Quiz 1 Flashcards
The study of the relationship between business decisions and the market value in the business
Corporate finance
3 types of decisions financial managers make:
- Capital budgeting
- Capital structure
- Working capital management
3 major forms of business in the United States:
- Sole proprietorship
- Partnership
- Corporation
What is the goal of financial management?
To maximize the current market value of the existing stock
Ownership stake in a company
Stock
A share in the ownership of the company
A share of stock
Stock is also referred to as
Equity
Number of shares issued by a company that are actually owned by someone
Outstanding stock
Financial market where transaction takes places directly between issuer and investor
Primary markets
Financial market where transaction takes place between investors
Secondary markets
How does a small company sell its stock?
The owners themselves find an investor willing to buy the shares, negotiate a price, and the investor pays the company directly for the stock
How does a large company sell its stock?
Companies that meet certain size requirements can have their stock listed on an exchange
Pros of issuing stock?
- The company does not have to pay money back to purchasers of stock
- Easier for good companies to attract investors who want an ownership stake, higher returns
Cons of issuing stock?
- Current owners are giving up a piece of their stake in the company
- Equity investors usually require a higher potential return than bond investors
- Dividends are not tax-deductible, unlike interest payments on loans or bonds
Features of common stock
- Voting rights
- Proxy voting
- Clases of stock
A contract between a borrower and investor
bond
Interest payments made by the company are __ __
tax deductible
T/F
Bond holders do not have an ownership stake in the company
True
They are just lenders and not owners
T/F
Bonds can be traded between investors the same way as stocks
True
Pros of bonds?
- Selling bonds does not force current owners to give up management or ownership control of the company
- Unlike stock, bonds have a limited life
- Since the company can deduct interest payments from income for tax purposes, the cost to the company of issuing and holding debt in the form of bonds is typically lower than that of stock
Cons of bonds
- Usually, periodic interest payments must be made. This reduces the company’s liquidity, and can even force the company into bankruptcy
- Unlike stockholders, the company is obligated to make a payment to bondholders at a specified period of time
- May be harder to sell bonds than stock in certain circumstances
Investment grade bond ratings (2):
- High Grade
- Medium Grade
Non investment grade bond ratings (2):
- Low grade
- Very low grade
Aaa and AAA bonds capacity to pay is __
extremely strong
Aa and AA bonds capacity to pay is __
very strong
Moody’s A and S&P A bonds capacity to pay is __ but _______
strong
more susceptible to changes in circumstances
Moody’s Baa and S&P BBB capacity to pay is __ but adverse conditions will have ___
adequate
more impact on the firm’s ability to pay
Ba and B and BB and B are considered possible that the capacity to pay will ___
degenerate
Moody’s C and D and S&P C and D are income bonds with no ____
interest being paid
In terms of bonds, D=
default with principal and interest in arrears
Above bonds can also be known as ___ or __ bonds
“High Yield”
“Junk”
Pool money from many investors to buy individual securities
Mutual funds
T/F
Mutual fund managers help investors gain exposure to companies with no charge
False
They charge a fee for the service
T/F Mutual funds happen within a broad category of security and type
False
Mutual funds focus on one type of security (stocks or bonds) and have a particular focus within that security type (large company stocks, government bonds)
3 things to consider when examining a balance sheet (from a Finance perspective)
Liquidity
Debt vs. equity
Market value vs. book value
Liquidity refers to the ease and quickness with which assets can be converted to ______
cash quickly and without a significant loss in value
The more liquid a firm’s assets, the less likely the firm is to ____
experience problems meeting short-term obligations
Liquid assets frequently have _____ than fixed assets
lower rates of return
Equity holders are entitled to only the ____
residual value
Creditors have the first claim to a firms ____
cash flow
The balance sheet provides the ____ of the assets, liabilities, and equity
book value
____ value is the price at which the assets, liabilities, or equity can actually be bought or sold
Market
How big the company’s equity is based on the current price of the stock
Market Capitalization
Market cap formula
number of shares outstanding * current price of the stock on the market
When is revenue recognized?
At the time of sale
Expenses charged against revenues that do not directly affect cash flow
Noncash items
noncash items (3):
- Depreciation
- Amortization
- Deferred taxes
Amount of cash flow available for distribution to investors
Cash flow from assets
Positive cash flow =
firm generates more than enough cash to cover its operating needs
Ratios allow for better comparison through __ or between __
time
companies
T/F
Ratios are only used internally
False
They are used internally and externally
Current assets / current liabilities
Current ratio
(current assets-inventory)/(current liabilities)
Quick ratio
Cash / current liabilities
Cash ratio
Measures a company’s debt relative to other parts of the balance sheet
Long-term solvency ratios
Measures how liquid a company is, or how able they are to meet their obligations over the next 12 motnhs
Liquidity ratios
(Total assets - total equity) / total assets
Total debt ratio
Measures how likely a company is to meet its interest obligations
Coverage ratios
Earnings before interest and taxes / interest
Times interest earned
(EBIT + depreciation) / interest
Cash coverage
Net income / sales
profit margin
net income / total assets
return on assets
net income / total equity
return on equity
price per share / earnings per share
PE ratio
price per share / sales per share
price-sales ratio
price per share / book value per share
Market-to-book ratio
Why evaluate financial statements?
-Performance evaluation
Planning for the future
-Investment potential
-Lending evaluation
Potential benchmarking problems
- Difficult for diversified firms
- No underlying theory
- Globalization and international competition makes comparison more difficult
- Varying accounting procedures
- Different fiscal years
- Extraordinary events
Elements of financial policy (4):
- Investment in new assets
- Degree of financial leverage
- Cash paid to shareholders
- Liquidity and working capital requirements
Dimensions of financial planning (3):
- Planning horizon
- Aggregation
- Assumptions and scenarios
What is a major drawback to Corporations?
Double taxation
Which of the following is an advantage of a sole proprietorship?
A. Unlimited life
B. Double taxation
C. Unlimited liability
D. Easier to start and run/less paperwork
D. Easier to start and run/less paperwork
T/F
In a partnership, if there are 20 partners and one dies, you can still keep the partnership going with the remaining 19 partners
False
What is the main goal of financial management?
To maximize the value of the firm to the owners
