Term
| What are three key finance functions among organizations? |
|
Definition
1) Investment Decisions
2) Financing Decisions
3) Dividend Decisions |
|
|
Term
| What are four main functions of financial managers? |
|
Definition
1) raise funds from external financial sources
2) allocate funds among different uses
3) manage the flow of funds involved in the operation of the enterprise
4) provide for returns to investors and other sources of financing of the firm
|
|
|
Term
| Why is shareholder wealth maximization a better operating goal than profit maximization? |
|
Definition
| Profit maximization would have to be from a long-run stand point to be meaningful at all. However, it would still be deficient in not considering the risk of alternative income streams. Wealth maximization is a better goal because it takes into account both the stream of income, or cash flows, over a period of years and the appropriate capitilization factor which reflects the degree of risk involved. |
|
|
Term
| What are the issues in the conflict of interest between stockholders and managers and how can they be resolved? |
|
Definition
| Managers control the firm and may do things in their own self-interest at the expense of the owners. Methods that can be used to solve the agency problem include: 1) establish outside audit committees to review and limit abuses 2) limit the authority of lower levels of management over potentially troublesome items (hiring of additional staff and use of company cars) 3) and provide managers with stock options, stock bonuses, and other forms of compensation that align their interest with those of shareholders. |
|
|
Term
| What are the potential conflicts of interest between shareholders and bondholders and how can they be resolved? |
|
Definition
| Shareholders have limited liability, but recieve all the returns after the fixed payments to the bondholders are made. After obtaining funds from bondholders, the shareholders may seek to make more risky investments because they can benefit without limit, but the bondholders are still limited to the returns that have already been fixed. This issue can be resolved by: 1) contracts for obtaining funds (bond indenture) will have written provisions restricting the ability of the shareholders from taking actions that increase the risk to bondholders and 2) bondholders should require a high rate of interest in advance because of the risk that the bond convenants (provisions) may not fully anticipate all the ways that shareholders may take actions adverse to the bondholders. |
|
|
Term
| Define the risk-return tradeoff. |
|
Definition
The principle that potential return rises with an increase in risk. According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost.
|
|
|
Term
| What opportunities and threats are created for financial managers by increased international competition? |
|
Definition
Opportunities include: 1) larger markets for U.S products due to globalization 2) increased efficiency encouraged to compete effectively 3) access to international financial markets and 4) opportunities to learn foreign firms.
Threats include: 1) added uncertainty of fluctuating currency exchange rates 2) competition from lower-costs producers in developing countries and 3) increased world capacity and conditions of supply that may create downward pressures on prices and profit margins |
|
|
Term
| What is an income statement? |
|
Definition
| An income statement shows the activities as measured by the revenues (or sales) and expenses of the firm throughout a given period. |
|
|
Term
| What does the term net sales indicate? |
|
Definition
| The term net sales indicates that gross sales have been reduced for returned products, discounts taken for prompt payment of invoices, and allowances made for damaged products. |
|
|
Term
| Define cost of sales. What expenses are associated with the cost of sales? |
|
Definition
| The cost of sales captures the manufacturing expenses for the products sold. The cost of sales include raw material, direct labor of the people producing the product, and factory overhead; which includes direct and indirect overhead expenses such as: 1) electricity 2) property taxes 3) insurance 4) maintenance 5) salaries 6) employee benefits 7) employment taxes of production supervisors and plant general management and 8) depreciation expense for the plant and production equipment. |
|
|
Term
| Define selling, general, and administrative (SG&A) expenses. What expenses are included in SG&A? |
|
Definition
| Selling, general, and administrative expenses (SG&A) is an expense account, included on an income statement, in which its sum includes all direct and indirect selling expenses and all general and administrative expenses of a company. |
|
|
Term
| How can one obtain earnings before interest and taxes (EBIT)? |
|
Definition
| Revenue - (Cost of Sales + Operating Expenses) |
|
|
Term
| What is a capitalized interest account? |
|
Definition
| A capitalized interest account is an account created in the income statement that holds a suitable amount of funds meant to pay off upcoming interest payments. |
|
|
Term
|
Definition
| A balance sheet provides a snapshot of what the firm owns and what the firm owes at a specific time. |
|
|
Term
| How can stockholder's equity be calculated? |
|
Definition
| stockholder's equity = total assets - total liabilities |
|
|
Term
| How can the book value per share be calculated? |
|
Definition
| book value per share = value of stockholder equity/total shares outstanding |
|
|
Term
| How can the market capitilization of a firm be calculated? |
|
Definition
| market capitilization = market value per share * total shares outstanding |
|
|
Term
| Define 'First In, First Out' (FIFO). What does FIFO assume in regards to taxation purposes? |
|
Definition
| FIFO is an asset management and valuation method in which the assets produced or acquired first are sold, used or disposed of first. For taxation purposes, FIFO assumes that the assets that are remaining in inventory are matched to the assets that are most recently produced or acquired. Because of this assumption, there are a number of tax minimization strategies associated with using the FIFO asset management and valuation method. |
|
|
Term
| Define 'Last In, First Out' LIFO). |
|
Definition
| An asset management and valuation method that assumes that assets produced or acquired last are the ones that are used, sold, or disposed of first. If an asset is sold for less than it is acquired for, then the differene is considered a capital loss. If an asset is sold for more than it is acquired for, then the difference is considered a capital gain. |
|
|
Term
| How can net assets be calculated? |
|
Definition
| net assets = total assets - non-interest bearning current debt |
|
|
Term
|
Definition
| Deferred taxes represents the difference between the total amount of tax obligations incurred by the firm during the accounting period and the amount of taxes actually paid. |
|
|
Term
| What is a statement of cash flows? |
|
Definition
| A statement of cash flows lists the sources and uses of cash that resulted throughout the period. The statement of cash flows describes the underlying transactions that caused the cash and cash equivalents (from the balance sheet) to change over time. |
|
|
Term
| Explain restructuring charges. |
|
Definition
The accumulation of anticipated expenses associated with the closing of a plant, division or other business segment.
