there are high labour costs. c. there is high debt. d. there are high fixed costs.
d. there are high fixed costs.
Financial markets allocate capital based on:
Select one:
a. the pricing mechanism.
b. intervention by the Bank of Canada.
c. the efforts of financial intermediaries.
d. the number of treasury bills outstanding.
a. the pricing mechanism
A conservatively financed firm would:
Select one:
a. finance a portion of permanent assets and short-term assets with short-term debt.
b. use long-term financing for all capital assets and short-term financing for all other assets.
c. use equity to finance capital assets, long-term debt to finance permanent assets, and short-term debt to finance fluctuating current assets.
d. use long-term financing for permanent assets and capital assets and a portion of the short-term fluctuating assets and use short-term financing for all other short-term assets.
d. use long-term financing for permanent assets and capital assets and a portion of the short-term fluctuating assets and use short-term financing for all other short-term assets.
Which of the following combinations of asset structures and financing patterns is likely to create the least volatile earnings?
Select one:
a. Liquid assets and no debt
b. Illiquid assets and heavy short-term borrowing
c. Liquid assets and heavy long-term borrowing
d. Illiquid assets and heavy long-term borrowing
a. Liquid assets and no debt
The yield on a 2 year security is 8.8%. If the yield of a security maturing in 1 year is 9.6%, what is the expected yield on a 1 year security maturing at the end of year 2?
Select one:
a. 8.8%
b. 9.6%
c. 8.0%
d. 8.4%
c. 8.0%
When actual sales are greater than forecasted sales:
Select one:
a. production schedules remain constant.
b. inventory will increase.
c. accounts receivable will decrease.
d. production schedules might have to be revised upward.
d. production schedules might have to be revised upward.
Ideally, which of the following types of assets should be financed with long-term financing?
Select one:
a. Capital assets and temporary current assets
b. Capital assets and permanent current assets
c. Capital assets only
d. Temporary and permanent current assets
b. Capital assets and permanent current assets
One advantage of level production is that:
Select one:
a. current assets fluctuate more than with seasonal production.
b. seasonal bulges and sharp declines in current assets occur.
c. manpower and equipment are used efficiently at lower cost.
d. the risk of obsolete inventory increases.
c. manpower and equipment are used efficiently at lower cost.
Ideally, all current assets will be: Select one: a. financed by short-term debt. b. self-liquidating. c. long-term in nature. d. internally financed.
b. self-liquidating.
A firm will usually increase the ratio of short-term debt to long-term debt when:
Select one:
a. the firm is undertaking a large capital budgeting project.
b. short-term debt has a lower cost than long-term equity.
c. the term structure is upward sloping and expected to shift up.
d. the term structure is inverted and expected to shift down.
d. the term structure is inverted and expected to shift down.
The term structure of interest rates:
Select one:
a. shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A, BBB, etc.
b. changes daily to reflect current competitive conditions in the money and capital markets.
c. depicts interest rates for T-bills over the last year.
d. plots returns for securities of different risk.
b. changes daily to reflect current competitive conditions in the money and capital markets.
A “normal” term structure of interest rates would depict:
Select one:
a. no general relationship between short-and long-term rates.
b. long-term rates higher than short-term rates.
c. medium rates (1-5 years) lower than both short-term and long-term rates.
d. short-term rates higher than long-term rates.
b. long-term rates higher than short-term rates.
The term structure of interest rates is not influenced by: Select one: a. Bank of Canada activities. b. the normal yield curve. c. inflation. d. money supply.
b. the normal yield curve.
An aggressive, risk-oriented firm will likely:
Select one:
a. borrow short-term and carry low levels of liquidity.
b. borrow long-term and carry low levels of liquidity.
c. borrow short-term and carry high levels of liquidity.
d. borrow long-term and carry high levels of liquidity.
a. borrow short-term and carry low levels of liquidity.
McKinsee Inc. is developing a plan to finance its asset base. The firm has $5 million in current assets, of which 20% are permanent, and $12 million in capital assets. McKinsee Inc. is considering a financing plan with 20% of assets financed by long-term sources and 80% of assets financed by short-term sources. Long-term rates are currently 9.5% and short-term rates are 7%. McKinsee’s tax rate is 30%.
The best term to describe the structure of this financing plan is
aggressive (risky) conservative (cautious) hedged balanced .............. $1,275,000 $238,000 $1,530,000 not enough information to tell ................... $3,307,500 $3,129,000 $4,470,000 $4,725,000
aggress$3,307,500ive (ris$1,275,000ky)
If a firm has total accounts receivable of $6,000,000 and its average daily credit sales are $45,000 what is its collection period? Select one: a. 133 days b. 156 days c. 45 days d. 120 days
a. 133 days
The three primary policy variables to consider when extending credit include all of the following except: Select one: a. the terms of trade. b. the level of interest rates. c. collection policy. d. credit standards.
b. the level of interest rates.
Average daily remittances are $5 million, and "extended disbursement float" adds 5 days to the disbursement schedule, how much should the firm be willing to pay for a cash management system if the firm earns 12% on excess funds. Select one: a. $3,000,000 b. $0 c. $1,000,000 d. $600,000
a. $3,000,000
“Float” takes place because:
Select one:
a. a firm is early in paying its bills.
b. a lag exists between writing a cheque and it being debited to the bank account.
c. the level of cash on the firm’s books is equal to the level of cash in the bank.
d. a customer writes “hot” cheques.
b. a lag exists between writing a cheque and it being debited to the bank account.
