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Financial Management (FIN-315) > Week 1 > Flashcards

Week 1 Flashcards

1
Q

What is the Required Rate of Return (RRR) using the CAPM formula?

A

CAPM = rRF + (rM - rRF) x Beta (B)

rM: Market rate (expected return on the market as a whole)
(rM - rRF): Market Risk Premium (Equity Risk Premium (the excess or premium amount over and above the risk-free rate)).

B: Beta Coefficient (used to “customize” the formula for an individual firm).

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2
Q

What are the 3 forms of business?

A

1.) Sole Proprietorship
2.) Partnership
3.) Corporation

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3
Q

What are the advantages and disadvantages of a Sole Proprietorship?

A

Advantages:
- Easy to Form
- Subject to fewer government regulations
- Avoids corporate income tax

Disadvantages:
- Limited financial capital
- Limited human capital
- Unlimited Liability
- Limited Life
- Difficult to value and sell

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4
Q

What are the advantages and disadvantages of a partnership?

A

Advantages:
- Easy to form
- Subject to fewer government regulations
- Avoids corporate income tax

Disadvantages:
- Limited financial capital
- Limited human capital
- Unlimited Liability
- Limited Life
- Difficult to value and sell

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5
Q

What are the advantages and disadvantages of a corporation?

A

Advantages:
- Unlimited Life
- Easily transferred ownership
- Limited liability
- Greater access to financial capital

Disadvantages:
- More difficult and expensive to create
- Double taxation
- More expensive reporting requirements

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6
Q

What are the 4 types of hybrid forms of business?

A

1.) Sub-Chapter S Corporations
2.) Limited Liability Corporations
3.) Limited Liability Partnerships
4.) Professional Corporations

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7
Q

What is opportunity cost?

A

Ans: The next best option that could have been chosen.

Ex.: Opportunity cost of studying.
Ans: Going out with friends

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8
Q

What are externalities?

A

Ans: “A consequence of and economic activity that is experienced by unrelated third parties.”

English definition: Something that affects us, but over which we have no control.

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9
Q

What is scarcity?

A

Ans: Things that are NOT available in unlimited quantities.

Ex’s.: Time, money

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10
Q

Why do/should you buy shares in a corporation?

A

Ans: If you think it is a good investment, you should buy shares so its value will increase over time.

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11
Q

How do you measure the increase in value of an investment portfolio?

A

Ans: The value of your investment is equal to the number of shares you own times the share price.

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12
Q

What is risk?

A

Definition: Risk is the element of uncertainty about the future; the degree of likelihood that something will happen.

Ex.: Sporting game; you play and take your chances, you don’t know what the outcome will be

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13
Q

What is the Risk - Reward Trade-Off?

A

Seeking out risk because the perceived potential for injury or loss is outweighed by the benefits/fun.

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14
Q

Risk aversion or Risk tolerance is?

A

The amount of risk a person is willing to bear.

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15
Q

What is the equation for total return?

A

Total Return = rRF + IP + DP + LP + MP

rRF: Risk-Free rate
IP: Inflation Premium
DP: Default Premium
LP: Liquidity Premium
MP: Maturity Premium

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16
Q

What is an Inflation Premium

A

Ans: amount of risk to account for inflation over time.

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17
Q

What is a Default Premium?

A

Ans: Amount of risk due to the firm possibly being unable to meet its financial obligations, or in extreme cases, go out of business.

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18
Q

What is a Liquidity Premium?

A

Ans: Amount of risk based on how marketable the investment is. Low liquidity increases risk because of the inability to divest it should it be warranted.

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19
Q

What is a Maturity Premium?

A

Ans: Amount of risk involved based on the certainty of the maturity value of the investment.

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20
Q

Systemic risk is?

A

Ans: System-wide risk factors such as fluctuating prices, fluctuating interest rates, inflation, and exchange rates.

21
Q

Non-Systemic risk is?