|
|
|
Term
| Explain discontinued operations. |
|
Definition
| Current-period income or loss from a business that has been identified to be discontinued through a shutdown or divestiture. |
|
|
Term
| Define accelerated depreciation. |
|
Definition
| A method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years of the life of an asset. |
|
|
Term
| In November 1987, the Financial Accounting Standards Board (FASB) issued its Statement of Financial Accounting Standards No. 95, Statement of Cash Flows (FASB 95). What is FASB 95? |
|
Definition
The FASB is a statement that accepts the use of two methods to measure cash flows:
1) the direct method - recognizes cash collected from customers and cash paid to suppliers. It also recognizes cash used to buy equipment or pay off loans.
2) the indirect method - provides a reconciling link with the balance sheet and income statement. |
|
|
Term
| What are the three sections within the consolidated statement of cash flows? |
|
Definition
1) cash flows from operations
2) cash flows (used for) investments
3) cash flows from (used for) financing |
|
|
Term
| What are the nine reporting requirements the Securities Exchange Commission (SEC) requires among corporations? |
|
Definition
1) Consolidated Income Statement
2) Consolidated Balance Sheet
3) Consolidated Cash Flow Statement
4) SEC Reports: 10K, 10Q
5) Tax Books and Filings
6) Divisional Financial Statements
7) Cost Accounting Reports
8) Annual Budgets and Financial Plans
9) Project Requests and Reviews |
|
|
Term
| What calculation is used to determine the future value interest factor? |
|
Definition
|
|
Term
| What calculation is used to determine the present value interest factor? |
|
Definition
|
|
Term
| What calculation is used to determine the future value interest factor of an annuity? |
|
Definition
|
|
Term
| What calculation is used to determine the present value interest factor of an annuity? |
|
Definition
|
|
Term
| In regards to time value, what is future value? What is the calculation for future value? |
|
Definition
Future value is the value of an asset or an amount of cash at a specified date in the future that is equivalent in value to a specified sum in the present.
FVr,n = P0(1+r)n |
|
|
Term
| In regards to time value, what is present value? What is the present value calculation? |
|
Definition
Present value is the current worth of a future sum of money given a specified rate of return.
PVr,n = P0(1+r)-n |
|
|
Term
|
Definition
| If one divides 72 by a given interest rate, one can obtain the number of years required for an investment to double. |
|
|
Term
| What is the basic principle of investment decisions? |
|
Definition
| An investment is acceptable only if it earns at least the risk-adjusted market interest rate or opportunity cost of funds. |
|
|
Term
| What is an annuity? What is the difference between an ordinary annuity and an annuity due? |
|
Definition
| An annuity is defined as a series of payments or receipts for a specified number of periods. An ordinary annuity is an annuity in which its payments or receipts occur at the end of the year. An annuity due is an annuity in which its payments or receipts occur at the beginning of the year. |
|
|
Term
| In regards to time value, what does the future value of an annuity measure? How can it be calculated? |
|
Definition
The future value of an annuity measures how much cash you would have in the future given a specified rate of return or discount rate. The future cash flows of the annutiy grow at the discount rate, thus the higher the discount rate the higher the future value of the annuity.
FVAr,t = a[(1+r)n-1/r] |
|
|
Term
| In regards to time value, what is present value of an annuity? How can it be calculated? |
|
Definition
The present value of an annuity is the current value of a set of cash flows in the future, given a specified rate of return or discount rate. The future cash flows of the annuity are discounted at the discount rate, and the higher the discount rate, the lower the present value of the annuity.
PVAr,t = a[1-(1+r)-n/r] |
|
|
Term
|
Definition
| A constant stream of identical cash flows that continues forever. |
|
|
Term
| What is continuous compounding? How can it be calculated? |
|
Definition
The process of earning interest on top of interest. The interest is earned constantly, and immediately begins earning interest on itself.
FVr,t = P0ert |
|
|
Term
| How can continuous discounting be calculated? |
|
Definition
|
|
Term
| What is the general calculation for "within-the-year" compounding (multiple compounding within the year)? |
|
Definition
|
|
Term
| What is annual percentage rate? How can it be calculated? |
|
Definition
The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents the actual yearly cost of funds over the term of the loan.
APR = (1+r/q)q-1 |
|
|
Term
| What is discrete compounding? How can it be calculated? |
|
Definition
Discrete compounding refers to the method by which interest is calculated and added to the principal at certain set points in time.