The costs of carrying inventory do not include:
Select one:
a. the cost of warehouse space.
b. the interest on funds tied up in inventory.
c. ordering costs.
d. insurance and handling costs.
c. ordering costs.
Driveline Sprockets expects total sales of $20,000. The price per unit is $5. The firm estimates an ordering cost of $9.00 per order, with an inventory carrying cost of $1.20 per unit. What is the optimum order size? Select one: a. 245 units b. 173 units c. 1,852 units d. 2,000 units
a. 245 units
A bankers’ acceptance:
Select one:
a. is a long term investment accepted by the bank.
b. may be accepted by the corporation for future payment.
c. is a draft drawn on a corporation.
d. is traded in a relatively liquid market until maturity.
d. is traded in a relatively liquid market until maturity
Commercial paper is selling for 97.682 of par and matures in 91 days. What is the yield as quoted in the market?
9.52%
8.76%
2.185%
9.06%
……………………
The effective annual rate is
9.87%
9.762%
2.185%
8.76%
……………………………
- 52%
9. 87%
Mountain Home Systems, Inc. is debating whether to expand its sales in a new market. Sales are currently $5,000,000 annually, but MHS Inc. expects sales to increase to $7,000,000 annually if it enters this market. MHS Inc. also knows that 15% of its sales are ultimately be uncollectible. In addition, collection costs will be 2% of sales and the firm’s production costs are 72% of sales. Selling expenses are 8% of sales and Mountain Home has an opportunity cost of funds (before tax) of 20%. Mountain Home can turn its receivables 5 times per year. Should Mountain Home Systems Co. enter the new market?
The incremental contribution margin is:
560,000 1,400,000 1,440,000 1,960,000 .............................. The incremental bad debt expense is:
(300,000) 300,000 1,050,000 (1,050,000) ............................... The incremental selling expenses are:
(160,000) (400,000) 560,000 (560,000 ......................... The change in accounts receivable is:
400,000
(400,000)
1,400,000
(1,400,000)
560,000
(300,000)
(160,000)
400,000
A 20-year bond pays 12% on a face value of $1,000. If similar bonds are currently yielding 9%, what is the market value of the bond? Select one: a. Over $1,200 b. Not enough information given to tell c. Over $1,000 d. Under $1,000
a. Over $1,200
A 10-year bond pays 8% annual interest (paid semi-annually). If similar bonds are currently yielding 6% annually, what is the market value of the bond? Select one: a. $1,148.77 b. $1,080.00 c. $1,000.00 d. $1,147.20
a. $1,148.77
A 14-year stripped (zero-coupon) bond was issued with a $1,000 par value and a coupon of 9%. If similar bonds are currently yielding 12%, what is the approximate market value of the bond? Select one: a. $299 b. $1,000 c. $205 d. $801
c. $205
A 10-year bond pays 12% interest on a $1,000 face value annually. If it currently sells for $1,100, what is its approximate yield to maturity? Select one: a. 11.00% b. 10.91% c. 12.00% d. 10.35%
d. 10.35%
A 4-year bond pays 4% annual interest (paid semi-annually). It currently sells for $872.25. What is the bond's yield to maturity? Select one: a. 4.59% b. 6.06% c. 7.78% d. 4.00%
c. 7.78%
A bond which has a yield to maturity less than its coupon interest rate will sell for a price:
Select one:
a. above par.
b. that is equal to the face value of the bond plus the value of all interest payments.
c. below par.
d. at par.
a. above par.
The dividend valuation model stresses the:
Select one:
a. importance of earnings per share.
b. importance of dividends and legal rules for maximum payment.
c. relationship of dividends to earnings per share.
d. relationship of dividends to market prices.
d. relationship of dividends to market prices.
An issue of common stock is selling for $57.20. The year-end dividend is expected to be $2.32 assuming a constant growth rate of 6%. What is the required rate of return? Select one: a. 10.3% b. 4.1% c. 10.1% d. 6.0%
c. 10.1%
A preferred share has a price of $40 and pays an annual dividend of $1.20. What is the preferred share’s yield?
Select one:
a. 0.03%
b. 30%
c. 3%
d. 0.3%
c. 3%
An issue of common stock has just paid a dividend of $3.75. Its growth rate is 8%. What is its price if the market's rate of return is 16%? Select one: a. $50.63 b. $46.88 c. $54.38 d. $25.01
a. $50.63
An issue of common stock is expected to pay a dividend of $4.80 at the end of the year. Its growth rate is equal to 8%. If the required rate of return is 13%, what is its current price? Select one: a. $48.00 b. $36.92 c. $103.68 d. $96.00
d. $96.00
An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm's common stock is 12%. What is the preferred stock price if the required rate of return is 10%? Select one: a. $41.67 b. $22.73 c. $50.00 d. $5.00
c. $50.00
Which is a characteristic of the cost of preferred stock?
Select one:
a. Preferred stock dividends are fixed, they are tax deductible.
b. The price earnings ratio stays the same.
c. Preferred stock is valued as a perpetuity.
d. Preferred stock has no maturity, the cost analysis is similar to that of debt.
c. Preferred stock is valued as a perpetuity.
The longer the supernormal growth period for a firm’s lasts,:
Select one:
a. the lower the required rate of return used in finding the price of its common stock.
b. the lower the value of its common stock.
c. the higher the value of its preferred stock.
d. the higher the value of its common stock.
d. the higher the value of its common stock.
Valuation of financial assets requires knowledge of:
Select one:
a. future cash flows.
b. appropriate discount rate.
c. past asset performance.
d. future cash flows and appropriate discount rate.
d. future cash flows and appropriate discount rate.