A

Ans: Firm specific risk factors such as default risk, business risk, financial risk, and externalities.

22
Q

Categorize the following as systematic risk or non-systematic risk:

  1. The general state of the economy
  2. Reinvestment rate risk
  3. Financial risk
  4. Inflation
  5. Union labor strikes
  6. Actions of competitors
  7. Fluctuating interest rates
  8. Changing currency values
  9. Core business operations
  10. Debt financing
  11. Interest rate risk
  12. Business risk
A
  1. (General state of Econ.) Systematic
  2. (Reinvestment rate risk) Systematic
  3. (Financial risk) Non-Systematic
  4. (Inflation) Systematic
  5. (Labor strikes) Non-Systematic
  6. (Competitors actions) Non-Systematic
  7. (Fluctuating interest rates) Systematic
  8. (Changing currency values) Systematic
  9. (Core business ops.) Non-Systematic
  10. (Debt financing) Non-Systematic
  11. (Interest rate risk) Systematic
  12. (Business risk) Non-Systematic
23
Q

What are potential harms to a company’s intrinsic values?

A

1.) Does not spend the time necessary to maximize a firms value ( i.e. little focus, directed to corporate strategy, objectives, etc.)

2.) Employs corporate resources for personal benefit

3.) Avoids difficult, but value-adding, decisions based on non-corporate factors

4.) Takes too much or not enough risk to maximize returns

5.) Invests (or stockpiles) corporate resources in investments with less-than-optimal returns, rather than returning the funds to stockholders

6.) Does not release all information desired by investors

24
Q

What is the current ratio formula?

A

Current assets/current liabilities

25
Q

What is the “quick” ratio?

A

Current assets - inventory/current liabilities

26
Q

What is the “net working capital” ratio?

A

Current assets - current liabilities

27
Q

What is the “Days Sales Outstanding (DSO)” ratio?

A

Accounts Receivable (A/R) / (Credit sales / 365)

28
Q

What is the “Days Sales in Inventory (DSI)” ratio?

A

Inventory / (COGS / 365)

29
Q

What is the “Fixed Asset Turnover (FATO)” ratio?

A

Sales / Net fixed assets

30
Q

What is the “Asset Turnover (ATO)” ratio?

A

Sales / total assets

31
Q

What is the “debt to assets” ratio?

A

Total debt / total assets

32
Q

What is the “liabilities to assets” ratio?

A

Total liabilities / total assets

33
Q

What is the “debt to equity” ratio?

A

Total debt / total equity

34
Q

What is the “financial leverage (equity multiplier)” ratio?

A

Total assets / total equity

35
Q

What is the “Times interest earned (TIE)” ratio?

A

EBIT / interest expense

36
Q

What is the “gross margin” ratio?

A

Gross profit / sales

37
Q

What is the “operating margin” ratio?

A

EBIT / sales

38
Q

What is the “profit margin” ratio?

A

Net income / sales

39
Q

What is the “ROA” ratio?

A

Net income / total assets

40
Q

What is the “ROE” ratio?

A

Net income / common equity

41
Q

What is the “Earnings Per Share (EPS)” ratio?

A

Net income / common shares outstanding

42
Q

What is the “P/E” ratio?

A

Market price / EPS

43
Q

What is the “earnings yield” ratio?

A

EPS / market price

44
Q

What is the “book value per share” ratio?

A

Common equity / common shares outstanding

45
Q

What is the “market to book” ratio?

A

Market price / book value per share

46
Q

What is the equation for Net operating profit after taxes (NOPAT)?

A

NOPAT = EBIT + (1 - tax rate)

47
Q

What is EBIT?

A

Earnings Before Interest and Tax

48
Q

How do you calculate free cash flow?

A

NOPAT +/- Non-Cash reserves +/- Changes in NOWC +/- Capital expenditures = Free cash flow

49
Q

What is NOWC?

A

NWC - non-operating assets - non-operating liabilities

Financial Management (FIN-315) (1 decks)

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