d=ec-1 |
|
|
Term
| What is the Financial Modernization Act (Gramm-Leach Bliley Act of 1999)? What was its significance? |
|
Definition
| The Financial Modernization Act (Gramm-Leach Bliley Act of 1999) was an act passed in 1999 in which its fundamental effect was the repeal of the Glass-Steagall Act of 1933 that established the seperation between commercial banking and securities underwriting. Because of the Financial Modernization Act, financial institutions were able to have a two-tier system for expanding activities. |
|
|
Term
| State the difference between a savings surplus unit and a savings deficit unit. |
|
Definition
| A savings surplus unit incurs financial assets while a savings deficit unit incurs a financial liability. |
|
|
Term
| What constitutes financial markets? |
|
Definition
| The creation and transfer of financial assets and liabilities. |
|
|
Term
| What constitutes money markets? |
|
Definition
| Financial claims and obligations bought and sold have maturities of less than one year. |
|
|
Term
| What constitutes capital markets? |
|
Definition
| Financial claims and obligations bought and sold have maturities greater than one year. |
|
|
Term
| What is financial intermediation? |
|
Definition
| Transactions in the financial markets that bring together the savings-surplus units and the savings-deficit units so that savings can be redistributed into their most productive uses. |
|
|
Term
| What are financial intermediaries? What are the major types of financial intermediaries? |
|
Definition
| Specialized business firms whose activities include the creation of financial assets and liabilities. The major types of financial intermediaries include: 1) commercial banks 2) life insurance companies 3) private pension funds 4) savings institutions 5) state and local pension funds 6) mutual funds 7) finance companies 8) money market funds and 9) credit unions |
|
|
Term
|
Definition
| Base money is the total amount of a currency that is either circulating in the hands of the public or in the commerical banks deposits held in the central bank's reserves. |
|
|
Term
| What is an open market operation (OMO)? What is an OMOs purpose? |
|
Definition
| An open market operation (OMO) is when a central bank buys or sells government bonds on the open market. The purpose of an OMO is to control the short term interest rates and the supply of base money in an economy, and thus indirectly control the total money supply. |
|
|
Term
| What are the three basic classifications of financial instruments? What do they represent? |
|
Definition
Currency - represents obligations issued by the U.S Treasury as coins and paper currency.
Debt/Credit - instruments that represent promises to pay to the creditor specified amounts plus interest at a future date or dates.
Equity Claims - also known as "common stock" which represents the equity or ownership claims on an organization. |
|
|
Term
| What are the four major forms of financial contracts? What are the sub-units of these contracts? Describe each of the sub-units. |
|
Definition
Debt Forms:
Zero Coupon - debt that has and has been used in selling U.S savings bonds.
Level Coupon - debt that is set at a fixed level (fixed rate home mortgages)
Floating-Rate Coupon - debt that has an ajustable-rate (adjustable-rate home mortgages)
Pricing Contracts:
Forward Contract - requires the purchase or sale of a particular asset at a specified date at a price set at the time the contract is made.
Future Contract - equivalent is concept to a forward contract but obligates the purchaser to buy a specified amount at a designated exercise price on the contract maturity date. Reduces default risk by daily calculation of gains or losses and by the requirement to post a bond as a form of guarantee.
Swaps - obligates two parties to exchange specified cash flows at designated intervals.
Options:
Calls - gives the owner the right (but not a requirement or obligation) to buy an asset by the end of a specified period.
Puts - gives the owner the right (but not a requirement or obligation) to sell an asset by the end of a specified period.
Ownership Position:
Long - means that one will gain if the price of an asset goes up. Owning a call represents a long position
Short- means that one will gain if the price of an asset goes down. Thus selling short means one will sell stock they do not own. |
|
|
Term
| What are over-the-counter (OTC) security markets? What types of transactions does the OTC market handle? |
|
Definition
| Over the counter security markets is the terms used for all the buying and selling activity in securities that does not take place on a stock exchange. The OTC market handles transactions in: 1) almost all bonds of U.S corporations 2) almost all bonds of federal, state, and local governments 3) open-end investment company shares of mutual funds 4) new issues of securities and 5) most secondary distributions of large blocks of stock, regardless of whether they are listed on an exchange. |
|
|
Term
| What is the National Association of Securities Dealers Automated Quotations (NASDAQ)? What is the relationship between the NASDAQ and NMS (National Market System)? |
|
Definition
| Founded in 1971, the NASDAQ was the first exchange to use high-technology systems to trade securities. In 1982 the NMS was formed in which its duty is to give price quotations and volume figures for NASDAQ securities throughout the trading day. |
|
|
Term
| What is the fourth market? |
|
Definition
| The fourth market refers to direct transfers of blocks of stock among institutional investors without an intermediary broker. |
|
|
Term
|
Definition
| A bond that is issued in a domestic market, by a foregin entity, in the domestic market's currency. |
|
|
Term
|
Definition
| A bond issued in a currency other than the currency of the country or market in which it is issued. Benefits of Eurobonds include: small par values and high liquidity. |
|
|
Term
| Define Euro commerical paper. |
|
Definition
| Short-term debt version of Eurobonds. |
|
|
Term
| What are the four main benefits of securities markets? |
|
Definition
1) security exchanges facilitate the investment process by providing a market place to conduct efficient and relatively inexpensive transactions. Investors are this assured that they will have a place to sell their securities, if they decide to do so.
2) they are capable of handling continuos transactions, testing the values of securities.
3) security prices are relatively more stable because of the operation of the security markets.
4) the securities markets aid in the digestion of new security issues and facilitate their successful flotation. |
|
|
Term
| What is an efficient market? |
|
Definition
| An efficient market is one where a security's current price gives the best estimate of its true worth. |
|
|
Term
| What is the difference between tax deductions and tax credits? |
|
Definition
| Tax deductions reduce the amount of a firm's (or individual's) taxable income while tax credits reduce the amount of tax owed. |
|
|
Term
| What are the two ways firms are taxed? Explain each. |
|
Definition
| Firms are taxed through: 1) capital gains/capital losses - gains and losses on the sale of capital assets such as buildings or security investments (assets not bought and sold in the ordinary course of a firm's business) and 2) ordinary income |
|
|
Term
| What is a net operating loss (NOL)? |
|
Definition
| A period in which a firm's allowable tax deductions are greater than its taxable income, resulting in a negative taxable income. This generally occurs when a firm has incurred more expenses than revenues during the period. |
|
|
Term
| What is marginal tax rate? What is average tax rate? |
|
Definition
Marginal Tax - the amount of tax paid on an additional dollar of income.
Average Tax - the total tax paid as a percentage of total income earned. |
|
|
Term
| How do you calculate the average income tax rate? |
|
Definition
| income tax expense/pretax income |
|
|
Term
| What is a sole proprietorship? What is a partnership? What is a limited partnership (LP)? What is a limited-liability partnership (LLP)? What is a limited-liability corporation (LLC)? |
|
Definition
Sole Proprietorship - a business owned by one individual
Partnership - the association of two or more persons to conduct a business enterprise.
Limited Partnership (LP) - a business that consists of at least one general partner and multiple limited partners. Each limited partner(s) risk of loss is limited to his/her investment in the entity. Only the general partner(s) are liable to creditors.
Limited-Liability Partnership (LLP) - owerns of an LLP are also general partners. An LLP partner cannont be held liable for a malpractice committed by other partners. Partners in a registered LLP are still treated as general partners for commercial debt.
Limited-Liability Corporation - a business in which none of the owners are personally liable for its debts. |
|
|
Term
| What is a corporation? What are the four major advantages of a corporation? What are the six general information clauses in a certificate of incorporation? |
|
Definition
| A corporation is a legal entity created by a government. It is a separate entity, distinct from its owners and managers. The four main advantages of a corporation are: 1) it has an unlimited life 2) it permits limited liability 3) the residual risk of the owners is divided into many units so that the risk exposure in any one firm can be small and diversification by investors across many firms is facilitated and 4) it permits easy transferability of ownership interest in the firm. The six general clauses in a certificate of incorporation include: 1) name of proposed corporation 2) purposes 3) the amount of capital stock 4) number of directors 5) names and addresses of directors and 6) the duration (if limited). |
|
|
Term
| What is an S Corporation? |
|
Definition
| An S Corporation is a business that is still incorporated but still is taxed as proprietorships or partnerships because certain technical requirements are met. |
|
|
Term
| Why is personal income tax information important to the study of business finance? |
|
Definition
| A great majority of firms are organized as individual proprietorships or as partnerships. For these firms, the personal income tax is equivalent to a business tax. The dividend policies of a corporation also take into account the personal tax status of their shareholders. |
|
|
Term
| Define the nominal rate of return. |
|
Definition
| The amount of money generated by an investment before expenses such as taxes, investment fees and inflation are considered. |
|
|
Term
| Define the real rate of return. |
|
Definition
The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external effects. This method expresses the nominal rate of return in real terms, which keeps the purchasing power of a given level of capital constant over time.
|
|
|
Term
| The nominal rate of return on any asset can be explained by four components. What are the four components? |
|
Definition
1) the expected rate of return
2) expected inflation over the life of the asset
3) liquidity of the asset
4) riskiness of the asset |
|
|
Term
| In respect to foregin currency markets, when is a firm said to be in a long position. Why? When is a firm said to be in a short position. Why? |
|
Definition
| A firm is said to be in a long position when claims exceed liabilities because the firm will benfit if the value of the foregin currency rises in value. A firm is said to be in a short position when liabilities exceed claims because the firm will gain if the foregin currency declines in value. |
|
|
Term
| When discussing the real rate of interest, is the demand schedule's slope downward or upward? Why? |
|
Definition
| The demand schedule is downward-sloping because it's assumed that as more money is invested, investors begin to run out of profitable projects and as a result, the expected rate of return on marginal investment declines. |
|
|
Term
| When discussing the real rate of interest, is the supply schedule's slope downward or upward? Why? |
|
Definition
| The supply schedule is upward-sloping because higher and higher rates of return are needed to induce suppliers to lend greater amounts of money. |
|
|
Term
| What is the major difference between international business finance and domestic business finance? |
|
Definition
| International business finance transactions and investments are conducted with more than one currency while domestic business finance is conducted with the same currency. |
|
|
Term
| State the difference between the 'spot rate' and the 'forward rate'. |
|
Definition
| The spot rate is the price that is quoted for immediate settlement on a commodity, a security, or a currency. Spot settlement is normally one or two business days from the trade date. The forward rate is the amount that it will cost to deliver a commodity, a security, or a currency some time in the future. |
|
|
Term
| What is the foreign exchange rate and how can it be expressed? |
|
Definition
The foreign exchange rate is the price of one currency in terms of another. Exchange rates may be expressed in dollars per foreign currency units or units of foreign currency per dollar.
|
Dfd = X1 – X0/X0 = E0 – E1/E1
Ddf = E1 – E0/E0 = X0 – x1/X1
|
|
|
|
Term
| What does the Fisher effect state? What is the calculation for the real rate of interest? What is the calculation for the nominal rate of interest? |
|
Definition
The Fisher describes the relationship between inflation and both real and nominal interest rates. The Fisher effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases.
Rn = [(1+r) (P1/P0)] -1 |
|
|
Term
| What does the interest rate parity theorem (IRPT) state? How can the IRPT be calculated? |
|
Definition
A theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate.
|
Xf/X0 = 1+Rfo/1+Rdo = E0/Ef
|
|
|
|
Term
| What does the purchasing power parity theorem (PPPT) state? How can the PPPT be calculated? |
|
Definition
An economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power.
CX = X1/X0 = (Pf1/Pfo) / (Pd1/Pdo) = RPC |
|
|
Term
| What are the five broadest groups of financial ratios? Describe each group. |
|
Definition
1) Liquidity - These metrics measure the firm's ability to meet its maturing short-term obligations.
2) Activity - These metrics measure how effectively the company is using its resources.
3) Leverage - These metrics measure the extent to which the firm's assets have been financed by debt.
4) Profitability - These metrics measure management's overall effectiveness in generating profits in relation to its sales or investment.
5) Market: These metrics measure the firm's relationship to the broader stock market. |
|
|
Term
| What are the individual performance metrics within the five broad groups of ratio analysis (Liquidity, Activity, Leverage, Profitability, Market)? |
|
Definition
Liquidity - Current Ratio, Net Working Capital, Quick Ratio, Cash Ratio
Activity - Total Asset Turnover, Fixed Asset Turnover, Capital Turnover, Accounts Receivable Turnover, Accounts Receivable Days Outstanding, Inventory Turnover, Inventory Days Outstanding
Leverage - Debt-To-Equity, Financial Leverage, Capitalization Ratio, Interest Coverage
Profitability - Net Margin, Pretax Margin, Operating Margin, Gross Margin, Return on Assets, Return on Net Assets, Return on Capital, Return on Equity
Market - Price/Earnings, Book To Market, Shareholder Returns, Dividend Yield |
|
|
Term
| Define the current ratio (liquidity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures a firm's ability to pay short-term obligations. The ratio shows strength when it is higher.
current assets/current liabilities
|
|
|
Term
| Define the net working capital ratio (liquidity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that represents the amount left over after a firm pays off all its immediate liabilities. The ratio shows strength when it is higher.
current assets - current liabilities |
|
|
Term
| Define the quick/acid ratio (liquidity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures a firms ability to meet its short-term obligations with its most liquid assets. The ratio shows strength when it is higher.
(current assets - inventories)/current liabilities |
|
|
Term
| Define the cash ratio (liquidity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that assumes that only cash and cash equivalents are available to pay off current liabilities. The ratio shows strength when is higher.
cash and cash equivalents/current liabilities |
|
|
Term
| Define the total asset turnover ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
The amount of sales generated for every dollar worth of assets. The ratio shows strength when it is higher.
sales/total assets |
|
|
Term
| Define the fixed asset turnover ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
The amount of sales generated for every dollar worth of fixed assets (P.P.E). The ratio shows strength when it is higher.
net sales/net P.P.E
|
|
|
Term
| Define the working capital turnover ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that compares the depletion of working capital to the generation of sales over a given period. The ratio shows strength when it is higher.
sales/working capital |
|
|
Term
| Define the accounts receivable turnover ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio used to quantify a firm's effectiveness in extending credit as well as collecting debts. The ratio shows strength when it is higher.
credit sales/accounts receivable |
|
|
Term
| Define the accounts receivable days outstanding ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures the length of time it take for a firm to collect debt from its customers after the sale has been made. The ratio shows strength when it is lower.
365/accounts receivable turnover |
|
|
Term
| Define the inventory turnover ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio showing how many times a firm's inventory is sold and replaced over a given period of time. The ratio shows strength when it is higher.
cogs/inventory |
|
|
Term
| Define the inventory days outstanding ratio (activity). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures how long it takes a firm to turn its inventory into sales. The ratio shows strength when it is lower.
365/inventory turnover |
|
|
Term
| Define the debt to equity ratio (leverage). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that indicates what proportion of equity and debt a firm is using to finance its assets. The ratio shows strength when it is lower.
liabilities/stockholder's equity |
|
|
Term
| Define the financial leverage ratio (leverage). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
Financial leverage illustrates the number of dollars of assets for every one dollar of stockholder's equity. The ratio shows strength when it is lower.
assets/stockholder's equity |
|
|
Term
| Define the capitalization ratio (leverage). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
The capitalization ratio calculates the percentage that interest-bearing debt represents of the total capital pool. The ratio shows strength when it is lower.
interest-bearing debt/(interest-bearing debt + equity) |
|
|
Term
| Define the interest coverage ratio (leverage). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio used to determine how easily a firm can pay interest on outstanding debt. The ratio shows strength when it is higher.
ebit/interest expense |
|
|
Term
| Define the net margin (return on sales) ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that shows how much of each dollar earned by a firm is translated into profit. The ratio shows strength when it is higher.
net income/sales |
|
|
Term
| Define the pretax margin ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that shows how profitable a firm is before considering the effects of income taxes. The ratio shows strength when it is higher.
pretax income/sales |
|
|
Term
| Define the operating margin ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures the proportion of a firm's revenue is left over after paying for variable costs of production such as wages, raw materials, ect. The ratio shows strength when it is higher.
operating income/sales |
|
|
Term
| Define the gross margin ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures how well each dollar of a firm's revenue is available to meet expenses after paying for the goods or services that were sold. The ratio shows strength when it is higher.
(sales - cogs)/sales |
|
|
Term
| Define the return on assets ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that illustrates how well a firm's management team is at employing its total assets to make a profit. The ratio shows strength when it is higher.
net income/total assets |
|
|
Term
| Define the return on net assets ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that represents the return on total assets less spontaneous current operating liabilities. The ratio shows strength when it is higher.
net income/net assets |
|
|
Term
| Define the return on capital ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures how effectively a firm is at utilizing its capital invested. The ratio shows strength when it is higher.
ebit (1 - tax rate)/(interest-bearing debt + equity) |
|
|
Term
| Define the return on equity ratio (profitability). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures a firm's profitability by revealing how much profit it generates with the money shareholder's have invested. The ratio shows strength when it is higher.
net income/equity |
|
|
Term
| Define the price/earnings ratio (market). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that compares the market price per share to earnings per share. The higher the growth rate of a firm, the higher the price/earnings ratio. The ratio shows strength when it is higher.
price per share/earnings per share |
|
|
Term
| Define the book-to-maket ratio (market). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio used to find the value of a company by comparing the book value of a firm to its market value. The ratio shows strength when it is higher.
book value/market value |
|
|
Term
| Define the shareholder returns ratio (market). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that measures what shareholders actually earn over a period of time. The period of time can be a month, quarter year, or a number of years. The ratio shows strength when it is higher.
(capital appreciation + dividends)/beginning stock price |
|
|
Term
| Define the dividend yield ratio (market). How can the ratio be calculated? When does the ratio show strength? |
|
Definition
A ratio that shows how much a firm pays out in dividends each year relative to its share price. The ratio shows strength when it is higher.
dividend per share/beginning stock price |
|
|
Term
| What is the DuPont ratio analysis? What is the significance of the analysis? |
|
Definition
| The DuPont analysis measures assets at their gross book value rather than at their net book value in order to produce a higher return on equity (ROE). The analysis states that ROE is affected by three things: 1) operating efficiency, which is measured by profit margin 2) asset use efficiency, which is measured by total asset turnover and 3) financial leverage, which is measured by the equity multiplier. By using the DuPont analysis, it is believed that the incentive to invest in new assets is removed. |
|
|
Term
| Define the performance metric economic value added (EVA). How can the metic be calculated? |
|
Definition
Economic value added (EVA) measures a firm's financial performance based on the residual weath calculated by deducting cost of capital form its operating profit
EVA = NOPAF (net operating profit after taxes) - (IC * COC) |
|
|
Term
|
Definition
| An estimation of the cash inflows and cash outflows for a firm for a specific period of time. Cash budgets are often used to asses whether a firm has sufficient cash to fulfill regular operations and/or whether too much cash is being left in unproductive capacities. |
|
|
Term
| What is a breakeven analysis? In what type of decisions will the breakeven analysis be utilized? |
|
Definition
| An analysis to determine the point at which revenues recieved equals the cost associated with receiving those revenues. Breakeven calculates what is called the margin of saftey, the amount that revenues exceed the breakeven point. This is the amount that revenues may fall while still staying above the breakeven point. Types of decesions when the breakeven analysis will be utilized include but are not limited to: 1) when a firm is planning a general expansion in the level of operations, it has to make a choice between the extent to which additional fixed plants will be purchased and whether additional facilities will be rented or leased 2) the concern associated with releasing new products 3) and analyzing whether to modernize or automate its operations. |
|
|
Term
| Define the degree of operating leverage. How can it be calculated? What does the figure obtained from calculating the degree of operating leverage indicate? |
|
Definition
The percentage change in operating income resulting from the percentage change in units sold. The higher the degree of operating leverage, the more volatile the EBIT figure will be relative to a given change in sales. The figure obtained from calculating the degree of operating leverage indicates that any percentage change in unites sold will magnify the percentage in profits by multiples of the figure.
(sales - variable costs)/(sales - variable costs - fixed costs) |
|
|
Term
| What are the five C's of credit? Describe each "C" What are the five C's used for? |
|
Definition
The five C's of credit are used to evaluate the credit risk of a potential customer.
1) character - refers to the probability that customers will try to honor their obligations. This factor is of considerable importance because every credit transaction implies a promise to pay.
2) capacity - refers to the ability of the customer to pay. This is judged by reviewing his or her past record of payments, observing the customer's plant or store, and evaluating his/her business methods.
3) capital - measured by the general financial position of the firm as indicated by financial ratio analysis, with special emphasis on the tangible net worth of the enterprise.
4) collateral - represented by assets that the customer may offer as a pledge for security of the credit extended.
5) conditions - refers to the impact of general economic trends on the firm, or to the special developments in certain areas of the economy that may affect the customer's ability to meet his/her obligations. |
|
|
Term
| Define the economic order quantity (EOQ). Why is it used? What are the three variables that are used in determining EOQ? How can the EOQ be calculated? |
|
Definition
An inventory-related equation that determines the optimum order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variables. It is used to minimize total inventory costs. The three variables used in determining the EOQ are: 1) fixed costs of placing and receiving an order (f) 2) annual sales in units (s) and 3) carrying cost per unit of inventory (c).
(TAKE THE SQUARE ROOT OF) 2FS/C |
|
|
Term
| List the three main sources of short-term (debt that is scheduled to be paid within one year) financing and rank them by their relative importance in supplying credit to business. Define/describe each main source. |
|
Definition
1) trade credit - supplies and materials (that are needed to operate a firm) that are credited to accounts payable in which the total amount will be payed at a later date(s).
2) commercial banks - banks who lend money to firms in which different methods are applied to measure the effective rate of interest. The different methods are: 1) simple interest method 2) discount method 3) compensating balance method 4) average amortized loan method and discounted amortized loan method.
3) commercial paper - consists of promissory notes of large firms and is sold primarily to other business firms, insurance companies, pension funds, and banks. Maturities of commercial paper vary from two to six months, with an average of about five months. |
|
|
Term
| What are the four main phases that will increase the likelihood of success in relation to capital investments? |
|
Definition
1) planning
2) project or capital evaluation
3) status reporting
4) post completion reviews |
|
|
Term
| What does the value additivity principle imply? |
|
Definition
| The value additivity principle implies that if one knows the value of separate projects accepted by management, then simply adding their values will give the value of the firm. |
|
|
Term
| Define the payback period (PBP). What are the disadvantages when using this evaluation technique? |
|
Definition
| The payback period (PBP) represents the number of years required for a given project to return the original investment. The disadvantages of the PBP include: 1) PBP does not look beyond the PBP and 2) the PBP does not consider the time value of money. |
|
|
Term
| Define the net present value (NPV). How can it be calculated? What is implied if a project has a NPV of 0? |
|
Definition
| Net present value (NPV) is the present value of the projected future cash flows, discounted at an appropriate cost of capital or hurdle rate, less the cost of the investment. If a project has a NPV of 0, it implies that: 1) all interest payments to creditors who have lent money to finance the project have been paid 2) all expected returns (dividends and capital gains) to shareholders who have put up equity for the project have been paid and 3) the original investment to start the project has been paid. |
|
|
Term
| Define the internal rate of return (IRR). How can the rate be calculated? |
|
Definition
| Sometimes referred to as the economic rate of return, the internal rate of return (IRR) is a discount rate often used in capital budgeting that makes the net present value (NPV) of all cash flows from a particular project zero. Generally speaking, the higher a project's IRR, the more desirable it is to undertake the project. |
|
|
Term
| Define the modified internal rate of return (MIRR). How can the MIRR be calculated? |
|
Definition
| A discount rate that assumes that positive cash flows are reinvested at the firm's cost of capital, and the initial outlays are financed at the firm's financing cost. |
|
|
Term
| Define the discounted payback period. What is the main disadvantage when using this evaluation technique? |
|
Definition
| The discounted payback period reflects the number of years required to return the original investment based on the estimated future cash flows, which are discounted at an appropriate cost of capital or hurdle rate. The main disadvantage of the discounted payback period is that the technique does not consider the time value of money. |
|
|
Term
| What does the profitability index rule state? How does the profitability index differ from the net present value (NPV)? How can one calculate the profitability index? |
|
Definition
| The profitability index rule states that if the profitability index or ratio is greater than one, the project is profitable. The profitability index differs from the net present value (NPV) due to the fact that it's a ratio, which ignores the scale of investment and provides no indication of the size of the actual cash flows. |
|
|
Term
| Define opportunity costs. |
|
Definition
| The benefits you could have received by taking an alternative action. |
|
|
Term
| What is the difference between cost savings and cost avoidance? |
|
Definition
| Cost savings occur when a project's implementation reduces expenses from the current level of expenditures. Costs avoidance occurs whenever a project's implementation reduces expenses from a projected level of expenditures. |
|
|
Term
| What are the six general steps in the basic capital replacement decision? |
|
Definition
1) estimate the initial investment
2) determine the incremental operating cash flows
3) project the terminal cash flows or expected salvage value
4) add the terminal cash flows to the operating cash flows
5) find the present value of the total incremental cash flows
6) determine whether the net present value (NPV) is positive. |
|
|
Term
| Define incremental cash flow. |
|
Definition
| The additional operating cash flow that an organization receives from taking on a new project. |
|
|
Term
|
Definition
| The required return necessary to make a capital budgeting project worthwhile. Cost of capital includes cost of debt and cost of equity (preffered stock and common stock). |
|
|
Term
| What is weighted average cost of capital (WACC). |
|
Definition
| A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. An increase in the weighted average cost of capital (WACC) notes a decrease in a (firm's) valuation along with a higher risk. |
|
|
Term
| Define cost of debt. How can it be calculated (after-tax)? |
|
Definition
| The effective rate that a firm pays on its current debt. This can be measured in either before or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. |
|
|
Term
| Define preferred stock. How can the cost of preferred stock be calculated? |
|
Definition
| A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stockgenerally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. |
|
|
Term
| There are three different approaches to determine the cost of common equity. What are they? |
|
Definition
1) dividend growth model
2) capital asset pricing model (CAPM)
3) arbitrage pricing theory (APT) |
|
|
Term
| Define the dividend growth model. How can the model be calculated? |
|
Definition
| A model that is used to determine the cost of common equity. The dividend growth model finds the discount rate that equates the future projected dividends (which are projected to infinity) to the current stock price. If a firm does not pay a dividend or has an erratic or uncertain growth rate, the dividend growth rate model cannot be used. |
|
|
Term
| Define the Capital Asset Pricing Model (CAPM). How can the model be calculated? What are some of the issues in direct relation to CAPM? |
|
Definition
| A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. Issues regarding to CAPM include: 1) choices when selecting the risk-free rate 2) variations that are used to calculate the specific returns that underline the beta calculation 3) excess return of the market and 4) correlation between one stock and the market. |
|
|
Term
| Define the arbitrage pricing theory (APT). |
|
Definition
| A theory that predicts relationship between the returns of a portfolio and the returns of a single asset through a linear combination of many independent macroeconomic variables. |
|
|
Term
|
Definition
| A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is calculated using regression analysis. |
|
|
Term
| What are the four firm development stages (throughout the course of a firm's life)? What are the financing sources and/or financing options a firm can accept under each development stage? |
|
Definition
1) start-up: personal savings, personal loans, and government agencies
2) rapid growth: internal financing, bank credit, and venture capital
3) growth and maturity: going public, money markets, and capital markets
4) maturity: internal financing, debt repayment, share repurchases |
|
|
Term
| What is an underwriting agreement. |
|
Definition
| A contract between a group of investment bankers who form an underwriting group or syndicate, and the issuing corporation of a new securities issue. The underwriting agreement contains the details of the transaction, including the underwriting group's commitment to purchase the new securities issue, the pricethat the underwriting group will pay to the issuing corporation and the initial resale price. |
|
|
Term
| What is investment banking? |
|
Definition
| A specific division of banking related to the creation of capital for other companies. Investment banks underwrite new debt and equity securities for all types of corporations.Investment banks also provide guidance to issuers regarding the issue and placement of stock. |
|
|
Term
|
Definition
| A contract between an issuer of bonds and the bondholder stating the time period before repayment, amount of interest paid, if the bond is convertible (and if so, at what priceor what ratio), if the bond is callable and the amount of money that is to be repaid. |
|
|
Term
| Define a call provision (bonds). |
|
Definition
| A provision on a bond or other fixed-income instrument that allows the original issuer to repurchase and retire the bonds. If there is a call provision in place, it will typically come with a time window under which the bond can be called, and a specific priceto be paid to bondholders and any accrued interest are defined. |
|
|
Term
|
Definition
| A type of bond that is secured by the issuer's pledge of a specific asset, which is a form of collateral on the loan. In the event of a default, the bond issuer passes title of the asset or the money that has been set aside onto the bondholders. Secured bonds can also be secured with a revenue stream that comes from the project that the bond issue was used to finance. |
|
|
Term
| What ia a debenture. What is a subordinated debenture. |
|
Definition
debenture - an unsecured bond and provides no lien on specific property as security for the obligation. Debenture holders, therefore, are general creditors whose claim is protected by property not otherwise pledged.
subordinated debenture - a loan (or security) that ranks below other loans (or securities) with regard to claims on assets or earnings. |
|
|
Term
|
Definition
| A type of debt security in which only the face valuef the bond is promised to be paid to the investor, with any coupon payments being paid only if the issuing company has enough earnings to pay for the coupon payment. |
|
|
Term
| Define a floating-rate note (FRN). |
|
Definition
| A note with a variable interest rate.The adjustments to the interest rate are usually made every six months and are tied to a certain money-market index.These protect investors against a rise in interest rates (which have an inverse relationship with bond prices), but also carry lower yields than fixed notes of the same maturity. |
|
|
Term
| What are the seven general collective rights given to common stockholders? |
|
Definition
1) the right to amend the charter with the approval of the appropriate officials in the state of the corporation.
2) the right to adopt and amend bylaws
3) the right to elect the directors of the corporation
4) the right to authorize the sale of fixed assets
5) the right to enter into mergers
6) the right to change the amount of authorized common stock
7) the right to issue preferred stock, debentures, bonds, and other securities. |
|
|
Term
|
Definition
| An agentlegally authorized to act on behalf of another party. Shareholder's not attending a firm's annual meeting may choose to vote their shares by proxy by allowing someone else to cast votes on their behalf. |
|
|
Term
| Define cumulative voting. |
|
Definition
| Voting that permits multiple votes for a single director (the stockholder can accumulate the votes and cast all for one director). Cumulative voting is designed to enable a minority group of stockholders to obtain some voice in the control of the company by electing at least one director to the board. |
|
|
Term
|
Definition
| A right that gives holders of common stock the first option to purchase additional issues of common stock. This protects the power of control for present stockholders and affords stockholders concerns dilution of value. |
|
|
Term
|
Definition
| An arrangement where the seller of an asset leases back the same asset from the purchaser.The lease arrangement is made immediately after the sale of the asset with the amount of the payments and the time period specified. Essentially, the seller of the asset becomes the lessee and the purchaser becomes the lessor in this arrangement. |
|
|
Term
| Define an operating lease. |
|
Definition
| A lease contract that allows the use of an asset, but does not convey rights similar to ownership of the asset. |
|
|
Term
| Why are convertible preferred stock and staged capital commitment employed by venture capitalists? |
|
Definition
| Preferred stock is less risky than common stock due tot he order of bankruptcy if the firm should not survive. The convertibility feature allows participation as the firm grows and succeeds. Staged capital commitment permits the venture capitalist to fund the firm in stages. After the first stage has been successfully completed and management demonstrates its abilities, a second round of financing is provided. Both techniques are aimed at reducing risk. |
|
|
Term
| Under what conditions would a firm prefer a fixed interest rate over a fluctuating interest rate? Fluctuating interest rate over a fixed interest rate? |
|
Definition
| A fixed rate eliminates all interest rate risk due to fluctuating market rates; therefore, a firm should prefer a fixed interest rate if management has reason to believe that the market rates will increase in the future. If a firm believes market rates will decrease in the future, management may want to take advantage of a floating interest rate. |
|
|
Term
For each term, indicate if the term provides a "sweetener" for this issuer or buyer of a security. Provide a short explanation.
1) convertibility
2) callable
3) convenants
4) sinking fund
5) voting rights
6) cumulative dividends |
|
Definition
1) convertibility (buyer): allows conversion (participation) to common stock
2) callable (issuer): allows the issuer to call the bond early if the rates decrease
3) convenants (buyer): protects the buyer from subsequent actions of the issuer
4) sinking fund (buyer): protects the buyer by requiring the issuer to accumulate funds to payoff the principal
5) voting rights (buyer): allows participation in the management of a firm
6) cumulative dividends (buyer): protects the buyer if management decides to suspend dividends |
|
|
